Corporation tax and investment | Institute for Tax Studies

Summary

Business investment in the UK is the lowest in the G7 and one of the lowest in the developed world.

Taxation has a role to play in shaping investment incentives, and the UK corporate tax system is one of the extremes. While the corporate tax rate (19%) is exceptionally low, UK investment allowances are among the least generous in the developed world. As a result, effective tax rates in the UK (a measure that takes into account the generosity of benefits as well as the headline rate) are poor by international standards. But they vary enormously across different types of investment, favoring investment in some assets over others and encouraging borrowing to finance investment.

In this chapter, we take a close look at the nature of these distortions. We examine how the broad package of corporate tax cuts announced in the recent “mini-budget” is likely to shape investment incentives and what balance it strikes between encouraging domestic investment and attracting new investors. profitable foreign companies.

Finally, we consider the road ahead. We look at the likely impact of rising inflation and interest rates. We emphasize the importance of stability and establishing a clear long-term plan. And we have argued for genuine structural corporate tax reform that could address distortions in the allocation and financing of investment as well as its level.

This chapter was finalized following the “mini-budget” presented in the House of Commons by Kwasi Kwarteng on September 23, 2022. Since then, the main corporation tax announcement in the mini-budget has been canceled and Chancellor Kwarteng and Prime Minister Minister Truss resigned. These developments came too late to be integrated into the chapter before publication. A brief postscript (Section 6.8) acknowledges their implications.

Figure 1. Business investment in OECD countries, 2019

Note: Ireland is excluded due to the high volatility of its investment statistics. The OECD average is the unweighted average of the OECD countries for which data are available (excluding Ireland). G7 countries are shaded black.
Source: OECD, National Accounts of OECD Countries: Business Investment, https://doi.org/10.1787/abd72f11-en

Main conclusions

1. Business investment rates in the UK are among the lowest in the developed world. In 2019, the UK had the lowest level of business investment in the G7 and the third lowest in the OECD: 10.5% of GDP, compared to an OECD average of 13.6%.

2. The UK’s approach to taxation of business investment is one of the extremes. The UK’s overall corporate tax rate (19%) is one of the lowest of any advanced economy. At the same time, however, UK investment allowances are among the least generous in the OECD. As a result, effective tax rates in the UK (a measure that takes into account both the tax rate and the generosity of benefits) are poor by international standards.

3. Equally important, effective tax rates vary significantly from investment to investment. Investing in some assets is much more penalized than investing in others. Meanwhile, investments financed by debt can benefit from substantial subsidies, encourage companies to take on more debt and invest in low-return projects that would otherwise not be viable.

4. As inflation rises, these distortions are exacerbated, increase the premium for carrying out genuine structural reform that rationalizes the system and reduces these distortions.

5. Kwasi Kwarteng’s spectacular September ‘mini-budget’ announced the reversal of a previously planned increase in the corporate tax rate from 19% to 25%, a move which the Treasury said would cost a sum of substantial. £15billion a year in lost revenue (in terms of 2022-23). Along with this came a (fiscally more modest) increasing the permanent level of the Annual Investment Allowance (AIA) from £200,000 to £1 million, allowing businesses to immediately deduct a larger portion of their investment expenses from their taxable profits.

6. Lowering the corporate tax rate will reduce all tax-related distortions. However, the tax reduction would be greater for the most profitable investments: it would be less effective in reducing the tax on the borderline investments most likely to be discouraged by the tax. While reducing the rate reduces distortions in the level, allocation and financing of investment, unless it is reduced to zero, it cannot completely eliminate these distortions.

seven. Increase AIA, in the meantime, is more cost-effective as a means of encouraging investment at the national level – it eliminates the disincentive for equity-funded investments in eligible assets – although not necessarily as a means of increasing the UK’s international competitiveness. This also increases subsidies for low-yielding debt-financed investments – investments that have a cost for the Treasury but little for growth.

8. There is strong evidence that, other things being equal, such corporate tax cuts should increase investment in the UK. But they will only if they are expected to last. Investment decisions are long-term by their nature and the current political environment – ​​and a long history of political instability – will likely make it more difficult for the Chancellor to increase investment through the tax system (at least in the short term).

9. Although taxation matters for investment, it is not all that matters. If interest rates are pushed up, or if the UK is perceived as providing an unstable environment in which to do business, this could easily offset the beneficial effects of lower corporate tax. In other words, corporate tax changes need to fit into a sensible and credible fiscal framework and broader policy environment if they are to be effective in stimulating investment.

ten. Only real structural reform how the investment is treated by the tax system – as opposed to changing individual characteristics – can eliminate distortions in the level, distribution and financing of investments. There is more than one way to achieve this, but it must involve reforming the treatment of debt and equity financing as well as tax rates and capital cost allowances.

11. What is needed is a coherent plan for the future of corporation tax as part of a broader, clearly communicated tax strategy that businesses and investors can use as a credible guide to what to expect in the future. There are definitely improvements that could be made. Apart from this, some stability would be nice.