Low corporate tax does not mean more FDI

Tax cuts have been the dividing line between the two finalists in the race for the leadership of the Conservative Party in the UK, the winner of which will become the country’s next prime minister. Both Liz Truss and Rishi Sunak want to cut taxes, but they disagree on when those tax cuts should be introduced.

Frontrunner Truss is the candidate who has promised to cut a series of taxes to boost Britain’s growth, which is expected to be the weakest of any G7 country in 2023, according to the International Monetary Fund (IMF). Among his promises is dropping a planned increase in the UK’s headline corporate tax rate from 19% to 25% from April 2023. Truss says the move will provide more incentive for businesses to invest.

However, the evidence supporting the economic benefits of Truss’ plans is thin on the ground. Even if maintaining a low corporate tax rate encouraged domestic businesses to invest more, such investments would be inherently inflationary at a time when inflation is widely seen as the greatest economic challenge facing the UK and many other countries.

Besides the impact on domestic businesses, would his plans help attract more foreign direct investment (FDI) to the UK? Along with waiving corporation tax, Truss also promised “fat free ports,” which would presumably allow companies operating there to pay even less corporation tax.

But do low corporate tax rates lead to higher FDI? The evidence suggests not.

“The effectiveness of tax incentives as a tool to generate economic growth has been widely questioned,” says Emilio Pineda, head of the tax and municipal management division at the Inter-American Development Bank, citing research conducted by the IMF in 2015 and the University of Florida in 2013.

“In many cases, these are redundant elements,” he adds. “The investment would have been made even without the incentive and it has not been shown that incentives necessarily increase foreign investment, nor that they always generate growth.”

The UK corporate tax rate is already low

The UK has long been one of the most popular destinations for FDI in the world, thanks to a highly educated population, good quality of life, strong legal protections for businesses, business-friendly regulations, decent infrastructure, a world-leading financial sector and global trade links.

According to the United Nations Conference on Trade and Development (UNCTAD), only the United States and Germany recorded more inward FDI projects in 2021 than the United Kingdom, but FDI inflows to the United Kingdom UK have been depressed in recent years.

While total FDI inflows to the UK increased slightly in 2021, to $27.5 billion, according to UNCTAD, this remains below pre-Covid levels ($45.5 billion in 2019) . Between 2011 and 2019, there was only one year (2014) where total inflows fell below $30 billion. Since the UK lowered its corporate tax rate to 19% in 2017, total FDI inflows have followed a downward trend.

Thus, the fall in the UK’s headline corporate tax rate has not led to an increase in FDI, with other factors including Brexit and the Covid-19 pandemic having a serious dampening effect on investments.

No evidence at the international level of a link between corporate tax rates and FDI

It is not just in the UK where the link between corporate tax rates and FDI inflows is tenuous at best. When looking at the corporate tax rates of the countries that attracted the most FDI projects in 2021, only a small minority have a lower rate than the UK.

There is, if at all, a correlation between higher corporate tax rates and high FDI inflows. This does not prove the existence of a causal link, but probably means that countries able to attract significant foreign investment are able to increase corporate tax rates to increase economic benefits for the country of origin. ‘welcome.

Of the ten countries that attracted the most FDI projects in 2021, only Singapore has a lower overall rate than the UK (although few companies in the UAE [UAE] pay the headline rate, and many pay no corporation tax).

Not all businesses operate on the same margins, of course, and the corporate tax cut is more important for some sectors than others. In countries with the lowest corporate tax rates, tourism and services attract the most FDI.

Both Truss and Sunak are committed to the UK government’s leveling policy, but the investments needed to bridge regional economic disparities in sectors such as advanced engineering, supply chains, emerging technologies and infrastructure are not the type motivated by low tax rates.

“Tax incentives also distort resource allocation,” says Pineda. “The discrimination in favor of some and against other investments implies that taxes, rather than differences in productivity, determine the allocation of resources. This distortion reduces average productivity and lowers per capita income.

UK out of step with global tax trends

The eagerness of Truss and other Conservative leadership candidates to cut corporate taxes to spur growth is not only unsupported by evidence, but out of step with the direction of travel for other countries. rich.

The OECD aims to introduce a minimum global corporate tax rate of 15% by 2024 to end bottom-up competition in corporate taxation. While the impact of this initiative will be felt most in developing countries, which are more likely to compete on tax rates, many wealthy countries have responded by planning increases in their tax rates. corporate taxation.

President Joe Biden plans to raise the federal corporate tax rate in the United States from 21% to 28%, while the UAE, historically low or zero, will establish a new minimum corporate tax of 9% from 2023, which will apply to most companies.

With countries having to compete less on corporate tax rates, the UK is unlikely to attract much additional investment by keeping its rate low, but it would certainly be deprived of tax revenue.

John Peterson, one of the architects of the OECD’s global anti-base erosion rules, said Investment Monitor that the new minimum tax rules are expected to generate around $150 billion in additional global tax revenue per year.

“This includes not only the revenue expected from the application of the rules themselves, but also the additional corporation tax revenue expected from the resulting reduction in profit shifting activity as a result of the introduction rules,” he said.

Truss is the favorite to become the UK’s next prime minister, thanks in part to how well her promises to cut taxes and boost growth have been received by members of the Conservative Party. However, if it wants to increase FDI to the UK, it would do better to focus on the main drivers of FDI and improve the country’s skills base, reduce Brexit-related trade frictions, upgrade infrastructure outside of London and working on ways to bring inflation down.

If it needed to find funds for these initiatives, it could always raise corporate tax rates, at least to a level similar to that of the markets the UK competes with for FDI.