Dr Bruce Morley is a lecturer in the Department of Economics in the University of Bath. His main research interests are in macroeconomics and finance, especially international finance, where he has done most of his research into the exchange rate and monetary policy, including analysing risk and the risk premium in the exchange rate.
The recent budget has been a complex mix of tax increases and cuts, with the main headline being a 2% reduction in national insurance. However, there will also in effect be tax increases, as tax thresholds will be frozen until 2027/28, as well as taxes on vaping, an extra year of taxing the energy companies through the energy profits levy and the end of the non-dom status, which had previously allowed those not domiciled in the UK to pay limited taxes. In some studies, such as this one by the Institute of Fiscal Studies (IFS), it is estimated that personal taxes will in fact continue rising, mainly due to the freezing of the thresholds, despite the cut in national insurance.
The chancellor has emphasised this budget will not involve much extra borrowing, as he is constrained in what he can do unless economic growth increases. To allow tax cuts without increasing government borrowing will require either lower public spending or increased economic growth. However most economic forecasters are suggesting UK economic growth in 2024 will be fairly low and likely to be below 1% for the year. Slow growth also makes cuts to public expenditure more difficult.
The main constraint to more borrowing is the current levels of outstanding public debt. Currently government borrowing is about 100% of annual GDP which is historically high, so increasing borrowing to fund government spending or tax cuts is difficult for the foreseeable future. Government debt has increased substantially following the pandemic due to increased government expenditure to support the economy during the lockdown and during the recent high energy prices, which involved extra spending on financial help for those struggling with the high energy prices. These levels of debt have not been experienced since the early 1960s, but back then the debt to annual GDP ratio was falling, following large scale borrowing to fund the second world war. More recently a debt to annual GDP ratio of 60% has been felt to be the upper limit, for instance this was the maximum value allowed under the Maastricht criteria for countries wishing to join the European single currency in 1999.
The problem with high debt levels is that it pushes up the long-term interest rate. In the recent era of low short-term interest rates and quantitative easing, when the Bank of England purchased mostly government debt shouldn’t be a problem, but we are now in an era of quantitative tightening, which is pushing the interest rates up again. Any rises in the long-term interest rate can have negative effects on the economy, especially the housing market as mortgage rates tend to follow long-term rates. There is also some evidence that as debt/GDP approaches 100%, it can have a negative effect on economic growth. The effects of high tax levels on economic growth depend on the type of tax, with some taxes such as environmental taxes having less harmful effects.
In general, cutting tax can have an unpredictable effect on tax revenue, as it depends on the position of the tax rate on the Laffer curve and the type of tax. However, there is some evidence, in the paper linked in the sentence below that cutting corporation tax is likely to increase total tax revenue, in addition to ensuring a country is attractive to international businesses. There has been extensive analysis of this, for instance an analysis of studies on international corporate tax avoidance by multinationals found evidence of profit shifting by multinationals as well as tax revenue loss by countries with high tax rates.
There are many ways in which multinationals can minimise their corporation tax bills. For instance, using transfer mis-pricing where prices of goods vary between countries, so that lower prices are charged for the exported goods from high to low tax countries. In addition, multinationals can move their high-value intellectual properties to a low tax regime, as well as licensing the goods sold in high tax regimes to a subsidiary in a low tax country. There are many other similar strategies for moving profits and earnings from high tax to low tax regimes, with the intention of minimising the firm’s tax bill. It should be stressed that this is tax avoidance and so is legal, rather than tax evasion which would be illegal.
To prevent the types of tax avoidance that have become more commonplace as multinationals have become more powerful, especially in the technology sector, the international community through the OECD decided to impose a minimum effective corporation tax rate of 15%. This was announced in 2021 and implemented across the signatories by the beginning of 2024. This covers most countries around the world although some developing countries have decided not to sign the agreement. Although the aim of the agreement is to ensure a fairer international tax system, it is a more complex system and so increases the potential for disputes. This agreement implies countries with lower corporation tax have an advantage over those with higher tax. In spite of this after years of reducing corporation tax in the UK, the rate has recently been increased, from 19% to 25% beginning in April 2023. The UK corporation tax rate had traditionally been high, with a value of 30% until 2008, and slowly cut to 19% by 2017 before the recent rise. However, it is arguably more complicated than this as countries allow some forms of investment to be tax deductible known as full expensing. In the UK, a temporary form of this policy has recently been introduced. In addition, the UK currently has one of the lowest corporate tax rates in the main economies, although there are many tax havens with much lower corporation tax rates that multinationals can use.
Taxes have important implications for the UK economy, not just determining how much revenue the government can spend on public services such as the NHS, but also the future competitiveness and productivity of the UK economy.
All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.
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