What we really don't like about corporation tax

Most readers of this blog will be aware that we don't much like corporation tax. In various blogs, articles and reports we've called for its abolition and replacement. We've argued that it falls heavily on workers, discourages investment and encourages excessive accumulations of debt.

But I think it's worth getting into the fundamentals of why we think corporation tax is so harmful and what you'd need to do to fix that.

Simply put, corporation tax taxes capital (goods that produce other goods, from new machinery to training and professional development) and taxing capital deters firms from investing in their workforce, lowering productivity and wages.

People invest money today in order to spend it at a later date. By taxing investment you essentially are imposing an uneven tax on consumption. You're taxing people who invest and wait to spend their money at a higher rate than people who spend it immediately. And it gets worse: the longer you wait to spend your money the higher the consumption tax rate will be when you do. In fact, relatively low tax rates on investment can imply extremely high rates on consumption down the line. I wrote a blog a few months back explaining the maths behind that.

But while there's a lot wrong with corporation tax, fixing it is actually quite simple. Let's think about this from the point of view of a business. Pretend you own a widget factory and you're deciding on whether or not to invest in a new Widgetmatic 3000 widget-making machine. You'll only make a marginal investment if the return you get from it outweighs the cost of investing.

There's a lot for you to consider. First, you need to know how much the actual machine costs to buy, then you need to know at what rate it will depreciate at and what the interest rate is. You also need to know what tax rate you'll face on the investment. If the return from the investment will be taxed that will increase the cost as well. For instance, if the rate of corporation tax is 20% and you can't deduct the cost of the investment at all from your taxable income then that adds 25% onto your cost of capital. (Think of it like a sales tax: 20% off a £125 jacket raises £25 leaving the retailer with £100. In essence, the sales tax has increased the price from £100 to £125, a 25% increase.)

But suppose you could deduct half the value of the investment from your taxable income. That'd lower the cost of capital to 12.5%. The bigger the deduction, the smaller the effect the headline tax rate has on the cost of capital. If it's a full deduction, then the tax rate is irrelevant. If you want a more mathematical proof, check out Alan Cole's Tax Foundation report on it.

As it stands businesses can gradually deduct the cost of an investment from their tax bill over the years as it depreciates. But unlike normal business costs like purchasing pens and papers, the purchase of a new widget-machine wouldn't necessarily be deducted in full the year it was bought.

Herein lies the problem – things are worth more now than they are tomorrow. It's simply better to have £50 today than £10 every year for five years. That's because you can put that £50 in the bank and collect interest. You've also got to deal with the value of that £50 being eroded by inflation.

If you let people deduct the full cost of an investment just like any other business cost, then the tax rate doesn't matter. Corporation tax would become what we call a cash-flow tax, a much simpler way of raising revenue. It would effectively tax consumption and profits above the normal rate of return (what economists call rents).

Instead of complicated corporation rates where businesses have to hire accountants to manage a range of investment allowances and depreciation schedules, a business would only be taxed on its annual turnover minus its investments and normal business costs.

Moving to such a system would be rocket-fuel for investment, boosting GDP and wages. When Estonia replaced their corporate income tax with a cash-flow tax levied on shareholders they attracted significantly more investment than neighbouring countries. This is the idea at the heart of a lot of free-market plans to abolish corporation tax, with both the IEA's Diego Zualaga's and the TPA's Single Income Tax plans featuring Estonian-style dividend taxes.

Many economists have argued the theoretical case for increasing and speeding up depreciation deductions, but it's been hard to prove empirically because we can't usually isolate the effect on investment from other bigger macroeconomic changes. However, a new paper from the Oxford Centre for Business Taxation backs up the intuition that it's the deductibility of an investment that really matters with proper empirical evidence.

On the EU's recommendation in 2004, the Labour government changed the definition of SME, allowing many more companies to qualify for First Year Allowances (FYAs). FYAs let you immediately deduct the full cost of an investment up to a certain amount (rather than deducting it as it depreciates). Devereux and colleagues compared those firms that now qualified for these deductions with firms that never qualified throughout the process. They found that investment rates increased 11% relative to firms that didn't qualify.

Over the past few years, the government has been focused on lowering the corporate tax rate. This is broadly speaking a good thing: the corporation tax as it stands deters investment and a lower rate will deter it less. But as The Tax Foundation's Kyle Pomerleau points out there's been a big problem. As they've cut the headline rate, they've also lengthened depreciation schedules. Think back to the widget example, they may have the main rate but they've also cut the deduction to make up the revenue.

That's a problem. Pomerleau points out that even though the corporate income tax rate has declined in the United Kingdom, the effective marginal tax rate on corporate investment has actually increased. We actually have a higher effective marginal tax rate on corporate investment than the US (the third highest in the OECD). In tax terms, the cost of buying a new Widgetmatic 3000 is higher now.

That explains why despite having one of the lowest corporate tax rates in the OECD, Britain persistently invests significantly less than the OECD average. It might even go some of the way to explaining why Britain's consistently lags behind our friends in Europe and America.

Devereux's findings shed light on the solution. Let's switch to a cash-flow tax to boost investment and give British workers a well-needed pay-rise.

A little something about those child poverty figures

When some statistic that we're all supposed to be shocked and disgusted by is trundled out it's always worth pondering upon what the statistic actually is:

The upward trend in child poverty in the UK has continued for the third year running, with the percentage of children classed as poor at its highest level since the start of the decade, latest official figures show.

Child poverty is an emotional term but it does not mean waifs about to be stuffed up chimneys in order to earn their daily crust:

About 100,000 children fell into relative poverty in 2015-16, a year on year increase of one percentage point, according to household data published by the government on Thursday. About 4 million, or around 30%, are now classed as poor.

This is relative poverty. Children living where household income is below 60% of the median, adjusted for household size - and usually measured after housing costs. This is not a measure of poverty of course, it is a measure of inequality. And as such there's a point or two that can be made about it:

The Institute for Fiscal Studies said income for working-age adults was no higher than eight years ago. Inequality and poverty remain slightly lower than before the financial crisis.

Recessions cut inequality and therefore, bizarrely, cut poverty by this measure. It is profits and capital incomes which fall fastest and furthest in a recession, meaning that it is the richer, where such are concentrated, who lose most. This compresses inequality. And as the recession recedes then it is capital incomes which grow again, increasing inequality.

We're thus using a very odd measure of poverty here, one which shrinks as we all get poorer (a recession does do that) and grows as we all get richer (a boom does do that).

However, we can go further than that too:

The data showed that nearly half of single-parent children are poor, with a noticeable surge in poverty over the past year among children of lone parents who work full-time.

Note again what our measure is here, it's household income. One which we might think is going to be lower where there's only one potentially working adult rather than two. And 25% of households containing children are headed by a single adult, 75% by a married or cohabiting couple. Their working arrangements being:

In spring 2004 most working-age families with dependent children (couples and lone parent families combined) had at least one resident parent in employment (84 per cent) and a half had two parents in employment (50 per cent).

The median income is, as we know, where 50% of households, assuming we are measuring median household income of course, where 50% of the units are below, 50% above. 50% of UK households with children in have two adults working, 50% have only one or perhaps none.

It is not hugely surprising that a majority of the children in families with only one potential bread earner are in households with income significantly below the median given that modal set up of the two earner family.

At which point what is our child poverty statistic really telling us? Britain has a certain amount of inequality, a little less than it had 8 years ago but rising again as we climb out of the effects of the recession. This may or may not worry you. It does not particularly worry us.

Britain's child poverty is also, in large part, caused by measuring it against median household income, something which is naturally going to be lower in single parent households where the norm is two earner households. This also does not worry us very much on the grounds that if people prefer to live their lives this way then who are we to gainsay them? This is not widows struggling to bring up their semi-orphaned children after all.

It also poses something of a policy problem - if it is single parenthood where this dreadful child poverty, that inequality, problem is concentrated then what actions should be taken about it? Anyone up for returning to the social pressures of old where the insistence was upon two adults raising children?

No, us neither even though that would seem to be a solution which would largely solve the problem being complained about. Ourselves we say leave people to make those decisions as they will for we are in fact liberals. We just have to put up with the resultant inequality of incomes in households containing children.

What we can't see as being quite just is to tax those doubling up that child raising duty in order to provide for those who eschewed that choice. To tax to relieve actual poverty, deprivation, yes, we can see that, but not inequality brought about by choice.

What Brexit means for Ireland

What Brexit means for Ireland

As the ASI’s resident Irishman, I was asked to speak at an event at the Irish Embassy yesterday to consider, among other things, what sort of impact Brexit will have on Ireland and the Irish people. Although Ireland is small, its destiny matters to Britain. Ireland is the United Kingdom’s only land neighbour, Northern Ireland is still unstable, 5.1% of British exports go to Ireland (nearly as many as the 5.7% that go to France), half a million people born in the Republic of Ireland live in the UK, and six million Brits have at least one Irish grandparent.

We thoroughly approve of this national insurance backtracking

This will be, is being in fact, painted as a disastrous u-turn, career ending damage, the beginning of an omnishambles, (cont. page 94.) and yet we here thoroughly approve of the reverse that has happened in this short period since the Budget over national insurance contributions for the self-employed.

Not because of any insistence we have over the policy itself nor of the personalities involved. The collective view veers one way and the other on those two but none of us think that they're hugely important. But reversing a mistake, now that is welcome.

For mistakes do always happen, there is never going to be a system containing human beings and human decisions that doesn't contain more than the occasional oopsie. As here:

Philip Hammond has abandoned plans to raise national insurance for self-employed workers in this Parliament after admitting that it breached the "spirit" of the manifesto.

The Chancellor provoked a furious reaction from Tory back-benchers after using his Budget to announce plans to raise NI contributions for the self-employed by 2 per cent. 

Mr Hammond has written to Tory MPs saying that while the changes are justified the Government has chosen not to go forward with the rise in "class 4" national insurance contributions. 

Oopsies will happen, just as most business ideas will fail, there's always going to be a business cycle, bad luck will dog some people and so on. What matters is what we do when that mistake is made, that bankruptcy is obvious, that recession arrives, that disaster is visited upon the unfortunate.

One reason we so like the market system is that the mistake of a bad business idea becomes rapidly obvious and people stop making that mistake. They run out of money and that's that. Politics tends not to work that way because all the playing is done with other peoples' money and as St. Maggie pointed out it takes a long time to run out of all of that. Until it does happen the practice is run upon reputation, careers, ego - and it's easy enough to spend an awful lot of other peoples' money on protecting those. Yet here we've had only a week to reverse what is said to be a mistake, something we find encouraging.

We're note really sure whether it was a mistake or not, whether the reversal is one or not. But normally political mistakes run on and are stoutly defended to the death of the last kulak. That politics might correct such errors rather earlier, more like a market system would, we think to be a Good Thing. 

Transforming National Insurance

The now-withdrawn proposal to raise National Insurance rates for self-employed people from 9% to first 10% and then 11% has achieved one positive thing.  It has drawn attention to the absurdity of the dual system of income tax and national insurance.  Dan Hannan’s piece in the International Business Times makes the point that the retention of National Insurance is done to conceal how much tax people are paying.  He says people would be very angry if they knew that in addition to their basic rate of income tax at 20%, their National Insurance payments took it to a very much higher level.

He is correct, but an honest government should let people know what tax they are paying, even if it changes their readiness to submit to tax increases.  The two taxes on income should be merged.  In the first instance the myth of insurance should be exposed by renaming it a National Insurance Tax, and having it at the same rates and thresholds as income tax.  Income Tax plus National Insurance Tax would together constitute a “Personal Tax’ that people paid on all earnings above the starting threshold.  A basic Income Tax of 20% plus the 12% employee contribution to National Insurance Tax would give a Personal Tax of 32%.

Government could thus merge the two without having the headline basic rate of Income tax leap through the roof.  It would, however, make clear to people what they were actually paying in Personal Tax, and would end the anomalies of having different thresholds and separate calculations.

There is more, though.  In addition to the employee contribution to NI, there is the so-called employer contribution of 13.8%, so-called because in reality it comes from the wages pool paid by the employer and would otherwise be available as wages.  Although it is called an employer contribution, in fact its incidence falls on the employee.  This could initially be renamed the employer contribution to National Insurance Tax.  Personal Tax would then consist of 32% paid by the employee, and 13.8% paid by the employer, for a total of 45.8%.

Once this change had bedded in and yielded savings in simplification, the employer contribution to National Insurance Tax might be given its real name, “Employment Tax.”  It would be seen for what it is: a disincentive to create employment.  It might also add to popular pressure for further simplification of the tax code and to heightened intolerance of government wastage.

The FT's odd suggestion about the EIB

As we all know the government is considering asking for the capital back from the European Investment Bank when Brexit occurs. There's perhaps € 10 billion in there and according to the rules shareholders in the EIB must be EU members. All of which seems pretty cut and dried to us.

Which brings us to this remarkable suggestion in the FT

:But the obvious point here is that a proportional slice of the EIB’s funds is far smaller than the cash the UK would receive over the years by remaining a member. A one off payment in return for losing billions of yearly funding.

Err, what?

I shouldn't sell my stock in Barclay's because of the loans I can get from Barclay's?  Loans which I do have to pay back note, so the loans aren't free money. While that return of capital is in fact free money, money that we're free to deploy in any manner we desire.

More than this it's not exactly as if the UK has a problem in borrowing money these days, is it? The Treasury can in fact borrow near unlimited amounts at present, almost certainly at lower interest rates than the EIB would offer too.

Whether or not Britain should stay in the EIB isn't something we have a collective view upon. But the argument that we should stay in just because they might lend us some money is ludicrous.

Failing to spot that the problem with Ethiopia is....

Things are not going well in Ethiopia, this we know. Riots and protests erupt. This is not a good sign for a society. It's also very much a pity - not just for the usual reasons that violence is a pity - because Ethiopia is one of those places discovering the joys of the early stages of a lift off into the Industrial Revolution. They're taking those first baby steps to getting rich, that thing that we've all done and which has escaped all too much of the world until very recently.

What's happening is that those living on a piece of land, working it perhaps, are being thrown off it in favour of those doing something else with it. But why?

The Guardian tells us what is happening but doesn't quite manage to grasp that cause, even though they mention it:

All land is theoretically owned by the government, merely leased by tenants, and when the government says go, you have to go.

This is the problem that private property solves. OK, sure, you can construct a very rickety indeed case that all land is still owned by the Crown (it isn't, but) and that compulsory purchase equates to this. But that's not so - compulsory purchase means that you get paid at the market rate for having to move and then only in favour of a project which contributes to the public, not private, good.

But in a system where the government really does own all the land, and can allocate usage without reference to current occupiers, the end result is what we see in Ethiopia. Who gets to use the land depends upon access to the political system and those excluded riot as a result.

It might even be true that no one made the land so there's no reason why anyone should own it exclusively. Except that, as with democracy, all other systems are worse.

Absolutely not, no, no way ever

This is one of the more vile suggestions for public policy that we have seen in recent years. And the correct answer to the idea being put forward is absolutely not, no, no way ever.

Police forces raised more than £5 million last year by selling off a treasure chest of criminals' loot, including flash cars, luxury yachts, light aircraft – and even guns.

But now the windfall is at the centre of a political row as demands grow to allow forces keep more of the cash they get from such sales to fund frontline policing.

Currently, half of the proceeds are handed to the Home Office, with more money going to the courts and the prosecution service. But Thames Valley's police and crime commissioner Anthony Stansfeld said: 'I think we should have it all.'

We object to the basic idea, that property can ever, let alone should be, confiscated without conviction in a court of law of an actual crime other than having some property whose financing cannot be proven.

But we also do actually have a good example in front of us of what happens when incentives are aligned, as they are in the US. There police forces do indeed keep most to all of property taken. And the effect is that the population is subject to legalised plunder. As the ACLU, the IfJ, Cato and others continually point out.

Policing for profit is not something which has a place in anything approximating to a liberal polity. Those who do the confiscating must never be those who gain from the confiscation having been done.

Absolutely not, no, no way ever.

It's not obvious that the Mail has understood Corporation Tax

We're not quite sure whether to be amused here at the lack of knowledge or to beat our heads on the keyboard at the, err, lack of knowledge. For the Daily Mail has decided to give us a listing of companies not paying what they think is the correct amount of corporation tax.

They start by getting one thing right

All retailers are supposed to pay corporation tax — a levy on company profits, currently at a rate of 20 per cent but falling to 19 per cent next month. 

It is, as they say, a levy upon profits. We might want to add the tiny detail that it's upon cumulative profits but it is still a tax upon profits. At which point they have a go at Vodafone and EE:


Corporation tax: Nil

It’s because Vodafone handed over exorbitant sums to the Blair government for 3G licences, and set aside those costs and other investments against its earnings here.


Corporation tax: Nil

But even though it registered big sales and profits in 2015, it wasn’t liable for corporation tax because, like Vodafone, it has carried forward costs from the £8 billion it invested in 3G back in 2000.

That is, neither firm has been paying corporation tax because they haven't been making any profits. The reason they've not been making profits is because they've already given all of the money to the government anyway.

In these days when we're all being told that we must be vigilant against the threat of fake news we can't help but feel that the legacy media might up their game a bit.

If women disproportionately suffer from austerity then they must have disproportionately benefited from the previous system

This is not something which we insist is right or wrong, something that should be or not, it's just a logical truth which we think is worth pointing out:

Labour has urged the Conservatives to carry out a gender audit of its tax and spending policies, as the shadow equalities minister, Sarah Champion, published analysis showing that 86% of the burden of austerity since 2010 has fallen on women.

Champion said research carried out by the House of Commons library revealed that women were paying a “disproportionate” price for balancing the government’s books.

Leave aside even whether there has been any austerity (spending seems to keep on going up after all) and whether, if there has been, there should have been. Concentrate instead just upon the logical implications of this:

In total, the analysis estimates that the cuts will have cost women a total of £79bn since 2010, against £13bn for men.

It shows that, by 2020, men will have borne just 14% of the total burden of welfare cuts, compared with 86% for women.

If cutting that welfare state means that women are getting less out now then that obviously means that before the cuts to the welfare state then women were getting more out.

No, we don't know either what is the correct split between taxing everyone to benefit women and taxing everyone to benefit men is. We might even point out that as men make the higher wages they get taxed more to boot. But that is still the correct question to be pondering. Not how much has that distribution to male and female changed but what is the righteous and just structure of that distribution in the first place?