Is Labour’s opposition to corporation tax rises indefensible?

It has been heavily briefed out to the media that the chancellor is planning to raise corporation tax rates in next week’s Budget as a way of helping to restore stability to the public finances in the wake of the coronavirus pandemic and reversing some of the deep cuts in the levy imposed by Conservatives over the past decade.

But Labour has signalled that it would oppose such a move.

“This is not the time to do that,” said the party’s shadow chief secretary to the Treasury, James Murray, on the BBC this week.

That anti-tax rise position has created a storm of dismay within Labour, particularly on the left of the party.

Diane Abbott, the former shadow home secretary under the previous leader Jeremy Corbyn, pointed out that Keir Starmer had campaigned for the party’s leadership on a pledge to “reverse the Tories’ cuts in corporation tax”.

The activist Owen Jones was even more disappointed.

“The Labour leadership is now positioning itself to the right of the Tories on economic policy and refusing to rule out opposing Rishi Sunak hiking taxes on big businesses,” he tweeted.

“Farcical. Grotesque. Indefensible.”

But is Labour’s position really indefensible? Or is there, in fact, an economic logic for it?

The first thing to say is that Labour’s general position of opposing any tax rises, at the current juncture, is supported by just about every mainstream economist.

The logic is that any increases in taxes would suck spending power out of the economy at a time when it is severely depressed, hamper the recovery and risk permanently damaging our future growth capacity.

In the case of corporation tax, which is levied on firms’ profits, this would be felt through curbing firms’ investment incentives.

It’s notable that even economists who have long been in favour, in principle, of raising corporation tax, such as Oxford University’s Simon Wren-Lewis, argue against doing anything on this front in the upcoming Budget.

“I wouldn’t do it now,” he told an Institute for Government (IFG) event on Thursday. “I wouldn’t announce it now. I’d think about doing it in a year or two’s time, once the recovery is pretty well complete and interest rates have increased substantially.”

But do all near-term tax rises have to be a drag on growth? Some have suggested tax rises in the near term could be combined with near-term tax giveaways or spending increases.

That could, in theory, leave the overall Budget tax package neutral from a macroeconomic management perspective.

Advocates of this position argue that it is net tax rises in the near term, not tax rises per se, that need be avoided.

But James Smith, research director of the Resolution Foundation think tank, is sceptical of this “fiscal multitasking” approach.

“It risks muddying the waters of what the chancellor is trying to achieve,” he says.

“Yes, it’s definitely the net position that matters, but I would advocate stimulus now and fiscal policy later. It’s not obvious to me why you would want a policy mix that moves away from supporting firms right now.”

Carl Emmerson, deputy director of the Institute for Fiscal Studies (IFS), also points out that one should not assume that the state raising a certain additional amount in tax and simultaneously relinquishing a certain amount (based on official revenue forecasts) necessarily means the macroeconomic impact is cancelled out.

“Suppose the chancellor increased the rate of corporation tax and cut the rate of National Insurance Contributions (NICs) by the same amount [in £bn] – this would deliver a small stimulus to the economy as the demand multiplier on corporation tax is lower than that on NICs,” he explains.

But what about the incentives within the corporate tax regime? Some have suggested that, if the government is going to raise the corporation headline tax rate, it could offset the negative impact on investment incentives by increasing firms’ investment allowances (spending that firms can use to offset their bills) or narrowing the tax base in other ways.

Helen Miller, also of the IFS, is strongly in favour of rationalising the corporate tax regime, arguing that the UK system discourages investment much more than it needs to.

“It would be possible to do this while increasing rates in a way that improved investment incentives,” she says.

But, again, one should beware of assuming that any increase in investment allowances would necessarily offset the incentives impact of a hike in the headline corporation tax rate.

Miller points out that, with large firms often able to shift investment across borders, the impact on investment incentives of raising corporation tax rates depends on what other countries are doing to their own rates.

“Because of this international dimension I don’t think you can assume that any increase in rates could be balanced out by changes in the tax base – the rate would matter even if we had the perfect tax base,” she says.

Robert Chote, the former head of the Office for Budget Responsibility, makes a similar point, though he adds that the new Biden administration in the US has pledged to raise its own corporate tax rates significantly (from 21 per cent to 28 per cent).

“I think the [UK] government anticipates that with the trend of corporate tax rates in the US there’s a bit more space, economically and politically, than there otherwise would be,” he told the IFG.

Labour could, credibly, support corporation tax rates hikes by the government on the grounds that the dampening effect of investment at the moment is unlikely to be particularly severe because of the international context.

It’s possible – perhaps even likely – that any increase in corporation tax announced by Sunak next week would not take effect this financial year, but in 2022-23.

That could defray any economic drag given the economy could be growing strongly this time next year, although some, such as Simon Wren-Lewis, argue that even telegraphing rises now could still impede investment today by impacting firms’ expectations.

Tim Pitt, a former special adviser to Tory chancellors Philip Hammond and Sajid Javid, says, however, that there are political incentives to do so.

“It’s much easier to announce tax rises to kick in in a few years’ time if you’re also doing a big generous short-term support package,” he told the IFG.

“This will probably be the last Budget where [Sunak] will be doing that – so it makes a lot of political sense from that perspective.”

Yet Emmerson of the IFS points out there might also be practical arguments for waiting until the economic and fiscal outlook for the UK is clearer before committing to any tax rises, corporate or otherwise.

“It might be easier to announce a big set of measures in a single package - not just in terms of how they are sold, but also in terms of how they are designed to fit together -rather than doing a little bit in several successive statements,” he says.

So where does that leave us? The economics of raising corporation tax are not conclusive, but Labour’s position, from a macroeconomic management perspective, is defensible, not least because the party has not ruled out raising the levy in future.

From a political perspective this nuanced policy is, plainly, a trickier sell, particularly given the demands from the left of the party for certain companies which are seen to have profited greatly during the pandemic to make a greater contribution to the public coffers.

Though some of the strategists around the Labour leadership might well feel that, for a party which wants to change public perceptions (whether justified or not) that it is incorrigibly hostile to business, the current corporation tax furore might be no bad thing.