ChainWhat it assumes · how to break it
Start
The government cuts corporation tax, for example from 25% to 20%.
1
As a result, firms keep more of their profits after tax, so the after-tax return on investment rises.
retained profit · rate of return
retained profit · rate of return
Assumes: Firms are profitable.
But: Loss-making firms and start-ups pay no corporation tax and gain nothing.
2
This means firms invest more, and multinationals are more likely to locate new plants and offices in the UK.
investment · foreign direct investment
investment · foreign direct investment
Assumes: Tax is a major factor in investment and location decisions.
But: Firms weigh expected demand, skills and stability more heavily, and the 15% global minimum corporate tax limits how much tax competition can attract.
3
Consequently, new and expanding sites need workers, so the demand for labour rises, and the investment spending also raises AD.
derived demand · aggregate demand
derived demand · aggregate demand
Best link to attack
Assumes: The new capital needs extra workers to operate it.
Assumes: The new capital needs extra workers to operate it.
But: Investment in automation, such as robots and software, can replace workers rather than add to them.
4
In addition, new capital raises workers' productivity and marginal revenue product, so firms can afford to employ more people at the going wage.
marginal revenue product
marginal revenue product
Assumes: Firms use higher MRP to hire more workers.
But: Firms may pay existing workers more, or pay higher dividends, rather than hire.
End
Employment rises as firms invest and expand.
Evaluation chain
- E1However, the effect on employment depends on what kind of investment the tax cut encourages.
- E2If firms invest in automation, capital replaces labour in tasks such as assembly, warehousing and processing.
- E3As a result, output rises but employment in those firms may fall, although some jobs are created in making, installing and maintaining the new equipment.
- E4So a corporation tax cut may raise output more than employment, and could reduce employment in some industries.
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Questions this answers
- Assess the impact of a cut in corporation tax on employment.
- Discuss the effectiveness of market-based supply-side policies in reducing unemployment.
- Explain how lower business taxes might increase the demand for labour.
Diagram
Labour market: the demand for labour shifts right, raising employment and the wage rate. AD/AS can also show AD shifting right as investment rises.
Reverse and related
Corporation tax rise → lower post-tax returns → less investment and FDI → fewer new jobs.