ChainWhat it assumes · how to break it
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The government cuts corporation tax, for example from 25% to 20%.
1
As a result, at the existing level of profits, corporation tax receipts fall.
tax revenue
tax revenue
Assumes: Profits do not change straight away.
But: This direct cost is certain.
2
This means unless spending is cut, the budget deficit widens.
budget deficit
budget deficit
Assumes: Spending is not cut to match.
But: If spending is cut instead, the deficit is unchanged but services suffer.
3
However, a lower rate may attract investment and encourage firms to report more of their profits in the UK, so the tax base grows.
Laffer curve · profit shifting
Laffer curve · profit shifting
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Assumes: The tax base responds strongly.
Assumes: The tax base responds strongly.
But: The evidence is mixed: much of the rise in UK receipts after the 2010s cuts came with economic recovery, and the global minimum tax limits profit shifting.
4
In addition, if investment and growth rise, receipts from income tax and VAT rise too.
tax base
tax base
Assumes: The cut raises growth.
But: If investment does not respond, there is no growth dividend.
End
The budget deficit widens in the short run, and by less in the long run if the tax base grows.
Evaluation chain
- E1However, whether the cut recovers its cost depends on how strongly profits and investment respond to the lower rate.
- E2Because the 15% global minimum tax limits how much profit firms can shift between countries, the gain from profit shifting into the UK is limited.
- E3In addition, although UK corporation tax receipts rose in the 2010s after the cuts, that was also a period of recovery and rising profits, so the cut's own effect is hard to separate.
- E4So it is hard to show that the cut paid for itself, and the deficit probably widens by close to the direct cost.
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Questions this answers
- Assess the impact of a cut in corporation tax on government finances.
- Discuss whether cutting business taxes can raise tax revenue.
- Explain how a tax cut might affect the budget deficit.
Diagram
Laffer curve: whether revenue falls depends on which side of the peak the starting rate is.
Reverse and related
Corporation tax rise → receipts rise, unless profits move abroad.