Corporation tax cut → Growth: chain of analysis

ChainWhat it assumes · how to break it

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The government cuts corporation tax, for example from 25% to 20%.

As a result, firms keep more of their profits after tax.
retained profit

Assumes: Firms are profitable.

But: Loss-making firms and start-ups pay no corporation tax and gain nothing.

This means the after-tax return on investment rises, so more projects become worthwhile, and firms have more of their own funds to invest.
investment · rate of return

Best link to attack
Assumes: Tax is a major factor in investment decisions.

But: Investment depends more on expected demand, skills and stability. After the UK cut corporation tax from 28% to 19% between 2010 and 2017, business investment stayed weak.

In addition, the UK becomes more attractive to multinational firms, so foreign direct investment rises.
foreign direct investment

Assumes: Firms choose locations partly on tax.

But: The 15% global minimum corporate tax agreed through the OECD limits how much tax competition can attract.

Consequently, the capital stock grows, raising productivity and shifting LRAS right; the investment spending also raises AD.
LRAS · capital stock

Assumes: Firms invest the extra profit.

But: Firms may pay higher dividends or buy back shares instead of investing.

End

Long-run economic growth rises.

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Questions this answers

Assess the impact of a cut in corporation tax on economic growth.
Discuss the effectiveness of market-based supply-side policies.
Evaluate the view that lower business taxes increase investment.

Diagram

AD/AS: AD shifts right as investment rises; LRAS shifts right as the capital stock grows.

Reverse and related

Corporation tax rise → lower post-tax returns → investment may fall.

Questions this answers

Diagram

Reverse and related

GCSE version