Experts clash on impact of tax cuts

George Osborne’s cut to corporation tax could fail to have an impact on economic growth if sentiment does not improve, commentators warn.

The chancellor’s Budget an­nouncement last week included cutting the headline rate to 24% from next month, with a further reduction to 22% by 2014. While these measures are aimed at increasing incentives for business investment, a nervous corporate sector might be tempted to hoard the additional revenue rather than spend it.

As the chancellor made clear in his Budget address: “[The new rate is] an advertisement for investment and jobs in Britain. And a rate that puts our country within sight of a 20% rate of business tax that would align basic rate income tax, the small companies rate and the corporation tax rate.”

The move was described by Dominic Rossi, the global chief investment officer for equities at Fidelity Worldwide Investment, as a “great support to UK companies”.

Yet not all economists have welcomed the move. Michael Taylor, a senior economist at Lombard Street Research, says the tax cut will do little to encourage British companies to part with their cash reserves, which are worth about £700 billion. (Article continues below)

“The corporate sector is sitting on extreme amounts of cash and there’s perhaps an argument for taxing retained earnings. Reducing corporate tax rates may not have much of an effect as it doesn’t encourage companies to do anything with their cash piles,” he says.

The independent Office for Budget Responsibility (OBR) expects the cut to boost the level of business investment by a modest 1%. That would be a disappointing return from a policy that the OBR estimates will cost the government £405m in its first year rising to £920m in the 2016/17 tax year.

However, Osborne appears to be targeting foreign investment into Britain in a similar model to that used by Ireland. In a 2006 article in The Times the then-shadow chancellor praised Ireland’s low business tax of 12.5% stating “in a world where cheap, rapid communication means that investment decisions are made on a global basis, capital will go wherever investment is most attractive”.

Commenting on the Budget, EEF, a trade body representing almost a quarter of Britain’s manufacturing businesses, said: “The corporation tax cut is welcome but, on its own, it is not the silver bullet that will unlock the business investment our economy urgently needs.”

With the OBR projecting Britain’s budget deficit for the fiscal year could reach £127 billion, the government will hope it is one gamble that pays off.