U.K.'s Corporate Tax Cuts Offer a Lesson for Trump

(Bloomberg View) -- U.S. President Donald Trump's plans to cut corporation tax are likely to cost a lot. Will the cuts boost the economy or just prove to be a sop to the wealthy? The answer may lie in Britain, which is already running that experiment.

Together with large cuts to public spending, lo­­­wering corporate tax rates was former British Chancellor of the Exchequer George Osborne’s signature policy. When he arrived in 2010, the rate was 28 percent; now it is 19 percent and is set to fall to 17 percent in­ years to come. It’s a big policy, and it came with a big price tag.

According to the Institute for Fiscal Studies, the tax cuts and other savings to business announced since 2010 has cost the treasury £11 billon ($14 billion) a year in foregone revenues -- enough to meet Britain’s healthcare needs for about five weeks. That estimate includes the benefit to the exchequer of internationally mobile income arriving into the U.K. to take advantage of the low tax rate.

What the estimate does not take into account is how lower business taxation affects the wider economy -- which is what Trump is counting on to help finance his tax plan. The idea is that the tax cuts will lift firms' profitability, spurring investment, improving the productive capacity of the economy and ultimately pushing up household incomes, spending and tax revenues. 

In some corners, the benefits of Britain’s experiment with corporate taxation have been dismissed as paltry, because overall investment is lower as a share of GDP than in the past. But look at investment by just businesses and it is clear that the share is a good deal higher than in the 1970s when corporate taxes were more burdensome:

U.K.'s Corporate Tax Cuts Offer a Lesson for Trump

Investment has grown faster than GDP since cuts were announced in 2010 and the share of GDP is forecast by the independent Office for Budget Responsibility (OBR) to rise. Bloomberg Intelligence also expects spending to recover as a share of GDP following Brexit negotiations and in both cases that’s partly thanks to the corporation tax cuts.

Investment spending would probably be higher still, were it not for the Brexit vote. Economic uncertainty, captured by a Bloomberg Intelligence gauge in the chart below, has spiked. Conditions for starting major projects are not optimal, as surveys of investment intentions also show. And think of the counterfactual: Investment would probably have been lower if taxes had not been cut.

U.K.'s Corporate Tax Cuts Offer a Lesson for Trump

A government economic model suggests that lower tax rates do lift investment spending. The independent OBR has its own model, which reaches similar conclusions, and uses it to adjust its forecasts of business capital spending when policy changes. A one-percentage point cut in the corporation tax rate has in the past been estimated to lift business investment spending by as much as 0.5 percent within 5 years.

If that holds true then the planned 11 percentage point cut in corporation tax might create a medium-term boost to business investment of around 5 percent. There will be more machinery, buildings and software available to produce output than before the cuts. Still, even with this impact, cutting corporation tax is not even close to paying for itself. The government estimates that the cost of the cuts would be halved only over the course of a couple of decades.

The problem with these assessments is that they assume all else is equal, which it isn't. As others have rightly noted, the impact of corporate tax cuts on the economy depends on where the money to pay for the measure has come from. In the U.K., businesses have been induced to spend more but public investment has been shrinking relative to GDP. And spending on healthcare and education -- investment in human capital -- has been squeezed compared with historical norms.

Trump should take note. A lower U.S. corporate rate may encourage companies to invest more there. But if he decides to cut growth-friendly funding to win support for his corporation tax plans, the growth dividend he hopes will help pay for them may never materialize.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jamie Murray is chief EMEA economist for Bloomberg Intelligence.

To contact the author of this story: Jamie Murray at jmurray126@bloomberg.net.

For more columns from Bloomberg View, visit http://www.bloomberg.com/view.