The Scottish Government is living in La-La Laffer Land

Nationalist hopes for their proposed Corporation Tax cut are hopelessly misplaced, writes RICHARD MURPHY

 

John Swinney, Scottish Finance Minister issued a press release on 16 August saying:

“Scotland needs full control of the key economic levers to meet the specific challenges facing the Scottish economy – and the cross-party Scotland Bill Committee in the last parliament concluded that this power should be available to the Scottish Government if it is granted to Northern Ireland.

“Control over corporation tax would enable us to boost investment, bringing jobs to communities across Scotland, grow the economy and take the right decisions for Scotland.

“There is clear evidence from around the world of the benefits from lowering burdens on business – and this 54-page document sets out the compelling evidence in more detail than ever before.

“Lower corporation tax is a vital source of competitive advantage in an integrated global economy, helping to attract new businesses and highly-skilled jobs. A competitive corporation tax regime has been a feature of the economic success of many countries, and we want Scotland to have the same opportunities to bring in jobs and boost growth.”

And much more in similar style.

But as the Telegraph noted:

“Figures on Friday are expected to show that companies are not spending despite the Government’s best efforts to encourage corporate activity by slashing employers’ National Insurance contributions and corporation tax.

“Stagnant investment in the second quarter, as BarCap has forecast, would follow a 3.2pc decline in the first three months of the year. By contrast, the Office for Budget Responsibility expects business investment to expand by 6.7pc this year and contribute a third of total growth.”

Let’s explain that in simple terms: tax rates have never, and tax rates never will encourage real growth.

Low tax rates do encourage people to artificially relocate profits to low tax locations. But they never encourage people to make more real money. That’s because making money requires a strong top line and corporation tax is charged on what’s l;eft over at the bottom line.  And as is obvious, if government withdraws from the economy (as now) because it does not believe in tax then top lines are weak and bottom lines disappear – and tax considerations go out of the window in a panic about survival.

But John Swinney and the Office for Budget Responsibility are still living in the La-La Land of the Laffer curve that says cutting tax rates increases yields.

They rely on a graph like this:

They implicitly argue that we’re on the right hand side of the graph i.e. the downward sloping but of the graph and if only we cut tax rates then yield would increase.

The trouble is I did a survey of the academic literature a while back and found the only place that might be on the right hand side of the graph was Sweden and there was not a hope that any tax rate in the UK (including the 50% income tax rate we now have) would put us anywhere near that point.

So tax cuts in the UK always mean less tax.

And more corporate profit – none of which would stay in Scotland you can be sure.

So candidly, these people really are in La La land and it’s time they woke up and saw the reality of the harm they’re really proposing to the ordinary people who will suffer cuts in education, health care, pensions and other essential services as a result of their mad thinking. Because that’s what they’re really prescribing. Which is exactly why the Taxpayers’ Alliance sells this myth to them.

Richard Murphy is an economist who blogs at Tax Research UK, where this article was originally posted. Follow Richard on twitter at @RichardJMurphy.

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29 thoughts on “The Scottish Government is living in La-La Laffer Land

  1. Richard,

    you seem to imply that the Laffer Curve has some truthful application, e.g. if taxation is “high” to start with.

    Is that true. Is it accepted by economists?

      1. An expert who will know tomorrow why the things he predicted yesterday didn’t happen today.

  2. I wonder if Mr Murphy had the same to say of previous UK Labour governments who used their tax varying powers as an economic stimulator when they felt they had to. All political parties promise to reduce the tax burden when they can, it never seems to give me more to spend however!
    Nor do people in the Eurozone seem to agree with Murphy, as they want Ireland to up its rate, to stop them being too attractive to investors.
    Perhaps Mr Murphy would prefer all tax powers to be held by Brussels and to be fixed at a set rate. I would bet he doesnt.

    1. The case in Ireland is explicitly addressed here: “Low tax rates do encourage people to artificially relocate profits to low tax locations. But they never encourage people to make more real money”.

      Speaking personally, I would prefer corporation tax to be set in a band within the EU. France and Germany have tabled a proposal for this within the Eurozone, which would include Ireland.

      Irelands extremely low corporation tax rate has blatantly not provided it with a strong real economy, otherwise it would not require huge bailouts from other countries. What it has done is encourage companies to adopt complex corporate structures and bounce their profits through there. See http://en.wikipedia.org/wiki/Double_Irish_Arrangement for more detail on this.

  3. Dear Richard,

    I really enjoy your tweets (I’m @CGBiketours) and articles (and heard you on 5Live this morning!). But here’s a question that stumps me.

    I understand the role that Government plays in maintaining and creating demand. I own my own business, and for one reason or another have quite a lot of contact with a couple of Local Authorities. I see astonishing waste and incompetence – a lot of it.

    Is crap Government spending still good? Does it end up creating demand if it’s wasteful?

    Is wasteful spending justifiable purely on the ‘maintaining total demand’ principle?

    If the public sector is generally less efficient (and I believe it is) is it still good to steer activity towards the public sector?

    If the private sector could do the same task with less beauracracy, better outcomes, fewer staff, better use of technology, etc., but with less waste and less payroll, is there a ‘make-work’ argument that says it’s still better to employ more people, do the task more wastefully, because even wasted money circulates?

    Searching for answers Richard, not spouting an idealogical position. I’d be really grateful for your comments.

    Best regards,

    Bernard, Exeter

    1. That’s an interesting question. I used to work for a giant multi-mnational. I saw astonishing waste and incompetence too. I suspect that that “wasted” spending could still have had “good” outcomes, so why not “crap” public sector spending?

      I read a piece many years ago about how Japanese department stores employ “greeters”, people who shake your hand and welcome you to the shop…. not exactly an obviously value-add activity.

      The theory was that, as industrial employment fluctuated, low-skilled workers were employed/shed by e.g. car manufacturers.

      In hard times, the numbers in “pointless” jobs (such as greeters) increased. Thus the private sector performed a social welfare role by employing people who would otherwise be out of work, people stayed in employment of a sort, the welfare bill stayed lower than it could have been and more money circulated than otherwise would have.

      Was the expenditure used in keeping these people “employed” wasted?

      1. Having ‘greeters’ is a business decision. I don’t know about Japan, but several giant chain retailers in the US, including WalMart and Home Dept, employ [or have employed] ‘greeters’. A good, inexpensive PR move in my opinion. Nice to be greeted at store entrance with a friendly, “welcome to – – – – – “, and then pointed in right direction to the correct merchandise location.

      2. I always thought greeters were employed to attend funerals where the deceased was anything but popular and they needed a few mourners. No matter how old you are, you always learn something new. Well done, Labour Hame!

    2. I think there may be an argument that even “waste” and “inefficiency” in the public sector is not totally wasted.

      Ultimately, money being spent is actually being transferred – either to outside companies who overcharge (something I am familiar with) or to employees who do not “earn their keep”. This money is then spent elsewhere in the real economy.

      Thats not to say that such waste and inefficiency shouldnt be reduced, but there are probably many other areas that need addressing first.

    3. Bernard, I’m not an economist but here’s my thoughts.

      Whilst private companies can often initially undercut the public sector for some tasks or services, citing efficiencies, at the end of the day they are out to make a profit, one which they will want to grow over time – at the tax payers expense. Once the prices are raised, the public sector department has lost the employees/expertise/infrastructure to do the service ‘in house’ and the tax payer just has to cough up the extra cost.

      The private sector works by externalising costs – which often need to be picked up by the public sector at a later date. For example: if the private sector staff’s jobs are temporary and less secure, it is the public purse that will pay the health bills for stressed staff, it is the pubic purse that will pay for the benefits they claim when out of work between temporary posts etc.

      Other, more direct forms of externalising occur – for instance a private courier/delivery company is paid to deliver a parcel. If the parcel is going to somewhere they can’t deliver to efficiently (say a rural, outlying area) they may stick the parcel in the regular post because it has to deliver to all areas. In this way, they cream off the more lucrative business of delivering in cities and can offer the universal service without the infrastructure and costs to provide it. This means that the regular post service is unable to use the more profitable business to offset the cost of less profitable business to provide the public with a universal service.

      This creaming off of the ‘easy’ profits, whilst leaving the rest happens in other sectors e.g. health, where private health providers use the NHS as a back up to their services – so people who pay the company can end up paying for NHS treatment that they were entitled to for free!

      The problem is that the public requires all of these services, and the value of them is in their universality. Without being able to use more ‘profitable’ (or cheaper to provide) aspects to subsidise the others, the bill to the tax payer goes up and universal services are undermined, whilst a few private companies make a profit.

      If genuine efficiencies can be made in the public sector (that don’t just externalise costs onto other public departments) isn’t it better that these savings are achieved within the public sector and used to improve/extend the service provided for the benefit for everyone, rather than proving profits for a few individuals? This may mean hiring people from outside the public sector either as full staff, or temporarily for consulting to identify savings, but then those savings are used properly.

      I mean companies like A4E don’t do anything that Job Centres couldn’t do (and indeed used to do) but it has made the founder a millionaire – paid for by the public. Private companies do the minimum necessary to achieve their targets, even if it means the results are temporary or skewed by, say, under-employing people.

      Public service has an interest in genuine results. The NHS doesn’t profit by you remaining sick, Job Centres don’t profit by putting you forward for short term, pretend vacancies that’ll leave you out of work in the near future, the Police don’t profit by increased crime and the Prison Service doesn’t profit by reoffending. If these are privatised, perverse incentives will be created to do the minimum possible to meet targets whilst not actually resolving the problems so to increase repeat business and profits.

      Rant over. You get the idea. I don’t have a problem with genuine private businesses, but privatisation (either in part or full) of public services doesn’t do what it says on the tin (reducing costs due to inefficencies) just look at the railways where the only people who benefit are the extra lawyers, accountants and administrators required to liase between different operating companies. Tax payers pay more to travel, pay for the track and take all the risks, whilst private companies take the fares. How is that beneficial or fair?

      We also need to think about the kind of jobs we want in this country. The private wisdom seems to be that the more scared people are to lose their jobs, the better they will work. But that kind of stress is harmful, distracting at work, means people spend less in the economy (they’ll be saving up for that rainy day) and stunts creativity and beneficial risk-taking.

      I realise that not all private companies work this way, but it seems to be what people have in mind when they complain about inefficency in public services.

      The public sector also has a role in counter-cyclic stimulation of the economy, able to keep the benefit bill due to unemployment low when the private sector can’t afford to employ as many people and to increase demand.

      1. Oops. Ignore the bit about Private Companies taking the cheaper treatments off of the NHS. Whilst it is pretty cheeky to have people pay a private company for treatment that the private company gets the NHS to provide for free, it isn’t the same argument as that of the postal service.

        I was conflating two issues. Sorry. Whilst I’m handing out random criticisms of private healthcare though, I’ll add them benefiting from unnecessary treatment and all people (regardless of income) needing to be kept healthy both for moral and economic reasons.

  4. “A 10 percent decrease in corporate tax rates is associated with a higher GDP growth rate (from 1.1 percent to 1.8 percent) even when taking into account country-specific factors including primary school enrollment rates, inflation rates and population growth rates.” – Young Lee and Roger H. Gordon, “Tax Structure and Economic Growth,” Journal of Public Economics (89), June 2005

    1. Mac a slightly selective reporting of the paper and its conclusions…

      Full paper here…. http://www.aiecon.org/advanced/suggestedreadings/PDF/sug334.pdf

      The authors also say…”We report evidence that lower corporate tax rates lead to lower personal tax revenue, a result consistent with a lower corporate tax rate encouraging more entrepreneurial activity.

      However, the aggregate information reported here is insufficient to draw a definitive conclusion about the precise source of the links between tax rates and growth.”

      Sorry of this is a bit geeky but it is clear that the responsiveness (elasticity) is very sensitive to the starting point (which is a point Richard Murphy acknowledges). Some of the impact is simply related to switching from employment to self employment at lower cost without changing output.
      It is not at all clear that the claimed additional growth would be anything like sufficient to replace the lost revenue from both the lower rate itself and the switching out of employment to benefit from more favourable tax treatment. So if it were a policy that could be pursued there would have to be a decision about what would be cut from the budget to pay for what is in effect an increased distributions to shareholders. (who may of course not live in Scotland or spend the extra income in Scotland at all). Do the SNP really want to promote a policy that could cut the Scottish Budget to line the pockets of wealthy English shareholders?
      The experience of the Axis of prosperity – notably Ireland might be instructive here where dramatic cuts in corporation taxes (from 40-20%) were initially associated with increased revenue income through a certain amount of tax tourism but this is no longer the case – presumably in the face of the global recession but corporation tax revenue and growth have both fallen in Ireland far quicker than in other jurisdictions with higher corporate tax rates.
      Absent the cited paper (and even that doesn’t really make the case for cuting corporation tax as a means of generating growth) there is little evidence outside of conservative think tanks or vested interests for tax cutting as a long term engine for growth.
      My own view is that John Swinney’s interest in this stems far more from the politics of it an opportunity for a fight with the UK government. To do so over something which at least has sufficient complexity for few people to follow the detail but can be wrapped up in a couple of we love Scotland you hate Scotland sound bites.
      In addition to knowing what the overall loss in revenue might be for the Scottish budget I would be interested to know what the tax implications of differential corporation taxes (in Scotland and the rest of the UK) would be on income from dividends for income tax purposes, and what the additional cost of administering self assessment might be. If there were someone out there who had some insight…

      1. Other tax changes, such as income tax rate, VAT and other marginal tax rates do not significantly affect GDP growth rates.

        Only a reduction in Corporation tax stimulates economic growth. The OECD reported average for industrial countries is 23%. The UK economy is till not competing on this tax.

        1. Mac

          “Only a reduction in Corporation tax stimulates economic growth”
          The paper you chose to cite disagrees.. “However, the aggregate information reported here is insufficient to draw a definitive conclusion about the precise source of the links between tax rates and growth.”
          You are, I think, simply mistaken on that point. Happy to see some evidence but generally it is assumed that cuts in other taxes including particularly non wage labour taxes might be beneficial for GDP growth. Without wishing to misunderstand you I think most people would also agree that there are other ways of stimulating economic growth without altering tax rates (like education and training for example) so at best what you might be saying is that of the tax cutting possibilities cuts in corporation tax are the only ones that stimulate economic growth, and if that’s what you are saying I still think you are mistaken.
          If the only objective is economic growth maybe there is an argument for no taxes at all.
          My view would be that taxes are the price of living in a civilised society, we need to raise taxes to provide for public and social goods (and bluntly to ameliorate the injustice of capitalism) and broadly that is a view shared by all political parties.
          Lets assume we agree that cutting corporation taxes might create some GDP growth (and there is lots of room for debate about the scale of the effect) the central question we are interested in is would the additional growth be sufficient to either net the same amount of tax revenue (at a push we could also include the additional benefit in growth somehow compensating for the lost benefits we could have bought with the lost tax revenue) or not.
          This leads us on to a subsidiary question which broadly is ”If the objective is GDP growth, then are there better ways of securing GDP growth than cutting corporation taxes?”
          In essence, all things considered, is Scotland better off with lower corporation taxes or not?
          That’s the argument you have to make to say we should cut corporation taxes in Scotland.
          I would have some respect for an argument that said corporation tax revenues should be directly collected in Scotland because we have a vision for how to stimulate economic growth but are unwilling to bear the costs of that (or the costs are too great) unless we reap the rewards in higher corporation tax receipts. That is not the argument being made by the SNP government.
          Your point about “the UK not competing on this tax” is correct in so far as it is also true that we do not compete globally on low wages, poor conditions for workers etc. either. There is nothing inherently virtuous about being at, above or below OECD averages for tax rates. Corporation taxes are only one of a set of costs faced by business and Scotland cannot and must not engage in a race to the bottom, a separate Scotland wouldn’t engage in a race to the bottom either.
          The reality is that the SNP don’t want to cut corporation taxes in Scotland because there really isn’t a compelling case for doing so. If they had the money to do it there are lots of things that would be better for Scotland to spend it on, and John Swinney knows that. This is about politics plain and simple.
          Demanding control over corporation taxes allows a very simple response to any criticism of their economic record. Unemployment goes up – the SNP can and will say” It just goes to show that we need more control over the levers” … in other words they want to use it as “a get out of jail free card” on the economy. It creates a point of argument with the UK, and creates an opportunity to claim that our relationship with the UK is holding us back. Any criticism of the policy will be dismissed as an example of lacking ambition for the Scottish people. Look out for it in the future and you will see accompanying every statement about the economy a throw away comment (as if it were self evidently true) … if only we had greater control over the levers of power we could …. Great politics in spite of being a dubious policy priority.
          It has the added virtue that talking about lower corporation tax is inordinately popular with people who run businesses (not to mention potential donors to the SNP) because whether or not there would be any other effects on the economy as a whole it would make them better off (immediately, without any obligation on their part to do anything different).
          I think companies who benefit from the society our taxes support, the education and welfare services for their workers, the infrastructure for the distribution of good and services, the protection they get from the emergency services, and yes some contribution to looking after those people who are less well off, should make a contribution to paying for it. Corporation taxes are a fair price to pay from the profits made out of operating in the kind of Scotland we want to live in.
          And no I dont lack ambition for Scotland I think Scotland is a great place to live work and run a business and I accept the need to pay taxes to pay for it.

          1. The conclusions of the paper are definitive;

            This paper finds that the corporate tax rate is significantly negatively correlated with economic growth in a cross-section data set of 70 countries during 1970–1997, controlling for many other determinants/covariates of economic growth. We also find that other tax variables, including the average tax rate on labor income and Koester and Kormendi’s effective overall marginal tax rates, are not significantly associated with economic growth rates. The estimates suggest that cutting the corporate tax rate by 10 percentage points can increase the annual growth rate by around 1.1%. In fixed-effects estimates using a panel data set constructed for the same overall time period, estimated effects are larger, with the same tax change implying an increase in the annual growth rate of around 1.8%.

            I suggest you are confusing corporate taxes with other tax variables.

          2. Max

            I’m sorry I dont think your quote or the paper supports Mac’s assertion that:

            “Only a reduction in Corporation tax stimulates economic growth”

            I provided a link to the full paper so of course everyone can take a look.

            Suggesting I’m confused about an assertion I didnt make seems a bit unreasonable but perhaps I’ll try that myself next time someone makes an argument I dont like.

            The post by Richard Murphy provides some evidence that the relationship between lower corporation tax and growth had not been seen in the UK’s recent tax cuts and (lack of) resultant growth. In my posts I accept the likelyhood of some general relationship between cutting taxes and economic growth. Richard Murphy’s analysis is that cutting corporation taxes would lead to a fall in tax revenues – something not adressed in the paper at all. If it does lead to a fall in tax revenues then is the resultant potential GDP growth worth it?

            Is there any reason for thinking cutting corporation taxes would be a good choice for Scotland? If I’m bored a bit later I might make up your oppinion on that and criticise you for getting it so wrong.

    2. That paper studies corporation tax rates far higher than the current UK corporation tax rate, a mean of 41.3% compared to the current UK rate of 26%

      As Richard points out in the article, the Laffer curve is theoretically correct, however it’s inapplicable to the UK.

      So well done for citing some actual evidence, but keep trying on the “things that are applicable to the topic under discussion” front eh?

  5. We need to challenge the idea that a low-corporation tax is beneficial to ordinary people (as opposed to multinationals looking to put a HQ plaque on a building, any building so long as their tax bill is slightly lower than elsewhere). The problem with basing our economic policy on having a lower corporation tax than our neighbours is that we can’t decide the level that they set theirs, resulting in a race to the bottom.

    Why don’t we look at the economic policies of countries like Germany, rather than countries like Ireland?

    Keep corporation taxes where they are (or even raise them), forget about the bargin-hunting multinationals (somewhere else will always be cheaper anyway) and concentrate on encouraging home-grown businesses (of all sizes) and educating/training people. The quality multinationals will be attracted by a highly skilled workforce and thriving local economies (with lots of potential customers) to invest in anyway.

    We need good regional development, perhaps including local banks which invest and reinvest in the local business economy.

  6. The SNP should be given nothing.

    Their mini-parliament victory represents a tiny proportion of the population of the British isles. Corporation tax is just another way they are searching for to rest power away from Westminster.

    If we don’t stop them, then we are to blame.

  7. The next G.E is just a cybernat with (w)resting the piss. Don’t fall for it.

  8. In reality, cutting Corporation Tax in Scotland would undermine investment in public services and engage us in a fruitless race to the bottom that will have no winners.

    We should have learned by now that marketing ourselves as a bargain basement destination for inward investment is not going to work for Scotland, even in the medium term. Scotland can’t compete on operational cost, the outsourcing of services to India amongst our countries is proof enough of that. It’s just not our market.

    1. Apologies these are not my words!- I cut this to use as a quotation in another replyand inadvertently cut it in here.. My intended reply to this post is below.

  9. I have no economics training and therefore bow to your knowledge of the subject but from a layman’s viewpoint can I say: There appears to be some factors in the overall corporation tax argument which you have not visited, presumably in your desire to simplify the issue. Your assessment seems to assume that the only net effect from the change in corporate tax rate which interests us is the overall revenue collection. However, there will be a potential effect also upon labour through substitution of labour for capital. (Harbergers model). At a time when job creation is high on the agenda the creation of jobs is as welcome as the collection of revenue, and will clearly contribute to the overall bottom line..

    There is also a redistribution effect through the effects on wages of the corporate tax rate. It is shown (e.g.” Passing the burden- Corporate tax incidence in open economies” R Alison Felix 2007) that reduction in the rates of corporate tax will create increase in wage levels of the skilled and unskilled workers within the corporation. http://www.kansascityfed.org/Publicat/RegionalRWP/RRWP07-01.pdf
    The fundamental principle being that there is a fixed capital flow for a project which will be distributed and redistributed within the model being enforced. This is also a desitrable side effect of manipulation of corporate tax rates.

    There was a wide study carried out by the World Bank in conjunction with Harvard University “The Effect of Corporate Taxes on Investment and Entrepreneurship” released in 2009.
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1091238)

    This Price Waterhouse Cooper backed study looked at the effects of Corporate tax in 85 countries and clearly showed a major correlation between low corporate tax rates and inward investment, with the effects being greater on the manufacturing sector than the service sector. This differential may make a more complex tax model desirable, which unless the levers are in the hands of the SG is not possible.
    Similarly major capital projects may be attracted by specifically tailored tax rates for specific industries and major projects, the development of renewable energy production being a case in point. Unless the levers are in Scottish Governments hands none of these things can even be considered.

  10. The more tax and other fiscal powers are located in the Scottish Parliament the better for Scotland no matter who is in power. It forces all political parties to up their game and justify their economic policies (and makes the opposition come up with costed alternatives). No more “it wisnae me” syndrome.

  11. Let’s leave the economics to one side and stick to history. We might to be on safer ground there.

    Did Gordon Brown cut corporation tax in the 1997 and 2007 budgets? I know that the reality is more complex, but to look at the headline rates you’d think so, and from Brown’s speeches it seems that listeners were supposed to take away the impression that this was indeed the case. Finally, on both occasions he made a point of proclaiming that this would produce not just the lowest-ever UK headline corporation tax rate, but also a rate lower than in France, the USA, etc.

    It’s easy enough to find an economist to support almost any position, but here we seem to have a Chancellor of the Exchequer, and a Labour one too, who was willing to be seen to cut corporation tax, and who apparently thought it worth emphasising that these rates were lower than those in potential competitor countries. What has changed since then?

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