Corporation Tax U-turn: A pro-growth tax policy has been blown off course

The sacking of Kwasi Kwarteng and subsequent U-turn on corporation tax to calm the markets is a big blow for UK business and has blown a pro-growth tax policy off course.

Corporation Tax was the obvious candidate for a U-turn. The projected tax revenue forgone as a result of not increasing the rate was the largest element of the “tax cutting” Mini-Budget. It was unlikely that the prime minister and new Chancellor would roll back on the NIC and Income Tax measures. Corporation Tax was their only wriggle room, and the impact of changing course here is large enough to affect the markets.

This is a shame as the business elements of the Mini-Budget were well received by UK companies, especially against the backdrop of the significant increase in energy costs. Prior to Covid-19 and the Ukraine war, the government’s ‘Business tax road map’ had the UK on a path to having the lowest corporation tax rate in the G20 at 17%, to encourage investment (both domestic and inbound) and growth in the UK. A U-turn on this particular measure is a significant setback and is likely to have a negative impact on the UK’s international competitiveness.

Empirical research has shown an inverse relationship between Corporation Tax rates and wages. As the Corporation Tax rate rises, average wages fall, mainly because of lower business investment. Of course, the government need to pay attention to the markets, but it is still crucial they put in places measures to put the UK in a better position to secure investment.

For example, the current system of deferring capital allowances means that, due to the impact of inflation, an investor will never get tax relief on 100% of the cost of an investment. This is a disincentive to invest. Ideally, we should have a permanent 100% deduction for all new investment in qualifying plant and machinery.

Hopefully the proposal to increase the Annual Investment Allowance (AIA) to £1m permanently, which goes some way towards this, will remain post any U-turn.

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