Why Maurice Saatchi’s corporation tax cut is just too good to be true

June 23, 2014 by
Filed under: Enterprise 

Anyone who has heard of the ad man-turned-politician Maurice Saatchi will know he is a colourful character. So too it seems is his latest flagship policy.

Last week Lord Saatchi launched a new report with the Centre for Policy Studies calling for the abolition of corporation tax for small businesses with fewer than 50 employees. Corporation tax, for those unaware of it, is currently levied at a rate of 20 per cent on profits under £300,000 (a higher rate is charged on profits that exceed this amount). The rationale for the tax break is that small businesses would funnel a large part of the extra cash back into the business, either in the form of capital investment (machinery, tools etc.) or employee compensation (paying staff more or taking on new staff). The CPS report says it would cost the exchequer a small amount up front, but this would soon be recouped in the form of stronger economic growth and tax receipts.

Writing in the Daily Telegraph, Lord Saatchi puts it more spiritedly:

The Policy, as I call it, would therefore abolish corporation tax for 90 per cent of UK companies, reduce the deficit faster than predicted by the Office for Budget Responsibility (OBR) , expand employment faster than it predicts, increase competition, challenge cartel capitalism and let millions of people grow tall.

If the tone of this blog already sounds cynical, that’s because I’m highly sceptical of the policy. In fairness, there is a lot to be said for Saatchi’s ideological zeal. No one can doubt that he genuinely wants to see small businesses thrive, and that this ambition is founded on a deeply held moralistic stance that everyone should be masters of their own fates – or ‘captains of their own ships’ as he puts it. Indeed, many of the passages in his new report – particularly those around dismantling cartel capitalism – echo the sentiments of the RSA’s new agenda on the Power to Create, which is about distributing power more evenly so that everyone can play a part in shaping the world around them.

Yet if something sounds too good to be true, then I’m afraid it usually is. And this is almost certainly the case with the new policy from the CPS. I’ve read the full report and have to concede that the new policy is well thought through and largely evidence-based. For example, much of the economic modelling used to gauge the future impact of the corporation tax repeal is based on figures from the Office for Budget Responsibility’s existing predictions. However, beyond this there are just too many assumptions at play that don’t stand up to scrutiny.

The most fundamental of these is the belief that many of the small business owners benefiting from the scheme will use the extra flush of cash to take on new recruits – and at average wages. The figure below, taken from the report, indicates that the effect of the tax break will be to create almost 1.8 million extra jobs over the next parliament than would have been the case without the policy. If this staggering figure were true, it would slash government spending on Job Seekers Allowance and sharply increase government revenue from National Insurance contributions (which all the newly employed would pay). According to the CPS’s calculations, JSA spending would fall by a further £1.4bn while revenue from NICs would jump up by an extra £7bn over 4-5 years – which helps to explain how the £8bn cost of the scheme could be recovered.

SAATCHIBLOG

Yet this near perfect model begins to fracture when you actually look at how the recruitment patterns of small businesses have played out in recent years. The CPS model seems to assume that around 15 per cent of all businesses would take on staff as a result of the corporation tax abolition (as far as I can tell, page 35 has the only reference to their recruitment assumptions). However we know from government surveys that sole traders, which make up 75 per cent of all businesses, are notoriously reluctant to take on employees. Less than 5 per cent took on and retained staff over the period from 2007 and 2012. Would the tax break change these habits? The experience of other initiatives suggests not. Both the Youth Contract and the recent National Insurance contribution holiday had extremely low take-up rates – and these were explicitly designed to stimulate recruitment.

Whether we like it or not, the truth is that tax is a red herring. Of course, tax matters to the ability of people to run successful businesses that support their livelihoods. But it doesn’t matter as much as we all think it does, especially when it comes to the inclination of people to grow their business. Take the findings from the latest Small Business Survey from the Department for Business, Innovation and Skills. When asked unprompted to pick the biggest obstacle to their business success, only 12 per cent of SMEs named burdensome taxes whereas 42 per cent cited the state of the economy. (In fact, of those who did say taxes, more than half said VAT was problematic but only 20 per cent said the same of Corporation Tax.)

As argued in previous blog posts, the overwhelming reliance on clunky policy levers such as hefty tax breaks to change the behaviour of business owners is grounded in an outdated view of them as being highly rational, calculating, and almost robotic individuals. The reality is that many of the barriers that hinder business growth are hidden and psychological in nature – for instance, people’s desire for independence and control that means they are unwilling to hand over the reins to someone else, or our tendency for myopia, which means business owners may overvalue the present and struggle to see the benefits that new staff could bring over the long-run.

The idea that abolishing corporation tax could be the silver bullet to all our social and economic woes is an attractive one – but just, I’m afraid, too good to be true.

The RSA and Etsy are exploring similar themes in a new project, The Power of Small. Click here to find out more.

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Comments

  • http://www.magnifiedlearning.com Nigel Rayment

    As an owner of a small private business I don’t full approve of Saatchi’s proposals as my company is committed to the redistributive principles of taxation. However, I think Benedict may underestimate the challenges currently faced by small businesses – we would most certainly use the redirected monies to take on extra staff to help us grow. I’m about to join my 2 business partners in cancelling my Fellowship because of what we perceive to be the RSA’s preoccupation with the third sector and lack of interest in small private enterprises and their social contribution.

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