Business taxation

For some reason, politicians always harp on about cutting corporation tax (raises about £45 bn annually, Tab C4). Let's go back to basics and look at a supply-demand chart in absence of any taxes. It's easiest, for the purpose of this post to assume that the 'supply' line = the costs that producers face, the more efficient ones having low costs; and the 'demand'  line is the price that consumers will pay (the price falls as quantity increases). So those producers whose income exceeds costs remain in business, and the equilibrium price is where price = costs, and the quantity produced results from that. This basic position is assumed to be the optimum allocation of resources. 



Now, let's look at what happens if producers have to pay corporation tax or income tax. Yes, of course these discourage enterprise and employment, but the tax is only a slice of producers' net profits, i.e. income (price) less costs (the supply line).

Very efficient producers (those at the left hand of the chart) pay a lot of tax, but they are still profitable so remain in business (and in any event, in the grander scheme of things, reinvested profits are not taxed - it is only unreinvested profits, whether retained or paid out as dividends that are taxed) and the tax does not affect marginal producers (whose costs are more or less equal to their income) as they are simply not making profits. So I'm not disputing that corporation tax slows down the rate of growth of businesses a bit, but it certainly doesn't drive anybody out of business, so it doesn't affect the total output very much.



Now let's look at the impact of VAT (raises nearly £80 bn per annum, see Tab C4, link as above, considerably more than corporation tax). It raises prices paid by consumers, reduces income of producers, drives marginal/low profit producers out of business, reduces the value of output and hence employment, and reduces corporation/income tax receipts, as well as adding another layer of bureaucracy and scope for fraud etc. and, apparently, is regressive (poor people are said to pay a slightly higher percentage of their income in VAT than rich people). I'm afraid the grey line for "Supply (tax-free)" is not visible, but it's in the same place as in the first chart.



The next worst tax is Employer's NI, for similar reasons - it reduces wages received by workers while raising the cost to employers, thus reducing employment levels and adding an extra layer of bureaucracy and crap.

I rest my case.