Gloriously muddled thinking on corporation tax.

Article in City AM this morning by John Penrose MP who "is Jeremy Hunt's policy guru".

After some fawning drivel about the German Mittelstand and dissing of UK businesses...

The OECD says that corporation tax is the most damaging and distortive, stopping investment flowing to wherever in the economy it is needed most.

This is clearly nonsense. Tariffs and turnover taxes (VAT) are the most distortionary and damaging taxes. Things like currency controls and foreign ownership restrictions (which the UK doesn't have, by and large) are awful non-tax distortions.

The distortionary effects of corporation tax are minimal:

Our businessman has some money to invest in starting or expanding his business. He ignores tax, and identifies Project A with an expected 20% return on investment and Project B with an expected 10% return on investment. He chooses Project A.

His accountant reminds him that he'll have to pay corporation tax on his profits, so actual expected returns are only 16% for Project A and 8% for Project B. The businessman will still choose Project A; corporation tax makes no difference for decision making purposes.

Also, UK plc pays twice as much in cash dividends to shareholders as it pays in corporation tax. If they really needed to retain cash for re-investment, they'd pay lower dividends.

At the moment, we've only got ourselves to blame, because our company tax system rewards firms which borrow much more than ones that invest... So why not reverse the incentives? Stop rewarding borrowers so lavishly and encourage investment instead? It would be fairly simple to do; we could make capital expenditure fully tax deductible as soon as it is spent, and stop company debt interest being tax deductible.

How thick is he? "Borrowing" is money coming in to the business and "investing" is money leaving it. These are completely separate things and have nothing to do with each other.

For example, a company could borrow from a bank and spend it on expanding the business. Does he count this as borrowing or investing? Similarly, it could borrow money without investing it (paying the cash out as dividends or a share buy back); or it could expand the business out of retained profits without borrowing.

The UK corporation tax system is pretty neutral on all this. If a company borrows from a UK bank, it gets a tax deduction for the interest paid and the bank pays an equal and opposite amount of tax on the interest it receives. If one company invests in shares of another, dividends paid on those shares are not an allowable expense of the paying company but are exempt from tax for the investing company. Both of these are completely tax neutral overall.
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UPDATE - to illustrate
Co A lends to Co B, receives £10 interest
Co B saves £2 tax (tax relief on interest paid)
Co A pays £2 corp tax on interest income
Co A ends up with £8 after tax.

Co A invests in Co B, receives £8 dividend
Co B makes £10 profit that 'belongs' to Co A, pays £2 corporation tax
Co B pays £8 dividend out of post-tax profits
Co A receives £8 dividend, on which it does not have to pay tax.
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He also has a very old fashioned view of modern business. Sure, some businesses make massive investments into physical plant and machinery. But by and large, businesses spend a lot more money on other things which help them grow - market research, R&D, staff training, advertising, renting larger premises and taking on more staff etc.

Such expenditure is fully allowable as a tax deduction when incurred; small businesses can claim 100% first year capital allowances but larger businesses are stuck with laughable 8% or 18% reducing balance capital allowances on qualifying items. So for this and many other reasons, 100% first year capital allowances for all businesses large or small are a good idea as it levels the playing field. So he's right for the wrong reasons - there is no particular reason to assume that the overall amount spent on plant and machinery would go up much.

Treating interest payment as a distribution of profits rather than as an expense is also a good idea, but not for the reasons he gives. The flip side would have to be that lenders don't pay tax on the interest they receive, so overall, the effect would be minimal; interest rates would just fall to the net of tax amount.