Economics Project: The Impact of Taxation on Economy

Economics Project
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INTRODUCTION
The impact of taxation on economy has been greatly debated among the scholars and
experts. This research report moves towards showing the effect of reduction of corporation tax on
UK economy. It makes the use of theoretical model to show the impact of reduction of corporation
tax.
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EFFECT OF REDUCTION IN CORPORATE TAX
Reduction in the corporate tax is evident in UK economy. Since 2010, UK government has
focused on increasing the transparency and sophistication of modelling of impacts of policies.
Published information of HMRC's Computable General Equilibrium is another step in this direction
(Jacobs & Wallis, 2010). Since the early 1970s, CGE models have been used in order to analyse the
economic effects of changes in taxation. All governments and institutions like World Bank, OECD
and IMF etc. use CGE models in some form. HMC's CGE model is enclosed with detailed
information about the UK tax system. It has the power to model the dynamic macroeconomic
effects and subsequent Exchequer revenue effects of major policy changes. Leading experts had
peered review of the model in their relevant field (Sentance, Taylor and Wieladek 2012). Results of
the peer review concluded that CGE models are valuable method for the assessment of tax policy
returns. UK government has reduced the rate of corporation tax in order to improve the
competitiveness of regime of UK corporate tax and to portrait that UK is an attractive place for
foreign investment.

Corporate Income Tax Rates 1981 - 2013
(Source: HMRC Corporation Tax Statistics, 2013

A downward trend in corporation tax in UK can be seen in the above graph. Corporate rates
have fallen from nearly 50% in the early years to around 25% in the recent years. A reversal trend
was not seen in this downward trend in corporation tax rates with following the financial crisis,
despite many advanced economies are required to undertake fiscal consolidations (Pesaran and
Pesaran, 2010). UK corporation tax rate remain unchanged from 1999 at 30% for almost 10 years.
Net corporation tax receipts
(Source: HMRC Corporation Tax Statistics, 2013)
The above graph shows UK onshore corporation tax receipts, net of tax credits from the year
1999 – 2000 to 2011- 2012 and future receipts from 2012-13 to 2017-18. At the starting, main rate
drop down against a backdrop of flat or slowly rising profits but it rises again after 2015-2016. It
rises in line with increasing profits as the economy grows (Dagoumas and Barker 2010). Costing of
government are based on the estimation of profits of firms which are paying the corporation tax. The
costing assumes a behavioural change for the account of changes in incentives for multinational
corporations to transact profits in and out of the UK. A reduction in corporation tax rate lead to

decrease in incentives to shift profits out and in providing protection to corporation tax base (Bell
and Jayne, 2010). HMRC in UK noticed that a one % point decrease in corporation tax rate would
lead to rise in the size of tax base of 0.83%.
Channels through which a reduction in Corporation tax affects GDP
(Source: Jacobs and Wallis 2010.)
The above graph reflects the alternative channels through which corporation tax could
impact GDP of UK economy. A reduction in corporation tax leads to rise in post tax earnings of
companies. After that, firms passes these higher profits in different type of manners. One of the
important ways for a change in corporation tax rate to affect GDP is through investment (Abreu,
Grinevich, Kitson and Savona, 2010). Further, this reduction also reduces the cost of capital for
firms. This indicates that marginal investment projects will achieve more profitability and will more
likely to go ahead due to availability of sufficient financing. Hence, such increased investment

opportunities and higher returns must increase the rate of domestic and foreign investment in the
economy. High investments results in high GPD because investment is an element of GDP (Kirby,
Meaning and Warren, 2014).
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A reduction in the corporation tax rate could also affect economical aspects such as wages
and employment. It also increases the demand for labour in turn raising wages. This type of effect is
somewhat offset through subsequent substitution of labour for capital (Bell and Jayne, 2010). An
increased reward to labour lead to increase in consumption and savings that are raising the level of
GDP. The lower cost of capital and higher returns could also translate into lower prices of corporate
sector output charged to consumers. The extent that company pass on the reduction in the burden of
corporation tax to consumers through lower prices depends on how easy it is for consumers to
switch goods produced by corporate sector for those not produced by the corporate sector like
imported goods (Dagoumas and Barker, 2010). Lower prices could further raise domestic
consumption by reducing the demand for imports and by increasing the demand for exports.
Lower corporation rate could also lead to increase in productivity and increase in GDP.
Growth in productivity arises when an improvement in education or technology in one period leads
to further increase in the next period. Companies are able to produce a higher value of output for the
same input from one period to the next so this affects the growth rate of GDP (Pesaran and Pesaran,
2010). Reduction in corporation tax also affects the productivity through increasing research and
development and foreign direct investment along with labour productivity and wages. Reduction in
the corporate tax also leads to positive effects on receipts. Stronger growth will eventually generate
tax revenues that recoup a proportion of the revenue lost directly from a lower corporation tax rate

(Sentance, Taylor and Wieladek, 2012). On the completion of extra investment that is resulting from
the corporation tax reduction will increase the profits that are leading to additional corporation tax
receipts. High rate of consumption will create extra VAT (Value Added Tax) and excise duty
receipts. Higher wages and employment will also increase income tax and National Insurance
Contributions (NICs) receipts (Jacobs and Wallis, 2010).

CONCLUSION
From the above study, it can be concluded that reduction in corporate tax carries a significant
impact on the economy of a country. Lots of aspects are affected such as domestic & foreign direct
investments, productivity, prices and GDP etc. of an economy.
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REFERENCES
Abreu and et.al., 2010. Policies to enhance the ‘hidden innovation’in services: evidence and lessons
from the UK. The Service Industries Journal, 30(1), pp. 99-118.
Bell, D and ayne, M. 2010. The creative countryside: Policy and practice in the UK rural cultural
economy. Journal of Rural Studies, 26(3), pp. 209-218.
Dagoumas, Α. S. And Barker, T. S. 2010. Pathways to a low-carbon economy for the UK with the
macro-econometric E3MG model. Energy Policy, 38(6), pp. 3067-3077.
Jacobs, J. P., and Wallis, K. F. 2010. Cointegration, long-run structural modelling and weak
exogeneity: Two models of the UK economy. Journal of Econometrics, 158(1) pp. 108-116.
Kirby, S., Meaning, J. And Warren, J. 2014. Prospects for the UK Economy.National Institute
Economic Review, 229(1), pp. F40-F64.
Pesaran, B., and Pesaran, M. H. 2010. Time Series Econometrics Using Microfit 5.0: A User's
Manual. Oxford University Press, Inc..
Sentance, A., Taylor, M. P., and Wieladek, T. 2012. How the UK economy weathered the financial
storm. Journal of International Money and Finance, 31(1), pp. 102-123.
Statistics at HMRC, 2013. [Online]. Available through
<https://www.gov.uk/government/organisations/hm-revenue-customs/about/statisticsl>.
[Accessed on 5th
March 2015].

Economics Project: The Impact of Taxation on Economy

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