Analysis: UK record challenges link between corporate tax cuts and jobs

MARKET BOSWORTH, England Wed Oct 17, 2012 9:06am EDT

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MARKET BOSWORTH, England (Reuters) - When precision engineer JJ Churchill bought costly new machinery and recruited workers to operate it, the firm was doing the bidding of successive British governments - investing in high value manufacturing and creating skilled jobs.

But its reason for spending 1 million pounds ($1.6 million) on two steel milling and grinding machines last year had little to do with the government's policy of helping British industry by steadily cutting corporate tax rates.

"If you're asking about what affects our investment levels, corporation tax is very, very far down the list," said Managing Director Andrew Churchill.

Speaking at the company's factory in the English Midlands, Churchill said he concentrates instead on ensuring such investments succeed and only when they produce profits does he start to think about tax rates.

"By the time you get to paying corporation tax you're obviously succeeding," he said against the hum of machines shaving blocks of steel into turbine blades.

Since 2007, Britain has slashed its tax on corporate income from 30 percent to 24 percent and plans to cut it further to 22 percent by 2014. But Churchill said his decision to increase investment, even after revenues had halved, reflected more the need to refocus his business on more profitable products.

Like many British manufacturers, the company has experienced its share of ups and downs since Churchill's grandfather Walter founded it in 1937. During World War Two, it made parts for Merlin fighter engines but Walter, an RAF ace, was killed in 1942 when his Spitfire was shot down during a raid on Italy.

Based in the small town of Market Bosworth, JJ Churchill once employed 168 people before having to cut numbers to 92. However, the machine purchase and other investments have pushed the workforce back up to about 130.

Dozens of countries have cut corporate tax to boost business and employment in the past decade. In the United States, Republican presidential candidate Mitt Romney says such cuts would encourage companies to start spending some of the hundreds of billions of dollars in cash that they - like British corporations - are hoarding.

But executives at other firms, some much bigger than JJ Churchill, often play down the importance of tax levels in their decision making. One such is Joe Hogan, Chief Executive of Swiss-based ABB, which employs 145,000 people in around 100 countries.

Asked if corporate tax cuts made any countries more or less attractive for investment, Hogan responded with a blunt "No".

"Let's just take the United States which has probably the most egregious (corporate rates) of any of them," he said.

There business had to live both with a culture of litigation and with its corporate tax rates of 35-39 percent, the highest in the developed world, he said. "It's still the world's biggest marketplace, so you have to put up with the lawyers and you have to put up with the tax rate."

NOT ONE JOB

Interviews with executives and official figures suggest the lower tax strategy hasn't worked for Britain.

Reuters asked a range of UK companies, from those included in the FTSE 100 index to smaller businesses, about the impact of the tax cuts on their businesses.

Only six said they believed the measures had made the UK more attractive for investment. The rest either declined to comment or said that the lower rates had no meaningful effect.

No company would identify a single business project which had gone ahead because of the cuts in the headline rate. The same applied for any jobs that were created or saved from loss.

Recent data doesn't point to a clear link between tax cuts and investment. British business investment has fallen 17 percent since 2008, when the then Labour government reduced the headline rate from 30 percent to 28 percent. The current Conservative-led coalition is pressing on with the cuts.

Falling investment is unsurprising due to the global economic downturn. Yet Britain's continental European peers which have not followed its lead in cutting business taxes have done at least a little better.

Between 2008 and 2011, investment was down a more modest 12 percent in the Netherlands and rose 1 percent in France.

Likewise, the UK unemployment rate rose by 2.6 percentage points over the period while French unemployment increased 2.4 percentage points and the Dutch rate 1.0 percent.

France's corporate tax was 34.4 percent during the period while the Dutch rate was 25-25.5 percent.

The UK experience challenges a number of studies which have found a link between economic growth and corporate tax rates.

One 2008 study by the Organisation for Economic Co-operation and Development (OECD) found that rises in effective corporate tax rates frequently coincided with lower growth. The study said the correlation was closer for rises in corporate tax than in personal or indirect tax, suggesting higher taxes on businesses were more likely to sap growth than other tax increases.

Another by Michael Devereux, director of Oxford University's Centre for Business Taxation, was more specific. "A 1 percentage point increase in the effective average tax rate in the UK would lead to reduction in the probability of a U.S. firm choosing to produce there by around 1.3 percentage points," it said.

Such research has been used to justify a broad reduction in corporate tax in the developed world in recent decades. The British rate has fallen steadily from 52 percent since 1982 while the headline U.S. rate has dropped from 53 percent in 1968-69 to 35 percent now - or up to 39 percent including state-level taxes. Romney wants to cut it to 25 percent.

Rates across the OECD have fallen to average 24 percent from 33 percent in 2000, data from the rich nations' club shows.

HOT TOPIC

Another question muddying the waters is how much tax firms actually pay, as opposed to the headline rate. This has become a hot topic in Britain after revelations that foreign corporations such as Starbucks and Google are making billions of dollars in UK revenues while paying almost no tax there.

Academics and tax advisers say no one knows exactly the effective tax rate businesses pay because rules on the disclosure of UK profits are weak. Campaigners say the effective rate big companies pay is well below the headline level because they ship profits into tax havens.

Many experts, including Nobel Prize-winning economist Paul Krugman and billionaire investor Warren Buffett, say no link has been proven between corporate tax rates and investment and jobs.

Duncan Weldon, Senior Policy Officer at the UK Trades Union Congress, said studies which inferred a causal link between taxes and growth were too simplistic. Many other factors were at play that these studies did not take into account, he said.

WHO BEARS THE BURDEN?

Many economists argue that the burden of corporate taxes is borne by workers.

The logic is that investors require a certain rate of return if they are to be persuaded to commit capital to a project or business. Since higher taxes could depress the net earnings, the price of other factors has to shift to ensure the rate of return still hits levels required by investors. This means the burden of a corporate tax is shifted either onto customers, in the form of higher prices, or workers, in the form of lower wages.

Helen Miller, of the Institute for Fiscal Studies think-tank, said opinions differed widely but many economists believed that around 70 percent of the cost was borne by workers. This should reduce the effect of tax cuts on investment.

Even if such tax cuts do create jobs, there's no consensus on whether they are the most cost effective way of achieving this. The UK Office for Budget Responsibility has estimated the cuts begun in 2007 will cost $8.5 billion annually by 2015. This money could be spent instead on reducing debt or cutting other taxes. France, by contrast, is trying to boost employment by reducing payroll taxes.

The money could also be used to boost growth through extra government spending. David Tonkin, CEO of the UK arm of engineering firm WS Atkins, said the best way to encourage his company to invest and hire more people would be for the government to commit to big new infrastructure projects.

Some companies believe a better way to boost investment would be to roll back the cuts and reinstate recent reductions in capital allowances, which allow businesses to write off equipment expenditure against tax in one year rather than over several. Lower capital allowances have been used to help finance tax cuts in the United States and Britain.

Manufacturers like Andrew Churchill say these allowances directly reward investment rather than tax cuts which only free up more cash for the business which may be invested overseas or returned to owners as dividends.

Economists say the risk of such investor payouts is especially high in a recession - when managers are pre-occupied by weak demand and investors are more attracted by cash than uncertain hopes of future growth - and tax cuts are therefore unlikely to boost job creation in a downturn.

Research by investment bank Morgan Stanley shows companies which have invested heavily in the past year have been punished by investors, while big dividend payers have outperformed. This suggests managers who want to boost their share prices should direct cash to shareholders rather than into new factories.

Some proponents of corporate tax cuts believe their value is as a signal. Finance minister George Osborne says they show that "Britain is open for business".

"The headline rate of corporation tax remains the most visible sign of how competitive our country is," Osborne said in his budget speech earlier this year. ($1 = 0.6216 British pounds)

(editing by David Stamp)

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