Following Brexit, the EU might apply tariffs to imports from the UK. That would put UK producers at a disadvantage to their EU competitors. If those UK firms also import some of their inputs from the EU, they could face a double whammy, with retaliatory tariffs on imports from the EU driving up their cost of production. If enough of these firms’ customers or suppliers were in the EU, they may be tempted to relocate there. Or they may simply go out of business. Brexit thus threatens the UK with “capital flight”.
Part of the answer is obvious. Even if the EU does not give the UK a free trade deal, the UK should refrain from retaliating with tariffs on imports from the EU. If EU politicians wish to punish EU citizens with tariffs that push up prices, let them do it alone.
The UK government should take the opportunity created by Brexit to eliminate all import tariffs, wherever the imports come from. Import tariffs are an economic and ethical scandal. They are legislative gifts to favoured producers at the expense of consumers. Millions of Brits are forced to pay unnecessarily high prices for lamb, for example, so that inefficient British farmers can stay in business.
Another part of the answer is not as obvious but just as simple. The UK government should abolish corporation tax. EU tariffs on British imports might drive some capital out of the UK, even if we did not retaliate. But the abolition of corporate tax would surely attract much more capital, not only from the EU but from all around the world and, especially, from the US.
Cutting the corporate tax rate to 12.5% had this effect in the Republic of Ireland. Cutting it to zero in the UK would surely have an even greater effect, not only because the rate is lower but because the UK has more to offer companies by way of customers and suppliers, including business services such as legal advice, consulting and financing.
Imagine it! A UK without import tariffs or corporate tax would be transformed into the most attractive place in the world to conduct business. It would set off an economic boom.
Two objections are likely to be raised. The first is the loss of tax revenues for the government. No loss arises from the abolition of tariffs, since those are paid to the EU. But in 2016/17, the UK government collected £43 billion in corporate tax. That it is a material sum, but it is only 6% of total tax revenue.
More importantly, the explosion of economic activity caused by the abolition of corporation tax would increase the amount tax the government collects from other sources, such as income tax and VAT. And any shortfall could be made up by a small increase to the rate of VAT or the elimination of exemptions.
A second likely objection concerns fairness. Over recent years, politicians, commentators and many among the public have become agitated by companies that avoid paying their “fair share” of tax through the use of tax havens, internal transfer pricing and other such measures. And the idea of cutting corporate tax rates – let alone to zero – causes similar agitation.
During the presidential 2008 Presidential campaign, for example, Barack Obama derided John McCain’s plan to lower the corporate tax rate, claiming this would mean tax breaks for “some of the richest companies in America”.
To the economically naïve, taxing companies sounds like a good idea. Who cares about companies? Can a company be hungry, homeless, uneducated? Will you put the interests of these wealthy inhuman entities ahead of real, flesh and blood people, many of whom are struggling to make ends meet?
But companies cannot be rich or poor; only the people who own them or work for them can be. Nor can the cost of taxation fall on a company; it must ultimately fall on the company’s owners, employees or customers. Before you can tell whether corporate tax is a good idea, you need to understand who bears the cost and how it affects their behaviour.
Once you do, it turns out that taxing companies is a bad idea. Research shows that the cost of corporate tax falls on the company’s shareholders (in lower dividends), employees (in lower wages) and customers (in higher prices) – the precise allocation varying with factors too complex to discuss here.
So, in terms of the “social justice” or “tax fairness”, corporate tax is no better than a combination of income and sales taxes. But, in terms of efficiency, it is worse. Corporate tax has a greater deadweight cost than income and sales taxes, because it discourages the allocation of resources to productive uses – in other words, it discourages investment.
And it is more distortionary than these other taxes, because the complexity of business activities and business accounting mean there are so many opportunities to take otherwise worthless actions for the simple purpose of reducing a firm’s tax liabilities.
Corporate tax and import tariffs are economically damaging. Brexit will give British politicians the opportunity to scrap them and, perhaps, a positive reason to. If they do, Brexit will prove to be an economic triumph.
By Dr Jamie Whyte, Director of Research at the Institute of Economic Affairs. In 2014 he was leader of the ACT Party of New Zealand, a position he resigned upon failing to be elected to parliament in the September general election.
The views expressed in this analysis post are those of the authors and not necessarily those of the UK in a Changing Europe initiative.