Question of the day: In the midst of an austerity budget, why does the UK have a corporate tax cut?
The Osborne budget has tax cuts for corporates because it's pro-growth and the closest to a "free lunch" available to create jobs in a country cutting back on government jobs.
Back in June, George Osborne, Chancellor of the Exchequer, pledged to cut corporate taxes by 1 percentage point annually for the next four years. The first cut was to begin in April and will reduce the rate to 27% at a static cost of GBP 400 million. Osborne announced he's going to cut the corporate tax rate 2 percentage points in 2011/12 and will continue to cut 1 percent per year until the rate hits 23%. This compares to 35% for the United States.
The Chancellor of the Exchequer is also expected to announce a series of incentives for growth such as looser planning rules, less regulation and the creation of new enterprise zones and more apprenticeships, according to the FT.
The goal is to offset the 300,000 government jobs the UK government is attempting to cut to dramatically reduce their budget deficit.
Another aspect of cutting government workers that won't be shouted from the top of Parliament is explained by Simon Nixon in the Wall Street Journal's Europe edition: "Cuts in public spending, particularly when achieved via cuts to the government wage bill, help to reduce private-sector wages, boosting corporate competitiveness and lead to much higher business investment -- crucial to a recovery.
"For example, Harvard University's Alberto Alesina showed in a 2002 study of fiscal consolidations that every one percentage point increase in public spending as a percentage of GDP decreased business investment as a proportion of GDP by 0.48 percentage points after one year and a cumulative 2.56 percentage points after five years."
The overwhelming takeaway here is that the UK is willing to make these cuts to corporate taxes at the same time they are making cuts to government spending because this will lead to private sector job growth and reduced future budget deficits. They choose competitiveness over increasing the tax base because it benefits society as a whole and not the coffers of the treasury.
The static economic analysis associated with static economic models doesn't capture the dynamic nature of positive tax policy that stimulates an increase in the capital stock and therefore generates a larger return for the economy. Any policy that increase taxes on income, savings and investment reduces the capital stock and reduces the ability of the private sector to create jobs.
Therefore, any US discussion or analysis about tax policy that doesn't include a simple focus on the impact on the capital stock is doomed to failure and ignores the reality of what is happening outside the United States.
The point for currencies is that the UK is attempting to do something extremely positive for the country and the British pound in the medium to long term. This will provide an overall bias to buy British pounds.
Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a contributor to CNBC's Money in Motion Currency Trading.You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch .
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