Government revenues: how beneficial is corporation tax?

Corporation tax liabilities, and the setting of rates at which they are levied, is a sensitive issue.

The public derides firms that are seen not to pay their share of tax, while business advocates and economists regularly decry the inefficiency of increasing the cost burden on SMEs – acting as a drag on both profitability and national economic growth.

So just how much does corporation tax contribute to Government income? Charles Purdy, Managing Director of Smart Currency Business, looks at why the rate is so hotly contested – and what can SME operators learn from examining the way the Government manages its finances?

Corporation tax in the UK
Essentially, corporation tax rates come down to global competitiveness – or perceived global competitiveness to be more precise. Headline rates can influence business decisions on where to base their overseas operations, and influence the desirability of making investments domestically.

Some people believe that corporation tax makes up a large chunk of Government revenues, which is why the Government puts so much effort into supporting business – particularly smaller businesses. However, the reality is quite different – business taxes actually make up a only very small proportion of the income flowing into the public coffers.

According to the Institute for Fiscal Studies, just 8 per cent of total Government revenues came from corporation tax in 2010-11 – to the tune of around £43 billion.

That leaves 92 per cent of revenues coming from other forms of taxation and alternative sources of income. From a tax perspective, the vast majority of UK Government revenues come from VAT on goods and services, and PAYE personal income taxes.

Who pays more tax?
Despite the Institute stating that some 80 per cent of all corporation tax receipts prior to the financial crisis were from the largest one per cent of companies operating here, there has been an increasing number of high-profile examples where multinationals pay little to no corporate tax in this country at all. Amazon, Google and Starbucks were among the most well-known names to attract public criticism at their tax avoidance, conducted through a complex web of legitimate legal technicalities.

It could then be argued that smaller British businesses, which make up the bulk of employment opportunities yet lack access to sophisticated tax avoidance measures, bear a disproportionate amount of the overall corporate tax burden. This affects the profitability of these firms, reducing their ability to generate new employment opportunities and contribute much-needed growth to the beleaguered economy.

Chancellor George Osborne has recognised the drag corporation tax has on the wider economy, which is why he committed to further cuts in the rate of corporate taxes; he has committed to reducing the eventual rate to 20 per cent.

However this will not come into effect until 2015, with cuts being gradually staggered over several years leading up to it. In other words, UK businesses, already struggling amidst a lacklustre economy and recession-plagued Europe, have to wait another two years before the rates hit their promised low.

It raises the question of why the UK does not cut corporate taxes more deeply and, crucially, more quickly, to allow firms to instead reinvest a greater portion of their profits into expansion plans and take on new staff. In return, the Government would receive higher levels of income taxes from these additional jobs to make up for the shortfall in lost business tax receipts, and simultaneously reduce the cost of unemployment benefits by increasing workforce participation.

Balancing the budget
It is this kind of budget rebalancing that businesses – particularly SMEs – must examine on an everyday basis. To be successful in these challenging times, business operators know that they must keep costs firmly under control, yet not cut off their nose to spite their face.

Indeed, the businesses which tend to perform best during a recession are the ones that ramp up their expansion plans, instead of scaling them back. In doing so, they benefit from discounts available from suppliers also struggling with the downturn, reduced wage pressures and access to skilled staff being made redundant from competing firms. There are also Government grants and tax rebates available, which may be watered down once the economy picks up again.

At the same time, these companies look to fund this expansion by generating efficiencies elsewhere in the business which will not hinder growth potential. Staffing is one of the major aspects of this.

Redirecting staff from under-performing areas of the business to higher growth functions, carefully targeting any redundancies to non key skilled sectors of the business and using freelance or contract workers rather than taking on new full-timers all drastically improve a company’s ability to direct funds to where they will generate the best returns. Essentially, these firms are “trimming the fat” in order to make them more nimble and quicker of the mark in pursuit of new opportunities.

Unfortunately in the public sector, such “rebalancing” generally results in the loss of essential front-line staff and services – police, emergency services, teachers, nurses and so forth. These employees are highly skilled, often in short supply. Demand for these services also is generally unaffected by economic conditions.

Far from boosting productivity and improve efficiencies, these cuts can hamper the quality, reliability and speed of service delivery. It leaves longer lasting effects as well, given these critical services are left exposed to chronic skills shortages once the economy returns to a more healthy state as workers are lost to other industries or other countries

What lessons can this have for SME operators?
Clearly there is a need for Government to look at where cost-cutting will be most effective in achieving spending cuts yet without damaging confidence or reducing economic growth. But there is much SMEs can learn from these comparisons to help strengthen their own businesses.

SMEs would be wise to take stock of the harm that can be done through cutting costs without targeting where they are cut from. Across-the-board spending cuts can actually be counter-productive and bring significant detrimental effects to the business.

Reducing expenditure on the provision of frontline products and services, as well as the key skilled staff delivering them, will likely reduce profits in the short term, and leave the business weakened going forward thanks to reduced capital reserves for reinvestment and lower skilled staff levels.

There are plenty of legitimate cost efficiencies that can be achieved, such as using specialist services specifically tailored to SME businesses or particular sectors, meaning only required services are paid for. This is in stark contrast to the one-size-fits-all fees and charges imposed by banks and major businesses.

Additional savings can be exploited by seeking discounts through the supply chain (which can be made easier with the help of trade finance and/or credit insurance) and shopping around for more tailored and cost-effective services such as communications plans.

The key point is that, in most instances, businesses should look at cost reductions only where there are legitimate savings to be made, without cutting investment in the areas which are generating the firm’s profits.