AS Easter Project Cai Pugh - 659783
1. Corporation tax on company profits above £250,000 to rise from 19% to 25% in April 2023:
Corporation tax is a direct tax imposed by a jurisdiction that all private limited companies (Ltd) and
public limited companies (PLC) are legally bound to pay. As of April 2023, corporation tax on company
profits above £250,000 will rise to 25%. However, smaller firms may benefit from this change through
the ‘small profits rate’ and the extra tax breaks Sunak is proposing to encourage investment. This
change has raised such a controversy within the UK government, with economist Paul Johnson calling
the move ‘risky’ on Twitter.
Throughout the pandemic, the UK Government has provided a total of £100 billion to support
businesses. With this in mind, Chancellor Rishi Sunak said that: “it is only fair and necessary to ask
them to contribute to our recovery” (Source: Budget 2021: Tax on company profits to rise to 25% -
BBC News). However in my opinion, this upcoming proposal will make government schemes such as
‘Eat Out to Help Out’ appear as a loan which the larger companies are paying for in a form of
taxation.
A rise in corporation tax will decrease the post-tax profits of businesses, which in theory, will
decrease the funds available to allocate towards capital investment such as new factories and
machinery. This is because profits are used to fund investment, so profit levels are used to determine
how much investment they can afford to fund. The effect this would have is that aggregate demand
(AD) would ultimately shift to the left as the level of investment will decrease (AD = C + I + G + X – M).
However, real output (Y) decreases proportionately since larger firms will now have less revenue to
spend on new factories and machinery. This will lower their overall productivity as they cannot
produce as much as they did beforehand. As a result, firms incur fewer costs when producing less, so
resources are becoming more surplus which lowers their value. Therefore, the price level (PL) drops
subsequent to this change. This change is shown through figure 1.1:
At AD1 there is little spare capacity in the economy, and the economy is
at risk of high inflation. A fall to AD2 sees a significant price drop from
PL1 to PL2, and a drop in real output from Y1 and Y2. This is because
real output will decrease because with less demand, there is less of an
incentive for firms to produce. Further drops in AD will only lead to a
lower level of real output due to the multiplier effect.
Figure 1.1.
In addition, the LRAS may be affected as a lower profit level will result in a reduced amount of
machinery investment, which lowers the economic resource of capital. This means that the economy
will be capable of producing less in a given time scale. The LRAS movement is shown in figure 1.2:
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, AS Easter Project Cai Pugh - 659783
A fall in economic resources shift the curve left from LRAS1 to LRAS2.
The price level rises since firms are producing less meaning they have
to sell at a higher price to maximise profit. Real output (Y) also falls
since less is demanded at a higher price of PL2.
Figure 1.2.
Moreover, if consumer income falls then there will be less money to spend on goods and services. As
a result, overall consumer spending is reduced and may convert to cheaper alternatives. Switching
from high-end brands to supermarket brands is a common behaviour. Because businesses will expect
to sell less, as shown in figure 1.2, they will plan to limit their expenditure and possibly make some
staff redundant which increases the unemployment level.
In addition, raising the corporation tax rate will mean that the government will have more revenue to
allocate to important areas of their budget such as social protection and healthcare, which equates to
over 50% of their budget allocation. However, corporation taxes are typically taken after firms deduct
their business expenses; compared with income tax and national insurance, which is taken
automatically before pay slips are released, corporation tax allows businesses to have more control
over their cash flow opposed to workers. The rise in corporation tax to 25% may result in businesses
increasing their expenses in an attempt to lower their taxable income, which will limit the
government’s revenue also.
Likewise, an increase in corporate taxation disincentivises entrepreneurial activity. This is because if
profits are decreased, then less people are likely to want to start-up their own business since money
acts as an incentive for the majority of people. This would also shift the LRAS curve to the left, as
seen in figure 1.2, since the number of new firms entering the market will decrease substantially
which will ultimately lower the amount of the economic resource enterprise in the UK workforce.
To conclude, I believe that the government’s move to increase corporation tax to 25% completely
undermines what was announced in the Conservative party’s manifesto prior to the general election
in December 2019. Their original plan was to reduce corporation tax from 19% to 17%, compared
with the Labour party’s proposal of 26%. This contradictory move makes me believe that their
original proposal was for their own political self-interest, and to increase their chances of success in
the general election. The decision to reduce corporation tax may have been rushed through to gain
voters, and so with their new contradictory move, it may lack in providing the expected long-term
benefits considered throughout. This decision may ultimately source to government failure, and have
a detrimental effect on the government’s image since their decision may result in the public,
specifically business owners, losing their trust in the UK government. On the contrary, the proposed
rise of corporation tax to 25% may be the result of a poor economic prosperity due the pandemic,
and in normal circumstances, they may have fulfilled their original plan of reduction. This is difficult
to tell as there is no exact measurement for a situation like this since the pandemic was so
unpredictable.
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