The Conservatives are doomed to repeat history, where tax cuts don’t meet expectations of growth – unless UK companies are made to invest again in people and infrastructure, writes Andrew O'Brien.
Unsurprisingly, the whole Conservative Party leadership race has been dominated by the debate around tax cuts. We’ve had NI tax cuts, income tax cuts, VAT tax cuts and once again we are debating the merits of corporation tax cuts. Do they boost growth or not? How should they be funded?
The truth is that broad-based tax cuts are the reward for strong economic performance, not a magic wand that can be waved to rid ourselves of our problems.
For some time now the Conservative Party has ignored the growing disconnect in our economy, between our long-term needs and the choices we make as a nation. This is true for both households and companies, but it is particularly stark within UK plc.
It is generally agreed that the biggest problem facing the UK is low productivity which is holding back growth and holding down wages. Key to this has been a lack of investment in people and capital.
The Chartered Institute for Personnel and Development has found that training days per employee have fallen by 18% between 2011 and 2017. An increasing portion of that training is health and safety rather than productivity-enhancing. Investment in training per employee has fallen by 6.3% over the same period. Standards are also patchy, with a third of apprenticeship providers rated as inadequate or requiring improvement.
Business investment has also been weak, both in overall terms and in terms of capital available per employee. A lack of investment has been a long-term problem for the UK and little has changed over the past decade. As Giles Wilkes has written for the Institute for Government, this is not just a problem in high-tech manufacturing, it is across our entire economy.
Conservatives have tried to use tax cuts to boost investment repeatedly over the past forty years and it simply has not worked. As former Chancellor Rishi Sunak highlighted on the Today programme, the economic orthodoxy was that cuts to corporation tax by the Coalition would boost growth. Under the Coalition, Corporation Tax was cut again with a net cost to the Exchequer of £72.6 billion between 2010 and 2018. My analysis for Social Enterprise UK & the Social Market Foundation found that in only one year did the increase in business investment outweigh the cost of the Corporation Tax cut. Even the much vaunted super-deduction has only seen a net increase of business investment of £1.4 billion so far, an accounting error in the grand scheme of things.
Rather than investing, companies are choosing to pocket the cash. In 2000, UK non-financial company profits were equivalent to around 40% of UK business investment. Now, they are equivalent to around 60%. Research by Common Wealth has found that shareholder buybacks and dividends from FTSE100 grew from 43% of profits in 2011 to 103% in 2018.
This is not just recent history, it is current practice. Share buybacks in the FTSE100 have increased significantly. Tesco has announced plans to buy back £1 billion in shares, despite the cost-of-living crisis at the tills. BP has announced $4 billion in share buybacks every year till 2025, at a time when the Government is trying to encourage investment in energy supplies. This is not just the big guys. Share buybacks announced by FTSE350 companies have increased by 96% comparing Q1 2019 with Q1 2022. This money is not going into our pensions either. UK pension funds ownership of UK equities fell from around a third to around one twentieth between 1990 and 2018. Increased dividends and buybacks are only likely to be felt by overseas investors and the richest UK households.
Tax cuts are not being used to fuel investment in people or capital. The transmission mechanism has been broken. This is the truth the Conservative leadership candidates need to tell their MPs and members. The reason why the state is spending more is because the private sector is investing less. If Conservatives want a small state, they need to reform the economy to increase investment to boost productivity. Tax has a part to play, but not in the way some people think. Tax cuts which reform the structure of the economy and incentivise business models which create long term value are the key, not broad, untargeted tax cuts. Reforming UK company law and the UK state investing in our social and physical infrastructure are also critical.
In the short-term, the Conservatives should focus tax cuts on reliefs or reforms that encourage investment such as full expensing of capital expenditure. The government should look to create a Human Capital Allowance to go alongside our physical capital allowances to incentivise training and development of staff. We also need targeted grants to crowd-in private investment. Programmes such as Help to Grow should be expanded to reach more businesses. The Government should cut taxes for firms such as co-operatives and social enterprises which have a track record of investment, and which can be trusted to pump tax cuts back into our economy. Not all business is equal.
Longer term, the Conservatives need to reform UK company law. A growing body of evidence has shown that companies which have a purpose beyond generating profits invest more in people and capital. Ironically this generates bigger returns over the long term. We need to look at ways to make UK plc a patient and consistent investor in our country. The party must be capitalism’s critical friend.
The Conservatives need to rediscover their values of responsibility and thrift. If we can get UK companies investing again in people and plant, there is a chance for lower taxes and a smaller state in the future. Tax cuts today without reforms, given all we know, would be money down the drain. This is the truth the Conservative Party must confront.