Tax and grow
Today’s Budget uses taxation policy to try to encourage corporate investment. The idea is that reducing corporation tax will increase investment and employment, benefitting us all. The problem is that such tax cuts in the 1980s, both in the UK and the USA, did not increase investment but merely changed the composition of where the total tax bill came from and had a regressive effect on income distribution.
So what is wrong with focusing on taxes to increase investment? While the concept of, ‘animal spirits’ came back after the financial crisis to explain the ‘herd-behaviour’ that characterised financial markets, its main lesson did not. Keynes’ primary insight was that business investment, the most volatile element of spending in GDP, is not a function of taxes or interest rates but of ‘animal spirits’ - the gut instinct of business regarding the future growth prospects of a particular sector (eg. the future of biotech), a particular stock or of an entire economy (eg. emerging markets).
These growth expectations are affected by the key structural and institutional properties of a country. These include a country's education system - which widens the pool of potential innovators; its science base - which provides the fruit that determines new technological opportunities that incumbents and new entrants can profit from; regional and national agencies which encourage networking between businesses and between businesses and academia; the openness of a country’s lead sectors to new entrants and competition and finally, its venture capital system and institutional arrangements (eg. an efficient patent system).
Reagan’s and Thatcher’s tax cuts did not increase business investment because they were not accompanied by a serious industrial policy targeting such investments in a systematic way. During that same period Japanese growth soared due to a successful industrial policy, which saw its Ministry of International Trade and Industry (MITI) tackling many of the aspects mentioned above.
How does today’s Budget deliver on such fronts? The carrots came in various forms, but unfortunately as separate blips rather than as part of a coherent industrial policy that could revolutionise infrastructure, education, networking and the other fundamental aspects that increase 'animal spirits'. The Budget includes some excellent initiatives, such as funding for 24 new university technical colleges, 25,000 new apprenticeships, the Green Investment Bank, and 21 new 'enterprise zones'. But given this is all happening at the same time as Regional Development Agencies have disappeared; the UK Film Council has been abolished (a successful and efficient funder of one of the UK’s top sectors); many universities are seeing their teaching budgets cut by 80 per cent; research budgets cut by up to 40 per cent (except in STEM subjects); and EMA cuts damaging the ability of youths to stay in school.
Only once the carrots become more substantial and targeted towards long-run investments and growth opportunities will they stop serving only token purposes to hide the impact of the cuts - which, for now, are very real in their impact on the current low 1.7 per cent growth rate.