Corporation Tax and Aggregate Demand & Supply

In this short video we look at how a cut in the main rate of corporation tax in the UK might impact on aggregate demand and supply.

Basics on corporation tax

• Most corporation tax revenue comes from the taxable profits of limited companies after taking account deductions and allowances.
• The main rate of corporation tax in the UK is 19%.
• Corporation tax was the fourth largest tax in 2018, raising £60 billion for the government.
• The main corporation tax rate is being lowered to 17% in April 2020.

Corporation tax rates in selected countries (2019)

• United Arab Emirates – Zero per cent
• Macedonia – 10 per cent
• Ireland – 12.5 per cent
• Singapore – 17 per cent
• United Kingdom – 19 per cent
• Vietnam – 20 per cent
• United States – 21 per cent

Cutting corporation tax to 17 percent

• A fall in corporation tax will increase the post-tax profits of businesses
• In theory this will increase funds available to fund capital investment e.g. in new plant, factories and technologies.
• This would then cause an outward shift of aggregate demand (AD=C+I+G+X-M)
• This increases demand / output and profits of businesses operating in the capital-goods industries e.g. machine manufacturers
• An increase in investment might also lead to an outward shift of LRAS as a country’s productive capacity increases

Evaluation Points:

1. Business confidence might be low – this would limit the impact of a corporation tax cut
2. A tax reduction only benefits businesses making profits – many SMEs in the UK struggle to achieve a sustainable profit
3. Other countries might be cutting corporation tax too which might limit the impact on inward investment
4. Higher post tax profits might be shared as more generous dividends to shareholders rather than funding increased capital investment