Corporate tax policy under the Labour government, 1997–2010

Between 1997 and 2010, the UK Labour government implemented extensive reforms of the corporate income tax system. The key aim was to foster investment in an era of increasing capital mobility.

In response to increased mobility of capital and profits, developed countries have cut corporation tax rates and reformed their taxation of foreign profits to attract mobile investment and mobile profits. In this context and also under the pressure of the European Court of Justice (ECJ), the Labour government reformed virtually every part of the UK corporate tax system. Fundamental reforms of dividends and capital gains taxation aligned the UK to its competitors and to EU law. In particular, the adoption of the territorial system of taxation whereby foreign profits of UK companies became exempt from UK taxation made the UK a more attractive location for headquarters of multinationals.

The corporate statutory income tax rate was cut from 33% to 28% and the tax base expanded. The increase in the tax base, and the tax rate cuts in other countries, explain why a comparison of effective tax rates shows that the UK lost ground to other OECD countries after 2003–4. However, the overall tax burden on small and medium sized enterprises (SMEs) was reduced substantially.

But the overall effect of the Labour’s tax policy on aggregate investment was small, for three reasons. Increases in real investment between 1997 and 2007 are largely explained by the economic cycle, while the reduction in the tax component of the user cost of capital was small. The increase in aggregate investment was led by an exceptional surge in investment in structures driven by a real estate boom. And most investment was undertaken by large companies, and was therefore unaffected by the reforms focusing on SMEs.

Giorgia Maffini, Corporate tax policy under the Labour government, 1997–2010, Oxford Review of Economic Policy, 29 (1), 2013, pp. 142-164.