All taxes distort the behaviour of private economic agents, but some do so more than others. Economists have recently investigated the costs associated with high rates of personal income tax – which could arise from lower effort or moving to a different jurisdiction, as well as the real costs associated with evasion and avoidance. These costs are important: while payment of £1 in tax reduces the private wealth of the tax payer, society as a whole does not lose out because that money is available for spending by the government. But the additional costs associated with taxes represent a real waste of resources to society as a whole.
Recently published Centre research has developed techniques for assessing the social costs of taxes on corporate profit. This research uses data from the population of UK corporation tax returns between 2001 and 2008 available in a new secure Datalab in HMRC. The empirical procedure is to estimate the elasticity of corporate taxable income with respect to the statutory corporation tax rate. Under certain circumstances this elasticity can be a “sufficient statistic” for evaluating the social costs of corporation tax. We also develop a method for assessing how far differences in personal and corporate taxes affect the share of total income declared in the two different forms.
The research exploits two types of variation in corporation tax rates to identify its effects. The first arises from a number of reforms to the corporation tax regime for small companies, including the introduction, reform and abolition of a starting rate between 1999 and 2006. The second arises from discrete and sometimes large changes to the marginal tax rate at various points in the tax schedule.
Overall, our results suggest that the elasticity of corporate taxable income, and hence the social cost of the tax, varies depending on the size of the company. But especially for smaller companies, we estimate that the social cost could be as high as 29% of the revenue collected. That is, for every additional £100 of tax revenue generated from small companies, the cost to the companies is around £129, and the loss to society as a whole is £29.
Michael Devereux, Li Liu and Simon Loretz, 2014. The elasticity of corporate taxable income: new evidence from UK tax records. American Economic Journal: Economic Policy, 6(2), pp.19-53, CBT Working Paper 12/23. Forthcoming in American Economic Journal: Economic Policy