Is cutting taxes the best way to boost growth?

Image copyright Reuters Image caption Centrist Emmanuel Macron wants to cut corporation tax rates to encourage investment in the French economy

The French president, Emmanuel Macron, says he wants to cut French corporation tax rates from the current 35% to 23% by 2022, paving the way for other European countries to do the same.

It is welcome news for Mr Macron, who has long been criticised by opponents for lacking a strong, coherent tax policy. The move is aimed at attracting more investment to France.

But with economic growth in France lagging behind other European economies, economists are concerned the proposed cuts will distort prices too much, making it more expensive for workers and consumers to buy goods and services.

So is cutting taxes the right way to boost economic growth and living standards?

When is a tax cut not a tax cut?

The Organisation for Economic Co-operation and Development (OECD) measures tax as being spent when, on average, governments give an explicit benefit to the public sector.

The basic notion is that tax should reflect the burden the government takes on its finances from the private sector, with the lowest taxes being passed on to the public sector by the highest earners – who then pay less tax.

Given that the new rate in France would be 23%, according to the OECD this is not a cut in taxes, in so far as it is paid by private businesses and is taxed by them.

Does tax need to come down to spur growth?

Economists point out that lowering taxes does not necessarily make things better. Since when did central bankers need to raise taxes to stimulate spending and economic growth?

However, central bankers want to boost investment – a politically unpopular move, because employees get less pay when investment stagnates.

Central bankers argue that supply-side stimulus – cutting taxes on investment – makes central banks’ jobs a lot easier because it increases the likelihood that businesses will invest in expansion.

Plenty of central bankers say this (though with different methods). Paul Polman, the chief executive of Unilever, is a big fan. He says the central bank must do more to make investment a priority.

After all, it’s the only way the economy will recover from the financial crisis, he says, or become less reliant on low interest rates.

Is there a trade-off here?

Image copyright Getty Images Image caption Central bankers used to have to persuade companies to invest in growth rather than shareholder dividends

The important point to remember is that all the big central banks – the Bank of England, European Central Bank and Bank of Japan – are trying to lift growth and inflation. And the cost of investment is going up as a result of an increase in global borrowing costs that they can push up through interest rate rises.

The problem is that policymakers are finding it harder and harder to convince businesses to spend more on future growth and less on future dividends. But it is hard to argue that in central banking terms it is the proper course of action to put more focus on boosting investment.

We know the bank is already aggressively targeting growth, which makes it all the more difficult to persuade businesses to grow.

(Inflation, on the other hand, takes the form of the price index, which sets the benchmark level at which rises and falls in prices will not be allowed.)

Because inflation expectations are shaped by changing perceptions of the future, there is a trade-off between higher inflation and lower growth that central bankers have to take into account when they set interest rates.

Inflation targets across the OECD have been steadily moving upwards, though that doesn’t necessarily mean there is less of a risk of recession down the line.

On the contrary, growth in the average OECD country is still slowing – growth was 2.3% in 2016 but the OECD forecasts it to reach 2.1% by 2020.

That is still below what it was around a decade ago.

What about the poor?

Everyone agrees that low wages are a driver of poor living standards. But the issue of taxes, and the constraints that they impose on investment, is a different matter.

In this area, governments would be quite happy to stay with their current tax levels.

In the UK, with the lowest national unemployment rate for 40 years and a buoyant housing market, the top rate of income tax is only 26%.

The only question is whether there is room to cut tax further without endangering the economy.

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