The Tax Hikes

As of April 2023, The UK Conservative Party, currently holding the UK government, has raised corporation tax from 19% to 25%. Furthermore, the current President of the USA, Joe Biden of the Democratic Party, is attempting to raise corporation tax from 21% to 28% as part of his 2024 budget plan. Both of these tax hikes are being pitched with claims that the money raised will be used to reduce the high levels of inflation that both nations are experiencing. An additional angle, one that is so popular among much of the population is the “collective good vs evil” pitch whereby people believe that it is a moral good to pay corporate tax so the government is justified in enforcing this plan. But this raises an interesting question, do these tax hikes have consequences for the people of the UK and USA?

The Inflation Reduction Pitch

Inflation is the reduction of a currency’s buying power. The specific causes of inflation can vary but analysis of historical periods of inflation allows us to summarise causes of inflation into two categories, cost-push inflation, and demand-pull inflation. Some argue that there are 6 types of inflation as they include creeping, walking & galloping inflation, and hyperinflation but these terms provide descriptions of severity and time, where as cost-push and demand-pull inflation provide descriptions of causation only and can be used in combination with the former severity and time descriptors.

Cost-Push

Cost-push inflation occurs when a company’s cost of goods and services rises, (costs ‘pushed up’), leading to them needing to increase their prices. All companies share certain cost burdens but those burdens affect specific companies and sectors differently. For example, all sectors share the burden of energy costs but manufacturing companies are more dependent on this cost as the need to run machines all year requires more energy than the average engineering company that only needs to worry about heating and computing power. Similarly, all companies are required to pay corporation tax but a local cafe is highly dependent on this cost because it must pay it unlike a large company like Starbucks which has access to foreign markets and can move money to another nation by charging its local business for services to legally and artificially create expenses to reduce local profits which lead to a reduced tax bill. When the government of a nation tampers with these cost burdens, well intentioned or not, it negatively affects businesses as they seek stability and need to pass their increased costs onto their customers. This is how cost-push inflation is created with the people of that nation expected to pay the increased prices. The solution to cost-push inflation is to work to reduce the shared cost burden either by removing the cause of the increased cost, in these cases, working to reduce energy prices and  reducing corporation tax burdens.

Demand-Pull

Demand-pull inflation occurs when the demand for goods and services rises (goods ‘pulled in’). It manifests when the population has relatively more units of money to spend. Salary increases, excessive money printing or issuing too much debt are mechanisms that lead to demand-pull inflation as the additional units of money in the consumer’s pocket increases their spending confidence causing an increased demand of goods and services and resulting in price increases to satisfy the concomitant reduction in supply. Solutions to demand-pull inflation are a bit more complicated as some of the causes manifest long after the cause. For example, excess money printing even when specified goes unnoticed by the population at the point of printing but when consumers begin to spend that money, companies must raise prices to quell demand considering that they don’t want to sit and wait while their supplier manufactures new goods.

Current Inflation

Considering that the current period of inflation in the UK and the USA is due to energy price rises associated to replacing unclean fossil fuels with less efficient clean energy and was exacerbated by the war in Ukraine, both nations are experiencing cost-push inflation. The proposition of both governments, to raise corporate taxes must, by logical deduction, also have an impact on the overall prices of goods and services regardless of the success of the claimed benefits because the strategy enforces a sudden cost increase for all providers of goods and services, with the most likely result being a further increase in inflation as small companies will be forced to pass the cost on to their customers via higher prices. Furthermore, considering that neither government has provided a spending plan, knowing that there has, to date, been no proven mechanism of governmental spending that has successfully reduced inflation, the people of those nations are being forced to pay the government, via higher prices, for a plan that has no historical evidence of success. Interestingly, the central banks of the UK and USA have decided to raise interest rates to quell inflation in an attempt to reduce the supply of debt as they claim that the concomitant reduced spending will quell inflation. The problem is that this tactic only useful when a country is experiencing demand-pull inflation as the rise in interest rates increases price of debt which deters people from borrowing money to buy things, reducing demand. But it is useless against cost-push inflation as the cause of the cost push still exists regardless of the fact that spending has reduced.

The Good vs Evil Pitch

Enforcing and increasing corporation tax often has a “Good vs Evil” element to it with the big corporations being labelled as the evil side and the government being seen as the good who seeks to punish evil. In reality, corporation tax laws apply to all corporations but they only affect small corporations. A corporation is considered to be small if its annual revenue is below £50 million. Examples include your local café, laundrette, or personal trainer. Large corporations such as Amazon and Starbucks compete with these small corporations but when corporation taxes rise, large corporations have own additional and distinct businesses in other nations so they can easily move money between their domestic and foreign businesses by getting their domestic business to purchase services from their foreign business which happens to be situated in a nation where corporation tax is close to 0%. For example, Starbucks UK may pay Starbucks Panama for the rights to use the Starbucks trademark in the UK. This payment is a business expense for the UK business and, if the price happens to cost exactly what Starbucks UK generated in gross profit at the end of the tax year, then Starbucks UK doesn’t have to pay anything in tax as it has not made a profit. If Starbuck UK wants to invest in their business the following year, Starbucks Panama can then loan money to Starbucks UK and, as the government can’t implement taxes on loans, this money is tax free. Starbucks UK can then pay this loan back from its revenue with interest and put that down as a cost to the business for the following years, then continue the cycle. Many large businesses implement similar systems and small businesses cannot do this considering that they don’t have access to foreign operations. The British and American governments must also know this but have decided to raise corporate taxes regardless of the fact that they are hindering small businesses and are providing a big advantage to large businesses over their smaller competitors. Standard liberal practice of criticising big corporations for using these techniques is unhelpful considering that they have not done anything illegal and have enough size and power to use the laws of nations that are more suited to their goals of increasing profits to reinvest in their business.

Uneven Playing Field

Starbucks UK, a large corporation, owns hundreds of physical Starbucks cafes. Each of these cafes directly competes against local cafes for market share on the same street. This means that a local café isn’t competing with a large corporation, it is competing with another café of a similar size that happens to be a part of a large corporation called Starbucks UK. With existing corporate tax policies, these individual Starbucks cafes send their gross profits up to Starbucks UK which in turn converts the cash to tax-free and debt. On the other hand, the small café must pay 25% of their gross profit to the government in corporation tax. When the branch manager of the Starbuck café wants to reinvest in the store the following tax year, by hiring new staff for example, they can apply to Starbucks UK for funding, and, considering that the café generated profit that wasn’t subject to corporation tax, the Starbucks café manager can has access to more money from corporate savings than the local café as the local café owner had to pay 25% of their revenue to the government before paying into their corporate saving account. This means that individual Starbucks cafes are being given a bigger advantage over their local British competitors.

Alternative Action

If the governments of the UK and USA are serious about reducing inflation they should be working to reduce the price of energy as quickly as possible. This might mean making tough decisions like increasing use of fossil fuels and supporting the increase with increased production via controversial techniques such as fracking, or by reducing ineffective hostilities with Russia. Opting instead to increase corporation tax is nothing more than a burden on small businesses but this burden isn’t limited to those businesses as their increased tax liability increases their cost of production which they must pass onto consumers via price increases, further increasing inflation via the cost-push mechanism. Considering that big businesses don’t need to pay tax, they won’t be affected by these changes hence they will not need to increase prices and will take sales away from the small businesses that compete with them. For this reason, the governments should be working to reduce corporate taxes in an attempt to reduce the cost of production which will likely lead to reduced prices hence reduced inflation.

The Real World

UPDATE 05/06/2023: Turkey inflation dips to 39.6% on relief from free gas: Link to Article

This news from Turkey provides living proof of the theory that energy price reductions provide rapid reductions in inflation.

Every business runs on a simple concept; sell you product at a higher pice than its costs. Every company must pay for energy. Therefore, changes in energy access via low prices, affect the costs of every buiness along a given supply chain. For example, a supermarket sells bread at a certain price. The supermarket pays for energy to keeps the lights and AC on, the truck driver needs to pay for fuel to transport it and the bread manufacturer needs to pay for energy for production, lighting and AC. Therefore, changes to energy prices reduce costs for all businesses which leads to lower prices along the chain, leading to lower prices for consumers.

This is the most likely explantion Erdogan’s success in Turkey, hence it ebgs the question fo why Western nations are focussing on trying to make money more scarce by raising interest rate instead of focussing trying to reduce energy costs.