Small Business Tax Increases – Do the

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Small business tax increases – do the economic costs outweigh the fiscal gains?

Final Report for the Federation of Small Businesses

October 2009

centre for economics and business research ltd Unit 1, 4 Bath Street, London EC1V 9DX t: 020 7324 2850 f: 020 7324 2855 w: www.cebr.com

Disclaimer Whilst every effort has been made to ensure the accuracy of the material in this document, neither centre for economics and business research ltd nor the report’s authors will be liable for any loss or damages incurred through the use of the report.

Authorship and acknowledgements This report has been produced by Charles Davis, Ben Read and Richard Snook of the centre for economics and business research London, October 2009

All rights reserved. Copyright © centre for economics and business research ltd, 2009

Executive summary
Small businesses play a vital role in the United Kingdom economy. They account for 58 per cent of the private sector workforce, and directly contribute 52 per cent of United Kingdom GDP. Small businesses are drivers of innovation and entrepreneurship, and disproportionately provide opportunities for people that have previously been unemployed to get back into the workplace.

This r ep ort e xami nes the impact of taxati on on small b usi ne sse s, and co nsi ders how diffe rent type s of ta xation affe ct t he be haviour of small bu si ne sse s, particul arly i n the conte xt of small bu si ne sse s’ strengt hs a s employer s a nd i n nov ators. This i s don e i n t he co nt ext of t he pre cipito us po siti on on publi c fi na nce s. One of the mai n le ga cie s of the credit crun ch and the subse q ue nt global econ omi c cri si s is that the United Ki ng dom fa ces it’ s worst budget defi cit si nce t he S e cond World War. There now appea rs t o be a poli tical con sensus for major publi c spendi ng cuts i n order to reduce t he struct ural defi cit facing t he publi c fi nance s, but it al so se ems likel y tha t ta xation will have to take some of the burden in corre cti ng t he deficit. We te st whe th er var ious change s in sma ll busine ss taxation are likel y to be effecti ve i n improvi ng the publi c fi na nces po si tion, a nd what the co nse quent knock-o n effe ct s wo uld be on empl oyme nt a nd e conomi c a ct ivity with in the sm all busin esse s se ct or and t he wide r e co nomy. Taxation leads to reduced investment, innovation and employment

Almost all empi ric al evidence show s that increa si ng b usi ne ss taxati on provides di si ncentiv es for small b usi ne sse s to e ngag e in a ctivitie s t hat they have parti cula r st rengt hs i n: e nt re pr ene uri al activit y, i nve st me nt a nd inn ovati on , a nd employme nt. Mo re spe cifi call y, ta xe s on capital a nd profit s, such a s corpo ratio n tax a nd bu si ne ss ra tes r educ e incen tives for busi ne sse s to inve st in n ew equipme nt, te chnol ogy a nd re sear ch a nd d evelopment , a s t he y reduce the expe cted level s of re turn on such i nve stme nt. In a ddition, su ch taxe s red uce t he ra te of en trepreneurial a ctivity i n the e co no my. Increa se d taxe s o n l abou r, such as empl oyers’ nati on al insurance, red uce the ability of small bu si ne sse s to take on ne w staff, and can lea d to b usi ne sse s redu cing he ad count due to higher co sts. The empirical evidence linki ng hig he r labour ta xati on to higher unemp loyme nt a nd lowe r employment i s st ro ng. In due course we wil l be looking at the ta xation of the self-em ployed in more detail.

3

Building the case for supporting small businesses

Policy tests show that increased taxation on small businesses would damage employment and growth, and have a relatively small impact on public finances

We have used cebr’ s str uct ural e conomic model “U KMO D” to te st t he knockon effe cts of three spe cifi c tax i ncr ea se s on small bu si ne sses thro ugh the econ omy. Thi s ena bles us to mea sure not o nly t he...
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