Scrap Corporation Tax and Capital Gains Tax on small firms, says CPS

June 18, 2014 10:17 AM

Centre for Policy Studies (CPS) chairman Maurice Saatchi has called for small businesses to be exempt from Corporation Tax and investments in small businesses to be exempt from Capital Gains Tax. The policy is being launched at their Liberty 2014 conference to mark the group's 40th anniversary.

The proposals are a superb addition to the tax policy debate and would significantly enhance incentives for people to start new businesses and grow existing ones. The proposals use the existing legal definition of a small business and end the special treatment of dividends for Income Tax for eligible companies. The CPS estimates that the static cost of the policy is £11.5 billion in the first year but it would become revenue-neutral within 4 years due to dynamic effects of increased investment, jobs and output.

The CPS policy bears significant resemblance to the small business trial I proposed in our How to fix corporate taxes paper published last year. That policy would have introduced a 'lite' version of the Single Income Tax on net distributed funds for small companies. It's great that the CPS have explained in some detail how their version of the idea could work, practically.

Unfortunately, the policy has three key disadvantages compared to both the status quo and the Single Income Tax transitional proposals.

First, by retaining the existing high rates of Income Tax while simultaneously leaving retained earnings untaxed, certain avoidance opportunities could be more prone to abuse.

Secondly, the policy requires that businesses remain small if they want to retain the tax treatment involved, thereby creating a disincentive to grow beyond the threshold otherwise known as a 'cliff edge'. It might have been wiser to allow companies to retain the treatment indefinitely, perhaps requiring merged companies to reapply to prevent larger companies 'reversing' into smaller ones to take advantage of the policy.

Finally, it lacks the more fundamental neutrality benefits of taxing net distributions and so does not fix problems like the debt bias or the incumbancy advantage. But this policy is intended as an immediately implementable policy that would apply to the 90 per cent of businesses which are small, representing 50 per cent of employment. And while it is not as ambitious as the Single Income Tax, it is nonetheless both bold and worthwhile.

Overall, the CPS's proposal would represent a substantial, welcome and meaningful first step in a move towards a better tax system. Politicians should take note.

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