Charlotte James

Discuss ways in which the UK tax system could be redesigned to facilitate a rebalancing of the economy towards increased investment, entrepreneurship and exporting in the longer run (20 marks)

According to Gov.uk rebalancing the economy refers to the process of spreading success more evenly - both geographically and by sector - and supporting the world class industries we already have, as well as the new ones that we’re developing.

Firstly, in order to increase investment, the government could implement a reduction in corporation tax. This would work by encouraging firms to enter the market, if they are made aware that the tax on their profits will be reduced. If this is the case, the promised profit margin will be greater, and so a firm will require less revenue to break even, or indeed make supernormal profit. This is an attractive feature for firms that are entering markets, as it is common that the first few years will not result in much, if any, profit. Moreover, firms who are already in the market may decide to invest in new machinery from the extra profit they can now keep. This will increase output, as there will be a greater scope for firms to produce more goods over and above the level which they were producing before. This will increase the export rate, reducing the current account deficit which is one of the government’s main macroeconomic aims. Furthermore, foreign firms may choose to set up companies in the UK if the corporation tax is lower than in their own country. The UK, incidentally, has a relatively low corporation tax, and is set to fall again on April 1st to 20%.

However, this could be counterproductive for entrepreneurship. If there is a lower tax rate, there may be less tax revenue for the government. The Laffer curve shows the ideal tax rate to maximise revenue, shown below. If tax revenue falls, the government will have less money to spend on education, apprenticeships and different schemes which are currently available to students, which aim to encourage them to become entrepreneurs. In this way, lower corporation tax may have a great impact upon firms who are already in the market, but may have a detrimental effect on the future generation of entrepreneurs which may not see their opportunity to enter the market.

Secondly, reduced income tax may increase investment, exports and entrepreneurship. In the UK, we have a progressive tax system. This means that there are certain brackets of income, and those on larger incomes pay the highest percentage of tax, which, in the UK is 45% currently. Reducing income tax means that there is a greater incentive for investment to increase exports, which in turn will earn workers a greater wage. If the top rate of tax is reduced, these firms may no longer find that capping their wages slightly below the top rate bracket is no longer necessary, and so people will become better off and the economy will grow as a result. There is also a greater incentive for entrepreneurship if you are confident that you will retain more of your earnings as a result of

Charlotte James

working hard. Exports will benefit because firms will be expanding their output in order to profit maximise.

Thirdly, increasing the personal allowance of tax will encourage people who are unemployed and claiming job seekers allowance to find jobs even if they are minimum wage, as they will retain all of their pay. This is an incentive for those who may find themselves out of pocket if they choose to work as opposed to claiming benefits as the taxes can cause their disposable income to go be spent on this. In this way, with more people in to work than there previously was, there is less of an output gap, and the PPF curve will shift to the right. This means that, overall, there will be a greater output from the UK economy and also a falling budget deficit.

In conclusion, it seems that factors which will affect businesses in a positive way could have the largest effect overall. As well as the factor mentioned previously, a reduction in stamp duty could cause increased entrepreneurship, exports and investment. This is because houses and places of work will become cheaper, encouraging businesses to move to the UK. This will mean that tax revenue comes in to the UK, and so the government can increase its spending on educational schemes which encourage young people in to entrepreneurial roles. This might include the young enterprise scheme, which has enthused teenagers across the UK giving them practical skills to apply in the work place.