The danger of cutting any tax rate is that it reduces the amount of money coming in and makes it more difficult to fund outgoings, with the result that the government has to borrow more. The question that needs to be asked is why the government, when it is trying to cut its budget deficit, has cut the level of corporation tax? The risk is that lowering tax rates in the UK prompts other countries to respond by lowering their own rates, in which case it becomes a zero-sum game.
One of the key aims when lowering corporation tax rates is to attract companies to the UK, because this should lead to higher employment, which in turn could lead to an increase in tax revenue and offset the fall in the tax rate. The evidence that this policy might be working was highlighted by the abortive bid from Pfizer, the giant US pharmaceutical company, for the UK firm AstraZeneca. Pfizer holds large cash reserves of about $49bn (£29bn) outside the US. If it brings this offshore money back into the US, it has to pay a rate of 35 per cent on profits earned outside the US. However, it does not have to pay this until the money is brought back into the US.
So US companies are being incentivised by their own government to keep their money outside the US. President Obama has proposed a minimum global tax and a corporation tax rate in the US of 28 per cent, but this is still well above UK levels.
The corporation tax rate in the UK is 21 per cent and will fall to 20 per cent in April 2015. In addition, the new Patent Box system in the UK allows companies to be taxed at only 10 per cent on profits earned from new patents. The attractions of this for Pfizer are obvious, with many commentators assuming it could have saved more than $1bn a year in tax alone.
Corporation tax has fallen from 30 per cent in 2006 to the current level of 21 per cent in the UK. Over the same period, average global corporation tax rates have fallen from 27.5 per cent to 24 per cent. So the UK has switched from being a high-tax country to a relatively low-tax one. However, rates are lower in some other countries: Ireland has one of the lowest rates of corporation tax at 12.5 per cent. This has already attracted the likes of Chiquita to look into merging with Fyffes and relocating to Ireland.
The danger is that if a lot of companies start moving to the UK, this could lead to retaliation by other countries. The first wave of companies to move is likely to include those with the sharpest tax accountants and the most nomadic tendencies. Although this policy might work in the short term, it could well store up problems in the longer term.
The trustees of charities with shares in AstraZeneca have to do what is in the best interest of their funds and objects. They might therefore have had to accept a bid from Pfizer if it had climbed to a sufficiently attractive level. If they had wanted to be more proactive, they could have tried to ensure, as the government seemed to be doing, that Pfizer made commitments to the UK on both the workforce and the local community.
Pfizer's interest in AstraZeneca highlighted the attractions of a low corporate tax rate and has shown that companies are considering moving to the UK. This is likely to prove positive for the UK and the UK equity market - so long as it does not result in retaliatory action by overseas governments or in the UK gradually losing control over its own economy.
John Hildebrand is an investment manager at Investec Wealth & Investment