The case for cutting corporation tax
We take a closer look at the report launched last month by the Economic Reform Group which argued that a reduced rate of corporation tax in Northern Ireland is the best way of quickly stimulating economic growth in the province
Published 16/03/2010 | 11:10
The argument that a separate low rate of corporation tax is the best way to boost Northern Ireland’s economy is not a new one.
It was previously floated in 2007 in a high profile campaign that was shot down by Gordon Brown in |his then role as Chancellor of the Exchequer.
After two years of severe recession some of the advocates of reduced corporation tax believe the time is now right to promote the concept again, particularly as the tenancy at 10 Downing Street of its main opponent may soon be coming to an end.
The Economic Reform Group (ERG) — made up primarily of economists, accountants and tax experts — presented a report into the idea designed to start the debate once again.
Here we look at some of its |key points.
Why is it needed?
Northern Ireland has the lowest average wages and lowest productivity of UK regions and has suffered the largest percentage loss of jobs in the recession. This happened despite the largest government support for business of any UK region — with many manufacturing, agriculture and services business with export potential receiving grants.
ERG argues the main attractiveness of Northern Ireland is to call centres seeking low wage graduate labour. Manufacturing companies considering Ireland have a stronger incentive to locate in the Republic.
Two in every seven people work in the public sector, the highest in the UK. This would not matter if Northern Ireland financed its public expenditure out of its own resources, but it does not.
ERG argues that half of all government expenditure here is financed by taxpayers in Britain, mostly in the South East of England. A stronger private sector would help finance local public spending and lower dependence on subvention.
The report argues that without radical change to existing economic development policy “it seems inevitable” Northern Ireland will remain the UK’s poorest region.
Are there no other options?
ERG believes lower corporation tax is the only way to dramatically accelerate economic growth in a short time period. The province already has a generous regime of grants but this will become constrained under EU rules.
From next year the EU will begin reducing the ceilings for the maximum amount of grant Invest NI can give private firms and after 2013 investment grants may not be permitted at all.
While some small European countries — for example Sweden and Finland — have developed high productivity knowledge-based economies, this has taken decades to achieve and has usually relied on the powers available to an independent state.
What gains would it bring?
The experience of the Republic suggests changing the corporate tax rate would encourage profit growth at existing indigenous Northern Ireland companies, existing UK companies who were prepared to migrate genuine trading activities to Northern Ireland and, most importantly, foreign corporations relocating their genuine trading activities to Northern Ireland.
ERG argues that lower tax attracts multinational companies that have already developed highly competitive products and markets.
A 12.5% rate in the Republic set in motion the successful Celtic Tiger years, making it a host location to multinational companies in high value sectors such as pharmaceuticals, medical devices and ICT.
Despite the current pressures on public finances the government in Dublin has said it intends to maintain the rate as it knows this has been crucial in attracting investors.
Benefits here would include potential for 90,000 extra jobs over 20 years, many on salary levels above the current average. Adding several thousand more jobs each year would help reduce unemployment and with less dependence on the public sector vulnerability to |national public spending cuts would also decrease.
Wouldn't a tax cut mean a big loss in revenues?
ERG estimates total tax revenues would initially fall, but subsequently build up rapidly, with a break-even point after only six years.
Much of this revenue, in the form of income tax, national insurance and VAT, would accrue directly to HM Treasury rather than to the Northern Ireland Executive.
With the Treasury gaining revenue, after six years subvention to NI would begin to reduce — likely by £1bn within 20 years. Corporation tax revenues would initially fall by around £200m, but begin to increase from this lower level as new investment takes place.
It would take more than the 20 years for the level of corporate |tax revenues to return to its original position.
As a result corporation tax revenues accruing to the Executive could potentially remain £100-250m per annum lower than at the original corporate tax level.
The cumulative loss of overall tax revenue would remain negative for 11 years but thereafter would become more positive.
Any reduction in revenues could reduce spending on public services, by up to 2%.
But ERG believes reductions could be absorbed by improved planning of underspending by Stormont departments.
What are the other risks?
The shifting of profits and firms from the mainland to Northern Ireland, to take advantage of a lower corporation tax rate, could result |in a net loss of revenue to the UK Exchequer.
But ERG thinks the Treasury has sufficient existing powers to control unreasonable company behaviour such as tax evasion or shell companies setting up here in name only.
It believes movement of genuine firms to Northern Ireland would not be large, based on the number that moved to the Republic.
Neither is it aware of a large number of potential movers from GB which only need a tax concession to stimulate such a move.
The Varney Review assumed a net Exchequer loss of £75m due to profit shifting. Even if this £75m was the true figure it is not large enough to prevent such a potentially valuable experiment going ahead, says ERG.
Federal countries such as the US, Canada and Germany, have |different rates of corporation tax at the state level in addition to a federal rate.
These countries have managed to operate such a system for years, which suggests that it is sustainable.
Is it legal?
ERG believes EU rules clearly permit a reduction of corporation tax in a region within a member state.
While not encouraged by the EU Commission, reduced tax rates were declared legal under the Azores Judgement of the European Court of Justice in 2006.
Regions are permitted to have lower rates than their national level if: the region has the political and administrative authority to introduce its own tax regime; the national government has no authority to influence such a decision; the region can bear the full fiscal consequences of introducing its own tax regime and, in particular, must not be compensated by the national authority for loss of tax revenue.
Treasury initially contested this view in response to requests from the NI Assembly for reduced tax rates, but in the Varney Review conceded that such a change was legal under EU law.
A number of other regions, including Gibraltar, have subsequently made tax changes under the Azores ruling.
The simplest way of dealing with the corporation tax adjustment is, the group suggests, to devolve the corporation tax revenues to the Northern Ireland Executive in return for a one-off reduction of the same amount in the baseline for the Executive’s Departmental Expenditure Limit.
What are the stumbling blocks?
Previous attempts to get a lower rate in Northern Ireland have been denied by the Treasury. Assuming the Conservatives are successful and assuming they back the idea, it is likely that the European Union would reject the plan. The group believes however, that it would be granted under appeal to the European Court of Justice.
ERG NI estimates that it would likely take two years for the process to go through. It thinks the lower rate would fit within existing UK tax legislation.
While there would be a requirement for new legislation, a significant amount of existing legislation should already facilitate the introduction of such new legislation.
Does the idea have support?
The group admits there is more chance of the idea being considered if Mr Brown loses the General Election, he being the main opponent of the last campaign.
It says it has received tacit support for the idea from the Conservative Party and believes David Cameron will outline his support for it in the run up to the General Election. Shadow Northern Ireland Secretary Owen Paterson has said the Tories want to make Northern Ireland an Enterprise Zone, with the separate tax rate one possible means of achieving this.
Several MLAs and MPs have backed the idea.
Members of the ERG this month met MLAs on the Stormont Enterprise and Finance committees. The Finance Committee suggested it might write to the Executive suggesting the group appear in front of ministers to make its recommendations directly. ERG also hopes to brief each of the political parties.
A motion requesting devolution of corporation tax powers would be required in the Assembly to get the ball rolling.
Even if it does pass the Assembly there is no cast iron certainty that a Conservative government and Treasury would back a lower rate.
A single corporation tax rate was previously seen as important for |national unity, so Treasury has resisted discussion of regionally differentiated rates. ERG sees that as short sighted.
“A more fiscally flexible UK is the only plausible means of achieving a more regionally balanced economy,” says ERG.
“Northern Ireland should be seen as the ideal experimental area for reduced corporation tax.”