Cutting company tax rate is not cure for all our ills
Published 26/10/2010 | 10:43
If corporation tax was devolved and the Northern Ireland Executive had responsibility for setting the tax rates, how would the Minister of Finance decide how to act?
There have been many pleas that Northern Ireland should match the Irish Government’s 12% rate. This change would make Northern Ireland a significantly more attractive location for external investment (FDI, or foreign direct investment).
That expectation, stated without qualifications, appeals both to businesses that might benefit and also has the support of some (but not all) senior political figures.
The usual assumption is that if Northern Ireland had the authority to change corporation tax, the decision would be to set a lower rate, to parallel the Republic. However, allowing Northern Ireland to set its own rate of corporation tax would bring other consequences that are more contentious and disadvantageous than is sometimes understood.
There are other options that might be tried.
The clearest problem is that any reduction in corporation tax collected in Northern Ireland (when compared to the overall Great Britain rates) must be financed by deducting the cost from the tax revenue accruing to the Executive.
If a corporation tax rate comparable to the Irish rate was applied, then the Executive might have an initial budget revenue loss of about £200m. Is the Executive willing to rebalance the local budget to allow this to be accommodated?
The proponents of the tax rate change acknowledge the problem but go on to argue that, over a period of years, the loss of tax revenue would be offset by incoming FDI.
Two issues raise precautionary concerns.
First, the advocates of the change to a lower overall rate of corporation tax rely on an estimated large increase in FDI, based on the results of an extension of incentives and the results in Ireland in the last two decades.
The assumptions in their model can be challenged as over-optimistic for the current world market conditions.
Second, whilst a more favourable corporation tax regime is attractive, this change alone will not generate a long-term shift in the underlying productivity of the local economy.
The problems of too few and inadequately trained and skilled people have not yet been seriously tackled.
There are planning and infrastructure deficiencies and Government operational delivery is perceived as lacking seamless coherence.
A favourable corporation tax system, alone, cannot compensate fully for the other weaknesses.
The debate about corporation tax should be more wideranging. To have authority to set Northern Ireland’s own rules for the tax does not necessarily mean that rates should be lowered to the Irish level. There are possible options.
To avoid the impact of the lower tax rate falling mainly on existing businesses with a lower net incentive effect for new businesses (the deadweight factor) some method should be sought which targets the objective more precisely.
A simple tax reduction for all existing and new businesses would mean that more than half of the initial cost would be to reduce the tax bills of the banks in Northern Ireland.
One option is that tax rates might be reduced by a smaller amount.
To attract investment from elsewhere in the UK, just to set a rate of 19% would bring some investments across the North Channel.
At 19%, the cost to the local budget would be more manageable.
A second option would be to shift the impact of changes in the structure of corporation tax by keeping the tax rate the same as the rest of the UK with a local scheme of tax allowances for business investment expenditure, training and marketing costs, and approved research and development budgets.
Tax rates might be varied slightly but the big impact could be in making the net profitability of business higher than elsewhere by charging tax on a different basis.
Only with some imagination will the Treasury and the European Commission support helpful changes.