Corporation tax: cutting to why it should matter
The tax firms pay on profits may not be a conversation-stopper - yet. But it could help create 90,000 jobs here. Have I got your attention now, asks Eamonn Donaghy
Yesterday - Thursday, March 24, 2011 - the words corporation tax took centre stage when the Secretary of State, the Exchequer Secretary, the First and Deputy First Ministers and the leaders of the five main parties in Northern Ireland came together for the launch of the Treasury consultation document on rebalancing the economy.
But what makes the rate of corporation tax such an important issue? As you might expect, companies which make profits will pay corporation tax.
Those companies that make a small amount of profit pay tax at 20% and those making larger profits, or are part of a larger group of companies, pay tax at 28%.
However, most companies see corporation tax as a cost to their business and, therefore, where there is an opportunity to reduce costs, businesses will look carefully at how they can achieve this.
In the Republic, the corporation tax rate is 12.5% for all trading companies and this is credited with attracting a large amount of foreign direct investment (FDI) over the last 20 years.
Indeed, in spite of the financial turmoil of 2010, the Irish government fiercely resisted calls from France and Germany to increase their corporation tax above 12.5%.
The rewards obtained from low corporation tax have since continued via the ongoing steady flow of foreign direct investment into Ireland. The obvious cost of increasing this rate would be an exit of such FDI companies which would locate in another country providing low corporation tax.
Many commentators - including the Northern Ireland Economic Reform Group (NIERG), as well as Secretary of State Owen Paterson - hailed a reduction in corporation tax for Northern Ireland as a means of kick-starting the economy, where the private sector is much smaller than other parts of the UK and the Republic.
To comply with EU rules, the Assembly would need to have devolution of tax-varying powers from Westminster before a reduction in corporation tax could be introduced.
This would, of course, require the consent of the Government. Mr Paterson has embraced this idea and is a very keen advocate of granting the necessary powers to the Assembly as a means of rebalancing the economy. The current consultation document seeks opinion on whether this is the right thing for Northern Ireland.
However, even if the decision to devolve corporation tax here was taken, a further EU requirement is that the Assembly must introduce the corporation tax rate reduction and also effectively pay for the privilege.
A reduction in the corporation tax rate could result in a reduction in the overall corporation tax yield from Northern Ireland companies. This reduced tax would have to be compensated for by a reduction in the block grant from the Treasury.
However, while this may seem to be an unwelcome loss of income for Northern Ireland, there are several key points which must be considered before claiming that a cost could not be afforded.
Firstly, the upfront cost could be significantly reduced if the reduction in corporation tax to 12.5% was phased and reduced by say 2.5% each year over a period of six years.
The estimated figures in the consultation document demonstrate that such phasing in would reduce the cost by more than 70% over the first five years.
Secondly, when considering the reduction in corporation tax yields, one must also consider that there will be additional jobs created within Northern Ireland.
The increased payroll taxes and VAT can and should be used to defray the corporation tax cost. Once again, this should have a significant impact in reducing the costs to the Northern Ireland block grant.
Thirdly, the reduced rate of tax need only apply to trading profits and not to investment income or capital gains. This is what happens in the Republic.
Not only would this target the relief at trading activities, which is where job creation comes from, but it would significantly reduce the cost of reducing the corporation tax rate.
Finally, the Northern Ireland Economic Reform Group estimates that more than 90,000 jobs could be created over 20 years by reducing the rate of corporation tax to 12.5%.
No other economic policy would appear to come close to achieving this type of job creation. Indeed, with Northern Ireland being unable to offer grants to new businesses with effect from 2013, it is hard to see how else many jobs will be created in the province via foreign direct investment in the short to medium term.
A reduced rate of corporation tax in Northern Ireland will attract foreign direct investment and encourage local companies to reinvest profits - both of which should grow the private sector and create long-term, sustainable and well-paid jobs.
That's why corporation tax is such an important issue.