Budget Special 2: We also share a border with Ireland

Last October I wrote an article for clickonwales Azores give grounds for Welsh tax break in which I argued that some recent European Court of Justice cases provided a strong argument for a lower rate of corporation tax in West Wales and the Valleys. In light of last week’s budget indication of the devolution of corporation tax to Northern Ireland, it is timely to re-iterate the potential for parts of Wales to have lower corporation tax.

BUDGET SPECIAL Tomorow Dylan Jones Evans says discretion over corporation tax would  give Wales a hand up rather than a hand out.

In summary, European Court of Justice case law indicates that a lower rate of corporation tax in part of a member state is only allowed in two situations:

• If the governmental body which legislates for a lower level of tax is an independent entity which has the necessary authority and bears the consequences of its actions; or
• If it applies to a severely disadvantaged area of the EU and is therefore permissible as an operating aid.

To satisfy the first approach the European Court of Justice said:

“In order that a decision taken by a regional or local authority can be regarded as having been adopted in the exercise of sufficiently autonomous powers, that authority must first have, from a constitutional point of view, a political and administrative status which is distinct from that of the central government. Next, the decision must have been adopted without the central government being able to intervene directly as regards its content. Finally, the financial consequences of a reduction of the national tax rate for undertakings in the region must not be offset by aid or subsidies from other regions or central government. Those three conditions are commonly considered to be the criteria of institutional, procedural, and economic and financial autonomy.”

It is on the basis of these criteria that the UK government has been considering giving corporate tax autonomy to Northern Ireland. In a recent article in the Financial Times, it was calculated that if Corporation Tax in Northern Ireland were lowered to the 12.5 per cent rate of the Republic of Ireland, there would be a cut in the block grant of £105 million in the first year, rising to £270 million of the block grant after five years.

Until the Referendum result on 3 March  this year it was very doubtful that the Welsh Government would have satisfied the tests laid down by the European Court of Justice, since the UK government clearly ‘intervened’ in the Welsh legislative process. However, the situation may well be different now that the National Assembly can pass laws without such interference. The new autonomy and dignity of the Welsh legislative process may now satisfy the European Court of Justice’s requirements if fiscal autonomy for corporation tax were transferred.

However, there is another and more interesting opportunity to vary corporation tax in Wales. Due to its comparative poverty, West Wales and the Valleys is a severely disadvantaged area of the EU, and is entitled to state aid. The UK government does not have to devolve decision making in respect of corporation tax to the Welsh Government in order to lower corporation tax in West Wales and the Valleys. There is a strong argument that it could do so now, and this would be treated as permissible state aid, as long as it were commensurate with the disadvantage suffered.

A simple approach to do this would be to take the GDP figures which the European Union uses to calculate whether a region is entitled to convergence funding, and use these as a percentage of the UK average and multiply this by the corporation tax rate. According to the latest Eurostat figures (albeit already rather out of date) the GDP per capita of West Wales and the Valleys is some 62 per cent of the UK average. On this basis it is arguable that it would be permissible to have a corporation tax rate (for larger companies) of 26 per cent from April (following the budget announcement) x 62 per cent = 16.12 per cent.  Whether or not such a simple approach was used it illustrates the potential reduction.

This tax rate would be competitive, and because it was permissible state aid applying to only part of Wales it would not require any reduction in the Barnett allocation.

What is the case for a lower corporation tax? The recently published UK government consultation paper Rebalancing the Northern Ireland economy sets it out succinctly for Northern Ireland:

“A lower corporation tax rate would, on its own, be likely to have a positive effect on local private sector investment and foreign direct investment (FDI) by increasing the return on capital to investors. In addition, a lower corporation tax rate means that businesses may have more post-tax profits available for internal investment. Increased investment, other things being equal, typically leads to increased growth and employment.

“Northern Ireland is one of the UK’s most disadvantaged regions and has a small private sector, which has led to a strong dependence on the public sector. The recent economic recession has had a serious impact on the Northern Ireland economy and Northern Ireland has had a larger increase in its unemployment rate over the last year than the rest of the UK. A reduced corporation tax rate could play a significant role in helping to rebalance the Northern Ireland economy, especially over the longer term, by encouraging private sector investment and growth.”

If this is true for Northern Ireland, it is no less true for Wales, and particularly so for West Wales and the Valleys. Chapter 4 of the document sets out a number of the issues that need to be considered in this context.  They are as relevant to Wales as they are to Northern Ireland.

It is clear that Chancellor George Osborne believes that corporation tax rates are an effective way of making the economy more competitive. This is why he lowered those rates for the UK as a whole in last week’s budget. In the 2010 budget he said

“The Government is determined that all parts of the UK benefit from sustainable economic growth, and that the private sector recovery is particularly strong in areas that are currently overly dependent on the public sector.”

Lowering corporation tax in West Wales and the Valleys will enable him to be as good as his word.

The border Wales shares with the Republic of Ireland is comparable in length with that of Northern Ireland, it just happens to be a sea border. For many people in north west Wales Dublin is their nearest capital city. When businesses are deciding which side of the Irish Sea to establish themselves, Wales should not be put at a disadvantage.

There is therefore a powerful case for considering a lower rate of corporation tax for West Wales and the Valleys.  There is a strong argument that it would comply with EU rules, and it is within the gift of the UK government. It would also be consistent with the current government’s policy of lower taxation rates to stimulate business recovery and expansion. The consultation being done for Northern Ireland in respect of the practical and financial implications should also encompass Wales.

Labour’s spokesman, Pontypridd MP Owen Smith has been quoted in the Western Mail as saying:

“I don’t think anybody is seriously suggesting that Wales could or should have a separate corporation tax threshold to England” (25 March).

If that is the case, one is forced to ask why not? In view of the fact that Wales and Ireland also have a common border, and the particular poverty of West Wales and the Valleys, Owen Smith should surely be making the case for something that would be beneficial to his constituents rather than merely dismissing it. Now is the time to strain every sinew to to use any permissible state aid allowed by the EU that would be for the benefit of Wales. The next Welsh Government should open discussions with Westminster as soon as possible on the potential of a lower corporation tax for West Wales and the Valleys.