Lining up tax dominoes across the British Isles

The recent report by the Northern Ireland Affairs Committee of the House of Commons on corporation tax brings the game of dominoes to mind. The report states that “On balance, we believe there is a convincing case for reducing the corporation tax rate in Northern Ireland, not least so it can better compete with the Republic of Ireland.” The committee acknowledged the practical difficulties of introducing this change.

Before dealing with those difficulties, the views of the committee need to be seen in context.  The Chancellor’s announcement in the recent budget that the main rate of corporation tax in the UK would be reduced to 23 per cent by 2014 demonstrates a belief that a lower rate of corporation tax is an important stimulus for business. Given his need to gather as much revenue as he can, he must also believe that a lower corporation tax will result in sufficient growth to make the change at least tax neutral.  The Secretary of State of Northern Ireland gave evidence to the committee that  he had wide support among the business community in Northern Ireland:

“Look at this group of businesses that did the jobs plan: CBI, Construction Employers Federation, the Centre for Competitiveness, the Northern Ireland Chamber of Commerce, IoD, Momentum, Northern Ireland Food and Drink, and the Northern Ireland Independent Retail Trade Association. They all said emphatically that the key thing they wanted was a low and competitive rate of corporation tax.”

The Committee’s Report continued:

“Many witnesses argued that while there had been many reviews of what was wrong with the Northern Ireland economy, all the previous prescriptions had not made a significant difference. The Northern Ireland Economic Reform Group told us:

‘…corporation tax is not just another policy instrument for promoting economic development. Rather it is, without exaggeration, the only means we know of comprehensively changing the economic environment, within a timescale of years rather than decades.’

“The Federation of Small Businesses echoed that call for a reduction in tax:

‘The initial feedback at the moment from our members is that 63 per cent would be in favour of a lower corporation tax. […] We have to do something dramatic […] to rebalance the economy in Northern Ireland. As you know, we have been too reliant on the public purse, and something radical has to be done to try to rebalance this.’ ”

Of course, these comments are equally relevant to Wales. Whatever the tax position of the Republic of Ireland, It is clear that corporation tax is considered a powerful tool to stimulate an underperforming economy. If it is true that the Republic of Ireland benefits economically by having a lower corporation tax rate than the UK, then it would be equally true that Wales would benefit from having a lower corporation tax rate than England.

One of the justifications of the Northern Ireland Select Committee’s recommendation is the parlous state of the Province’s economy. Its GVA per capita is £15,795, compared with £20,400 in England. But as the report acknowledges, the equivalent figure for Wales is even lower, at £14,842. The economic justification for a lower rate of corporation tax in Wales is therefore even greater.

The Committee sought to distinguish the case for Northern Ireland by relying on the fact that it has a land border with the Republic of Ireland. Yet, this portrayal of Northern Ireland’s case as unique is difficult to defend.

In the first place, if a lower corporation tax is regarded as an economic stimulus, the case for Wales is at least equal to that for Northern Ireland. Secondly,  Wales also shares a long border with the Republic of Ireland, albeit not a land border. It is arguable that businesses might choose to establish themselves and expand on the Welsh side of the Irish sea if the corporation tax rates were comparable. In addition, were Northern Ireland to receive a lower rate of corporation tax, Scotland would then find itself immediately adjacent to a Northern Ireland with lower tax rate. Doubtless, Alex Salmond’s government would find it even more unacceptable not have control over its own corporation tax.

As for the difficulties, they are numerous, but by no means insuperable. The initial problem is that HM Treasury and HM Revenue and Customs have no idea how much corporation tax is raised in Northern Ireland, since they do not break down the figures by country and region. Partly as a consequence of this there is no agreed methodology as to how corporation tax proceeds would be allocated.  At least in Scotland the Scottish government publishes Government Expenditure and Revenue Scotland. This provides a wealth of data on a Scottish basis, including the way they are calculated. It is high time that the Welsh Government created a similar database for Wales. In the second Holtham Report this issue was reviewed, and three estimates were given for Welsh corporation tax, The highest, at nearly £1.2 billion, came out as the one that used the Government Expenditure and Revenue Scotland methodology.

The transfer of the ability to levy and change the rate of corporation tax to the Northern Ireland Assembly is subject to European law. Nonetheless, it seems likely that the autonomy of the Assembly could satisfy the legal requirements laid out in the Azores case if the enabling legislation is appropriately drafted. This is underlined by the fact that, until the transfer of primary legislative power to the Welsh Assembly as a result of the referendum in March, it seemed highly unlikely that it would have satisfied the European criteria. Following that vote there is a much stronger case that the Welsh Assembly has sufficient autonomous powers for the devolution of corporation tax to be permissible.

The administration of a different rate of corporation tax (it is suggested that there would only be one rate), would also pose problems for Revenue and Customs which is not geared up to the task. In addition the Select Committee suggested that the Northern Ireland Executive should

“…pay for the administrative costs incurred by Revenue and Customs in managing the process and regulating any companies that wish to exploit the lower tax rate without creating any economic activity in Northern Ireland.”

Any decision to grant a power to vary the rate of corporation tax in Northern Ireland must necessarily require the granting of significant borrowing powers.  Since the yield of the corporation tax will be variable the Northern Ireland government must have the means of accessing the markets to smooth out its income stream. In addition if it chooses to lower corporation tax, there will be an immediate drop in its income (which cannot be made up by the UK government under European rules), and it is likely to be some time before economic expansion kicks in to increase the tax take.  Unless the Northern Ireland Executive is prepared to allow the whole shortfall to be taken from its other expenditure, for example on health and education, it will need some ability to borrow to maintain services while its economy adjusts.

There is also the risk that some of the economic benefit from a lower corporation tax results not in higher corporation tax receipts, but in higher income tax receipts, due to higher employment. In this case Northern Ireland may find itself in a position of having its block grant reduced for the benefit of the Treasury. The Select Committee stated that it did not think “it necessary to devolve any further tax measures at the moment”. Nonetheless, the inter-relationship between the various tax bases will clearly have to be considered carefully if the revenue framework is to be sustainable long term.

I have argued previously on ClickonWales that it would be open to the UK to legislate for a lower corporation tax in west Wales and the Valleys in accordance with EU legislation without reducing the block grant. If they believe what they say, the advantages for the UK government would be a higher growth rate in some of the UK’s poorest communities, an increase in the size of the private sector, and lower spending on unemployment benefit.

However, if this were not to happen then at the very least Wales should not be disadvantaged as compared with Northern Ireland. It is clear that both the political and business community there, and elsewhere, believe that lower corporation tax has the potential to affect the economic prospects of an area.  The Northern Ireland government is pushing strongly for the devolution of corporation tax, while the Scottish Government is doing the same for Scotland.

The Holtham report recommended that the Welsh Government should seek discussions with the UK government and the other devolved administrations about the feasibility of devolving corporation tax in Wales. It is time for the Welsh Government to make its own position clear. It should demand from the UK government that it be given economic and fiscal levers over the Welsh economy comparable to those granted to the other devolved administrations.