Written evidence from the Northern Ireland
Economic Reform Group (NIERG)
On behalf of the Northern Ireland Economic Reform
Group (NIERG) we are pleased to submit a contribution to the Northern
Ireland Affairs Committee inquiry into the establishment of a
differential rate of Corporation Tax for Northern Ireland. The
ERG is small group of economists, accountants and business representatives
in Northern Ireland and beyond, with concerns about Northern Ireland's
weak private sector, its dependence on GB taxpayers and its consequent
vulnerability to economic change.
The ERG was formed in 2009 specifically to advance
the case for transferring responsibility for Corporation Tax to
the Northern Ireland Executive. It is the Group's belief that
reduced corporation tax is the only policy innovation with the
potential to rapidly expand Northern Ireland's export base and
to begin closing the wide productivity gap between NI and GB.
The Group has produced a detailed report on the issues, both in
terms of the potential effectiveness of this policy and the practical
steps that would need to be taken to give it effect. This Report
('The Case For Reduced Corporation Tax in Northern Ireland') has
influenced the Secretary of State for NI in advancing reduced
corporation tax as a potential Coalition policy for reviving the
private sector in NI. A copy of the Report, which is being made
available to the Committee, forms the evidence base for the answer
to the Committee's questions below.
It is not our intention in this submission to rehearse
in detail all of the arguments for a differential rate of Corporation
Tax in Northern Ireland. However, we believe that it is essential
that the Committee grasp the fact that varying 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. For more than half a century Northern
Ireland has pursued a development policy that offers inducements
to invest by subsidising the costs companies face, be these capital
outlays, labour subsidies or research and development costs. This
policy sells Northern Ireland as essentially a low cost area in
which to do business and not surprisingly attracts companies with
a focus on cost reduction, many of them paying low wages. The
Corporation Tax policy, on the other hand, is based on selling
Northern Ireland as a place where investment can yield profits
that can be retained. It attracts a different type of company
where value added and profit is the main focus of their business,
and where wages and productivity are high. This changes the game
and will revolutionise the operations of development agencies
and those tasked with re-skilling the workforce. No other instrument
or combination of instruments has this potential to transform
how Northern Ireland does business and engages with the global
economy in anything like the same timescale.
Those who doubt this proposition need do no more
than compare the inward investment experience of Northern Ireland
with that of the Irish Republic. When all other factors are taken
into account it is clear that the ability to maintain low rates
of Corporation Tax has allowed the Irish authorities to bring
in large volumes of new investment from leading foreign companies
that Northern Ireland has no prospect of attracting. This success
has propelled Ireland from one of the poorest countries in the
European Union to one of most prosperous in under a generation,
a fact that remains true even after the recent financial difficulties.
Whilst we would be supportive of ability for the
Northern Ireland Assembly to introduce fiscal incentives other
than low corporation tax, we believe that the ability to vary
the rate of corporation tax is key to the ability of Northern
Ireland to make the necessary "step change" required
to remove its huge reliance on public expenditure and to accelerate
the growth of the private sector. We see this as being best achieved
in two main steps. Firstly the initial devolution of tax varying
powers to the Northern Ireland Assembly should be granted by the
Westminster Parliament. Secondly, following consideration of the
costs and obligations of varying the rate, the Northern Ireland
Assembly would vote to reduce the rate of corporation tax for
qualifying Northern Ireland companies.
We fully accept that this is a revolutionary policy,
unprecedented within the UK tax system, and one that involves
a number of serious administrative challenges. These challenges
are fully addressed within the ERG report and we believe that
they can be successfully managed. The prize for taking this bold
step is a beginning to a revival in the UK's weakest regional
economy, which can contribute to higher living standards in NI
with lower fiscal contributions from GB taxpayers. With this introduction
we turn to the specific questions the Committee has posed.
The members of the Group
are:
1. What effect will the reduction in the corporation tax
rate on a UK wide basis announced in the June 2010 Budget have
on the competiveness of the Northern Ireland economy?
We must first consider the size of the task facing Northern Ireland.
Output per person is barely 80% of the UK average, a figure that
has endured for decades. Thirty per cent of those in employment
actually work directly for the state and a substantial number
of the rest are indirectly supported by public spending. The region
as a whole runs a very substantial trade deficit (most of which
is financed by financial transfers from Whitehall) and only a
handful of firms are serious players in the export market.
The proposed UK-wide corporation tax rate reductions, even when
fully implemented, will reduce the main rate of corporation tax
to 24%, leaving the rate of corporation tax in Northern Ireland
for large businesses at nearly twice the Republic of Ireland (RoI)
rate of 12.5%.This reduction will enhance the UK's attractiveness
as being a good place to do business, but will have only a small
impact on the inflow of foreign direct investment (FDI) into the
UK including NI and not nearly as much as is the case in the RoI.
If other countries retaliate by matching the UK's tax reductions
the impact on FDI will be negligible. Even if other countries
do not retaliate, a UK-wide tax reduction will do little to close
the wide gap in wages and productivity between NI and GB. Also,
a UK-wide reduction in CT is likely to have a minor impact on
investment by existing firms in NI, but will otherwise leave the
competitiveness of these firms largely unchanged. In short there
may be some benefits but they would leave NI's relative disadvantage
largely unchanged.
2. What would be the benefits of equalizing the corporation
tax rate in Northern Ireland with that of the RoI?
The potential benefits are large. The extensive academic literature
suggests that new greenfield FDI responds strongly to low rates
of corporation tax. The ERG also uses new data specifically on
new FDI in export sectors to estimate the potential impact of
a 12.5% tax in NI. This analysis suggests that employment in NI
could increase by 90,000 jobs over 20 years. Since the majority
of these jobs can be expected to be in high value-added firms
there would be a substantial impact on average productivity and
wages in NI. The economic model which underlies the ERG report
suggests that total additional tax revenues would rise to around
£1 billion after 20 years. Most of this revenue would accrue
to the UK Exchequer rather than to the NI Executive. The Committee
is referred to the report for details.
For a practical application of low CT rates one has only to look
at the Republic of Ireland (RoI). It has attracted a far larger
share of global FDI flows than would be expected in a country
of its size. According to the latest UNCTAD World Investment Report
(2010), the Republic holds a $192 billion stock of FDI, some 2.3%
of Total EU FDI for 0.9% of its population. The Republic is ranked
in the top 20 global FDI destinations. In its most recent strategy
document, IDA Ireland sets out to create 105,000 high value added
jobs by 2014[11]. The
Varney Review of tax Policy in NI, and other commentators on the
RoI, suggests that low corporation tax is only one of several
factors attracting FDI to the RoI. We believe that this view is
based on a misunderstanding. While it is true that the RoI has
had to greatly improve its formerly poor educational, transport
and other standards to fully benefit from low corporation tax,
the question we are interested in is what impact does low CT have
on economies like NI which already have high standards of education
and transport and other infrastructure. It is this question
that is addressed in the attached NIERG report to produce the
estimates given in the previous paragraph.
The current difference in FDI inflow between NI and the RoI are,
we believe, very largely due to the contrasting rates of corporation
tax. Over the past 12 months, during the worst economic climate
ever experienced by the Irish state, the impact of a low rate
of corporation tax has been very significant in the attraction
of many new and additional inward investment projects and this
is confirmed by recent IDA Ireland announcements which have referred
to over 50 inward investment projects into the Republic of Ireland
since the start of 2010. A more competitive tax rate in Northern
Ireland would also give an impetus to make the other changes in
our economic development agencies needed to fully capitalise on
this opportunity. Whilst Invest NI will continue to have a very
important role to play in promoting NI and attracting FDI, the
way Invest NI works will have to change as will the various agencies
concerned with education and training if the needs of high end
companies previously out of our grasp have to be addressed. There
is no reason, in our view, why such reforms in NI, could not accompany
a reduction in the CT rate. We would also note that despite an
increase in almost all areas of taxation in Ireland over the past
24 months, many of which have arisen as a result of the need to
reduce the Government deficit arising from the global economic/financial
crisis, the Irish Government has not increased the rate of corporation
tax. This is a clear indication of how important this low tax
rate is to the continued success of the Irish economy.
There will also be a number of benefits to smaller local businesses
in the form of:
- Opportunities for them to provide services and goods to FDI
companies.
- New spin outs where individuals would gain or enhance their
skills within a large FDI and use these as a platform to set up
their own business.
One final point made by some commentators is that the Celtic Tiger
phenomenon occurred only decades after the introduction of low
CT in the RoI in the late 1950's. We believe that this point is
based on a superficial view of the Irish economy. Firstly, careful
economic analysis has shown that the impact on FDI of a reduced
profits tax in the RoI in the 1950s was immediate and has been
sustained. The impact accelerated in the 1990's since the EU Single
Market reforms allowed firms in Ireland to access a wider EU market.
In addition, the high technology boom of the 1990s increased investment
in precisely the R&D-intensive firms which gain most from
low CT. The Celtic Tiger effect was also of course promoted by
low interest rates within the Eurozone, but this is a separate,
and as we now know, unsustainable matter.
3. What alternative measures could be introduced by the
UK Government to make the NI economy more competitive
We are of the view that there are no alternative measures to a
reduced rate of corporation tax that would have the same potential
to significantly impact on the growth and development of the Northern
Ireland economy within a timeframe of a few years as opposed to
several decades.
Nevertheless, competitive Corporation Tax rates should be seen
as part of a package of policy measures designed to ensure that
Northern Ireland can connect with and operate effectively in a
globalised world economy. Apart from taxation the other key dimensions
of policy are:
- (a) An outstanding education and training system which
is flexible enough to cope with changing needs of the economy
in good time. While NI's educational attainment is good by UK
standards, the OECD's PISA results show that it is only average
by wider international standards, and well below leading EU nations
like Finland or even Estonia. Much more can be done to bring NI
standards up to international best practice. A recent DETI study
of small high productivity EU nations examines how this has been
achieved in countries like Finland.
- (b) A high rate of investment in R&D and innovation,
especially by businesses. Business investment in R&D (BERD)
in NI is very low at 0.6% of GDP. This is half the rate in the
RoI, and one fifth the rate in Sweden or Finland. We support the
conclusion of the Independent Review of Economic Policy in NI
(IREP) that the focus of economic development policy in NI should
give greater emphasis to promoting R&D and innovation.
- (c) NI's transport and Communications infrastructure is
generally good but first rate communications (both physical and
electronic) to connect to the wider world need to be fully maintained
to keep up with a fast changing global market.
- (d) Business friendly administrative arrangements. This
should include a planning regime that does not hold up necessary
investment, but more generally the NI Executive needs to take
much more seriously its commitment to reducing the productivity
gap with GB. Agreement on reduced corporation tax would send a
powerful signal of the Executive's intent to achieve this goal.
- (e) An entrepreneurial culture that celebrates wealth
creation. NI comes out poorly in the Techtrack league tables of
fast growing technology companies, published annually by the Sunday
Times. The promotion of new firms with high growth potential is
not well understood and requires more research.
Apart from the taxation issue most of these matters are in our
own hands, though some modest additional resources may help to
smooth the task of rebalancing the economy.
A useful mantra for a new economic development strategy might
be TAX-TALENT-TRANSFORMATION. Flexibility in taxation to attract
the best companies, an intelligent, disciplined and flexible workforce
and the willingness to transform our arrangements to meet the
challenge of competing in the global market place. It is clear
that NI needs to look well beyond the traditional regional policies
adopted within the UK. We believe that the recent DETI research
on small peripheral EU nations is a starting point for this process.
4. Is a reduction in corporation tax the simplest and quickest
way to make the NI economy more competitive and how long would
it be before NI realised the benefits?
Yes. There is no other policy suggestion that holds out a better
or faster prospect of bringing about the radical changes that
are necessary to get the Northern Ireland economy out of the bottom
few of the regional league table in the UK where it has languished
for more than half a century. A policy of reduced corporation
tax is the only mechanism that would contribute to a successful
economic development strategy in Northern Ireland over a reasonable
timescale. A low corporation tax rate has proved to be an indispensable
ingredient of faster growth in the Republic, and there is no reason
to believe that it would not make a major economic improvement
north of the border.
Northern Ireland has been heavily subsidised by the rest
of the UK for many decades. The fiscal deficit (£7.3 billion)
was equivalent to 26.1% of GVA in 2007-08 -around £4,160
per head.[12] Relative
to national/regional income, this is over five times higher than
the level of subsidy the Republic of Ireland was receiving from
the EU, and yet the Republic's economic take-off has so far proved
elusive north of the border. It is time for a different approach.
The benefits of a competitive rate would flow almost immediately.
Even an announcement that reduced corporation tax was on the way
would transform events such as the US Investment conference. We
know of one London-based Venture Capital company that has looked
afresh at NI on even a possibility of reduced CT. Over a decade,
and subject always to the caveat that the world economy does not
turn down, we should see a turnaround in the number and quality
of FDI companies coming to Northern Ireland.
Nevertheless, the other things that have been mentioned must not
be neglected. To take an analogy, corporation tax is the engine
that can take our rocket into space but we still have to make
the rocket, train the crew and build the launch facilities before
the voyage can begin.
One further thing to be clear about is that the corporation tax
policy is not intended to be a financial benefit to the Northern
Ireland Executive. There will be fiscal benefits through other
taxes such as income tax and VAT as the policy begins to work,
but these will flow to the Treasury and would represent a reduction
in the subvention needed by the region. The Executive's budget
will carry a cost but the best way of thinking of this is that
it is the cost of a very much more effective way of creating high
quality jobs than the grant regime we currently depend upon.
Indeed the Department for Enterprise, Trade and Investment in
Northern Ireland has recently indicated that over the last five
years more than 20 FDI projects have been lost to the Republic
of Ireland[13]. Whilst
it cannot be proved for certain that this was solely due to lower
corporation tax rate, the number is very high given the significantly
lower cost base that Northern Ireland had to offer during this
period, The response did not take into account other FDI opportunities
that considered Northern Ireland but which were then located in
other countries.
A firm commitment to a reduction in the rate of corporation tax
in Northern Ireland for a long term period would place Northern
Ireland at the forefront of many FDI decision making agendas.
The evidence from the Republic of Ireland, and from other countries,
is that a continued period of low corporation tax has been a huge
factor in the success of attracting FDI and that this continues
to be the case today.
5. What are the legal barriers to the introduction of different
corporation tax rates on a regional basis within the UK?
Chapter 6 and 7 of the ERG report cover this point and we would
refer the Committee to these chapters. The clear and simple conclusion
is that whilst certain legal issues arise at both a UK level and
at an EU level, these issues can all be addressed with appropriate
legislation. Indeed a conclusion of the report from Sir David
Varney confirmed that "a move to a differential corporation
tax rate for Northern Ireland was possible in principle"[14]
Chapters 6 and 7 also deal with the administrative changes needed
to avoid profit shifting, and other ways in which HMRC might lose
revenue to tax-avoiding firms. We believe that simple measures
can be applied to minimise this danger, although rigorous policing
of the measures would be needed to ensure success.
6. What would be the effect of reduced tax revenue in Northern
Ireland?
Under the EU State aid legislation as enunciated by the ruling
in the Azores case[15],
the cost of a reduction in the corporation tax for companies based
in Northern Ireland would have to be effectively borne by the
Northern Ireland Assembly and hence met from the Executive's budget.
The report of NIERG has attempted to quantify the annual cost
to the NI Assembly of reducing the rate of corporation tax to
12.5% but as highlighted in the report, this is a best estimate
and a reliable estimate of CT revenue raised in NI is not currently
available from HMRC. The NIERG estimate for the initial
annual cost of reducing CT in NI from 28% to 12.5% was £215
million. The Report points out that when the RoI extended its
reduced 12.5% rate to the service sector in 2002-05 there was
no fall in CT revenues.
We understand that absorbing any cost associated with introducing
a reduced rate of corporation tax will be difficult but we see
this cost as an investment in the long term economic growth and
development of the Northern Ireland economy and thus the potential
significant future benefits should clearly justify the short term
investment cost.
However we do recognise that it should ultimately be a matter
for the Northern Ireland Assembly to determine the level of investment
to be made and thus our recommendation is that the introduction
of a reduced rate of corporation tax in Northern Ireland would
be best achieved in a two phase approach - namely the initial
devolution of the appropriate tax varying powers to the Northern
Ireland Assembly followed by the implementation, taking all factors
into account,of an appropriate reduction in the rate of corporation
tax for qualifying Northern Ireland companies.
7. What evidence is there from other countries that having
different corporation tax rates on a regional basis is effective?
Apart from the transformation of the Republic of Ireland which
is discussed above, there are two other exemplar regions of the
EU in which a differential corporation tax rate has been effective.
The first region is the Azores where corporation tax was reduced
from 34% to 23.8% from 1999 until 2004 and from 25% to 17.5% from
2004 onwards. The justification for these tax reductions was to
accelerate the economic development of the Azores. Even though
the region eventually lost autonomy over corporation tax the operation
of a more favourable regime for almost a decade did accelerate
the development of what was a very agrarian economy.
An even better example is the Basque region of Spain which has
operated a largely autonomous fiscal system since 1979. The Basque
region is currently the wealthiest region in Spain, with GDP per
capita being 40% higher than the EU average and 33.8% higher than
Spain's average in 2008, at 31,712 EUR.
In September 2008 the European Court of Justice (ECJ) published
its judgement in respect of the Basque Country (cases C-428/06).
This judgement was sought by the Basque High Court of Justice
as to whether the Basque Country meets the three Azores conditions.
The ECJ preliminary judgement is that the Basque Country is sufficiently
politically autonomous and has the necessary tax varying powers.
On the question of whether it is economically autonomous the ECJ
did not come to a definitive view. There are financial transfers
between the Spanish government and the Basque administration but
these are unconnected to the tax scheme under consideration. The
matter is to be decided by the Supreme Court of Spain and it is
probable that the national court will confirm that the Basque
tax system meets the requirements of the three autonomy tests.
The Basque region's corporate tax autonomy has been an important
element in its economic development success to date.
8. What are the implications for other regions if there
were different levels of corporation tax within the UK?
We believe that whilst we are well placed to comment on the issue
of a reduction in the rate of corporation tax for Northern Ireland
we have not done any equivalent in-depth analysis in respect of
other regions of the UK.
However we would note that if other regions of the UK were to
fulfil the criteria laid down by the Azores ruling and that the
appropriately elected regional legislature wished to bear the
cost of tax varying powers that it would be appropriate for them
to do so.
We would fully support the introduction of appropriate measures
to ensure that the reduced rate of corporation tax would only
be applicable for companies that carried out trading activities
in Northern Ireland and that the reduced rate should not be available
for those purely seeking to reduce their liability to UK taxation.
We would point out that unlike any other region of the UK, Northern
Ireland has a border with another EU state which has a corporation
tax rate of less than half the rate applicable in Northern Ireland.
We know of companies that have located, or relocated just south
of the Irish border in order to avail of both the RoI's tax rate
and access to the NI ports or other facilities. Thus a reduction
in the rate of tax in Northern Ireland will undoubtedly have a
greater impact in Northern Ireland than it would in other regions
of the UK.
23 September 2010
11
"Horizon 2020: IDA Ireland Strategy" March 2020, page
2 Back
12
Northern Ireland Net Fiscal Balance Report 2007-08 (experimental).
Department of Finance and Personnel, September 2009 Back
13
Response to written Assembly question from Sinn Fein MLA Paul
Butler to the DETI minister. AQW 7422/10 Back
14
Section 3.20 of the Review of Tax Policy in Northern Ireland by
Sir David Varney December 2007 Back
15
European Court of Justice (ECJ) September 2006 (C 88/03) Back
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