Corporation Tax in Northern Ireland - Northern Ireland Affairs Committee Contents

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:

Eamonn Donaghy KPMG
Neil Gibson Oxford Economics Ltd
Dr. Graham Gudgin Centre for Business Research, University of Cambridge
Michael Hall Ernst and Young
Victor Hewitt Director ERINI
Sir George QuigleyChairman, Bombardier-Shorts
Michael Smyth University of Ulster

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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