Andrew Goudie: Taxing issues to consider

Both sides of the independence debate need to answer serious questions about the future of corporate tax in Scotland, writes Andrew Goudie

Opening of Amazon's new fulfilment centre in Dunfermline. First minister Alex Salmond on his tour of the centre.

The recent constitutional debate has been largely dominated by the question of whether Scotland, if it had the requisite powers, would be permitted to lower its corporate tax rate relative to its partners in a currency union, be that a sterling or euro monetary union. While this is a critical question, it is by no means the only one regarding the value of securing future corporate tax powers.

It is important to recognise immediately that, while this debate has commonly been framed in the context of a possible future independence model for Scotland, these issues are equally critical for those who advocate the transference of corporate tax powers as an integral element of an enhanced devolution model with the continuance of the UK, such as devo-plus and devo-max.

To date, both sets of advocates have largely chosen to ignore these serious questions and, instead, sought to rest in the comfort of repetitive assertion.

The starting point is that there is indeed a strong case that lowering corporate tax rates – in a world in which nothing else changes – could inject greater profitability and cash flow into corporate thinking and stimulate much-needed investment by both domestic and foreign investors, accelerated economic growth and increasing revenues that the government could direct to the further economic development of the nation.

As the lively debate over the possible transference of corporate tax powers to Northern Ireland has demonstrated, the economic context is an important consideration, and its economy is radically different from the rest of the UK. In Northern Ireland, there is a very small corporate sector and there is certainly a strong case that this economic instrument could make a real impact upon corporate development and economic growth.

The crucial challenge for us is can this instrument play a valuable role in medium-term economic development and in rebalancing economic performance across a monetary union, not least in the UK where there are increasingly signs of regional imbalance? If, in a monetary union, we see a common monetary policy and, increasingly, moves towards a common banking policy and other pressures for harmonisation, what tools are left for a government to stabilise and rebalance its economy if you cannot use taxation and spending powers? Can you have too much harmonisation in this context? Indeed, so much so that you can threaten the stability of the monetary union itself by inhibiting rebalancing? The potential value of a corporate tax power is therefore considerable.

But this analysis is too incomplete to provide any meaningful conclusion. It may be correct, but we need to establish that there is a high probability that the real world does not react to this single policy change in such a way that these potential benefits are outweighed by other events.

What are these national and global realities that we need to consider? Initially, we should look at the question that has been to the fore: would our partners in any currency and monetary union agree to one of its members securing a significant competitive advantage in this way? Would they need to agree or could Scotland just adopt the policy? And would there be a cost to Scotland of pursuing its own direction?

The key point here is about the essence of union: can one member seek, by mutual agreement, to benefit from the collective strength of the union and from the sharing of risk in some key areas of policy, while seeking in other areas of policy to go its own way, potentially to the detriment of the union?

Scotland might, for example, wish to continue to be a formal partner in a sterling union’s regulatory and oversight arrangements, or to be a beneficiary of lender of last resort facilities provided by a UK central bank, particularly where the rest of the UK saw no reason of its own to support a struggling Scottish financial institution or indeed a Scottish government. But would the union as a whole be content with these arrangements without securing its own safeguards against Scottish decisions that it deemed to be potentially destabilising to the collective union or excessively competitive and to the detriment of other states?

The noises from the south, at present, in response to this hypothetical challenge suggest this is unlikely. The noises from across the channel in response to this real challenge suggest this would be highly improbable.

But this is only one critical point to make in this debate. There are other crucial perspectives to consider here. First, if the reduction in the Scottish corporate tax rate were prima facie allowed or not preventable, would the comparative advantage be sustainable if it were to provoke a similar response from other members or regions of the union? What would be the cost of that response?

Second, would the desired outcomes of the policy change be forthcoming? Would the corporate sector respond to such a policy change as asserted? While a 12.5 per cent rate – relative to the 30 per cent rate of other economies – may shift taxable profits, corporate operations and investment and, indeed, corporate headquarters across the globe, would a 17 per cent rate compared with a 20 per cent rate elsewhere? And would this relatively small, but important, potential benefit tip the balance in the boardroom in favour of an investment in the face of very serious global and sectoral uncertainties with which we can expect to live for the foreseeable future?

Third, it is simply inappropriate to analyse the value of one tax in isolation from the system in which it operates. What is the accompanying policy change that provides the resources to support a corporate tax reduction?

Over the medium term, the stimulatory effect of the reduction may well generate lagged increased revenues – in line with the predictions of economist Arthur Laffer – depending on the other considerations raised here, but in the shorter term, the financial costs of financing this policy need to be accommodated. What would be the short-term – and hopefully transitory – compensating changes in policy and expenditure? That is, what is the opportunity cost of the corporate tax reduction in terms of foregone alternative policy and alternative public expenditure?

What then is the net effect of the corporate policy change over both the short and medium terms when these full system changes are taken into account? Even with the option of resorting to debt finance, we would still wish to satisfy ourselves that this net impact would make a positive contribution to the economic growth objective.

Finally, and perhaps most challenging of all for the advocates of corporate tax powers for the Scottish Parliament, does the corporate tax system in the UK economy – and, more accurately, the global economy – have any integrity and credibility now? Have not the Amazons and Googles of the world exposed the massive flaws in the existing system and the irrelevance of the textbook explanations of how the corporate tax system works, at least for the medium and large-scale international corporates?

So why would we want to lay claim to a power that apparently neither operates as intended, nor generates a “fair” tax contribution to the national economy from its corporate sector, nor indeed makes a “fair” tax contribution to the global economy, never mind the distribution of those revenues?

The obvious corollary to this is can a national corporate tax system be statutorily redefined, implemented and enforced within a global economy in order that it does indeed function as intended, with the current massive legal loopholes being effectively plugged, without imposing a massive economic disincentive upon the corporate sector?

In the United States, the corporate tax system has been developed to manage many of these real-world problems in a more pragmatic manner with a degree of success. Or is the rehabilitation of this discredited global corporate tax system, and the solution to this intrinsically global challenge, impossible without the type of global thinking and global institutional collaboration that has so far proved beyond global policymakers?

In this wider and global context, where the fundamental nature of corporate taxation is so clearly compromised and in need of an all-encompassing rethink, are both our unionist and nationalist friends right to place such great value and expectations on the shoulders of a single crumbling tax?

Does our economic future really rest so heavily on this fragile piece of policy?

• Andrew Goudie is visiting professor and special adviser to the principal at the University of Strathclyde and a former chief economic adviser to the Scottish Government. He has edited a book, Scotland’s Future: The Economics of Constitutional Change, www.dundee.ac.uk/dup