Gavin McCrone: Scotland risks backlash if it cuts taxes for businesses

THE Scottish Government is arguing for the Scotland Bill, at present going through the UK parliament, to give greater powers over taxation to the Scottish Parliament than are currently proposed. Ideally they would like to see complete fiscal autonomy, but one of the principal reasons for wanting this is to give them power to set their own rate of corporation tax. They argue that this is necessary to promote the growth of the Scottish economy.

It is not the first time this issue has been raised. In 1969, when I was adviser to the House of Commons Committee on Scottish Affairs, the Scottish CBI proposed that, to promote economic development, Scotland should have a lower rate of corporation tax than the rest of the UK. This was given short shrift by the Treasury at that time on the grounds that it was unworkable and would be unfair to other disadvantaged parts of the UK.

However, the Irish Republic has a corporation tax rate of only 12.5 per cent on trading profits (profits on non-trading activities such as rent, interest and capital gains are taxed at 25 per cent). This compares with the UK rate of 26 per cent. Irish ministers certainly see their low rate as very important for the development of their economy. It has undoubtedly enabled Ireland to attract a large volume of international investment, and the Irish have strongly resisted attempts by France and Germany to get them to raise it as a condition for their country’s recent financial bailout. Whether it will survive the proposals presently being developed for the eurozone, which aim to buttress the monetary union with some kind of fiscal union, remains to be seen. It may be that at some point Ireland will have to decide whether power over this tax is more important than remaining part of the eurozone.

Meanwhile, the Northern Ireland Executive, for whom competition with the Irish Republic is much more important than it is for France and Germany, consider themselves to be at a major disadvantage without the ability to match this low rate of corporation tax. The UK government is therefore considering this, and the Treasury’s paper “Rebalancing the Northern Ireland Economy” sets out the implications. It is against this background that Scottish ministers have published their own consultation paper arguing for Scotland also to have this power; and the Holtham Commission on Funding and Finance for Wales argues that if Northern Ireland gets it, Wales should have it too. None of this is welcome to ministers in Northern Ireland, who justifiably think that their land border with the Irish Republic gives them a special case, and believe that attempts by Scotland and Wales to climb on the bandwagon is only going to strengthen the resistance of the UK government.

So what are the arguments? Of all the taxes that the government collects, a cut in corporation tax is the most likely to improve economic growth. This is fully set out in the Treasury paper on Northern Ireland and applies equally to Scotland. If local businesses can retain more of their profits, they are likely to invest more, leading to more growth and higher employment; foreign businesses would see Scotland as a more attractive location in which to invest; and businesses in other parts of the UK might also decide to move to Scotland or base part of their operations there. More problematically, both foreign companies and UK companies with operations in more than one country or one part of the UK might try to arrange their accounts so that they declare as much as possible of their profits in Scotland to take advantage of the low rate of tax – profit-shifting, or what is known as the “brass plate” effect.

If there are beneficial effects, why don’t all countries reduce their rates of corporation tax? For the UK, Chancellor George Osborne is actually doing so; the June 2010 budget cut the main rate of corporation tax to 26 per cent, and it is to be reduced in stages to 23 per cent in 2014 (the rate for small companies is 20 per cent). The only reason he has not cut it by more or cut it faster is that he needs the revenue. And whereas the cut would affect revenue immediately, the beneficial effect of higher growth is uncertain, would take longer and any increase in government revenue would be long-term. The Scottish Government recognises that there would be a short-term hole in their finances if they cut the tax rate, and for this reason has set out various options that would mitigate this effect.

For business, the main implication would be that companies that are UK-wide would have to account for their Scottish operations separately from those they might have elsewhere in the UK. This would involve them in extra expense but would be well worth it if the difference in tax rates was significant. The Scottish Government’s paper says there are rules which would prevent artificial profit-shifting. No doubt this is so, but it would not be easy to police and I have always understood that it has been a significant factor benefiting Ireland.

What must worry the UK government is the need to preserve fair competition – a level playing field – in the encouragement of investment, both domestic and foreign, to locate in the various countries and regions of the UK.

If Scotland, and perhaps Wales, had lower rates of corporation tax than the rest of the UK, there would undoubtedly be a very strong reaction in the regions of England, especially in the north of England, which generally has a lower GDP per head and higher unemployment than Scotland. It is inconceivable that this would not lead to some reaction by the UK government. While it might be able to accept a lower rate for Northern Ireland because of its special circumstances – the land border with the Republic and the need to recover from the Troubles – I do not think it could take the same attitude to Scotland and Wales.

The European Union has rules intended to ensure that competition between countries is fair, and this has been tested before the European Court of Justice in the case of the Azores, where tax rates were different from the Portuguese mainland. The most important requirement would be that other parts of the UK must not subsidise Scotland for any cut it makes in corporation tax. This means that if corporation tax were devolved in full and if it yields £2.6 billion, excluding tax on North Sea oil, that amount would have to be deducted from the block grant that the Scottish Government receives. If Scotland’s geographical share of North Sea oil were included, the amount would, of course, be very much larger. Making good this cut would then depend on how much corporation tax, or for that matter other taxes, the Scottish Government decided to raise.

Although we have never had different rates of corporation tax between the component parts of the UK, the purpose of regional economic policy was to encourage investment to go to the parts of the country that suffered unemployment, decline of the older industries or poor rates of economic growth. The principal measures were, at different times, accelerated depreciation allowances or investment grants. Not much remains of this: although some grant assistance is still available, the main instrument – the regional development grant – was abolished in the 1980s. The Thatcher government, with its free market ideology, had little time for such measures. But if we are now to have differential rates of corporation tax, some degree of rationality is required across the component parts of the UK. Without this, even if Scotland were to leave the UK, serious feelings of injustice would lead to demands for retaliatory action. This would be in neither the interests of Scotland nor the UK.

• Gavin McCrone was formerly chief economist at the Scottish Office