George Kerevan: John Swinney approach may pay in the long term

HERE is a salutary tale for all politicians and economists. In 1990, President George Bush the First raised personal taxes to tackle a massive budget deficit. Yet over the next five years, the US economy actually grew at over 3 per cent per annum – a whopping amount.

I mention this not because I think higher taxes promote economic growth – they don’t – but to warn against simplistic nostrums that cutting taxes is the elixir of instant economic progress. Economies are damnably complex, unruly things. Remember, economies are just people and folk can be mighty contrary. Economies also operate with lengthy and little understood feedback mechanisms, which means you can be pumping the brakes when the car is already decelerating, as is the case with Chancellor George Osborne.

Yesterday on the BBC’s Good Morning Scotland programme, SNP finance secretary John Swinney revealed his likely approach to taxation in an independent Scotland. As I’ve long maintained, Swinney is a fiscal conservative, not a tax-and-spend statist. He does not see income tax rising, he won’t squeeze North Sea producers (unlike the UK Treasury), but we can definitely expect “competitive” corporation tax rates to attract foreign investment.

Some will be tempted to dismiss Mr Swinney’s plans as an irrelevance, on the grounds the nation will vote No next year. Let me remind you that regardless of the outcome of the referendum, the SNP will still be in government in the spring of 2016 when Holyrood becomes responsible for setting Scotland’s basic income tax rate.

The question is: will lower corporate taxes benefit growth in the current state of the Scottish economy? Taxes pay for schools and roads, so we need them. But they are also a cost to business, can distort resource allocation, and allow governments to persist in supporting daft subsidies that make us inefficient. Lesson: it’s not just the rate of tax that impacts on growth, but what the government does with the money.

It is clear Mr Swinney wants to cut business taxes to boost investment and jobs, while leaving income tax much as it stands. That is a long-term strategy that eschews populist tax give-aways. It might also increase the public deficit in the short-term.

The market will forgive the latter provided revenue spending is constrained and productivity growth outstrips the cost of borrowing. But for the strategy to work, Swinney needs to set out a ten-year industrial plan and convince voters and the markets that he will stick to his guns. Successful economies operate on public confidence as much as marginal tax rates.

I’m attracted to Swinney’s supply-side approach for two reasons. First, Scotland is too small to boost the economy permanently through increasing consumer spending by cutting income tax. Second, Scotland lives by exporting, yet the amount of our GDP that comes from exports (to the UK as well as abroad) is much smaller than you would expect. We need to sell more to other people. That means we need not just more investment, but investment in more productive technology.

This raises the obvious question of the role of tax competition between nations and regional jurisdictions. The classic criticism of such tax competition is that it leads to “a race to the bottom” as everyone cuts tax rates, yielding no economic benefits and reducing public revenues. This argument is used by the Treasury to oppose giving devolved tax powers to the regions of the UK, and by the European Commission to impose its own centralised control over everybody.

For example, last August Gordon Brown denounced SNP plans for lower corporation tax, arguing that “nationally varied corporation tax rates…will start a race to the bottom under which the good provider in one area would be undercut by the bad and the bad would be undercut by the worst”.

Yet academic studies have found scant evidence for any such “race to the bottom”. On the contrary, empirical evidence points in the direction that tax competition actually helps economic growth all round. By way of proof, national tax revenues from corporate profits have remained fairly stable across the industrial world, relative both to GDP and total tax revenue. If there had been a race to the bottom, we’d have seen such revenues decline.

The explanation is simple: economies (national and regional) have their own peculiarities, so perforce they require different tax requirements. Left to themselves, they will establish a tax regime that fits their needs – helping each to compete effectively. They will not just cut taxes willy-nilly. On the other hand, enforced tax harmonisation between nations and regions inevitably means a sub-optimal fiscal policy. And because tax harmonisation is usually imposed by the stronger party, the smaller economy inevitably is disadvantaged.Think about the Treasury’s desperate attempts to stop the devolution of corporation tax to Northern Ireland and you’ll get the point.

These findings have led Paul Krugmam, the left wing, Nobel Prize-wining economist, to propose a tax floor to stop big countries forcing smaller countries to set corporate tax rates higher than is good for their economies, as Germany and France want to do to Ireland.

Global companies are not indifferent to where they locate, so corporate tax rates only ever play a part in their final investment decisions. Foremost, multinational companies seek to locate where there already exist what economists term the benefits of “agglomeration”; in other words where there is already a pool of skilled labour, an existing supply chain and good logistics. Lower tax rates can’t compensate for the lack of such agglomerations but they can reinforce them.

The trick is for governments to concentrate on creating and reinforcing such industrial agglomerations. Scotland has them in finance, oil and gas, aerospace and defence, and in food production. In or out of the UK, a more competitive corporate tax rate based on Scotland’s unique needs could turn these sectors into global winners.