Pros and cons of a Scotland-only cut in corporation tax

In RECENT years, control of corporation tax has been a key plank of SNP economic policy. Lower rates of corporation tax tend to be associated with higher growth performance, though they are not by themselves guarantors of growth. The campaign for a Scottish-determined tax regime takes a step forward this week with the publication of a paper on lower business tax.

The case for lower corporation tax in principle has a strong body of support. It also informs the policy of the UK coalition government, which has cut the main rate from 28 per cent to 26 per cent effective from May, and which has pledged further reductions to 23 per cent by 2015. This would give the UK the lowest business tax rate in the G7.

By 2014-15, the UK’s tax rate would be 16 per cent lower than America, 11 per cent less than France and 7 per cent lower than Germany.

But the SNP proposals are looking for something bolder and more radical, and are being shaped by the debate in Northern Ireland where a lower tax regime is being pursued. However, powerful though the arguments are, some potent reservations have been expressed. The Calman Commission considered devolving corporation tax but rejected this in its recommendations.

Last weekend’s Scotland on Sunday reported concerns by Elspeth Orcharton, assistant director of tax at the Institute of Chartered Accountants in Scotland. She has warned First Minister Alex Salmond that he could de-stabilise Scotland’s finances by introducing a differential rate here and that businesses in Scotland would face another layer of tax and regulatory complexity.

So what are the concerns over Scottish control of corporate tax rates and what are the issues its advocates need to address to allay business concerns?

The most immediate concern is how a Scottish administration would cope with a fall in tax revenue resulting from a lower corporation tax rate before the expected Laffer Curve benefits kick in. According to Laffer Curve theory, tax revenues would rise after a cut in tax rates – though there is an immediate drop in revenue. The Exchequer Secretary to the Treasury recently said that, according to provisional figures from Her Majesty’s Revenue and Customs (HMRC), if the Scottish Government were to cut corporation tax to the same level as Ireland, it could result in a gap of more than £2.6 billion in the Scottish Budget. How could the administration maintain the range and quality of public services in the face of such an immediate cut in revenue?

Second, any benefit that Scotland might derive from a lower rate of corporation tax relative to the rest of the UK may well be short-lived if a Scottish reduction sparked a “race to the bottom”, with various UK regions clamouring for a similar cut, or offsetting tax reliefs and grants to compensate. These demands might be particularly strong in the hard-hit north east and north-west of England.

A third concern is an immediate rise in the administrative burden for business. There are two areas of potentially complex and costly interventions. The first relates to the determination of what is a Scottish-earned or derived profit for the purposes of the tax. A business based in Scotland and co-ordinating the assembly and manufacture of components across the UK and selling to customers outside of Scotland would need to fully account for where the profit arose. The second area of regulatory intervention would be tight HMRC supervision of business profits to ensure there was not opportunistic profit-shifting to take advantage of a lower corporation tax rate.

Finally, how sure can we be that a lower rate of corporation tax would bring about growth higher than would otherwise be the case? Efficacious results tend to arise in jurisdictions where lower business taxes are one of a number of business-friendly measures. It is doubtful if a cut in corporation tax on its own would work the magic expected of it.

The document this week will help stimulate debate and provide answers to some of these questions. And it may also have a more diffuse benefit: by posing the prospect of a corporation tax free-for-all, it will maintain pressure on the UK government to pursue further cuts in corporation tax. This may not be the outcome that the SNP advocates would like to see. But it would have an immediate benefit for a business community apprehensive as to how it is going to pull through the years of austerity ahead.