Rhona Irving: Taxing issue of devolving responsibility to Scotland

While the UK Treasury secretary, David Gauke, has asked for Holyrood to “realistically cost and fund the reforms it proposes”, finance secretary John Swinney has articulated the “compelling case” for Westminster to devolve the power to set and vary corporation tax to Holyrood. This, he has argued, would help attract a foreign direct investment, boost job creation and stimulate confidence among the Scottish business community.

In Northern Ireland there is wholesale political and business support for a cut in their corporation tax rate to match the 12.5 per cent rate on offer across the border with the Republic of Ireland. But while both Secretary of State Owen Paterson and Gauke favour giving Stormont the power to go head to head with Dublin, Scottish demands for similar powers are still creating much debate among politicians and business leaders.

Underlying the economic arguments in favour of reducing corporation tax in Northern Ireland and Scotland are two related assumptions: the first is that low corporation tax attracted the enormous levels of foreign direct investment that fuelled the Irish Celtic Tiger and high rates of economic growth in the 1990s and early 2000s. The second notion is that what worked for the Irish would work for Northern Ireland and for Scotland too.

Perhaps the most detailed analysis of the arguments was published back in January. The PwC report, Corporation Tax – Game Changer, or Game Over? found no evidence that the Republic of Ireland’s low corporation tax had by itself, attracted the high levels of foreign direct investment that fuelled the Celtic Tiger economy.

PwC’s economists and tax experts found that three decades of low corporation tax from the 1950 had delivered comparatively little new foreign direct investment. Also, when Irish corporation tax rose in the 1980s, it coincided with an increase in US investment, so it is hard to invoke low corporation tax as the sole reason for the boom.

Other factors in the Irish mix included a trained workforce; industry mix; incentives for research and development investment; policies to accelerate skills and productivity; a long-term government economic development strategy and a business friendly (and relatively simple) tax regime. The evidence indicated that while low corporation tax was nice to have, it would not necessarily, in isolation, stimulate enough new foreign direct investment for Scotland to outweigh the substantial impact on the block grant from Westminster.

As part of its review of the Scotland Bill, PwC compared rates of growth of the Northern Ireland and Scottish economies and found that, after London and the South East, Scotland has been one of the better performing UK regions. In contrast, Northern Ireland’s long-term growth performance has, at best, only tracked the UK average. In terms of prosperity, the report says Scotland has a level of Gross Value Added (GVA) per capita closer to the UK average than Northern Ireland. We can’t necessarily assume the impact of reduced corporation tax would be the same in both regions.

Equally, it is unclear that it would automatically have a positive effect. At the time, PwC’s “not proven” verdict on the likely impact of reducing corporation tax in Northern Ireland came in for some criticism. However, a subsequent report from the Economic Advisory Group – the think-tank that advises Northern Ireland’s economy minister – concluded that: “Corporation tax is a necessary but not, by itself, sufficient economic development tool… it must be accompanied by… an economic strategy that also priorities investment in R&D/innovation, skills, business growth and infrastructure, alongside other additional measures.”

Parachuting a low corporation tax regime into UK regions like Northern Ireland and Scotland also has difficult implications as it hits the block grant.

Changing corporation tax in any UK sub-region comes via a European Court ruling – the Azores Judgement. This says that if Westminster reduces a tax in a sub-region (like NI or Scotland), that sub-region must repay any “loss” to the parent parliament. Cutting corporation tax gives every company in the region a tax cut and that “lost” tax must be repaid. But, because the UK regions don’t operate at a surplus, the “repayment” has to come by way of a reduction in the block grant.

Here’s where it gets complicated. As the UK Treasury doesn’t measure how much corporation tax comes from UK regions (let alone how much is accrued in one region by large, diversified companies and paid in another), the cost to the block grant is uncertain. In July, Scottish Secretary Michael Moore told the Westminster Scottish Affairs Committee that cutting corporation tax in Scotland to the 12.5 per cent Irish rate would cost Holyrood around £10 billion to £12bn over a five-year period. A paper from HM Revenue & Customs (HMRC) says the direct and “behavioural” effects of cutting corporation tax to 12.5 per cent in Scotland would hit the Scottish block grant to the tune of £2.6bn a year. The Scottish Government rejected this.

Also, neither that HMRC paper, nor the Treasury’s equivalent in Northern Ireland, addressed what happens to any new tax income generated by additional investment. If Scotland has to repay lost corporation tax revenues, what can it keep? If cutting corporation tax stimulates 20,000 new jobs, can Scotland keep the “new” PAYE and National Insurance generated? And what about the new income tax?

The answer is, we don’t know, but if we are going to have a meaningful debate about devolving corporation tax – or any other tax – these are the questions we need answered.

l Rhona Irving is a tax partner with PwC Scotland