Too much Scottish business tax is still flying south

Last week the Scottish Government published a discussion paper on giving Holyrood the power to cut taxes on local business profits and so grow the Scottish economy – a demand spelled out in the SNP’s election manifesto. The loss of revenue to the UK Treasury would be compensated by a reduction in the block grant to Holyrood.

This plan mirrors a proposal to give the Northern Ireland Assembly powers to set corporation tax, a move backed by the coalition government at Westminster. In May, the Northern Ireland secretary of state, Tory MP Owen Paterson, told the Belfast Telegraph that devolving corporation tax would be “the economic equivalent of the peace process”.

However, opposition to devolving corporation tax powers to the Celtic administrations is coming under renewed fire – I suspect from discrete Treasury briefings. For the Treasury remains doggedly resistant to any loss of central control over fiscal policy. Example: the Scotland Bill presently being enacted with great fanfare by the coalition will give Holyrood control over a scant 15 per cent of tax revenues raised in Scotland – it’s more than 60 per cent in the German regional Lender.

Labour, for its own narrow reasons, is also backing continued central control of fiscal policy. The Labour administration in Wales, led by Carwyn Jones, has set its face against devolving corporation tax. Jones prefers to reform the Barnett block grant system, to give Cardiff a bigger annual lump sum. This approach is the economic equivalent of playing with a live grenade. In any reform of Barnett, you can expect the Treasury to take the opportunity to cut public spending across the board – not take from Scotland to give to Wales. Proof: the Treasury is already putting the squeeze on the Isle of Mann to take more of the island’s VAT revenue.

Professor Arthur Midwinter, posting on the Labour activist blog LabourHame, attacks wholesale fiscal devolution, contrasting it unfavourably with “the UK fiscal system’s focus on co-operation, equity and co-ordination.” Midwinter ignores the fact that Scotland’s perennial low economic growth over the last generation stems from the in-built, deflationary impact of high interest rates – set to counteract inflation in the English south-east – and the lack of any corresponding ability to offset this deflation through an expansionary Scottish fiscal policy. He misses the point: it’s not about how we share the cake, but how we make the cake bigger.

Devolving corporation tax also continues to be opposed by Scottish Labour MPs, who challenge the SNP to say how it would fund a tax cut. This shows their lack of economic understanding. A cut in the tax rate does not equal a cut in revenues. The trick is to announce you will phase in the rate cut over several years. This gives confidence to business to increase investment and output ahead of the cut, expanding the overall tax base head of any change. This elegant method has been successful in Canada and Sweden.

Cutting corporation tax has also been queried by the Institute of Chartered Accountants of Scotland (ICAS), though it is supported by many Scottish entrepreneurs, including Sir Tom Hunter and Jim McColl. ICAS is worried that internal UK tax competition would reduce rates (and revenue) to levels insufficient to fund public services.

Bizarrely, ICAS – which trains accountants throughout the globe – seems blissfully unaware that such tax competition is the norm in most of the industrialised world and does not result in the dire outcomes it posits – because lower corporation tax tends to promote economic growth.

In social democratic Canada, the various provinces levy their own business tax in addition to the federal rate. Last year, the provincial rate for larger companies varied between 11.5 per cent in the North-West Territories and 16 per cent in Nova Scotia. Tax competition has not harmed the Canadian economy or its publically-funded health service.

The state corporation tax varies immensely across the US. Iowa’s 12 per cent is the highest while Texas has a zero rate. Individual states maintain profits tax competitiveness even when geographically close – and without any fiscal “race to the bottom”. In New England, Connecticut’s 7.5 per cent rate is lower than Delaware’s 8.7, though both are in competition for corporate headquarters. In the industrial Mid West, Indiana (8.5) and Illinois (7.3) contrast with Ohio (3.4).

This week, a Financial Times editorial weighed in on the side of the antis – a sign, perhaps, of a Treasury whispering campaign. Ostensibly, the FT is worried that letting the Celtic administrations lower corporation tax would have a detrimental effect on England, unless there was a separate English parliament to set rates there.

It concludes: “There may be a case for establishing an English parliament, but doing so to vary corporation tax is not the obvious one.”

The FT is constructing a straw man. The central argument for devolved control over business taxation is that local economies within the UK vary tremendously, and so require tax regimes tailored to their individual needs. Cutting corporation tax in Scotland would not poach English firms, as most companies are generally specific to their local market conditions. In fact, Scotland’s problem is too few start-ups: in 2010 we had only 672 private firms per 10,000 adults, 25 per cent lower than for the UK. Holyrood would use control over corporation tax specifically to tailor tax breaks for new, indigenous small firms.

However, there is a strong case for future co-ordination between the devolved (or even independent) tax jurisdictions with the British Isles, as takes place in the likes of Germany and Canada. This would build confidence in the proposed reforms and show the people of England that the demand for fiscal devolution is not predatory.