Response to the Treasury's Consultation on Rebalancing the NI Economy

Committee Membership

Mr Alban Maginness (Chairperson)
Mr Steven Agnew
Mr Gordon Dunne
Mr Phil Flanagan
Dr Alasdair McDonnell
Mr Daithí McKay (Deputy Chairperson)
Mr David McIlveen
Mr Stephen Moutray
Mr Mike Nesbitt
Mr Robin Newton
Ms Sue Ramsey

Questions and issues

Government would welcome views on the following:

1. Whether there is a need to rebalance the Northern Ireland economy by strengthening the private sector over the longer term and to increase economic growth and promote significant new investment

and

2. Where there is most scope for increasing productivity, reducing labour market inactivity and increasing growth

There is a real need to grow the economy in Northern Ireland as the current balance is considered highly dependent on the public sector. The Prime Minister acknowledged this in his recent address to the NI Assembly. Despite the strengths of Northern Ireland (strong telecommunications infrastructure, educated and skilled workforce and links with Europe), the past and current policies have not been effective in creating an economy that is driven by the private sector. There is clearly a need to rebalance the economy through growing the private sector. The ultimate goal is for the economy to be driven by the private sector, creating more wealth, economic opportunities and jobs through new investment. Growing the private sector increases opportunities for entrepreneurs and business people to create employment and spending which creates more revenue through income tax, VAT, excise duty and National Insurance. Increased revenue provides the funds for maintaining and creating world class public services.

Foreign Direct Investment (FDI) has the potential to be highly successful in achieving the required rebalancing in the economy but it will also depend on other key economic factors being in place, including a corporation tax rate that will enable Northern Ireland to close the productivity gap with the rest of the UK and compete for investment with the Republic of Ireland.

If the appropriate conditions are provided this will also encourage indigenous business here to grow and export and contribute more to the economy. As Northern Ireland is a predominantly SME based economy this is an important factor in future economic growth. The appropriate conditions will also encourage SMEs to look for opportunities for Research and Development (R&D) to help grow their businesses. The uptake of R&D opportunities under EU Framework 7 is an area where Northern Ireland is currently underperforming due, in large part, to the nature of the SME based economy here. It is clear that a major change in economic policy, such as the reduction in corporation tax, is needed to significantly advance the NI economy.

The Government would welcome views, in the context of this report, on devolving corporation tax rate varying powers to Northern Ireland. In particular, the Government would welcome views on the following:

3. The importance of the headline corporation tax rate in encouraging investment

One of the main reasons why a lower rate of corporation tax is needed in Northern Ireland is to enable the economy here to compete with that in the Republic of Ireland, which has had a corporation tax rate of 12.5% for a number of years. There are very strong indications that this rate will continue for the long-term future.

The Committee agrees in principle that a reduction in corporation tax will encourage investment and provide a much needed boost to the Northern Ireland Economy. The Committee recognises that corporation tax is by no means the only factor, or necessarily the primary factor, in determining where a foreign company will invest. The other key factors quoted are: transport and logistics infrastructure; labour costs; potential productivity increase; telecommunications infrastructures; skills; and regulatory environment. In Northern Ireland, all these factors are well developed. Rather than providing detailed evidence of this it may be more appropriate to quote the Prime Minister in his statement to the Northern Ireland Assembly on 9 th June when he said,

“You’ve got excellent transport connections to the rest of the UK, Ireland and the rest of Europe; the English language; great educations result; two brilliant universities; highly competitive operating costs; 100% broadband access; Project Kelvin linking North America, Northern Ireland and Western Europe; a strongly pro-business climate led by the Executive…”

As all the other key factors are very well developed, and as further steps are required to encourage investment and stimulate the economy, the devolution of corporation tax must be the next important step in this process.

More concrete proposals for defining “enterprise zones” in Northern Ireland are also required. The Committee considers it important that the UK Government develops such proposals in conjunction with any plans for the devolution of corporation tax so that an overall integrated package of a business-friendly economy can be marketed to potential investors.

4. The extent to which a reduction in the rate of corporation tax in Northern Ireland could support additional investment, higher growth rates and increased employment in the Northern Ireland economy

The Committee recognises the significant variation in forecasts in relation to corporation tax and the impact of a corporation tax reduction on block grant allocation, investment, growth rates and increased employment. However, the Committee is encouraged to see that small peripheral economies have leveraged corporation tax to attract high levels of FDI. The Committee is also encouraged to see the results from the models that have been produced, even when forecasting a lower level of FDI to Northern Ireland. It is clear that maintaining the status quo is not an option. Members also called attention to the fact that Selective Financial Assistance (SFA) will end in 2013, and Invest NI will require other drivers to attract FDI. A reduction in corporation tax will be an essential element in the future economic mix.

In order to fully determine the impact that a reduction in corporation tax will have, it will be important to calculate the total tax rate after a corporation tax reduction is applied. The total tax rate (including other business taxes such as National Insurance) is currently 37.3% in the UK and 26.9% in the RoI. World rankings, based on the total tax taken from businesses, are UK: 76 th and RoI: 30 th. It will be essential, following a reduction in corporation tax, that Northern Ireland knows both the total tax rate and world ranking in order to understand how to compete with other economies.

5. The estimated costs arising from a lower corporation tax rate in Northern Ireland

It is accepted that Northern Ireland must bear the full cost implications of reducing corporation tax, specifically, a reduction to the block grant. Fundamental difficulties arise in attempting to estimate the costs associated with lowering the corporation tax rate because the figures are not available for the current rate of corporation tax or for revenue from other taxes. This is a central issue that has yet to be clarified and detailed. The current estimates in various reports are not accurate enough to make a definitive view on the costs implications for Northern Ireland. The first step is for Treasury to produce the accurate baseline figure for the number of individuals and organisations in Northern Ireland currently paying corporation tax and the amount of corporation tax that is collected from businesses in Northern Ireland. Treasury must also clarify how this will impact on the block grant. It is essential that the baseline is established prior to any announcement on the devolution of corporation tax rather than at the introduction stage. This is because economic activity may increase between an announcement and the implementation date.

Without the devolution of other tax revenues, any benefits of increased revenue in these areas would be realised by the UK Exchequer unless such tax effects can be considered when calculating the adjustment to the block grant. It is important that Treasury finds a solution to this issue that complies with the Azores judgement. It is also important that, in absorbing any costs associated with the devolution of corporation tax, Northern Ireland can avail of any indirect benefits of doing so including future increased tax receipts (from increased income tax, VAT, National Insurance, excise duty and corporation tax) due to increased economic activity.

6. The dynamic impacts on tax receipts arising from a lower corporation tax rate in Northern Ireland

The Committee is aware of the fiscal benefits that reducing corporation tax can bring in relation to retaining secondary tax receipts. It is accepted that, from a purely financial perspective, within 20-30 years, the benefits can be realised. However, how the Executive handles the shortfall from the block grant is crucial. This is why it is essential to know the exact cost of devolving corporation tax. It is also essential that there is a mechanism in place for calculating the amount of tax receipts that the Northern Ireland Executive will be able to retain.

Corporation tax is considered a highly volatile tax. Tax receipts can vary widely from year to year making public spending difficult to manage. The devolution of corporation tax may also require the Executive to have wider fiscal flexibility including the power to borrow to manage volatility in tax receipts.

7. The risks to the NI Executive arising from a devolved corporation tax rate in Northern Ireland

The Committee recognises the inherent risks associated with a reduction in corporation tax, and the concern that many of the measures to mitigate these have not been detailed or clarified. A key risk is the added burden that a reduction in public spending would place on public services in the current economic climate. It would be unacceptable and counter-productive if cuts in public spending fell in areas that help create and maintain a good business-friendly environment (infrastructure, skills, telecommunications etc.). Hence, it is crucial that Treasury calculate the cost and determine how associated tax gains will be realised by the Northern Ireland Executive.

There is a risk in that other regions including Wales and Scotland will lower own corporation tax thereby diluting the impact of a reduction in Northern Ireland. The Committee believes that, given the impact on its block grant, it is highly unlikely that the Scottish Executive will lower corporation tax to a similar level to that suggested for Northern Ireland. It is also within the responsibility of the Northern Ireland Executive to ensure that other measures are in place to ensure that Northern Ireland is in a position to compete as a region as well as with other EU regions and internationally.

In relation to financial risks, the systems to prevent profit-shifting, brass-plating and tax motivated incorporation must be effective, so that the benefits are not lost to the Northern Ireland Executive or the UK Exchequer.

There must be a determination from the Northern Ireland Executive that, once corporation tax is lowered, it will remain at the lower level. Any perception by a potential investor that the Executive is not committed in the long-term will inhibit future investment. The Republic of Ireland Government has demonstrated a stubborn resistance to increasing its corporation tax in the face of immense pressure from within the EU to increase its rate in order to secure a reduction in the interest rate on its bailout. It is important that the Northern Ireland Executive is single-minded in its resolve to maintain a lower corporation tax rate.

8. Potential compliance costs and administrative burdens for business arising from a devolved corporation tax rate in Northern Ireland

The cost of compliance and administration will be a significant factor in calculating the potential cost of devolving corporation tax powers. The Committee recognises that the Northern Ireland Executive may bear these responsibilities in order to comply with the Azores judgement.

Any compliance system which businesses find burdensome and costly would dilute the benefits of lowering the corporation tax. The Department for Enterprise, Trade & Investment has a good record in reducing bureaucracy on business and easing the burden of regulation through its ‘Better Regulation’ activity. Such experience could be brought to bear in the development of a business-friendly system of regulation. During Question Time in the Northern Ireland Assembly on 12 th June 2011, the Minister for Enterprise, Trade & Investment informed the House that at a meeting the previous week, attended by some of the major multi-nationals,

“ .…their tax advisers said that they did not see any difficulty in administrating a different tax rate in Northern Ireland from that in the rest of the United Kingdom….they felt that a differential tax rate in Northern Ireland could be dealt with quite easily from London.”

9. The approach that would be taken to adjust the block grant arising from a devolved corporation tax rate in Northern Ireland

Treasury must firstly accurately calculate the amount of corporation tax that is collected in Northern Ireland. Treasury must also establish a mechanism to enable the Northern Ireland Executive to retain the additional receipts from other taxes gained as a result of lowering corporation. The Committee understands that retaining these tax receipts will comply with the Azores criterion for fiscal autonomy, so long as the Northern Ireland Executive is not over-compensated.

10. The balance of potential costs and benefits of a reduced corporation tax rate in Northern Ireland

The potential costs of reducing corporation tax have been outlined earlier. It is recognised that, in purely fiscal terms, there will be considerable costs in the short-term and that, in the long-term, these costs will take considerable time to recover. However, the benefits to the economy are long-term and many of these will start to be realised in the short-term. For example, following a meeting with Northern Ireland business leaders earlier in June, the Northern Ireland Secretary of State, Owen Paterson said,

"I thought the star was the senior executive from Almac who said bluntly they would double their business - they would double the size of Almac, already employing 2,000 people in Northern Ireland if this came along,"

Statements such as this from one of Northern Ireland’s most respected businesses gives the Committee confidence that even the most optimistic predictions for economic growth following a reduction in corporation tax, may be realised.

In the long term, the benefits of increased FDI and rising employment will increase the standard of living in Northern Ireland, narrowing the gap with the rest of the UK and helping Northern Ireland to compete with the Republic of Ireland.

There are benefits for the Northern Ireland Executive, in relation to fiscal responsibility, as devolution of corporation tax will make the Executive more accountable.

To maximise the benefits and reduce the impact on the block grant there may be value in considering options for how corporation tax will be devolved. For example, lowering only the main rate of corporation tax may have the desired impact on FDI but protect a larger proportion of the block grant while preventing tax motivated incorporation.

11. The merits of a deferred implementation of a rate reduction in Northern Ireland and its potential impact on investment decisions

A deferred implementation of a lower corporation tax would give time for the Northern Ireland Executive to prepare for the necessary modifications to its processes/policies prior to the implementation date. This will help ensure that systems are efficient and effective both here and in GB .

Deferred implementation will also give potential investors time to consider and prepare and will provide Invest NI with the opportunity to attract investment prior to the implementation date and thereby help off-set a reduction in the block grant. As stated earlier, it is important that a baseline is established prior to any announcement.

12. The extent to which a phased reduction in the rate of corporation tax in Northern Ireland could support a rebalancing of the economy while allowing the costs of the reduction to be more effectively managed

It is clear that a phased reduction would lessen the ‘shock’ to the block grant and also provide Invest NI with the tool it needs to attract investment. The duration of phasing must be for the Northern Ireland Executive to consider.

13. The impact that restricting any reduction in corporation tax receipts to trading income only would have on the aim of rebalancing the Northern Ireland economy and the value for money of a corporation tax reduction

The main purpose of lowering corporation tax is to attract FDI, increase productivity, increase employment and create wealth. Restricting tax receipts to trading income would bring much benefit to the overall aim but without providing the loss in tax receipts from non-trading profits.

14. Whether there are other options to offset the cost to the NIE of a reduction in the rate of corporation tax that would be consistent with the overall aim of rebalancing the Northern Ireland economy

There are no other options which will comply with EU rules on ‘State Aid’ however there are other measures which can and must be taken in conjunction with the devolution of corporation tax. Many of these measures will be enhanced with the advent of lower corporation tax. This includes targeting by Invest NI of high value export orientated businesses, encouraging indigenous businesses to take advantage of lower corporation tax to grow their business and to export. This also has the additional benefit of more foreign and indigenous businesses being in a position to take advantage of R&D opportunities for which there are considerable funds available from the EU.

15. The extent to which changes to R&D tax credits, annual investment allowances, training credits or a national insurance holiday could provide feasible, effective, affordable and value for money support for the rebalancing of the Northern Ireland economy

Response: All these measures would be beneficial and should be included as part of an overall package to market Northern Ireland as a business-friendly region. These measures may fit in with what the UK Government considers an Enterprise Zone however it is for the UK Government to provide a clear definition of an Enterprise Zone and how this would be applied in Northern Ireland.