INITIAL SUBMISSION TO THE REVIEW OF THE ROLE OF TAX POLICY IN SUPPORT OF GROWTH AND INVESTMENT IN NORTHERN IRELAND BY SIR DAVID VARNEY (25 MAY 2007)
Members of the Committee for Finance and Personnel understand that your review into the role of tax policy in support of growth and investment in Northern Ireland (NI) will address the following terms of reference:
‘How current and future tax policy, and including the tax changes announced in the Budget, can support sustainable growth of business and long-term investment in Northern Ireland.’
Members are aware of your requirement to report by the autumn and welcome this initial opportunity to contribute to your review.
Initial discussions with Review Team officials suggests four key areas for discussion:
- analysis to date on fiscal incentives, including the recent research by Economic Research Institute of NI (ERINI);
- the position in the Republic of Ireland;
- the United Kingdom context; and
- other underpinning growth factors.
Previous Reports by the Transitional Assembly’s Economic Sub-group
In relation to these, and other issues we would wish to refer you in particular to the three reports by the Committee on the Preparation for Government (September – November 2006), sub-group on the Economic Challenges Facing Northern Ireland, and in particular to the recommendations on fiscal issues contained in these reports. All three reports were agreed by consensus by the five political parties represented on the Committee and its sub-group.
In its first report, the sub-group recognised the need for radical change, if we are to move to an economy where a growing and profitable private sector is contributing to the extra productivity and value-added needed to close the wealth gap between Northern Ireland and the UK and the growing disparity with the Republic of Ireland. It was agreed that Government needs to address the problems head on by establishing a fiscal environment that attracts high-productivity international companies and encourages local business to develop and grow through research and development into the export market.
Recommendations in the second report focused on fiscal issues such as:
- the necessity for tax reforms to raise Northern Ireland from its entrenched position as the UK’s poorest region (in terms of productivity and household income);
- the comparative priority for reduced corporation tax and/or R&D tax credits; and
- the need for fuel duties in Northern Ireland to be equivalent with the lower duties in the Republic of Ireland.
The third report highlighted the key research conclusions from ERINI, which underscore the case for Northern Ireland having a competitive rate of corporation tax if we are to compete successfully for foreign direct investment with our successful land neighbour.
The Committee on the Programme for Government’s economic sub-group considered the Government’s response to the previous three reports detailed above. A report issued on 29 January 2007 by the Committee reflected the sub-group’s consensus view that, whilst it had taken seriously the Government’s claim that the Northern Ireland economy is unsustainable, it was not convinced that the Government was serious about the fiscal changes and investment strategy required to make the economy work. The Government was again urged in the report to consider carefully the economic benefits identified in the ERINI research study into corporation tax that will quickly produce a Northern Ireland economy less dependent on a subvention from GB taxpayers.
The Committee for Finance and Personnel recommends that your review considers in detail both the recommendations contained in the four reports detailed above and substantial evidence base contained in the reports which supports these recommendations. The ERINI research on corporation tax was a particularly important piece of research considered by the sub-group. The Committee looks forward to a further opportunity to outline in more detail its views on the other underpinning growth factors which complement fiscal incentives.
Areas for Discussion
Analysis to date on fiscal incentives, in particular the recent ERINI research 1
The sub-group noted the ERINI report on corporation tax as the first systematic attempt to assess the roles of corporation tax and foreign direct investment in economic regeneration.
Key amongst the empirical findings in the report was that cutting corporation tax by 50% would set in train changes in the economy through new investment and increased activity that would reach a break even point in tax terms in 2013, after incurring an initial cost of £310m in the first year. Beyond 2013, there would be a net gain to both NI and UK finances.
The Secretary of State cast doubt on the legal basis for lowering corporation tax in Northern Ireland (i.e. whether a region of a member state could enjoy differential corporation tax rates without breaching EU competition law). In this regard, the European Commissioner for Competition has recently explained the implications of the European Court of Justice ruling on the Azores case as follows:
- that a differential rate was possible in cases in which a regional authority had a political and administrative status separate from central government;
- that any variation must take place without central government being able to intervene; and
- that there must be no subvention to make up for any loss in revenue.
The sub-group recognised these conditions and suggested possible approaches to addressing them in its Second Report. The explanation from the European Commissioner also concurs with the DETI legal advice provided to the sub-group for its Third Report.
On the separate issue of fuel duties, the sub-group called for these duties in Northern Ireland to be equivalent with the lower duties in the Republic of Ireland. It also recommended an extensive study of what the net loss of revenue might be, which would also take into account additional tax revenue flowing from any higher consumer spending that may accompany lower costs of fuels. The Committee for Finance and Personnel is aware that the Chancellor, when announcing his economic package for Northern Ireland on 22 March 2007, gave a commitment to further discussion between a restored Northern Ireland Executive and Her Majesty’s Revenue and Customs on the issue of excise duties.
Position in the Republic of Ireland
The unparalleled success of the Republic of Ireland convinced the sub-group that only a significant reduction in corporation tax could produce the desired step change in the Northern Ireland economy. The sub-group accepted the view of Victor Hewitt, Director, ERINI that marginal improvements to existing policy instruments would not be sufficient to attain a higher level of sustained performance. It is widely agreed that supporting policies, including successful investment in tertiary education have also played an important role in the Republic of Ireland. Large-scale investment in roads and other infrastructure is also adding to the attractiveness of the Republic as a destination for private sector investment.
United Kingdom Context
The Government’s response to the sub-group’s third report argued that the prevailing corporation tax rates place the UK economy in a competitive position internationally. The sub-group was not aware of the justification for this statement, nor did it accept that, even if prevailing tax rates were competitive for the UK as a whole, that this would help NI to converge towards UK average productivity levels. Both the standard (or headline) rate and the effective average tax rate are much higher in the UK than in ROI. The sub-group is aware that tax credits and allowances reduce the effective rate of tax in any particular year but the sub-group is advised that there are internationally recognised norms for comparing effective tax rates in the context of companies considering alternative locations for investment. Figures published by the Centre for European Research for 2005 show the rates for ROI and UK as 14.7% and 28.9% respectively.
The Government further argued that 96% of NI companies do not pay the 30% tax rate. The sub-group considered that this argument missed the point, as the strategic objective behind a call for fiscal reform is to expand our export base by attracting foreign direct investment flows similar to those in ROI. The companies that need to be attracted to NI will be taxed at the 30% rate under present circumstances.
In relation to the 96% of companies that pay the lower tax rate, the Committee recognises the vital importance of these small and medium size enterprises to the local economy and considers that the increase in the lower rate (i.e. from 19% to 22%), announced in the Chancellor’s Budget, will have a disproportionate affect in NI.
Other Underpinning Growth Factors
The sub-group agreed with the key drivers for the economy identified in the Economic Vision for Northern Ireland
The sub-group placed particular emphasis on the influence of financial and business services on productivity and wages in advanced economies. It made recommendations on increasing the proportion of graduates in NI to support a strategy based on financial and business services.
Detailed recommendations associated with each key driver are included in the sub-group’s reports, copies of which will accompany this paper. The reports and the weblink are also detailed below.
First Report on the Economic Challenges Facing Northern Ireland (4 Sept 2006)
Second Report on the Economic Challenges Facing Northern Ireland (6 Oct 2006)
Third Report on the Economic Challenges Facing Northern Ireland (15 Nov 2006)
Report on Government’s responses to the reports on the Economic Challenges Facing Northern Ireland form the Committee on the Preparation for Government(29 Jan 2007)
In a wider context, recent research has been undertaken into the case for a UK-wide cut in corporation tax. This research by the Centre for Economics and Business Research, on behalf of the Tax Payers Alliance, concludes that a cut in corporation tax to the rate in the Republic of Ireland would deliver 60% investment boost and 9% GDP, employment and disposable income boost after 15 years.