EVIDENCE ON VARNEY REVIEWS TO COMMITTEE FOR FINANCE AND PERSONNEL

SIR GEORGE QUIGLEY

1. The most noteworthy feature of Varney Report I I is that, whilst it purported to be a review of Northern Ireland’s competitiveness, it ignored the one respect in which Northern Ireland does not even begin to compete, namely the corporate tax regime. Varney would no doubt argue that this issue was disposed of in Varney Report I but Varney I showed no understanding at all of the fact (supported by a mass of evidence) that the differential rate of corporation tax on the island is a very significant factor in the competitiveness stakes.

2. Varney I I is equally perverse on the issue. Para 1.32 contains the remarkable assertion that:

"Northern Ireland, as part of the UK, has a competitive tax system both internationally and in relation to Ireland".

This assertion is made despite the fact that the headline rates for the UK and the Republic are, respectively, 28% and 12½% and that the gap in the effective average tax rates in 2005 was 14 percentage points. The gap will have reduced slightly with the subsequent reduction in the UK’s headline rate from 30% to 28% but it remains crucially significant for an investor seeking to maximise his post tax return. Indeed the rate of return to US-owned companies on their investments in the Republic is almost 20%, which is around three times the rate of return in the UK. The tax wedge on labour for 2006 (ie the gap between what the employer pays and the employee receives) was under 15% of average earnings in the Republic (which has the smallest wedge in the OECD) whereas the UK wedge was just under 30%. The greater the size of the tax wedge, the greater, obviously, is the pressure on pay levels, pushing up the employer’s costs. The only significant tax category for which the Republic has a higher rate than the UK is VAT but (as the National Competitiveness Council Report indicates) the VAT rate "is less likely to affect incentives to work or to invest".

3. All the information in the preceding paragraph which negates the assertion in Varney I I’s para 1.32 is taken from the 2007 Annual Report (Vol 1) of the Republic’s National Competitiveness Council (NCC) at pages 65 (corporation tax information); 31 (rate of return); 66 (tax wedge); and 67 (VAT). The NCC figures are themselves derived from the recognised international data banks. The NCC’s Annual Report can be accessed at www.competitiveness.ie.

4. The figures can scarcely be challenged by Varney since Varney I I (para 1.39) says that it was "particularly struck by the comprehensive nature" of the NCC’s Annual Reports and their "thorough, up-to-date and comparative data and analysis". Indeed Varney recommends (para 1.40) that a "somewhat similar" report should be prepared annually for Northern Ireland by an independent Competition Analysis Board (CAB) and that "the data to prepare the numeric analysis should be collected in co-operation with the work being carried out in Ireland".

5. This raises the very pertinent question: when the numbers would emerge from such an exercise indicating (as in para 2 above) Northern Ireland’s serious lack of competitiveness on key tax variables (and particularly on corporation tax), would the Northern Ireland Executive be expected, like Varney I & I I, to ignore this data? If so, what would the rationale be for refusing to act on this crucial information but for taking action on all the other data on competitiveness which, even cumulatively, is likely to be of lesser significance for Northern Ireland’s economic performance?

6. The same question arises on para 4.22 of Varney I I. This recommends that Northern Ireland should adopt a benchmarking approach which would inter alia "identify any of the elements of the Northern Ireland offer which appear to be uncompetitive". The benchmarking approach is defined as identifying (a) the strategic drivers that influence investment decisions in target sectors in which Northern Ireland has a demonstrable internationally competitive offer and (b) Northern Ireland’s "merits, in quantitative terms, measured against its main competitors". In light of the corporation tax differential, Northern Ireland would not on any realistic assessment be able to target the major sectors which have contributed a substantial proportion of the Republic’s FDI success. Would the Executive, following Varney’s lead, be expected merely to accept this situation, thereby confining itself to fishing in a restricted investment pool? The fact is that at present (as the two Governments acknowledge in their October 2006 "Island economy" document) Invest NI and IDA Ireland are in direct competition for relatively few projects, simply because the bait they are using attracts different kinds of fish – very much to Northern Ireland’s disadvantage. The corporation tax issue cannot be ducked. Every credible competitiveness stocktaking will confirm the need for action.

7. In my own evidence to Varney I I, I commended the National Competitiveness Council – style approach as offering "a template for the competitiveness agenda in Northern Ireland as well". The NCC’s work is, however, built around a very clearly structured competitiveness model and in my evidence to Varney I I I therefore went on to make the following key point:

"It would be intellectually dishonest to ignore the crucially important fact that, firmly embedded within the bottom layer of the Council’s ‘competitiveness pyramid’ (ie the key policy areas that affect the business environment) is taxation, of which the low rate of corporation tax is a vital component. All official studies of the economic development process in the Republic are similarly predicated on the existence and continuation of the favourable corporate tax regime".

Varney I I has ignored the model and this vital feature of it.

8. Whilst I support the idea of an NCC-style annual exercise in Northern Ireland, I see no need for the setting up of yet another body for the purpose. Surely ERINI, which has already done excellent work on the competitiveness theme, is the obvious candidate to undertake this task.

9. Varney’s lack of understanding of the special relevance of the tax issue in the context of the island is also illustrated starkly in the second point in Box 1.5 in para 1.33, which gives as one of the "measures in [ UK] Budget 2008 that will increase the competitiveness of the Northern Ireland economy" the following:

"Policies to maintain a competitive tax system. From April 2008 the main rate of corporation tax is being reduced to 28 per cent, the lowest ever rate of corporation tax in the UK and the lowest in the G7".

This is ingenuous in the extreme, when applied, as Varney applies it, to the Northern Ireland situation. The use of the word "maintain" suggests that Northern Ireland had a competitive tax position which had been eroded and had to be restored. It shows ignorance (which can only be wilful in light of the evidence Varney received) as to the nature of Northern Ireland’s concerns on tax competitiveness (these certainly do not relate to tax rates in the G7). Reducing the headline gap with the Republic from 17½ percentage points to 15½ percentage points has virtually no impact on those concerns.

10. Ministers and inward investors (as well as other senior business figures) in the Republic have repeatedly indicated the crucial role played by the low corporate tax rate. Varney I ignored all the evidence to this effect. Even more bizarrely, it ignored the crucial evidence on the views of those who spearheaded Ireland’s FDI drive as senior executives of IDA Ireland. For example:

A. "None of the companies I have mentioned here would have set up the operations they have in Ireland if we had the Corporate Tax Rate that pertains in Northern Ireland. Many companies prefer not to be as direct in pinpointing tax as the main factor in their decision-making, usually quoting such matters as the availability of a skilled workforce, good infrastructure access, suitable buildings etc. But I can assure you from my experience what the real position is. I firmly believe that Northern Ireland needs to match the 12.5% tax rate if it is to have any hope of being successful as a location for inward investment and overall industrial development".

B. "[ Tax] remains the IDA’s unique selling point, giving Ireland a critical advantage in winning new investment … The virtue of the scheme as marketed by the IDA was that it was simple and easy to understand….. The "[ tax] incentives remain to this day the unique and essential foundation stones of Ireland’s foreign investment boom …. The tax advantage helped overcome so many of our natural disadvantages of size and location".

C. "While economic success over the past 15 years can be ascribed to a range of domestic and international factors, it was not a fluke. Ireland has long had, and intends to sustain, low tax rates to attract investment".

11. Nothing could be less unequivocal. How does Varney justify ignoring such evidence? Yet, in the summary in Varney (para 1.35) of the "key ingredients of Ireland’s success" there is no explicit mention of one of the lowest corporate tax regimes in the developed world. The assumption must be that the Irish Government, senior business personnel and IDA professionals were considered incapable of reliable testimony regarding the Republic.

12. Box 1.1 on page 12 of Varney I I indicates that "a clear and unambiguous case for introducing a 12.5 percent rate … in Northern Ireland cannot be made, given the upfront cost and likely displacement of both capital and profits from the rest of the UK and other factors". But neither Varney I nor I I calculated what the effect would be of factoring into the Varney model the suggestions made in evidence as to how upfront costs and displacement effects could be dealt with. If this had been done, it would have been discovered that the tax reduction project is fully viable.

13. It is ironic that, whilst eschewing a key factor in the attraction of high value added FDI on a significant scale, Varney I I provides (in para 4.10) what is probably one of the most compelling cases yet made for radical action. It is worth reading in full but the central message can be distilled as follows:

"In the recent past much of Northern Ireland’s FDI is likely to have been drawn by the relatively low costs in Northern Ireland …. Northern Ireland will find it increasingly difficult to compete on cost. Furthermore, …. Northern Ireland has in the past attracted a relatively high amount of low-value FDI (for example call centres) that do not pay above the Northern Ireland private sector median salary, usually bring lower domestic demand and lead to fewer spillovers. To enhance its competitiveness in the future, Northern Ireland must complement its existing flow of FDI by attracting more FDI whose location is determined less by cost and more by quality".

In other words, one must attract the kind of FDI the Republic has been able to attract but without the bait of the very low corporate tax rate which those in the Republic who conducted the FDI drive regard as essential. Para 4.18 of Varney I I asserts confidently that:

"predominantly, success in attracting high value FDI will be a consequence of successful implementation of the wide range of other policies covered in this Review".

One is bound to ask: what is the evidence for this assertion, given that the Republic is also well able to excel in such policies but, crucially, can also differentiate itself by its ability to offer a very attractive corporate tax regime?

14. The sheer scale of the Republic’s performance is indicated by a footnote on page 65 of Varney I I: "FDI amounted to about $10 billion of inflows into the Irish economy in 2004 …. This compares with $224 million in 2004 for Northern Ireland, although this had almost doubled by 2006".

15. It is clearly a serious matter when a Government – sponsored Review is open to such criticism and when the findings of that Review are uncritically accepted by Government as the basis for its decision on tax change. It would be interesting to know whether, if the Varney outcome were subjected to Judicial Review, it could pass the test of reasonableness on the basis of the evidence presented.

16. I would suggest that it is on the major flaw at the heart of the Varney project that attention should be focussed in the forthcoming dialogue with the author of the Reviews. I therefore deal only briefly with other issues.

17. Varney I I’s Chapters on Employment, Skills, Investment, Innovation and Enterprise, whilst being a very useful compendium of relevant information, add little by way of fresh insight to matters already well traversed by Stormont Departments and others. They generally endorse the current direction of policy and its objectives, albeit on occasion suggesting the need for sharper focus or greater urgency. I doubt if much is to be gained by crawling over the detail.

18. It is interesting to note, however, on how many of the competitiveness measures Northern Ireland aligns with overall U.K. performance and how, on occasion, it is ahead. Para 5.21 of Varney I I, for example, concludes that, in many respects, Northern Ireland is ahead of UK-wide policy on innovation and of many UK regions and Ireland. Para 5.8 finds that our levels of business R&D spending are appropriate to our size and structure. Paras 6.2-6.4 conclude that, once one takes into account the sectoral make-up of existing industry, we have entreprenurial activity and start-up rates similar to the UK average, but lower failure rates. All this puts into perspective the often over-gloomy assessments of Northern Ireland’s competitiveness position.

19. There is only one point within these Chapters where it seemed as if Varney might be poised to develop the discussion in an innovative fashion but pulls up short at the jump. I refer to pages 30-37 dealing largely with what is of course already widely recognised as one of the major policy issues – namely how to get as many of the economically inactive as are capable of it into work. Thus in para. 2.9 Varney I I postulates that the low rate of private sector wages in Northern Ireland compared with nationally set benefits may indicate a potential benefits trap which could lead a higher proportion of the population here to choose to be unemployed or incentivised to claim Incapacity Benefit when they might be able to take on some work. But it ends rather lamely with the suggestion that "the Northern Ireland Executive may wish to gather more evidence to estabish whether this is the case", whilst para 2.12 suggests somewhat delphically that the UK Government should "set out how they might be able to support the Executive in the future to deliver challenging welfare reforms that tackle the stock of people on Incapacity Benefit". What is envisaged here? Is it a reduction in benefit levels? Is it a tailoring of the Treasury’s tax credits system to Northern Ireland’s circumstances? Whatever it is, Varney I I on this point seems tacitly to accept the possibility that national arrangements may not be appropriate to local circumstances and should be appropriately adjusted. Yet this is precisely the argument that Varney and Government have rejected so far as corporation tax is concerned.

20. Whilst eschewing the radical change needed to produce a step change in the growth of the private sector, Varney is very ready to say in Chapter 7 on Public Sector reform how the size of the public sector should be reduced through, for example, further asset sales. Part of the rationale given for this (para 7.24 of Varney I I) is to "ensure that all public assets are either contributing to the delivery of public services or, if not, and if their sale represents value for money to the taxpayer, are released in order to realise the maximum possible resources for the Northern Ireland Executive to re-invest".

21. However, para 7.24 then goes on to say:

"In addition to offering a new set of investment opportunities, this policy may create a means of growing the total value of the private sector in Northern Ireland, and help to narrow the pay gap with the public sector".

It has to be clearly understood that merely changing the ownership of public sector assets and having them reclassified within the private sector may alter the public/private sector balance in a statistical sense but it does nothing to achieve the strategic economic objectives which politicians in Northern Ireland set themselves in the intensive deliberations on the economy which preceded the establishment of the Executive and now pervade the Executive’s thinking. Those objectives are not about cosmetic change but require the growth of the private sector through the substantial enlargement of Northern Ireland’s high value added, export driven base which integrates the province more deeply into the global economy and enhances its external earning capability. It is this which can produce, over time, a genuine shift in the public/private sector balance. Disposing of public car parks, selling off venicle testing, transferring housing stock or privatising many of the large public corporations, whatever other purposes this might serve, will do nothing to increase or alter the nature of economic activity. Indeed to the extent that it were to divert private sector resources which might otherwise be invested in developing Northern Ireland’s manufacturing or internationally tradable services sectors, it could frustrate the objective of fundamental economic change.

22. In conclusion, the Varney project has proved very disappointing. The Reviews have been tone deaf to the lesson to be drawn from the Republic’s experience as to the vital importance of a competitive corporation tax rate in the mix of policy measures. There are no fresh insights as to how the private sector can be got on to a new growth trajectory or how a breakthrough can be achieved in accessing the FDI which is generally acknowledged to play a major role in a region’s growth ambitions. And the final emphasis on growing the private sector by transferring into it public sector assets and publicly delivered services raises doubts as to the project’s agenda and priorities. It is by drawing new export-orientated activities into the economic base rather than by rearranging the ownership structure that the necessary transformation of the economy can be achieved.