SUBGROUP ON ECONOMIC ISSUES
Thursday 14 December 2006
(Afternoon evidence session)
Members present for all or part of the proceedings:
The Chairman, Mr John O’Dowd
Mr Fra McCann
Dr Alasdair McDonnell
Mr Mitchel McLaughlin
Mr David McNarry
Mr Peter Robinson
Mr Mervyn Storey
Witnesses
Mr Ray Shostak, Director of Public Services, Her Majesty’s Treasury, HMT;
Mr Dan Rosenfield, Head of Devolved Countries and Regions Team, HMT;
Ms Judith Knott, Head of Corporate Taxation Team, HMT;
Mr Martin Beck, Economic Adviser on Corporate Taxation System, HMT;
Mr Mark Parkinson, Policy Analyst with Devolved Countries & RegionsTeam, HMT.
The evidence session started at 2.20 pm.
The Chairman (Mr O’Dowd): Good afternoon. I welcome the Treasury officials to this meeting of the Subgroup on Economic Issues, which is a subgroup of the Committee on the Programme for Government. Perhaps you would introduce yourselves and give your presentation, which will be followed by a question-and-answer session.
Mr Ray Shostak (HMT): I am the director of public services in the Treasury. This is Dan Rosenfield, who is head of the devolved countries and regions team, Judith Knott, who is head of our corporate taxation team, Martin Beck, who works in Judith’s team as an economic adviser on corporate taxation, and Mark Parkinson, who is head of the devolution branch in Dan Rosenfield’s team.
We are grateful for the opportunity to talk to you. I begin by thanking the subgroup for rearranging its timetable in order that we were able both to give evidence here and to deliver the Pre-Budget report. In my introductory remarks, I will set out the context for the Chancellor’s offer and then introduce the rationale and elements of the financial package. That will provide some background in order that we may field your questions.
You will know that the economic package has been put together in order to support the steps that the political parties and the Secretary of State are taking under the St Andrews Agreement. The package recognises the substantial progress that has already been achieved since the signing of the Good Friday Agreement, and it reflects the need to work on wide-ranging reform. The programme would promote the peace process and economic growth, strengthen involvement from the public and private sectors, and enhance the performance of the public sector so that peace is matched by economic prosperity.
The package comes at a time when the fiscal climate is much tighter than in the past, and is in the context of the two fiscal rules that have led to the strong macroeconomic stability of recent years. The first is the “golden rule”, which is that, over the economic cycle, the Government will borrow only to invest, and not to fund current spending. The second is the sustainable-investment rule, which dictates that public-sector net debt, as a proportion of gross domestic product (GDP), will be held at a stable and prudent level over the economic cycle.
The package also comes before the 2007 comprehensive spending review (CSR) which is within that much tighter fiscal climate, and which has led us to work with all Departments to ensure that spending and supply-side programmes, which promote economic growth, are cost-effective and provide value for money. That again reflects the tighter fiscal climate.
As you will know, the Northern Ireland Departments are carrying out their own spending review, and we are liaising closely with them — again, within that tighter fiscal climate. The Treasury and other Westminster Departments are determined to continue to make progress in that climate and look forward to working with you post-devolution also.
It is worth noting that the Government have already made several early settlements as part of the 2007 CSR. The Departments that have settled include the Department for Work and Pensions (DWP), HM Revenue and Customs and, indeed, the Treasury group, which have all settled at –5% for each of the three years in the CSR period.
In its recent pre-Budget report, the Treasury also announced –3% efficiencies year-on-year during the CSR period, with a focus on cashable efficiencies to facilitate reinvestment. That gives an indication of the approach of the 2007 CSR and some of the challenges that we have faced in relation to it.
Finally, the Treasury recognises that the St Andrew’s Agreement built on the considerable progress that has been made in Northern Ireland so far. Indeed, we touched on that point when we met with your advisors this morning. We also recognise that the Northern Ireland economy has prospered in recent years. Since 1996, the economy has grown every year, and the average annual rate of growth in nominal terms has been 5·4%, which is similar to the UK average. The unemployment rate is falling, from 8·2% in 1997 to 4·4% in 2006, compared to 5·5% in the UK. Whatever problems remain, particularly with productivity and inactivity, there is a strong platform from which to go forward. The Chancellor’s package is an attempt to work with you to build on that platform.
Work is ongoing to reduce dependency on the public sector and improve Northern Ireland’s public services. There are record levels of investment and, in nominal terms, public spending by the Northern Ireland Departments will be 20% higher in 2007-08 than it was in 2004-05. Public spending in Northern Ireland is 30% above the UK average and is by far the highest in the UK.
I am aware that members know those figures, but they create the context in which the package that the Chancellor put to you was formulated. The package is intended to reflect that context and, in the light of analysis and representations that were made to him, on 1 November 2006 the Chancellor announced a medium- and long-term funding package to provide the incoming administration with a secure and certain basis for planning spending. That package is, of course, contingent on the restoration of devolution. In view of the settlements that the Treasury has made with other Departments, that secure and certain basis has significant value.
In his letter of 8 November 2006, the Chancellor explained that the Government are prepared to offer a funding package in order to support the objectives that they share with the local parties. The aim is to promote a private-sector-led economic strategy for Northern Ireland and to create a world-class, modern and dynamic economy.
We want to answer any questions that you may have about that package and to develop a common understanding of it. The funding commitment for the next four years is a minimum of £35 billion. That confirms the existing departmental expenditure limit spending for 2007-08 and increases it by the rate of inflation over the following three years. I have no doubt that you will want to ask questions about that.
The CSR settlement will be confirmed next year and will be based on the updated Statement of Funding Policy. Should devolution return, the Executive would, inevitably, be consulted on that. The figures for each year are £8·5 billion, £8·7 billion, £9·0 billion and £9·2 billion.
The package also confirms the £200 million reinvestment and reform initiative (RRI) borrowing limit for 2007-08. That is in addition to departmental expenditure limit spending and is available to finance increased infrastructure investment. That facility is unique to Northern Ireland.
There is a long-term funding commitment of £18 billion for capital investment for the years 2005-17. That extends the existing 10-year strategy by two years and provides a framework for modernising Northern Ireland’s infrastructure. The package also commits to an end-of-year flexibility drawdown of £0·4 billion over the period to 2010-11. The Northern Ireland Executive would be able to carry forward all departmental expenditure limit underspending.
In order to boost capital investment, the Executive would also be allowed to retain the receipts from the planned sales of public sector assets, which are currently estimated at over £1 billion to 2010-11. There may be scope to identify further asset sales in the spending review.
The Executive would be allowed to retain all efficiency savings identified over the CSR period to strengthen frontline services. Those would, on current estimates, rise to at least £800 million in 2010-11.
2.30 pm
Work is in hand on value-for-money reviews to maximise those savings here as it is in the rest of the UK.
Finally, the Northern Ireland Executive would be allowed to retain EU receipts under the structural fund and peace funding. These are estimated at £500 million for the period 2007-13 and are designed to promote regional development and community cohesion. In aggregate, the package is worth around £50 billion.
We talked earlier with your advisors about our concerns relating to corporation tax. The Government are fully aware of the representations made in favour of reducing the rate in Northern Ireland, and have considered those carefully. The Government’s view is that the UK, including Northern Ireland, has a competitive tax structure.
According to the joint report on the ‘Comprehensive Study on the all-island economy’, direct taxation, as a percentage of income, is lower in Northern Ireland than in the Republic: 24·8% compared to 26·3%. A small-companies rate already exists; other allowances mean that the effective rate of tax paid is lower than 30%; and R&D tax credits are more generous in Northern Ireland than in the Republic. There are many difficulties associated with lower rates of central government taxes in Northern Ireland, and such an approach would be illegal. Instead, the Government envisage strengthening supply-side policies, such as that on skills and innovation. This is also advocated in the all-island report.
That leads us to two further aspects of the package that you may wish to discuss. The package proposes the setting up of an innovation fund to support R&D and innovation in Northern Ireland business and research. That reflects the importance of Northern Ireland focusing on developing a highly skilled workforce, building on its science and education sectors and responding to the challenges of globalisation.
Secondly, the package proposes to provide a corporation-tax office that will be a one-stop shop, offering advice to companies that are considering a potential investment in the Province, advising on business issues such as R&D tax credits, and advertising the skills and the new incentives to the world.
Members are welcome to ask questions and seek clarification today on the package. We are also here to help you research your report, which we look forward to.
In summary, this funding commitment is unique to Northern Ireland, particularly in the context of the overall CSR, and will ensure that Northern Ireland continues to have the highest levels of public spending in the UK. We will also work with the Northern Ireland Executive and the Republic to strengthen the development of the all-island economy, and improve value for money in public services across the island. We will co-operate with the Irish Government and devolved Ministers in relation to joint funding that the Irish Government may wish to put forward.
To conclude, the Treasury looks forward to working in partnership with devolved Ministers, when devolution returns, on public service and economic growth to reform and improve public service delivery, while at all times recognising that in those devolved areas it will be for the Northern Ireland Executive to decide their priorities and policies. That has been an important driving force in constructing the package, and it is the basis for any discussion or clarification that you may want during the course of the afternoon.
Dr McDonnell: Having attended the session with the Chancellor, most of the detail of the added money and the infrastructure fund is fairly clear-cut to me.
Can you tell us anything about the innovation fund that the Chancellor mentioned at that stage? Will it be additional to the existing health research funds that were established in England? If not, how does it relate to those funds? Will it be additional or will it be assumed that — [Inaudible due to mobile phone interference.]
The Chairman (Mr O’Dowd): I am sorry to interrupt you, Alasdair, but someone has left their mobile phone on. It is causing interference with the recording equipment. Can members please ensure that their mobile phones are turned off?
Dr McDonnell: Isthat research academic or commercial — they are very different animals. I, and many of my colleagues, believe that it would be wonderful to have money invested in academic research, but we really want investment in commercial research that will produce a profit at the end of the day.
Mr Shostak: We would be delighted to clarify that for you, and I welcome this opportunity to ask my colleague Dan Rosenfield to respond. To reflect the spirit of the question, we, too, as you will have gathered from my introduction, see the innovation fund as an important component in supporting the development of the economy in Northern Ireland.
Mr Rosenfield (HMT): The starting point, as you suggested, was your meeting with the Chancellor, at which he clearly signalled that he was committed to an innovation fund in Northern Ireland. He subsequently asked officials to follow up with details, which is where we come in. Our approach has been one of partnership with our colleagues in Northern Ireland on the idea and the overall context, but also of generating links with officials in the Republic of Ireland to identify opportunities across the piece.
I will briefly set out the context that informs that deliberation and the way in which we are trying to take it forward. I will pick up on your specific points as well.
We are very keen to meet some of the priorities set out at the meeting that the Chancellor had with the local political parties. The needs identified were to meet the perceived historical underinvestment in capital; to generate higher private-sector investment; to collaborate more closely with the Republic of Ireland; to develop Northern Ireland’s science and R&D base; and to create world-class universities, building on the solid base that already exists and ensuring that it is capable of meeting the specific challenges of globalisation.
We are also very mindful of the ‘Second Report on the Economic Challenges facing Northern Ireland’, particularly some of the points that it made about science and innovation. Equally, the study of the all-island economy touched on some of the evidence base we will take account of when thinking about how to structure and focus a fund.
Finally, it is important to recognise the partnership approach between reserved policy areas and what could be devolved policy areas. We are mindful that there is a UK science and innovation investment framework, which spans 10 years, and it would be critical that any fund complements and builds on it.
That is the broad context. I will now move to specific issues. Since the parties met the Chancellor, we have engaged directly with our colleagues in Northern Ireland, recognising the partnership nature of the approach and that there is already a significant amount of policy on which we would like to build, such as some of Invest Northern Ireland’s work.
If we got the design wrong, there would be a risk of duplicating already existing policy, which we are keen to avoid.
Equally, as I signalled, we opened up communications with the Republic of Ireland to explore some of the ideas around collaboration. However, at the very strategic level, while we do not want to be too prescriptive about the fund, we suspect that the overall approach wants to be one that seeks to increase business investment and innovation and to encourage innovative collaborative projects that include the private sector. So I am referring very much to a commercial angle as well as to the academic angle that you mention.
What does that mean in practice? Currently, dialogue and engagement are not prescriptive. Ideas and proposals at this stage include prioritising specific areas such as funding to encourage innovative R&D investment by companies in high-growth sectors, particularly with a focus on small to medium-sized enterprises and inward investors. One proposal is that that could be operated as a challenge fund, a model used in the Republic of Ireland and elsewhere.
Another priority might be an international innovation investment collaboration fund, which would recognise the global nature of the R&D innovation challenge and explore collaboration with countries across immediate borders, but also with global players such as the US, India and China.
We are also keen to explore how we might best use the funds to develop centres of world excellence by investing in innovative technologies and technology transfer, perhaps through joint investment between Northern Ireland and the Republic of Ireland universities, building on existing research centres and making sure that we are capturing the commercial angle of development and the spin-offs that one can realise from the more academic side of research.
Finally, we are interested in considering whether we can learn lessons that from some of the existing Northern Ireland policies around science parks, and those in other parts of the United Kingdom. We also want to look at the best practice of UK policies such as science cities, and to establish whether that could be applicable in a Northern Ireland context.
Dr McDonnell: Will the issue be 20% commercial and 80% academic or 20% academic or 80% commercial? How will the balance be struck, or who will decide that?
Secondly, you say that you are in dialogue with Invest NI. I do not want to offend or criticise those in Invest NI, but they are, by and large, people with a Civil Service background and frankly, when new, cutting-edge, hi-tech and highly innovative technology appears, it scares them because there is big risk involved.
How can we introduce necessary risk-taking? Where are we going to strike the balance?
There is much talk and action from a lot of tremendous people in the medical world here, but it is by-and-large all academic. It is impossible to persuade them that it is not dirty or prostituting to make money out of these projects. The challenge is to convince them otherwise.
In my view, the fund will work if it is commercial and radical in terms of risk. We must stop being scared of risk-taking; there are small companies throughout the country that would potentially take those risks, but we are not pulling any of them through.
The Chairman (Mr O’Dowd): Does anyone want to comment on those remarks?
Mr Rosenfield: Chairman, if I may respond. I suspect that our starting point is very much the same. Our interest in investment, innovation and R&D is because it is a key driver for improving productivity and therefore economic growth. If we agree on that and take it as our starting point, it rather suggests that the focus should be more heavily on the commercial side than the academic side.
While we do not want to be prescriptive about the specific balance, I think that we would share the thrust of your point on that. Similarly we seem to agree on how we can really exploit the current dialogue and make sure that it delivers the expertise we require to make a policy work in practice.
However, the critical element for me is that we see this as a collaboration with the private sector; that it should promote dialogue and encourages an element of challenge; and that we bring the private sector to the table in a way that frankly recognises, dare I say it, that the Civil Service does not always have the best answers to some commercial questions and that we are at our best when we create the right space in which to work in partnership with the private sector.
Mr McNarry: Thank you for taking the time to come and speak to us today. I hope that it will not be the last opportunity that we will have to discuss those issues.
The local media caused some confusion by reporting headlines of new money in the Chancellor’s package. Our local experts seem to have taken the £50 billion and reduced it to nothing. Can you state clearly what is new money beyond the public expenditure that we might reasonably have expected in Northern Ireland?
2.45 pm
Mr Shostak: I will ask Dan to go through the detail. I will take the direct question about the new money in the package.
Mr McNarry: It would help inform the public, because they have either been misinformed or misrepresented — or you have been misrepresented.
Mr Shostak: Indeed. Before Dan describes that for you, I remind you of my opening remarks and the context in which we are operating. It is a much sharper fiscal outlook, and settlements have already been made with Departments. What that does is create a climate in which we have tried to construct a package, so the direct question is entirely relevant.
Mr Rosenfield: Ray, in his opening statement, described all the elements of the package, totalling over £50 billion. The package contains the following elements that have already been announced: £8·5 billion departmental expenditure limit in 2007-08; £16 billion investment strategy; and £200 million for reinvestment and reform initiative borrowing in 2007-08.
The new announcements in the package are a commitment to: first, at least uprate the 2007-08 departmental expenditure limit by inflation in the comprehensive spending review, with the actual settlement to be announced next year in the normal way; secondly, an additional £2 billion, by extending the investment strategy by two years; thirdly, additional flexibilities, including drawdown of existing end-year flexibilities over the comprehensive spending review period, retention of over £1 billion of planned asset sales, retention of at least £800 million value-for-money and efficiency savings in 2010-11 and retention of £0·5 billion EU receipts up to 2013.
Mr McNarry: To help the poor soul who has difficulty in putting all that together, what is your assessment of how much of that, in total, is new out of the £50 billion? Can you give me a ballpark figure of £x billion?
Mr Rosenfield: The package totals around £50 billion — just over £50 billion.
Mr McNarry: I am well aware of that. Can you tell me what I have got now, that I might not have got, had colleagues not gone to see the Chancellor at 11 Downing Street?
Mr Shostak: It is difficult to tell you what you might not have got. Part of what we are doing is creating an early settlement for the new devolved Executive. In that respect, we are currently in the process of setting departmental budgets for 2008-11, and as part of that process we are going through with Departments zero-based reviews against all of their major negotiated spending lines.
The package that the Chancellor put to you creates that new certainty and is an allocation of resources, which provides that certainty now.
Mr McNarry: I am trying to say to you that the package as explained by the Chancellor has not penetrated and that whatever benefits are in it have not been grasped. Perhaps they need to be simplified so that the public can grasp them. Equally important is that the package is being presented in a climate in which the politicians in Northern Ireland — and I respect you and I am grateful that you are trying to help us — are coming to an arrangement whereby a devolved Government would be restored.
I am sure that if you were advising a potentially incoming devolved Government you would be asking them to find out what more money they will have in order to govern than they will inherit directly from the outgoing direct rulers. I suggest to you that work needs to be done to deal with the confusion, and now the perception, about the package. To be honest, I will need to think about your answer two or three times because I do not have a clue about what you have told me.
I will leave the matter for other colleagues, unless Mr Robinson wants to ask a supplementary question.
Mr P Robinson: I think I understood what was being said — we are being provided with certainty and not new money.
Mr McNarry: I agree.
Mr Rosenfield: If there is an issue about understanding I will restate the figures, specifically to answer direct questions, and then set out what I think is new, and I will be absolutely clear about that.
The overall package is around £50 billion and contains specific elements that have already been announced — the £8·5 billion departmental expenditure limit in 2007-08, the £16 billion investment strategy money, and £200 million reinvestment and reform initiative (RRI) borrowing in 2007-08.
There are three new elements in the package. First, there is the uprating of the 2007-08 departmental expenditure limit by inflation across the CSR. That will provide an incoming Executive with much greater certainty than Whitehall Departments currently enjoy, or, in Northern Ireland’s case, than a direct rule organisation would enjoy. An incoming Executive will be able to come into the CSR process in an environment of certainty and will be able to make plans on that basis.
Secondly, a new element, which is critical, is the extension of the Investment Strategy for Northern Ireland to 2017, which will provide an additional £2 billion. Behind that decision is specific recognition of the challenges for Northern Ireland to invest in infrastructure as a key driver to attracting private sector investment. An incoming Executive will be able to enjoy the longer-term certainty that that will provide as regards planning and funding.
Thirdly, there is the announcement of specific flexibilities, which is a new announcement. These include the points around end year flexibility and the retention of the receipts from the sale of public sector assets. I appreciate that the Subgroup on the Economic Challenges Facing Northern Ireland looked at the issue in its report. Those additional flexibilities provide greater certainty and spending power for an incoming Executive.
Mr McNarry: I will read that again with interest. I understand the aspect of certainty. I am concerned that what you outlined is what we could have reasonably expected. You appear to be ring-fencing with some certainty, what we would have reasonably been expecting. There will have to be some thought as to whether or not it is additional in real terms.
My second question concerns a press release from the Treasury, issued on 1 November 2006, which stated that:
“The UK Government will work with the Northern Ireland Executive to simplify the R&D tax credit rules”.
Can you outline what that simplification will entail? How will simplifying the rules encourage new opportunities, particularly those with environmental benefits? For example, how would it further the development of biomass opportunities for our hard-pressed farming community? That issue has recently come to the fore. Although we are advanced in some aspects, simplification of the R&D tax credit system could help some people immensely.
Ms Knott (HMT): To provide background, I will explain the basics of the R&D tax credit system. The system in the UK compares very favourably internationally. That assertion is supported by external research. For example, Deloitte has assessed the UK’s R&D tax credits as among the world’s most attractive regimes. Benchmarks set by the Organization for Economic Co-operation and Development benchmarks also rate the UK system as attractive compared to that in the Republic of Ireland.
Over recent years, we have consulted on R&D tax credits, most recently last year. That consultation made clear that improvement of the administration and delivery of the R&D tax credit was vital. Companies will not take advantage of R&D tax credits unless the system is simple to administer and will be managed in helpful and friendly way towards claimants.
Mr McNarry: You must appreciate that Northern Ireland has a large number of small companies that are not attracted to R&D because they do not see how it would benefit them.
Ms Knott: I fully understand that. The Treasury is also well aware that the problem with R&D is uptake, especially in Northern Ireland but also in the UK. As a result of the consultation, improvements in administration and delivery will ensure that the three core principles of the system — simplicity, consistency and certainty — are upheld. Certainty is vital; R&D will not be factored into an investment plan unless a business is certain that it will receive the tax relief.
A major initiative that has arisen from the consultation is the creation of new specialist units that will handle all R&D tax credit claims by small and medium-sized enterprises. The units will be centres of expertise and excellence within Her Majesty’s Revenue and Customs that will deal with tax credit claims. The units will also have a strong outreach function and will build strong links with the local R&D community and tax professionals. In addition, the units will have a major role in promoting the tax credit to help encourage uptake and will assist companies with claims.
Those elements of the simplification and promotional package are now in place. However, an additional element for Northern Ireland, as part of the financial package accompanying the St Andrews Agreement, is an extension to the corporation tax and VAT office in Belfast. That office will have a specific R&D remit and will act as a specialist unit for R&D claims. Furthermore, it will advise potential overseas investors on other aspects of the tax system. However, the R&D tax credit aspect, including promoting and dealing with claims, will be central to its operation.
3.00 pm
Mr McNarry: Would you be able to consider the additional aspect of R&D tax credits favourably for businesses now going into the environmental management of products?
Ms Knott: The general rules on qualification for R&D tax credits would apply to environmental and other areas in the same way. What emerged from consultation is that simplicity and certainty are key to the R&D tax credit. Putting more bells and whistles on particular types of investment would actually detract from the benefits of simplicity and certainty.
Mr McNarry: I can imagine a farmer going in to your corporation tax shop seeking help on diversification and bumping into a businessman looking for some information on corporation tax. I doubt if you would be able to give the businessman the information he requires, because from what you have said a reduced rate of corporation tax may not be introduced, although you may be able to help the farmer.
Ms Knott: The outreach function will serve the local business community. To the extent that farming is an element of local business, the outreach function will serve it.
Mr McLaughlin: Thank you very much. You are very welcome.
I will briefly set out the context. The parties that will form an Executive, if we arrive at that point, are represented in this subgroup. An Executive will have to address the challenges and very significant difficulties that will emerge.
We are emerging from a conflict that has lasted decades. We are dealing with very significant deficits in infrastructure and with the reality that our economy is unbalanced: we have a struggling private sector and a much stronger public sector, and we are committed to doing something about that.
In your statistical analysis you referred to what appeared to be very favourable and comparable employment statistics. But, of course, they do not tell the whole story, because we are dealing with a population of 1·6 million people, half a million of whom are economically inactive.
I do not want to waste time trying to find out where the extra money is. I want to cut straight to the chase. The Chancellor bowled short, because even if there is extra money in the £50 billion, the question is, is it sufficient? The answer is quite clear. It is not.
The Executive is being set up to fail, unless the Chancellor recognises the need to invest in the peace process and in the political process. The deficits have emerged over a period of time for various reasons, and there is no real benefit in going over that again.
No one is seriously disputing that investment is necessary if we are to rebalance the economy, attract investment and make the step change described in your presentation to a modern, dynamic and vibrant economy. If we had the resources we might be able to do that in five years, although that would be a miracle. It will probably be a 10-year programme to reorient third- and fourth-level education to produce the type of graduates who will manage this new economy.
We are living cheek by jowl with one of the most successful economies in the world, which is performing better than any collective region in the UK, or any individual region for that matter. Northern Ireland’s disadvantage is real, and is compounded by what appears to be a lack of appreciation. I know you are constrained by the policy as set out in the Chancellor’s statement, but the message has to go back very clearly that the investment is short of what is needed if we are going to succeed.
Presumably, Government want us to succeed.
The Chairman (Mr O’Dowd): Are you waiting on a response to that?
Mr McLaughlin: I do not expect a response.
Mr Shostak: We certainly want the devolved Administration to succeed.
Mr Rosenfield: Ray has already mentioned the tight fiscal climate, and the challenges of delivering the comprehensive spending review in that context. However, it is worth saying, more widely, that the Treasury and the Government are absolutely committed to working with an incoming Executive in order to make the Northern Ireland economy a success. We broadly share your initial analysis of the economic problems facing Northern Ireland at present. As Ray suggested earlier, it is important to be positive about the wins that Northern Ireland has experienced. For example, although some employment figures do not compare favourably to other regions across the UK, they do compare favourably to some of the historical figures. Therefore, progress has been made. We must celebrate that progress and learn to build on it.
There are three broad strands to the approach that we are taking in trying to make a success of the economy. First, there is macroeconomic stability. The Chancellor and the Treasury have worked hard to deliver 57 quarters of consecutive economic growth. That that has happened is in part due to the measures taken to make the Bank of England independent and to the prudent and cautious approach taken to managing the public finances. Let us not forget that that is critical to the investment decisions and the environment in which businesses operate. Clearly, however, that is not the whole picture, and we accept that analysis.
Secondly, in England, and I suspect that it also applies in Northern Ireland — although that would be for an incoming Executive to decide — one would need to supplement that macroeconomic stability with microeconomic reform and appropriate investment. Our analysis suggests that one can bend policies and public investment in order to help drive the underlying factors of productivity, as well as those factors that contribute to increasing and growing productivity in a way that brings stronger economic performance in the medium and long term.
Thirdly, as has been suggested, there are comparatively high levels of public spending in Northern Ireland. Northern Ireland has the highest level of comparative public spending per head of any UK region — around 30% higher than the UK average. Although that may affect the balance of the economy, it also presents a significant opportunity for an incoming Executive to use that resource most effectively in a way that drives microeconomic reform and facilitates and supports private-sector investment. The Treasury sees itself working in partnership with an incoming Executive in order to ensure that macroeconomic stability and microeconomic reform work hand in hand within a devolution framework, whereby the decisions that drive Northern Ireland’s economy and influence local people’s standard of living are taken at the right level, close to where market failure occurs and where those decisions have impact.
Mr McLaughlin: I would like some clarity on a final point. When the Prime Minister last visited here, he made a commitment to political parties and, in particular, to the business community that the Government were prepared to listen to arguments and specific proposals. There is, of course, a debate on the issue of corporation tax. In his remarks, however, the Prime Minister made it clear that a possible cocktail of measures and initiatives could create the level playing field that people believe is axiomatic if there is to be a successful political relaunch.
A step change is clearly required if, 12 years since street conflict ended, we are dealing with the fact that policies are being applied — under direct rule, expect for a brief interlude — in the way in which you described them; the fact that there is a dependency on the public sector; the fact that 96% of businesses are small and medium-sized enterprises (SMEs); and the fact that 500,000 people are economically inactive. We could manage that step change on the same basis, with the same resources, and still have the same outcomes.
However, we are describing a different future and a different world; we are talking about the economy’s ability to grow and to create employment opportunities. I know that you will not second-guess the Chancellor, but where in his statement are the proposals concerning a cocktail of measures on a broad fiscal policy, and the flexibility, that could lead to a step change?
Mr Rosenfield: My answer to that question is rooted in our approach, which has emerged in the financial package and the way in which we would wish to work with an incoming Executive. The Treasury is responsible for the reserved public spending framework, but it wants to create the space and opportunity for an incoming Executive to work in partnership with us in order to make decisions on spending and investment priorities. The challenge with a cocktail of measures — and the Treasury is addressing that issue — is to provide planning certainty on public spending and the appropriate resources. We are trying to create the space for you to make those decisions in partnership with the Treasury, where appropriate, in a way that you see fit.
Partnership is the approach that we seek. The Treasury would not want to be prescriptive about a cocktail of measures for the Northern Ireland economy. We want to work in partnership with you but, equally, we want to respect the space for an incoming Executive to make those decisions — and rightly so — in respect of devolved matters.
3.15 pm
Mr P Robinson: First of all, I welcome you all. When I am involved in negotiations, I often try to test how my words might sound to those sitting on the other side of the table. I rather suspect that it is only your good training and civility that stops you from biting your tongues at times. You could well say that you have produced a package worth £50 billion, yet these awkward people are quibbling about it.
I do not wish to give you a talk on the Union and how we should all benefit from the prosperity of the nation. The Chancellor and the Secretary of State have clearly indicated the need for significant investment in Northern Ireland. Any incoming Executive would applaud your certainty, particularly a future Minister of Finance and Personnel. It is helpful to know where we stand on those issues.
We are all old and experienced enough to recognise that, however the financial deal is packaged, it is essentially what a reasonable man might have expected it to be. However, we are being told about the financial package at an earlier stage. The newspapers and economists that have addressed the issue have more or less come to the same conclusion. If that is the position — and I have heard nothing today to persuade me otherwise — it really does not cut the mustard in addressing the very issues that have been recognised by the Chancellor and the Secretary of State. Mr McLaughlin and I share the same position on this issue, and we could not come from more diverse political viewpoints. If the financial package does not address Northern Ireland’s long-term economic structural problems, the quantum must be increased.
The Chancellor has not sent you here today to announce that the package will be upscaled. When we met the Chancellor, I sat directly opposite him; I noticed that his statement was handwritten and had not, perhaps, gone through the normal, official channels. You must accept that more work clearly needs to be done on that package.
Are we wasting our breath? Has the Chancellor made his offer based on our present situation, with the understanding that we can go to him some time between 7 March 2007 and 26 March 2007 — when he hopes that we will have sorted ourselves out — and say that progress has been made so that he can talk real business? The quantum must be increased.
I am sure that you wish that the corporate tax issue would go away and that we would stop talking about it, but it is recognised that a little corporation tax shop will not be enough to get the people from business and industry on to the American airlines and over to Northern Ireland. However, they will come if they have the incentive of a reduction in corporation tax. It is the most important element of a package that could help to raise our economy from its present level to being less dependent on the Treasury. We could move our economy away from being so heavily public sector-led to one that is more prosperous with greater private-sector investment.
3.15 pm
We do not want to have a long-term hands-out approach to the Treasury; we want to be able to change the mess that we are in, and we can do that only if we move up a few gears. There is no better way to do that than by reducing corporation tax. You will find that people — such as myself — in the awkward squad will continue to raise the issue until somebody listens to us and takes the step that can lift us out of our present circumstances and make us less dependent on Exchequer funding.
Mr Shostak: I will ask Judith to talk about corporation tax shortly.
Mr Robinson’s contribution contained today’s second reference to “any reasonable man” — which we all are — expecting certain sums of money. In the new financial climate, many of our discussions with Departments relate to what have been reasonable expectations about the period of growth that has been experienced over recent spending reviews. The comprehensive spending review is in a different climate from that. Therefore what was reasonable some years ago may not be in the assumptions that underpin the discussions that we are having now with other Departments or the context in which the financial package is being put on the table.
I hope that today is helpful in clarifying the nature of that financial package and the rationale behind it. It is about us supporting the subgroup’s aspirations in respect of an economic relationship with the Treasury and our objective to support Northern Ireland in developing its capacities, which we are desperate to do.
Judith will address your concerns on corporation tax.
Dr McDonnell: May I interrupt? I have two supplementary questions following on from Peter’s contribution. Has the Treasury taken a view on ERINI’s study of corporation tax?
Since we will keep on about the issue of corporation tax, what is the best way to take forward the discussion on it? We will probably keep annoying you about it, and you will probably keep annoying us by rejecting it. It does not square. However, it is better to ask those questions now rather than later.
Ms Knott: We have read with interest the ERINI report on reducing the rate of corporation tax for Northern Ireland. Having looked at it, we do not believe that such a measure would result in the benefits that the report claims would accrue, or that a reduction could overcome the serious practical problems involved in implementation — problems that the report itself does not consider in any depth.
Recent surveys by respected international bodies consistently show that the UK as a whole is successful in providing a business-friendly environment and a competitive tax system. Looking at the tax systems in total rather than the rate of corporation tax alone, we think that the Great Britain and Northern Ireland tax system enjoys a number of advantages over that of the Republic of Ireland. For example, the rate of VAT and the top rate of income tax are lower. Moreover, tax relief on dividends is beneficial, and that is quite important when looked at alongside the corporation-tax rate.
I have mentioned R&D, so I will not say anything further on it. The UK tax system is competitive. A cut in the rate of corporation tax in Northern Ireland would not represent good value for money for the Exchequer. It would have a significant revenue cost, which we estimate would be well above the cost that the ERINI report suggests, once allowance had been made for the encouragement that such a tax cut would give to tax avoidance.
The report explicitly assumes that there would not be shifts of production or profits from the rest of the UK to Northern Ireland. That assumption would not be borne out in reality. Most of the savings would accrue to existing businesses in Northern Ireland, so that would be dead-weight cost and would not represent good value for money. It would also exacerbate the problem of tax-motivated incorporation by introducing a differential between the self-employed and the corporate structures, and that would simply reduce tax revenues without there being any extra economic activity in Northern Ireland.
A change in the rate of corporation tax would also introduce complexity into the system. That would not be good for the rest of the UK — or for Northern Ireland, as Northern Ireland businesses would have to deal with the complexity. Essentially, a system would be created in Northern Ireland in which the rules that currently apply to cross-border transactions would have to be applied between Northern Ireland and the rest of the UK.
Perhaps most importantly, we do not believe that the corporate tax rate is core to developing Northern Ireland’s economy. International investors are interested in a variety of factors, both tax-related and non-tax-related, when deciding where to locate investment. Survey evidence and our own discussions with businesses, which have been extensive recently, suggest that the corporate tax burden is not at the top of their list. Rather, it comes below factors such as the availability of skills, cost of labour, transport infrastructure; and access to markets.
Finally, we do not believe that a change in the rate of corporation tax would be legal. We have looked at the issue on its merits and have not focused on the legality of any change, but we conclude that the case has not been made that a change in the rate would achieve the benefits that the report claims.
Mr P Robinson: I wish to make two comments. First, in response to Ray’s apologia, I must make it clear that there is a distinction to be drawn between saying to us that no new money is available and saying that there is currently a tight fiscal environment in the UK and that the climate is such that we might have expected to get less over coming years.
However, that does not address the issue that we have raised. If we are doing well to get much the same as we currently get, when in some areas we might have expected to get less, that is nevertheless not the new money that is needed to address the problems that the Chancellor, the Secretary of State and we ourselves have identified.
That is the problem that I have with the response.
Members may wish to engage with your team on the issue of corporation tax. It is not a question of whether that measure provides good value for money, because, with respect, I do not believe that the Treasury has thoroughly analysed the benefits that would accrue to the UK if that project were pursued.
There would undoubtedly be more business in Northern Ireland as a result of cutting corporation tax. That would result in less dependence on benefits and a greater tax take due to the resultant higher level of employment. There would also be greater National Insurance contributions and other benefits for the Treasury. The Exchequer might take a hit in the short term, but, before too long, it would receive considerable payback.
Judith’s comments possibly indicate that some consideration and analysis has been carried out on the matter. We have carried out our analysis, and shared that with the Treasury. I wonder whether the Treasury is prepared to share its analysis with us so that our team might be in a better position to persuade the Exchequer about areas in which its analysis is deficient. Perhaps we could also address what your team believe to be the deficiencies in our approach.
Ms Knott: We have examined the ERINI report, and some of our concerns are based on assumptions that that report admits to making. For example, it assumes that, if the corporation tax rate were cut, the economy of the North of Ireland’s foreign direct investment (FDI) would grow at the same rate as that of the Republic of Ireland in recent years. We believe that to be an overly optimistic assumption, and the report admits that its position is optimistic compared with the consensus of academic literature on tax rates and the growth of FDI.
A further issue rests on the assumption that there would not be artificial profit shifting from the rest of the UK into Northern Ireland as a result of a tax shift. Artificial profit shifting would significantly increase the cost of a cut in the corporation-tax rate. The report itself states that a 1% shift in profit from the rest of the UK to Northern Ireland would cost an additional £200 million. Therefore much of our analysis is based on points that are contained in the report.
Mr P Robinson: Your comments could be seen as contradictory. On the one hand, you pour cold water on the suggestion that the Northern Ireland economy might move at the same rate as the Republic’s, but, on the other hand, you then suggest that, if that happened, everyone in Great Britain would take to their boats and move to Northern Ireland.
Ms Knott: I had in mind artificial profit shifting, not the shifting of real activity. I had in mind the shifting of profit without any shift in the underlying economic activity. That would not actually help the Northern Ireland economy at all.
Mr Beck (HMT): A company in London that set up a so-called brass-plate office in Belfast could shift its profits to Belfast but keep its real economic activity in London.
Mr P Robinson: It would not be too difficult to implement regulations to prevent that from happening.
Dr McDonnell: As a supplement to Peter’s comments, it strikes me that, first, there are very few companies here that pay substantial amounts in corporation tax. Secondly, any loss in the short term would be swung into reverse gear and into profit within four or five years because of, as Peter has suggested, the amount of extra tax that would be collected.
3.30 pm
The political point about it is that if I go into a boardroom in New York with David McNarry and I say that I have the most wonderful tax regime in the world and I will give them this, that and whatever, and I have a cocktail of 25 different advantages — and David says that he will provide 12·5% corporation tax — who do you think is going to get the deal? David is going to get the deal every time. This is about the banner headline: the politics of it.
That is where we are coming from. We need that lower rate of corporation tax, as Peter Robinson suggested earlier, to kick-start us, to draw a line in the sand and say that the past is behind us and we are now going over the top in terms of the economy. It is a political trajectory that says that we are on a new platform. Within 10 or 12 years we would become a net contributor to the Treasury.
The Chairman (Mr O’Dowd): You are going beyond a supplementary question now, in all fairness.
Dr McDonnell: I am just making the point. Whether we grow at 80% compared to the Irish Republic, or 70% or 85%, is not the issue. The overall cumulative benefit would be the mood change and mind change that would move the whole equation on. That element needs to be factored in. I do not have the knowledge to disagree with your financial analysis, but there is a political dimension that says: “let us switch on the jet engine”. I can assure you that if David McNarry goes to New York and says to an investor that he will get 12·5% corporation tax, the guy will break his arm.
Mr McNarry: Clearly, the understanding is that we are not in negotiations with Treasury officials. If that were so I sense that things might be less friendly. Therefore, this is the preparation for negotiations to give people the confidence and encouragement to go forward into Government. From my party’s view, I will not be reporting back to the largest political membership in Northern Ireland that this session has been helpful. I am more likely to report that there is a deal-breaker in the offing. That goes against the grain in terms of the contribution that we all want to make to the restoration of Government here.
We are in an investigative mode. We have given you notice in writing of our intention to make counter-proposals. The question is much as Mr Robinson said: are we going with this or not? We want to be able to make an encouraging report that the financial deal is not going to hold back the other deals. Is it fair to ask how you would envisage how we can together manage and facilitate the counter-proposals that will be put to you in a manner that will bring a satisfactory outcome and encourage the formation of a devolved Government with the financial clout to proceed?
Mr McLaughlin: Can you also give us an indication that there will be an opportunity to engage further with you and the Chancellor around the proposals?
Mr Shostak: It has not been part of our remit to be part of a negotiating team. You have made reference to that already. Those are matters that you may want to take up with the Secretary of State; it would be inappropriate for us to comment on that as officials. What we have done today, I hope, is to help you to understand the nature of the package and to see the strength of what is being put on the table, in order to be able to support what sounds like a shared set of ambitions as regards a devolved Administration.
I am not sure that I can add much more to that. We are aware that you are preparing a report, which we look forward to receiving. The Chancellor has made an absolute commitment to consider that report, and he has deputed us to meet with you to help in producing it.
Mr McNarry: It would be useful if you could accommodate any counter-proposals that the subgroup might have and then produce a report on how those were received. That would give clear guidance to the Committee on the Programme for Government, which was established by the Secretary of State.
Mr Shostak: I can note that, but it is a matter for the Secretary of State.
Mr McNarry: Does the notion of a reasonable man not apply? [Laughter.]
The Chairman (Mr O’Dowd): I thank Mr Shostak and his team for their co-operation with the subgroup and for meeting with its officials throughout the day. I also thank them for the time that they have spent with us for this afternoon’s question-and-answer session.
Mr Shostak: Thank you for inviting us, and we look forward to working with you in the devolved Administration.
Adjourned at 3.36 pm.