Issues

Rebalancing the economy: looking back to the future

PWC-high-res Esmond Birnie and Martin Fleetwood look back at a decade of debate and suggest that Northern Ireland needs to redouble its determination to stay in the race.

A decision on devolving corporation tax varying powers to the Northern Ireland Executive is postponed yet again; now it’s to be the other side of the Scottish independence referendum, which is scheduled for 18 September 2014.

That’s a decision that will disappoint but it won’t surprise, given that the debate around devolving corporation tax has been running for at least the past six years.

Nevertheless, the further deferral of any decision to beyond the Scottish independence poll is a blow and has prompted the question of whether Northern Ireland needs a so-called ‘Plan B’ to either fill the fiscal devolution vacuum or even pre-empt a ‘no’ on corporation tax, should that be the ultimate outcome.

Devolution

What’s more, a detailed review of the devolution landscape suggests that devolution is in the air, everywhere that is, except in Northern Ireland.

The Scotland Act gives the Scottish Parliament tax-raising powers, a Scottish rate of income tax (SIT), devolution of land tax and landfill tax, extensive new borrowing powers and the potential to create or devolve other taxes, subject to negotiation with the UK Government.

Wales too, is on the devolution trail, with the final outcome of the Silk Commission (due late 2013) likely to recommend that the National Assembly for Wales be granted broadly similar powers to Scotland, with perhaps even greater flexibility around devolution of some taxes.

The English regions may also get an unprecedented level of devolution thanks to the recommendations of Lord Heseltine’s No Stone Unturned report, which proposed devolving around

£49 billion of Westminster funding to the English regions, as well as radical reform of how the regions are funded.

While the Westminster mood is supportive of fiscal devolution across the UK, the sting in the tail is an implicit commitment to reforming the Barnett formula contained in the coalition’s Programme for Government.

If all this adds up to a new era of regional autonomy and tax devolution, Northern Ireland needs to get back into the debate, particularly so when DETI’s Economic Strategy, with an horizon through to 2030, makes some assumptions around the granting of the power to cut corporation tax.

Do we really need a Plan B?

So what should Northern Ireland’s Plan B look like? There has, in fact, always been an available Plan B; indeed, for a brief period, it arguably was the Assembly’s Plan A.

As far back as 2002, the Milford Group think tank, supported by the Business Alliance, political parties and the then first and deputy First Ministers, had begun to lobby Westminster for devolution of fiscal powers to boost productivity, international competitiveness and inward investment through aggressive tax breaks for investment in R&D, skills and export development. Their collective proposals were summarised in the July 2004 paper: Business Alliance: Economic Agenda.

Indeed, when the Assembly met after a period of suspension on 16 May 2006, the Business Alliance was invited to present its recommendations to Assembly members followed by a debate on the economic challenges facing the region. Indeed, it was only after robust opposition by Gordon Brown and Treasury (most notably in the Varney Review) that the call to devolve much wider fiscal powers was replaced by a campaign to reduce corporation tax to match that of the Republic of Ireland.

Ironically, Northern Ireland, the first UK region to press for devolution of local tax incentives, is now the only part of the UK that is not actively engaged in the broader devolution process.

Nevertheless, the analysis that underpinned the Milford Group, Business Alliance and political lobby for devolution of wider fiscal powers, including corporation tax, is broadly similar to that invoked by the Calman and Holtham commissions and Heseltine: it’s about productivity.

It’s all about productivity

Sixteen major reviews of Northern Ireland economic policy between 1957 and 2012 identified the need to develop policies to deliver productivity improvement, and particularly narrowing the gap relative to average UK productivity levels, as critical to economic regeneration and future prosperity

Productivity is ideally raised through a combination of measures to promote innovation, skills, management capacity and leadership. It’s also understood that, as foreign direct investment (FDI) plays a crucial role in raising productivity, the ability to lower the rate of corporation tax would be a further advantage. Indeed, the attraction of policies that promote productivity is that they entail building up the economic capacity which makes it much more likely that Northern Ireland would ultimately be well placed to exploit any reduction in corporation tax.

The Coalition Government seems to have accepted this analysis. The tax incentives introduced in recent budgets and the 2012 Autumn Statement make the UK increasingly attractive to FDI. On 1 April, we saw the introduction of the new UK Patent Box regime which allows UK companies to benefit from an effective 10 per cent tax rate on profits attributable to patents.

Deftly used, a tax break like Patent Box is effectively a tool for reducing corporation tax for every company selling a product with at least one patented invention embedded within it. Regardless of how minor that patented invention is, the entire sales revenue attributable to that product may potentially fall within the Patent Box, with the profits taxable at an effective rate of 10 per cent.

Greater incentives for R&D announced in the March Budget further incentivise our biggest manufacturing exporters and any SMEs receiving R&D grants or undertaking R&D sub-contract work for clients. The improved R&D tax credit, which also came into force on 1 April, will cut the cost of doing R&D in the UK, making R&D centres more globally competitive for inward investment and indigenous companies. And, for the first time, large companies will be able to get cash credit on R&D, as will smaller businesses: those with less than 500 employees and undertaking R&D for customers or receiving grant funding towards R&D.

In addition, corporation tax falling to 20 per cent in 2015 gives the UK the lowest level of corporation tax amongst the G20 members. Even before the 2 per cent cut in corporation tax announced in the Autumn Statement and March Budget, the UK was in 16th place amongst 185 countries worldwide in the 2012 PwC, World Bank and IFC, Paying Taxes study. In tax terms, the Paying Taxes report says the UK is one of the most competitive regions in the world in which to do business. By way of comparison, the Republic of Ireland is currently in 6th place, unchanged from its 2011 position.

One argument for cutting corporation tax in Northern Ireland was that a low headline profits tax is simple and transparent and easily understood by FDI. While that is true, today’s mobile investors are highly sophisticated when it comes to utilising tax incentives, investing in tax regimes that suit their complex businesses; research goes where the universities and R&D incentives lie and manufacturing goes where the tax incentives support skills, logistics, infrastructure and training.

Back to the future when it comes to tax

In arguing for fiscal incentives to support and reward R&D, skills innovation and exports, the Milford Group, Business Alliance and politicians anticipated what the Chancellor has since begun to implement, so in that regard alone, their ‘Plan A’ position has been wholly vindicated and Northern Ireland is already much more attractive to FDI and for indigenous companies. FDI investment and reinvestment in the UK are steadily increasing and it is fair to ask if Northern Ireland policy-makers clearly understand just how attractive these incentives are and if we are marketing them as aggressively as we might.

Given the mood to devolve powers to Scotland, Wales and the English regions, there may be an opportunity for the Executive to revisit the potential devolution of fiscal levers to increase productivity and rebalance the economy. And, unlike corporation tax, where there is a huge annual cost to the block grant, those original proposals were broadly fiscally neutral, didn’t contravene EU state aid regulations, rewarded only those who used them and would directly impact on improving productivity.

The issue of raising productivity was partially eclipsed by the campaign to reduce corporation tax, which correctly assumed that higher levels of FDI might lead to higher levels of productivity. However, it was also generally acknowledged that would be a long process and a focus on FDI alone would do little to actively increase productivity amongst indigenous companies.

At the end of the day, it’s back to the future when it comes to tax. Westminster is focused on using tax and fiscal incentives to attract FDI, encourage investment and boost productivity. We might do worse that dust off those original proposals that seemed the answer less than a decade ago. And with devolution in the air, negotiating for the tools to incentivise greater productivity would perfectly prepare the region for any downstream devolution in corporation tax.

Esmond Birnie is PwC’s chief economist in Northern Ireland and Martin Fleetwood is a PwC Northern Ireland partner and tax leader.

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