Unite Scotland Economic Brief – Corporation Tax

16 Aug

What is corporation tax?

Corporation tax is the tax due on a company’s profits.

What’s the big deal with corporation tax now?

Corporation tax is right at the forefront of economic debate at present, especially in Scotland.  The Scottish Government is to argue for powers to be given to Scotland to change its corporation tax rate so that it does not have to charge the same rate as the rest of the United Kingdom.

Northern Ireland is also arguing for the right to set its own corporation tax rate.  Northern Ireland looks like it will reduce its corporation tax rate to 12.5% for all companies. The current rate in the UK as a whole is 26% of large companies who earn more than £1.5 million profit year and 20% small companies. Northern Ireland is set in this rate because the Republic of Ireland has a 12.5% corporation tax rate.

It looks as though the Scottish Government might want to match any tax rate that Northern Ireland sets, in which case Scotland could have a 12.5% corporation tax rate.

Is this good news for Scotland?

It is claimed by those supporting reductions in corporation tax rates that these cuts will have beneficial effects on the economy.  The argument is that one or all of these things happens:

  • Existing businesses in the country have their tax rate cut so they have more money left to invest in new jobs;
  • Because the tax rate has been reduced the return from running a company is increased and so more new businesses are created, which in turn means more jobs;
  • Reduced tax rates encourage foreign companies to relocate to the country because they can make a bigger, overall, rate of profit as a result – this brings in new investment, and that in turn creates new jobs.

No one, least of all a trade union, wants to turn down the opportunity of new jobs.  If these promises could be delivered then such a change might be good news for Scotland.

Can the promise of new jobs be delivered?

This is where the problems begin to arise, and there are lots of problems:

  • There is no guarantee that existing companies in Scotland will invest their increased after-tax profits in new jobs – they might just pay them out to their shareholders. The tax increase would in that case simply make some of the better off people in Scotland better off still.
  • While there is some undoubted evidence of a link between lower corporation tax rates and higher rates of employment, the relationship between the two is very weak indeed.  Research has shown that only 7% of additional employment can be explained by low corporation tax rates in the countries that have them.   In that case there are many better, and more cost-effective, ways of creating new jobs.  Grants remain one such option.
  • It is undoubtedly true that for a while the Republic of Ireland appeared to benefit from having low corporation tax rates that increased employment.  This process has, however, come to an end.  The Irish economy has collapsed, unemployment has risen, people are emigrating, major employers have left including companies like Dell computers, and hardship has followed on.  If the model did work – and that is highly questionable – it doesn’t any more.

But isn’t it worth a try?

There is always an argument for taking a risk when there is no cost in doing so. Unfortunately, if Scotland cut its corporation tax rate there would be a considerable cost, no one is quite sure what it would be, as yet, but there are complex European rules that would have to be adhered to.

This would mean that the amount of money granted to Scotland by the Westminster Government would have to be cut by the same amount as the corporation tax cut.  No one has ever calculated precisely the total value of corporation taxes paid by Scottish companies, and no one is sure how they could precisely calculate this figure. But, it is presently estimated that Northern Ireland will lose £300 million a year if it cuts its corporation tax rate.  It is safe to assume that the cost to Scotland would be much more, and could run into billions of pounds a year.

But if the right number of jobs were created wouldn’t it still pay to take that risk?

We can only decide that by looking at the evidence.   The best, and most optimistic, evidence currently available comes from those promoting this reform in Northern Ireland. They have suggested that losing a grant of £272 million a year from Westminster will generate 4500 new jobs a year in Northern Ireland.  But note the cost: that’s almost £61,000 a job.   Average pay in Northern Ireland is about £22,000 a year.

A generous estimate of the amount of tax that each new job will generate is £8,000 a year. Northern Ireland is allowed to claim credit for that additional tax paid, but it will still be losing £53,000 a year on the jobs created in the first year.

Now admittedly, presuming those jobs continue to the second year the loss in that year will only be £45,000 per job created.  But on this logic (which those promoting this idea have accepted as correct) and assuming no jobs are lost it will take up to 15 years for this cut in corporation tax to be paid back in terms of extra revenue earned from new jobs created in Northern Ireland.  Put in that context this is a risk not worth taking, and a cost that’s unreasonable for each job created.

So is there any remaining reason to cut corporation tax in Scotland?

Not that we can find.  But we can find lots of reasons why Scotland should not cut its corporation tax rate.   For example, as the UK’s Chartered Institute of Tax has pointed out, any such change would massively increase the administrative hassle for companies which were trading in both England and Scotland.  In fact, the additional costs of proving that a business has allocated their profits correctly between the two nations could more than offset any tax saved.

And on top of that England would have to pass laws to prevent profits being artificially relocated to Scotland.  This would make it harder for companies to relocate to Scotland.  We might actually see obstacles being put in the way of investment in Scotland just because we have a lower corporation tax rate.  That would be a particularly perverse outcome of any such change.

Finally, and most importantly, there is the issue of social justice.   The fact is that, as has been proven time and again, societies work best when they are equal. The most likely outcome of cutting corporation tax rates in Scotland is that the richest in our community will get richer, whilst the rest of us will become worse off.  Scotland will be worse off because of the cut in services that would result from the reduction of the grant from Westminster.  Inequality in Scotland will, in all probability, rise.  This is an outcome that we can’t accept as being just, fair or good for Scotland as a whole.

This special economic brief  has been produced in cooperation with Unite Scotland by tax expert Richard Murphyin response to the launch of the Scottish Government’s Corporation Tax Discussion Paper, ‘Options for Reform’ .  You can keep up to date with Richard’s analysis of tax and economics at Tax Research UK.  You can also follow Richard on Twitter: @RichardJMurphy 

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