“Symbols, Symbolism and Institutional Complexity : Some Economic Reflections on Corporation Tax Variation” Dr Graham Bro

“Symbols, Symbolism and Institutional Complexity : Some Economic Reflections on Corporation Tax Variation” Dr Graham Brownlow (Queen’s University Management School and Director Centre for Irish Business and Economic Performance, QUB) October 2012

“Most of economics can be summarized in four words: ‘People respond to incentives’. The rest is commentary” (Landsburg, 1993, p.3). “Whenever a theory appears to you as the only possible one, take this as a sign that you have neither understood the theory nor the problem which it was intended to solve” (Popper, 1972).

Some Ground Rules • Just 30 mins so: • I’ll focus on empirics etc in discussion; • Try not to overlap too much with the Oxford Economics/DEL line of argument; • I’ll focus on the economics and not the political-legal implications or symbolism.

Some Takeaway Points 1 • The consensus view among economists – irrespective of their views on corporation tax - is that the NI economy requires rebalancing away from a large public sector and towards an export-led private sector. Such a view is obviously correct; • The key is what path to rebalancing should be taken. HMT lumped together rebalancing and corporation tax (Plan A), but Economists may disagree on the right path to rebalancing as well as the issue of corporation tax variation;

Some Takeaway Points 2 • As a matter of economic theory, a corporation tax variation for a region has highly uncertain outcomes. Likewise, different modelling assumptions can make a big difference to predicted outcomes. • The HMT analysis of the issue of corporation tax variation owes a lot to academic research on the topic. All of which highlights the uncertainty of outcomes and the importance of institutional design for final outcomes.

Some Takeaway Points 3 • Sequencing matters. Thekind of inward investment that NI can attracts depends on the skill-base. It is arguable that lower corporation tax should follow rather than precede moving to a high-skill, high-productivity and high-wage economy. • Different scenarios could exist. It’s much easier to see quantity rather than quality implications in models, so productivity and equity effects are more difficult to model and the business world in 2030 is anybody’s guess.

Structure • Introduction: Setting the Scene • Some Theoretical Observations on Corporation Tax Variation for a Regional Economy • From Theory to Application: HMT Analysis • From Theory to Application: evaluating arguments • Conclusions: Implications for the Community and Voluntary Sector

NI in a Global Context • Trade globally is growing quickly despite recession 2009-2012 global trade volume grew by 25%. • World trade in goods and services growth: 2011: 7.5% 2012: 5.8% (forecast) • Emerging economies (such as the BRICs) is the basis of this export-led growth (even if Chinese growth falters).

Looking from the Outside In: the Need for Export-led Rebalancing • Public expenditure in NI accounts for 63% of output compared to 39% in GB; • Public sector output in NI accounts for 26% of total output compared to 18% in GB; • Public sector jobs account for 36% of all jobs in NI compared to 28% in GB. • Rebalance by deflation (i.e. public sector cuts) and/or private sector (export)-led growth? (NICVA, 2011).

Figure 1: The Consensus View and Diagnosis (source: Crone, 2011) NI economy is most dependent on public spending NI @81% of UK average GVA/capita

Figure 2: The Consensus View and Prescription (source HMT, 2011a, DETI,2012)

Setting the Scene 1 • Northern Ireland’s economic problems in 2012 are: • Those it shares with rest of the UK (i.e. we in NI consume more than we produce → productivity/subvention); • Magnified versions of those problems shares with the UK (e.g. skills, export structure, innovation, rebalancing); • Problems unique to NI (e.g. border/divided society/legacy issues → impact on voluntary and community sector).

Setting the Scene 2 • Note 1-3 all have long-standing causes and all shape issues relevant to NICVA. • Corporation tax variation discussed in terms of 1, 2 and 3. • Move away from “Silver Bullet”/game changer rhetoric. • Symbols and complexity.

State of Play October 2012 • The NI economic strategy provides the following vision of a ‘rebalanced’ NI in 2030: “An economy characterised by a sustainable and growing private sector, where a greater number of firms compete in global markets and there is growing employment and prosperity”. • Motherhood and Apple Pie?

Figure 3 (Source: Centre for Policy Studies, 2012)

Scotland 1 • Independent Expert Group (IEG, 2009) advised on Calman and considered the theoretical and empirical issues in corporation tax variation. • Considered FDI attraction and noted academic evidence shows repeatedly tax rate not the only (or indeed the dominant) determinant. • Profit shifting noted.

Scotland 2 • Moreover, it’s the transaction costs (compliance and administrative) associated with monitoring this situation (and the burden of who pays) that the IEG highlights (note HMT, 2011a influenced by this). • Canadian experience (10 different provincial corporation tax rates) → transaction costs ↑ • Tax competition can lead to efficient outcomes, but it can also lead to “race to the bottom”. • IEG downplay this relative to transaction costs problems and lean to income tax variation .

Wales 1 • Welsh discussions more on (needs-based) Barnett reform than corporation tax. • Holtham (2012) If cost is £300m to NIE budget and the tax rate is 12.5% then to get an extra £300m revenue would require an additional £2.4bn pa in profits (i.e.£300m is 12.5% of £2.4bn). • £2.4bn Holtham estimates translates into an additional £10bn of GVA (current is £28bn).

Wales 2 • So to break even on the budget requires the economy to grow by over a third. • Yet optimistic estimates place the economy 14 per cent higher a decade and a half after a tax cut. • As (with Scotland) Holtham suggests devolution of income tax etc, but he notes NIE will face issues of volatility and administrative burdens. • Implicit is the notion of sequencing of reform.

As a Matter of Economic Theory 1 • Based on the contemporary academic literature, which influenced IEG/Welsh experts, we can try to disentangle the arguments that shape HMT. • Lower corporation tax for NI than the rest of the UK implies, all other things being equal in a regional context: • The competitive advantage of the region increases relative to the other regions of the UK and; • The complexity of the tax landscape of the UK increases;

As a Matter of Economic Theory 2 C) Greater complexity of taxation needs to be monitored and complied with someone needs to pay these compliance, administration and monitoring (transaction) costs; D) Corporation tax rests on profitability is highly cyclical (and subject to avoidance back to C) and may require economic reform prior to its introduction if it is to pay back its revenue (i.e. Sequencing).

Figure 4: Three (or Four) Issues of Institutional Design and Economic Efficiency in Corporation Tax Variation A. Low Corporation Tax stimulates investment but at what cost? (possible net benefits) B. Questions of Effectiveness (Variability and universality) C. Variation of corporate tax rates in the UK (greater complexity and compliance costs) D. Equity issues (implications for society and/or environment)

Figure 1: Three (or Four) Issues of Institutional Design and Economic Efficiency in Corporation Tax Variation A. Low Corporation Tax stimulates investment but at what cost? (possible net benefits) B. Questions of Effectiveness (Variability and universality) C. Variation of corporate tax rates in the UK (greater complexity and compliance costs) D. Equity issues (implications for society and/or environment)

Figure 4 (again): Three (or Four) Issues of Institutional Design and Economic Efficiency in Corporation Tax Variation A. Low Corporation Tax stimulates investment but at what cost? (possible net benefits) B. Questions of Effectiveness (Variability and universality) C. Variation of corporate tax rates in the UK (greater complexity and compliance costs) D. Equity issues (implications for society and/or environment)

HMT (2011a) • HMT (2011a; 2011b) in its report on rebalancing identifies some costs and benefits of corporation tax variation for NI. • This report (as well as Economic Strategy) lump together rebalancing (implicitly presenting corporation tax as Plan A). • Yet as a piece of economic logic rebalancing (however defined) is not synonymous with corporation tax variation (Plan B).

HMT Benefits (HMT, 2011a, p.34) • “Additional investment by foreign owned firms; • Additional internal investment by existing firms; • Increased economic growth and a stronger private sector to help contribute to the rebalancing of the Northern Ireland economy; • Potential long term employment benefits as a result of stronger private sector; • Positive indirect impact on tax receipts as a result of [output and employment] growth; • Potential downward pressure on long term unemployment and welfare costs as a result of [a] stronger private sector”. (notice that the benefits all relate to A, B and C are marginalised, D ignored)

HMT Costs (HMT, 2011a, p.34) • “Fiscal cost borne by NIE as a result of lower corporate tax receipts and associated impact on Northern Ireland economy of lower public spending; • UK exchequer risk from artificial profit shifting to benefit from a lower corporation tax rate in Northern Ireland; • Increased NIE budget volatility due to dependence on potentially volatile corporate tax receipts; • Additional administrative and collection costs borne by NIE; • Administrative burden for businesses operating in both Northern Ireland and the rest of the UK”. (Notice that these all relate to B and C, D ignored and A downplayed)

Some Further Points • HMT (2011a, p.23) notes the role of absorptive capacity in determining the net impact of corporation tax rates on an economy (neglected but important). • The assumption is a elasticity of user cost equal to 0.4 (i.e. A 1% ↓ in user cost → A 0.4% ↑ in investment). • The assumption is a elasticity of tax rate with respect to FDI of -5.9 (i.e. A 1% ↓ in tax rate → A 5.9% ↑ in FDI levels).

Figure 4 (one last time): Three (or Four) Issues of Institutional Design and Economic Efficiency in Corporation Tax Variation A. Low Corporation Tax stimulates investment but at what cost? (possible net benefits) B. Questions of Effectiveness (Variability and universality) C. Variation of corporate tax rates in the UK (greater complexity and compliance costs) D. Equity issues (implications for society and/or environment)

Some Observations • On A) significant uncertainties exist (e.g. different sectors have different elasticities with respect to corporation tax rates impact on investment and employment). • On B) and C) likewise highlights institutional design. • D) NICVA has highlighted, but painless rebalancing?

Sequencing • Corporation tax reduction assuming its universal all firms benefit from it (NICVA, 2011). • If skills shape the kind of inward investment a region can attract then failure to raise skills prior to attracting inward investment. • Hence while employment gains seem plausible, productivity gains are more doubtful. • The sequence of reform/rebalancing may matter (different scenarios).

Creative Destruction, ‘Rebalancing’ and the world in 2030 “The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as U.S. Steel illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism” (Schumpeter, 1942, p. 83).

On Being Ahead of the Curve Moretti (2012) • Wide-ranging and brilliant synthesis of Schumpeter, economic geography, regional & urban economics and labour markets (NICVA). • Skill-Productivity-Wage equilibria, exports and inward investment the focus (hence relevant to NI). • Sustainability of corporation tax in ROI mentioned and questioned (p.203). • The key is that an innovation sector (high skill-wage jobs) drives employment of lower-skilled and wage groups e.g. each software designer’s consumption creates 5 jobs (A Moretti Multiplier)

Figure 5: % Share of exports going to BRICS (Source: IMF, DETINI)

Implications for the Community and Voluntary Sector • Rebalancing will be painful rather than painless. • Issues going forward e.g. sources of funding, matching them to policy levers/objectives. • Will the existing structures hold or will the need for scale economies promote mergers and/or collaborations? • Distributional impacts.

Thank you for listeningAny questions/comments? graham.brownlow@qub.ac.uk

“The master-economist must possess a rare combination of gifts. He must be mathematician, historian, statesman, philosopher–in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought. He must study the present in the light of the past for the purposes of the future. No part of man’s nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician.” -John Maynard Keynes

Sources 1 • M. Crone, ‘Inward Investment in Northern Ireland with particular emphasis on ‘traded services’ since the late 1990s’, Guest Lecture, Queen’s University Belfast, 25 Nov 2011 • CPS, Growth Bulletin, April 19th 2012. • DETINI, DETI Economic Commentary, 30 January 2012.

Sources 2 • HM Treasury, Rebalancing the Northern Ireland Economy, March (HMT, London, 2011a). • HM Treasury, Rebalancing the Northern Ireland Economy: a Summary of Consultation Responses, December (HMT, London, 2011b). • G. Holtham, Devolution of Tax Powers and the Northern Ireland Economy, Paper Presented at the Annual Northern Ireland Economic Conference (2012)

Sources 3 • Independent Expert Group (IEG), Independent Expert Group: Final Report – the Consultation Response (2009). • S. Landsburg, The Armchair Economist (The Free Press, New York, 1993). • N. Ireland Executive, Economic Strategy Priorities for Sustainable Growth and Prosperity, November 2011. • E. Moretti, The New Geography of Jobs (Houghton, Miflin, Harcourt, New York, 2012).

Sources 4 • NICVA, ‘Consultation Response to Rebalancing the Northern Ireland Economy’, Consultation document (NICVA, Belfast, 2011). • K. Popper, Objective Knowledge: An Evolutionary Approach(1972). • J. Schumpeter, Capitalism, Socialism and Democracy (1942).

“Symbols, Symbolism and Institutional Complexity : Some Economic Reflections on Corporation Tax Variation” Dr Graham Bro