UK coalition government driven by corporation tax cutters

From TJN’s Department of You Couldn’t Make This Up

The minority UK government elected last week is scrambling to agree a ‘confidence and supply’ agreement with a tiny party from Northern Ireland called the DUP (originally the Democratic Unionist Party).  The DUP has attracted considerable attention in the past 24 hours because of its Protestant fundamentalist religious values and general social conservatism.  TJN would like to point out the DUP’s commitment to tax havenry, and in particular its policy of competing with other countries within the United Kingdom in a race-to-the-bottom on the corporate income tax rate. For many years the DUP has persisted with demanding devolution of power to set a corporate income tax rate from Whitehall to Belfast, and is committed to lowering the corporate income tax rate to 12.5 percent, matching the rate in the Irish republic.  According to the DUP:

“For years, business organisations campaigned for the need to devolve Corporation Tax and setting a lower rate by Government. It has been described as a potential game-changer for our economy. While other parties had second thoughts and gave up on achieving it, the DUP persisted and we have now secured the power, with a date set for lowering the tax in 2018 to a rate of 12.5%.”

The DUP seems to assume that cutting corporate income tax rates is the route to economic development nirvana.  Perhaps they should pay attention to the Kansas experiment of race-to-the-bottom economics which went so disastrously wrong (see here and here).  Or maybe they should pay attention to the UK experience since 2007, where the sharp lowering of corporate income tax rates has attracted little investment outside real estate and mergers and aquisitions (in other words just buying up existing companies rather than making new or greenfield investment).  This has certainly lost the UK a vast sum of much-needed tax revenue, but without yielding the promised investment flows – see chart below.

Instead of seeing the Kansas and UK experiences as the horrible warnings they undoubtedly are, the DUP seems to want to persist with a tax policy that will probably achieve nothing apart from undermining the tax revenues of their immediate neighbours in the United Kingdom.

Chart 1: UK corporate income tax rates, inwards FDI flows, and corporate tax receipts (2006-2014)

sources: TJN and UK Office for National Statistics

As Richard Murphy commented in January 2015, the Bill devolving this tax setting power included important exclusions relating to financial services providers, and there is little likelihood of this tax competition achieving anything other than a massive loss of revenue that is urgently needed to remedy one of Northern Ireland’s deep-rooted economic problems: weak productivity.

Like the UK as a whole, Northern Ireland has a productivity problem.  While output per hour worked in France, Germany and the USA is between one-quarter to one-third higher than the UK average, Northern Ireland sits firmly at the bottom end of the UK productivity level, and the situation has worsened in recent years.  Since the great financial crisis in 2007, the productivity gap in Northern Ireland has fallen from 85 percent of the UK average to slightly over 80 percent.

This productivity weakness arises from several factors, including the generally low productivity levels of existing industries, but the low level of job skills, low levels of investment in research and product development, and poor infrastructure combine to contribute to the productivity gap.  Cutting corporate income tax rates will not paste over this structural weakness.

Furthermore, the DUP’s commitment to Brexit will exacerbate the problem.  We have previously blogged about the Celtic Tiger myth, arguing that what really triggered the growth of the Irish economy in the 1990s was accession to the European Union’s Single Market in 1993.  Take a look at chart 2 below and you’ll see what we’re talking about.  Any serious foreign investor will regard access to the Single Market as a, probably the, key reason for investing in Ireland.  The DUP is committed to Brexit, and have been brought in as ‘confidence and supply’ partners for Mrs May’s minority government precisely because they will support her in the negotiations of a Brexit which takes the UK out of both the Customs Union and the Single Market.

Chart 2: Irish Republic’s GNP per capita relative to EU average GNP per capita (1955-2013)

source: TJN

There are many reasons for being concerned about having a minority UK government that is dependent on a ‘confidence and supply’ agreement with a tiny party from Northern Ireland.  We’d argue that the DUP’s position on tax competition should be a prime matter of concern, not just for the rest of the United Kingdom but also for the rest of the world.  A race-to-the-bottom on corporate income tax rates is a loser’s race which no-one in their right mind would want to win.