What’s more effective at creating jobs and driving investment, corporate tax cuts or investing in education and skills?

One of the key arguments from advocates of the proposed Corporation Tax cut is that cutting taxes will stimulate job growth and attract foreign direct investment (FDI).  The paper on the DETI website quotes an OECD paper, which states that for every percentage point decrease in Corporation Tax, FDI increases by between 0% and 5%.

However, the OECD paper was published in February 2008, and from an economic point of view, the world is a very different place to what it was then.  What happens if we look at more recent data?

FDI

This graph shows, on the x-axis, the average corporate tax rate between 2009 and 2013, and on the y-axis, the average level of FDI as a percentage of GDP.  There are a couple of items of interest here.  The first is that, excluding outliers, there doesn’t appear to be a particularly strong relationship between corporation tax and the amount of FDI that a country has been able to attract.  Hungary, for instance, has one of the lowest corporation tax rates in Europe, but has had negative total FDI over the last five years, whilst Portugal, with one of the highest rates, have managed to attract FDI of 3.8% of GDP.

The even more notable aspect to this graph are the three outliers: Belgium, Ireland and Luxembourg.  These countries have managed to attract spectacular amounts of investment, with Luxembourg attracting an incredible 42.1% of GDP over the last five years.  Ireland, of course, has a 12.5% Corporation Tax rate, but neither Belgium nor Luxembourg has low rates.  What could these three countries have in common, that has proved so successful in attracting foreign investment?

The answer lies with taxation, but not of the regular Corporation Tax variety.  For instance, Belgium is the only country in the world, apart from China, that has signed a double taxation treaty with Hong Kong.  It has also signed a double-taxation treaty with over 80 other countries. For instance, if an American company establishes a Belgian subsidiary which then sets up a company in Hong Kong, it can trade in China, and then pass along profits back to the US without paying much in the way of tax at all.

Ireland has, for the last few years, allowed companies to avail themselves of the tasty (in many senses of the word), and soon to be outlawed, “Double Irish with a Dutch Sandwich”, which through a complex series of transactions between multiple Irish companies and tax havens, allows companies to avoid paying even the low 12.5% Corporation Tax rate.

The star at attracting FDI, Luxembourg, has an even more attractive tax quirk.  In one of those boring-sounding but actually rather interesting tax rules, Luxembourg allows companies to offset impairment losses on investments made in the country against tax.  Ok, so this doesn’t sound particularly revelatory, so let me put it another way.  It means that companies can use costs that they haven’t actually incurred, and then they can use these “losses” to reduce their tax bill anywhere in the world.

This means that companies can say “whoops, our Luxembourg subsidiary is now worth a few billion less than we thought it was worth yesterday”, and then lend money at a high rate of interest from the Luxembourg subsidiary to the parent company in another country.  It can lower its taxable income by the interest charge in the parent company’s country, but it doesn’t have to pay any tax in Luxembourg because of the loss incurred when the Luxembourg subsidiary had its most unfortunate fall in its value.  The tax, in a sense, just disappears.

It’s as if you came back from a holiday to Luxembourg, and as a permanent souvenir of your happy and carefree weeks exploring Luxembourg City and the Oesling, decided to purchase a plastic bust of Jean-Claude Juncker for €5.  To your own delight, when you get home, you decide that your statue is worth a lot more than you paid for it, and you now value it at €250 billion.  Five minutes later, you burst into tears as you decide it’s only worth €1 billion.  To console yourself, you remind yourself that the loss you’ve just incurred of €249 billion means that you’ll never have to pay any income tax for the rest of your life.  They do say every cloud has a silver lining.

It is left as an exercise to the reader to judge if such an attractive quirk could be the reason why Luxembourg has been, relative to the size of its economy, over forty times more successful at attracting investment than across the border in Germany.  Taxation is a big deal when it comes to attracting FDI, but it’s not the draw of a few percentage points off their local Corporation Tax bill that is that is the big draw.  It’s the allure of paying nothing, anywhere.

With all the understatement one could possibly muster, it is unlikely that any of these wheezes would work in Northern Ireland.  Although possibly amusing to imagine it being tried.  One can see David Cameron and George Osbourne, tetchily wondering what the latest demands are from Belfast today.  “Oh, the usual, flags, parades, language… wait, this is new.  They want to sign a double taxation treaty with Hong Kong now?  And they also mentioned something indecipherable about impairment losses.”

So, if cutting Corporation Tax rates doesn’t have much of a visible impact on FDI, then how about a possible impact on unemployment?  Do countries with lower rates of Corporation Tax have corresponding lower rates of unemployment?

Unemployment

No.  No they don’t.  So if cutting corporate taxes doesn’t lead to low unemployment, is there anything a country can do to create jobs?  As it happens, there is.

Tertiary Education

There is a fairly strong relationship between Tertiary education spending and the unemployment rate, which stands to reason, as countries that invest in endowing their citizens with skills are creating desirable employees.  The large dots show Northern Ireland, as if it was an independent country, as it is today and as it might be after the proposed cuts in tertiary education are implemented.  The draft budget has proposed cuts of up to £49m to the universities budget, which if implemented which would be sizeable enough to reduce university spending from 29% of GDP per capita per student (e.g. Iceland) to 24% of GDP per capita per student (e.g. Estonia).  If unemployment moved accordingly with the reduction in education investment, then it would be expected to lead to a four percentage point increase in structural unemployment.

It is worth bearing in mind that, even given the local context, £49m is fairly small beer.  It is, as W[r]ite Noise Maeve points out, less than half the sum borrowed by Belfast City Council to spruce up a few leisure centres.  In terms of cuts that have the potential to cause severe harm to long term economic prosperity, it would appear to be almost divinely inspired as an act of political foolishness to raid the Higher Education budget to pay for short term tax cuts.

  • And can I just be the annoying person that reminds everyone, if you agree with ol’ Salmon of Data and think that education and skills need greater investment TODAY IS THE LAST DAY TO RESPOND TO THE DEL CONSULTATION PAPER – http://www.delni.gov.uk/del-draft-budget-2015-16

    Thanks!

  • Zeno1

    Do they not just ignore the feedback from the consultations?

  • Zeno1

    ” it would appear to be almost divinely inspired as an act of political foolishness to raid the Higher Education budget to pay for short term tax cuts.”

    But because of the political system we have to endure our politicians are not motivated by the greater good. They are only interested in votes. Votes mean power and power means money.
    We don’t have great leaders, we have people who are good at manipulating the weak minded and less intelligent with their stories. It’s that simple, and even better taking funding from education keeps them uneducated and propagates the lie.

    They are not fools. They just have different motives and goals than what the proletariat think they are electing them for.

  • Zig70

    Lines through shotgun patterns? What is the error on that fit? A good read but aren’t there loads of other factors? Even they vary wildly between industries.

  • Probably. But try again. Fail again. Fail better etc. Consultation closes at 5pm!

  • salmonofdata

    The R-squared is 33% – take out the outliers of Ireland, Spain and Portugal, each of which have unique unemployment problems, and it increases to 50%. Statistically it’s not a very strong trend, which is inevitable given the paucity of data points, and as you say there are loads of other factors. But there is more of a correlation between unemployment and tertiary education spending than there is between unemployment and corporation tax rates, where there is no relationship whatsoever.

  • chrisjones2

    How do you know what skills (beyond literacy numeracy and core IT skills) investors really want? I have heard the Blessed Arlene at this as well …and its arrant nonsense. Lets take languages as an exqmple. The demand for languages depends upon what jobs you think will be attracted – that means there needs to be a vision of what we are creating and there aint

  • chrisjones2

    “it is unlikely that any of these wheezes would work in Northern Ireland”

    Want to bet? WHat about a triple Irish? The problem is that HMRC have to prove its evasive and they are always playing catch up

  • Am Ghobsmacht

    “If you’re going to do something then do it right” or sumfin like that.

    To pin all their hopes on Corporation Tax without sorting out the other things that attract businesses (infrastructure, business friendly facilities, transport etc) or things that scare them off (fleggers, annual tensions, high rates etc) is very hopeful in the extreme.

    I’m up for a corpo-tax reduction BUT ONLY if things are geared to facilitate businesses.

    In a slightly off topic note I’d highlight the great wallpapering exercise when they spent a 7 figure sum papering over shops to make them look like, well, ‘shops’.

    Could they not just have given rate relief to the tune of a similar 7 figure sum to take the strain off local businesses and give them some breathing space?

    I think that before we play our trump card (?) we should gear everything around it to ensure its chances of success i.e. in this case I’d be angling for a revamp in the railway (as per the previous Belfast congestion posts) and rate reduction as well as trying to ensure that NI-ltd doesn’t come to a halt every carnival season.

    A few more posh restaurants, wine bars and revamped golf courses wouldn’t hurt either (c’mon, if you want CEO’s to take yer town seriously you have to have ‘the scene’ taken care of…)

  • notimetoshine

    While I certainly don’t agree with the cuts to higher education which I find to be moronic in extremis I would like to say that students here have the ability to avail of many higher education opportunities at quality institutions over the water.

    Of course they don’t go in large enough numbers at the moment but the one consolation is that even if the cuts cause a reduction in quality of our local UNIs they have easily accessible institutions in England Scotland and Wales which I imagine could offset the damage to the education quality of our workforce. Of course then one has the problem of getting them to come back…

  • Reader

    X-axis on the final graph is :”Tertiary education spending as percentage of GDP per capita per student”
    My head is spinning with all those multiplications and divisions. It looks like the story is that prosperous countries spend a lot on education, or were we meant to reach a different conclusion?
    Also, why did you move Northern Ireland from below the line to onto the line? (I can see why you moved us left, though you ignore the English and Scottish universities, which is a good trick) But why did you move us up disproportionately? Are you also going to move all of the other countries onto the line (Good news for the rest of Ireland)?
    But; lies, damned lies and statistics aside; the real problem with this analysis is that we are already producing lots of graduates for export.

  • salmonofdata

    The reason for putting that metric on the x-axis was because that’s the way the World Bank report the data, and they were the source I used for the data (http://data.worldbank.org/indicator/SE.XPD.TOTL.GD.ZS). The proposed cuts would change spending from £5,261 per student (29% of GDP per capita in NI) to £4,314 per student (24% of GDP per capita).

    The new forecast for unemployment was derived by taking the new value for the x-axis (24%) and plugging it in to the formula for the trend curve. Yes, I appreciate that this means that I am not taking into account Northern Ireland’s present favourable unemployment situation vis-a-vis its tertiary education spend, but that seemed reasonable enough given that the planned public sector job cuts are likely to add substantially to the ranks of the unemployed.

    You’re right, of course, that richer countries tend to spend more on education. But there’s more to it; consider Belgium and the Netherlands, two countries with similar GDP per capita values. The Netherlands has a higher education spend, and has a lower unemployment rate. Slovenia is less wealthy than Slovakia, but spends substantially more on tertiary education and has a lower unemployment rate.

    I didn’t ignore the English and Scottish universities, these form the vast majority of the data that makes up the United Kingdom data point. The World Bank didn’t split up the UK data into England, Wales and Scotland, the data for these I derived from the figures at the Higher Education Statistics Agency (https://www.hesa.ac.uk/stats-finance).

    Trying to forecast cause and effect for items as complex as unemployment and education spending is hard. The point is, I hope, not “well, it’s not possible to directly compare the situation in Northern Ireland and (say) Iceland, so the entire analysis is junk”. The point is “well there doesn’t appear to be a link between unemployment and corporation tax rates, and as for the idea there may be a correlation between higher education funding and unemployment, there might be something in that.” Those advocating cutting corporation tax to spur employment growth aren’t explaining the details of how their forecast models work.

    And as for the notion that there are somehow too many graduates already, well, I simply don’t agree. There are many skills shortages in areas such as (ahem) data analysis.

  • Bryan Magee

    Surely the relevant correlation is with investment not unemployment?

  • Zeno1

    Ireland has a Corporation Tax Rate of 12.5% + a lot of other Tax related inducements. Their unemployed figure is down to 10.7% and falling steadily, but that is not the whole picture. Almost 39,000 left the unemployed ranks which is good, but Emigration from Ireland in the twelve months to April 2014 is estimated to have been 81,900. The figures speak for themselves.

  • Bryan Magee

    Isn’t the relevant correlation with investment, rather than unemployment?

  • Zeno1

    I was supporting the argument that cutting Corporation Tax does not necessarily produce jobs. ROI appear to be losing jobs rather than increasing the numbers in employment.
    But I’m not sure I understand your point. Is investment not meant to bring jobs and reduce unemployment?

  • Bryan Magee

    I think it is more meant to bring high quality high productivity jobs in the private sector, rather than being about unemployment.

  • Zeno1

    Ah, I’m with you now. There are two problems that jump out right away. One, we don’t have that many people who could fill high quality productivity jobs. (How many £35k/£40k plus people do you think we have signing on?)
    Two it is going to cost us at least £1 billion to find that out. (£700 million for redundancies and £300 million+ from cutting CT)

  • Bryan Magee

    I think it would not be overnight that the jobs would all come – rather you’d expect to see a few thousand per year as investment flows come in at a distinctly higher level than at present (the recent investment record has been good by the way).

    Second, you would not expect unskilled people to jump from unemployment into these jobs. Rather they would be filled from people from three sources: (i) the skilled end of the existing work force switching employers to these jobs, to be replaced with others further down the food chain, (ii) recent graduates who otherwise might leave NI in pursuit of higher-end employment, (iii) other people from outside NI, possibly those who lived in NI previously, returning/moving for employment in NI. I don’t think there’s a shortage of people willing to supply labour in NI.

    But I would agree that the private sector investment should be accompanied by investment in the Universities.

    That said, most good companies do their own in-house investment in skills – in fact that is one of the main benefits of FDI that it brings in management systems that lead to in-house training and investment in local skills.

  • I would have thought the biggest obstacle to investment here were perceptions of political instability. Political grandstanding and perceptions of constant lack of agreement are major deterrents. No matter what rate we set for Corporation Tax those perceptions will dominate. Cost of solving that problem, negative as it would result in the reduction of other pointless expenditure.

  • Zeno1

    But if we didn’t have all that ,how would our “Politicians” get elected?

  • aber1991

    I am probably missing something so perhaps some kind person will explain why so many assume that reducing the rate of Corporation Tax will attract investment to Northern Ireland. Why should any Company be waiting for the reduction in taxation before investing in Newry if, already, it can invest in the already lower taxation regime in Dundalk just down the road from Newry? Or in Derry, when it can already enjoy lower taxation 30 miles to the west of Derry in Letterkenny? Or in Strabane when it can invest 1 mile further west in Lifford?

    I hope that I am wrong but I fear a reduction in the rate of Corporation Tax will not be the panacea it is being presented to be.

  • Zeno1

    So in 5 years time we will have replaced the 10,000 or so Jobs lost in the Public Sector with 10,000 Private Sector Jobs BUT the 70,000 currently on the dole will still be there and it will only have cost us. £2.2 billion ish? (£700 million for redundancy + 5 * £300 million to pay for CT cuts).
    And that’s if it all goes extremely well and the Businesses don’t just pocket the money and create zero jobs?

    Has anyone done a risk assessment on this?

  • Zeno1

    It’s OK, Peter Robinson says it will create 50,000 to 60,000 Jobs inside the next 10 years and we all know how honest and reliable he is.

  • Nimn

    Excellent post. CT is certainly not the silver bullet that our politicos or the CBI make it out to be.

  • Bryan Magee

    I wouldn’t say that there won’t be new jobs net. However I would emphasise that there would be an increase in the supply of labour – because highly trained people would either not leave, or come to, NI.

    Yes, there have been numerous studies of corporation tax and on the whole in the NI context it seems a worthwhile move, especially given the low rate in the south.

    I would be more concerned about potential volatility of this source of revenue, as profits are one of the highest-variance things that government tax. (Compare VAT which is low variance).

  • salmonofdata

    If all the other levers of fiscal policy were left unchanged, you might expect a Corporation Tax cut to have a beneficial impact on jobs growth.

    But that is emphatically not the case here. The Corporation Tax cut is taking place within the context of an overall fiscal contraction, with the added kicker that it is being primarily funded by a reduction of investment in human capital, i.e. education and skills.

    I’m not arguing that lower corporate taxes are, of themselves, an undesirable policy outcome. Were they able to make (genuine) efficiency savings, such as the increased spending that results when parallel services are run in adjacent but tribally different areas, and this was being used to fund a reduction in business taxes, or a reduction in business rates, then this would be a more sensible idea than what is being proposed.

    Care must be taken when pondering tax competitiveness with the South. The allure of the Double Irish (i.e. an effective Corporation Tax rate of zero) has arguably been the big draw there. That particular loophole is being closed from New Year’s Day. It might have been an idea to wait to see what happens to jobs and investment with tax at a genuine 12.5% rate across the border before deciding to sell the family silver and jump in.

  • Zeno1

    “I wouldn’t say that there won’t be new jobs net.”

    Why do you want Corporation Tax cut?

  • Bryan Magee

    The argument for a CT cut is an argument for more business investment, particularly from FDI. Studies have shown that productivity enhancements are associated with international businesses being located in an economy.

  • Bryan Magee

    It has not yet been decided how CT will be funded, or even whether CT will be cut. And the power to do so cannot become effective before 2017 I believe, when the macro situation may be different.

    The CT cut is a long term supply side policy, which should increase productivity, if it brings the expected investment, while fiscal policy is a short term demand side consideration. Its certainly true that you don’t want to cut on education and skills, as that is part of a supply side package, though its worth noting that good international businesses invest in the skills of their workforce.

  • SeaanUiNeill

    Indeed, AG, it would need all this and more to re-vitalise the economy here, but the Corporation Tax cut policy is being driven by “Cargo Cult/Monkey See, Monkey Do” thinking, like everything else up on the hill. It’s an “It worked for the others, my turn now” mindset, that is simply looking for magic bullets to get them out of a situation created by the lazy hope that the EU, or UK Government, or the USA, or anyone (anyone!) would keep paying or lending Danegelt to them to not keep hitting each other.

    This is not a serious, carefully prepared plan to develop a local economy, it’s a pathetic attempt to find some single thing that will let them avoid the kind of hard sustained work that really needs to be put in to actually create a productive community.

  • salmonofdata

    But it has been decided how the CT cut is to be funded. The Chancellor said that Corporation Tax cutting powers will be devolved “provided the Northern Ireland Executive can show that it is able to manage the financial implications.”

    The reduction in spending of £214m is, by stunning coincedence, nearly identical to the foregone revenues that would be incurred if the CT tax is implemented. Due to increases in Health, DETI, and Education, nearly half a billion of cuts are to be made to support the overall budget reduction.

    Most of the cuts being made are cuts to the Education budgets. If and when the Draft Budget is approved, they might as well go ahead and cut the CT rate. It will, after all, already have been paid for up front.

    Hoping that the training and skills gap would be made up by companies moving to NI because of the CT rate, and then providing the education funding themselves out of their own pockets, seems to be layering optimism upon wishful thinking.

  • Reader

    salmonofdata: I didn’t ignore the English and Scottish universities, these form the vast majority of the data that makes up the United Kingdom data point.
    I was pointing out that a lot of our potential graduates are going to Scottish and English universities without needing any help from Stormont right now, some of them coming back, and some QUB/UU graduates crossing the water. Under the circumstances: using a highly abstract calculation as the X-axis; ignoring the huge external factor of graduate migration, and then using a dodgy rationale to nudge a data point up to a curve fittted to a shotgun pattern of data points – well, I think even the numpties up on the hill have a better chance of picking a good policy!
    However, I’m intrigued by your mention of the skills shortage in data analysis. It sounds like fun and does not look too demanding. What’s the money like?

  • Bryan Magee

    I believe you are wrong to say that the CT tax cut will have been paid for up front. The £214 that you mention is not part of a CT calculation, it is part of the broader reductions that the coalition have had to introduce to avoid fiscal deficit from increasing to unsustainable levels, and the consequent backlash from international credit markets.

    It has certainly been decided that *if* the NI Assembly votes for a CT tax cut, then the cost of that must be taken from NI’s grant, in some manner. (Though we have not yet been given the details of how that calculation will be done – that is to come in the legislation.) We do not know how it would be funded by the NI executive, i.e. what part of the public sector would see the greatest reductions in spending, or whether the NI Assembly will opt to bring in a CT cut gradually or quickly.

    The remark about training levels in international firms has come out of research; one of the advantages of international investment is that best skills and practice tend to come in too, especially if the investment is in businesses that require higher-skill work.

  • salmonofdata

    Ok, I didn’t quite understand your point, but I think I get it now. Although I am remain unconvinced that, as a policy decision, deliberately wanting bright young people to go away to university is the greatest idea. The Department of Employment and Learning estimate that less than 40% of those who leave Northern Ireland to go to university ever return.

    As for the “highly abstract” calculation on the x-axis, well, the World Bank use this particular metric for calculating education spending, so I suggest that you take your argument up with them. I would only hazard that they are using this metric as spending $1,000 on education goes a lot further in Burundi than it might do in, say, Norway.

    The trend line has an R-squared of 0.33, and 0.5 if you remove outliers. This suggests that there may, in fact, be a relationship between higher education spending and unemployment. Compare the relationship between Corporation Tax levels and unemployment, where there is no trend at all. If Northern Ireland embarks upon a massive round of redundancies, then unemployment will rise, and if it cuts investment in education, then you might expect a rise in unemployment as there are fewer skilled workers being created/retained. This is why Northern Ireland goes up and to the left on the chart.

    According to indeed.co.uk, there are currently 209 open data analyst vacancies in Northern Ireland, 1,129 in the Republic of Ireland, and 19,348 vacancies in Great Britain. You can find salary scale data at http://www.payscale.com/research/UK/Job=Data_Analyst/Salary Also, LinkedIn have listed Statistical Analysis and Data Mining as number one in their list of most in-demand professional skills of 2014.

    You are half right on your last point. Data analysis is, indeed, good fun.

  • Am Ghobsmacht

    “Danegeld”. Love it Mr ui Neill.

  • Zeno1

    The first people to benefit from a cut will be the already profitable local businesses. Since most of them are SME’s one making 300k a year will be 22.5k a year better off. I’m not sure how many there are but they will surely gobble up 10’s of millions while not benefiting by enough to create any Jobs. Will the banks benefit? They are cutting Staff and won’t be increasing their workforce in the foreseeable future?
    if we want FDI that is guaranteed to create jobs then why not target the companies we really want and offer them 15k for every job over 30k that they create?
    That way we are guaranteed 20,000 Jobs for every
    £300 million we spend and with the companies we want, instead of possibly no jobs.

  • Superfluous

    I’m not defending dipping into the education budget, but the problem Northern Ireland faces is that the well educated population will leave to get better jobs elsewhere.

  • Bryan Magee

    You make good points. The CT cut isn’t well “targeted” – Tesco and RBS will be big beneficiaries. I think that’s part of why the Treasury has been sceptical of it. I would prefer to be able to cut CT to specific sectors – export sectors such as manufacturing or high tech for example.