1. Economics
July 6, 2016

Want to help UK cities thrive? Give them their share of corporation tax

By Jessica Studdert

Chancellor George Osborne’s announcement that he will reduce corporation tax rate to below 15 per cent was designed to encourage business investment to continue, despite Brexit. But a new NLGN report argues that control over a third of the proceeds of this tax should be given to cities to help them address the country’s underperformance on productivity.

With post-Brexit fall-out consuming energy in SW1, there is a risk that devolution will fall down the political agenda – but the issues laid bare by the vote show that we can no longer leave structural imbalances in our national economy unchecked. Local economies built on cheap labour and low skilled industry are not making people richer or happier: too many communities feel left behind from globalisation.

The key to spreading prosperity around the country is productivity: sustainably increasing the value of output per hour worked will raise living standards over time. But the UK is an international laggard, and much of the problem lies in the regions, where de-industrialisation has left a long-term legacy of economic underperformance.

It is increasingly clear that cities have a major role to play in solving the regional productivity puzzle. They have increasing power to build human capital, deliver housing and infrastructure and promote innovation. But local government currently has no financial incentive to improve productivity. In fact, plans for business rate localisation could drive the creation of even more low skilled jobs.

The solution is to give cities control over a third of the Corporation Tax generated in their areas. This would create a stronger incentive for local government to invest in measures which support productive growth and business creation.

Plans for Business Rates localisation by 2020 are an important first step towards fiscal devolution – but alone they are not a sufficient basis from which to plan future growth strategies. The business rate is levied on the estimated rental value of a premises; so localising this revenue stream alone will give councils an incentive to bring in companies which occupy a lot of space. This could lead to an over-dominance of businesses that are relatively low value and low productivity: large out of town retail developments or warehouses, for example, employing staff on or near the minimum wage.

But to be sustainable, local economies also need to also support denser, intensive clusters of innovative SMEs that employ highly skilled individuals with huge growth potential. We need to address how the right sort of growth can be incentivised, providing a better balance with more high value growth in knowledge-driven industries. Profits are a much better indicator of productivity than is the size of a company’s office – so corporation tax is the best tool to incentive councils to increase local prosperity.

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Giving cities control over a third of the revenue stream based on business profits will give them a stronger stake in driving collaboration for productivity between businesses, higher education and other stakeholders. This should be matched with new devolved responsibility over public services, including the skills system; this would result in stronger local networks of support for in-work upskilling, targeted sector-specific business scale-up advice, and more focussed investment in innovation to develop comparative advantage.

Some may argue that devolving corporation tax could be deemed too difficult: property-based taxes are certainly easier to identify, as they are literally fixed to the ground. But our research shows that local models of business taxation in our closest, and more productive, international peers – France, Germany and the US – all contain a direct link between local governance and productive business outputs in their local fiscal frameworks. In the UK, by contrast, all revenue linked to productive output goes straight to the Exchequer. There is a missing link in our towns and cities.

For fiscal devolution to create a different set of incentives to drive growth that raises living standards overall, we need to start from first principles. By devolving a share of the revenue stream linked to business profitability, we can help turn local economies into healthier environments for business to prosper – and help residents to benefit from rising living standards.

Jessica Studdert is deputy director of NLGN and the author of “Smarter, Not Harder: How devolution can make places more productive”.

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