Monday, October 04, 2010

Is Ireland Inc. more than a tax haven?

Nobody will doubt the importance of multi-nationals to this country but the question of corporate taxation shouldn't be so sacred. I think it may well be positive to discuss this and consider our options and their implications.

Ireland's friendly enterprise environment drew massive foreign corporate investment here. Our english-speaking European isle with it's young under-employed workforce was an attractive product, and, in case the raw charm of our officials wasn't enough, the government threw in generous state aid and zero-to-low corporation tax. It worked - they're here and we would like them to stay, and invest more. But do we still need to smear ourselves in honey?

Unfortunately, the government seem to be fumbling this one. Ireland really needs to reassess its position and ask itself a few important questions. We're clearly not the backwater we were in the 70s but right now we seem to be squarely mired. We cannot afford to loose our paddles but we cannot sit still for much longer either.

Here's some questions the government should consider before the forthcoming budget: what is ireland's comparative advantage? how sensitive are MNC in ireland to marginal tax adjustments? what shape is the laffer curve here? how can the "four-year plan" be used to best order and communicate (frame) a possible tax increase to have least impact? how can ireland hold and attract foreign investment in the advent of a (~temporary) tax increase? how can ireland best harness and leverage the current agglomerative advantages it has built-up?

Since tax harmonization is an ultimate part of the European project - Ireland should really stop fooling itself about being able to hold Europe back on this issue. Consider our No votes to treaties in the past, at a time when we were must less obviously dependent on the Union. The country should prepare for the inevitable and start planning to compete on a level international playing field.

7 comments:

Liam Delaney said...

Ron Davies and others have done work on the sensitivity of MNC investment to corporate tax rates. Going for a broad panel regression to predict a single country at a given point in time is a tricky exercise. Judging from the regressions then moving from 12.5 to 20 wouldn't kill us but the debate is whether there are specific contemperaneous Irish factors that would lead to capital flight if we did this e.g. breaking the signal that we are a low-tax economy etc., I am not sure about any of the "level playing field" stuff. Sovereign countries are entitled to set their tax rates as they want. The moral arguments are very thin here.

Peter Carney said...

Good stuff.. I would encourage Ron to make the paper known to the Dept. of Finance - i don't think they have much of a tradition of reading academic journals or working papers. But the elasticity here is the central issue- they one that should determine the rate adjustment, if any.

Framing is vital to doing this and the key way we insure against a flight of capital. A 2.5 percentage point increase in the rate to 15% with a promise to reduce it by 0.5% per year over the next 3 years could work as it inverts their long-term elasticity and provides essential front-loaded revenue to the exchequer - roughly €600m extra revenue in 2011, €450m in 2012, €300m in 2013, and about €150m thereafter. At a total of €1.5bn over the next 4 years the idea is at least worth considering.

Furthermore, at 15%, and falling, I believe Ireland is still very much an attractive place to do business. We'll remain relatively cheaper - average across Eurozone is about 20%. and reasonably, MNCs will not want to incur hefty relocation costs regardless of cost other considerations. Remember that other EU countries, to the best of my knowledge, cannot offer state-aid to corporations relocating- which was one important tool for Ireland in attracting some of the initial set-up here.

The reality seems to be that we need the revenue - and MNC's understand business. I would argue that the ones that are hyper-sensitive to marginal tax rates are probably not the ones the country has any longer-term strategic future with anyhow.

Moreover, since the 70s/80s/90s our costs here HAVE increased dramatically and note the firms that left and the ones that stayed, or arrived. With those same costs currently falling here (for the past two years) i believe we shouldn't be in great fear of an exodus resulting from a reasonable marginal increase in taxation.

Ireland has changed dramatically. I believe its still in shock at what's happened the past few months and has forgotten about where it has come from- someone needs to sit it down and remind it of what it has accomplished in the past 30 years. The fighting Irish and all that stuff might be useful but essentially I believe Ireland just needs to buck up and be confident in it's natural strengths vis-s-vis it's competitors.

Ireland, you don't have to put on a red light..

Finally, moral questions aside, the point about playing on a level playing field related to what i see as an inevitability that, as a country, we need to come to terms with.

Peter Carney said...

A 15% tax rate in 2011, reducing by 0.5% each year for the next 4 years would yield an extra €1.23bn in revenue.

440m in 2011
350m in 2012
260m in 2013
180m in 2014

Based on this evening's exchequer figures rather than my earlier approximations.

Liam Delaney said...

Ron posted on irisheconomy a few times. its a slightly different context. in this post, he was arguing that Obama's proposed restriction on US companies using places like Ireland as low tax zones would have a limited employment effect but might harm tax revenue generation in Ireland.

http://bit.ly/YZ4f1

Martin Ryan said...

Peter,

For more background, some papers that might be of interest are as follows, though both unfortunately are from 1993.

1. TAX REFORM SINCE THE COMMISSION ON TAXATION
FRANCIS OTOOLE
Trinity College, Dublin
(read before the Society, 9 December 1993):

http://bit.ly/cFicI9


2. CORPORATION TAX STATISTICS
from the records of the Revenue Commissioners
NORMAN GILLANDERS
Legislation and Statistics Branch, Office of the Revenue Commissioners
(Read before the Society, 11 February 1993):

http://bit.ly/cLdlB7

Peter Carney said...

Thanks Martin. i'll take a look.

If you're interested here's a round up of current European corporation rates:

Austria 25%; Belgium 34%; Bulgaria 10%; Croatia 20%; Czech Republic 21%; Denmark 25%; Estonia 20%; Finland 26%; France 33%; Germany 35%; Greece 25%; Hungary 16%; Iceland 26%; Ireland 12.5%; Italy 31%; Latvia 15% Lithuania 20%; Luxembourg 30%; Macedonia 10%; Montenegro 9%; Netherlands 25.5%; Norway 28%; Poland 19%; Portugal 27.5%; Romania 16%; Russia 24%; Serbia 10%; Slovakia 19%; Slovenia 22%; Spain 30%; Sweden 26%; Switzerland 25%; United Kingdom 28%.

ronbdavies said...

A few quick thoughts on the issues raised:

1. Taxes matter, but are only part of the equation. And they are a relatively small part compared to wage costs. Think about it this way, which is a greater part of firm costs, taxes or labor costs? A 5% rise in taxes means far less to profits than a 5% rise in labor costs. As for a specific elasticity estimate, I don't know of any Irish specific studies since there's not much time series variation in the federal tax and, as far as I know, no local taxes to use in panel/cross-sectional analysis.

2. Tax issues are complicated. If Ireland raised their tax rate, this would likely hit high tax Germany and France FDI as much as ours since the US combines all overseas income together. So our low tax rate here subsidizes German FDI. (google income baskets for more info). Not to say there's no effect on our FDI, but the data indicates it affects other countries in a negative fashion too. Off the top of my head, I think Jim Hines has been doing some of this stuff.

3. Tax sensitivity varies across firms. For high investment cost firms (i.e. manufacturing), they're not going to build a new factory if taxes go up a little bit. It's more likely that low capital intensity firms (i.e. finance) might relocate. This might mean that big numbers of Euros will move, but that little will happen to employment, especially in blue collar type jobs. I don't know how much a reduction in the size of, say, PWC would mean to us since I don't know job numbers, salaries for those jobs (and hence tax take on them), or what they contribute in actual tax revenues.

4. We likely won't have much choice but to raise our tax. This issue will arise again and again. As long as taxes are set at the state level and those are the majority of taxes, high tax countries will complain about us. In the US there are low tax states (Delaware), but since most taxation is federal, not state, it's not such an issue. One day, I expect that to be how it will be in the EU. One thing that will lead to that is I expect us to forfeit some of our sovereignty on this issue in exchange for a bailout in the next year. I REALLY hope I am wrong on the need for that, but I haven't seen anything to give me much hope in the last, oh, 18 months.