Notes on the Front

Wherever two or more are gathered in the name of the Left, the conversation will eventually turn to the corporate tax rate. This is understandable. Tesco, Burger King and property development companies pay such a ridiculously low tax rate – while our public services are in shambles, while we suffer one of the highest poverty rates in the EU. The logical and seemingly equitable response is to increase the tax rate. I would, however, argue caution. For the issues involved are complex and it is necessary to keep our eyes focused on the real problems and solutions – of which the corporate tax rate is only one element.

A little history: The 12.5% corporate tax rate (CTR) was introduced on a phased basis back in 1996. Prior to that there were a number of rates: the 10% manufacturing CTR, a 20 year exemption from CTR on primarily export-based companies, and the 40% CTR for all other companies – non-traded and service sectors (there were other reliefs –Shannon, Financial Services Centre, etc.). However, the EU told Ireland it could no longer discriminate in such a fashion. Thus, the single CTR we have today – 12.5%.

There are a number of points to make at this stage:

a)  The adoption of the single 12.5% CTR had little to do with the Celtic Tiger boom. That was largely the result of foreign direct investment (FDI) which had already benefited from the low tax rates listed above. Indeed, generous tax breaks for the export sector go all the way back to 1956. If anything, the 12.5% CTR actually raised the tax rate for this sector.

b)  Those tax breaks for mainly the multi-national sector were crucial to Ireland’s economic boom. The IDA aggressively sold the low tax rates abroad. Without those breaks, we would not have had the same level of foreign direct investment. And that would have been disastrous as it was apparent by the late 1970s and early 1980s that indigenous enterprise was enfeebled.

c)  The current rate was definitely set too low. At the time, business and banking economists expected the rate to be set at between 15% and 17.5%. If that had been done, Ireland would have still have a clear competitive advantage and the IDA could still sell Ireland as a low-tax country. The 12.5% was gratuitous. With a rate of 17.5% we could have been enjoying an extra €1 billion a year in government revenue. That can buy you a lot of hospital, school and public transport capacity (Paul Sweeney tells an interesting story about how the Department of Finance advice was ignored at the time; instead the Government heeded the advice of private consultants who were later implicated in the Enron scandal).

But that was then and this is now.

First, is Ireland being short-changed, relative to other industrialised countries, regarding the level of corporate tax revenue we receive? The answer is no.

As a percentage of our GDP, Ireland raises more tax revenue from the corporate sector than most other OECD and EU economies. The reason for this is two-fold:

One, a high-tax rate regime may have so many reliefs and exemptions that the revenue derived is substantially reduced. Conversely, a low-rate regime may have relatively few tax breaks and high revenue. Ireland veers towards the latter. In other words, a broad tax base may offset a low rate structure, while a narrow tax base may reduce revenue from a high tax rate.

Second, a friend in the Department of Finance attributes this revenue performance to Ireland’s glorified tax shelter status or ‘tax laundering’ regime. The effect of transfer price fixing and the presence of brass-plate operations (companies that ‘set-up’ in Ireland but effectively do their business somewhere else) means we receive considerable revenue because of the low tax rate, not because we have a lot of ‘entrepreneurial’ activity.

Whatever the reasons, Ireland does reasonably well in terms of corporate tax revenue and, on this basis, the argument to increase the rate is not as strong as if we were being short-changed (increasing Employers PRSI, however, is a stronger argument on this score – we are really getting hosed on this one).

The real problem is Ireland’s excessive reliance on FDI. Foreign investors are the driving force behind the ‘modern’ industries (e.g. chemicals, pharmaceuticals, etc.) where wages are high; they are responsible for a disproportionate amount of innovation, productivity and R&D; they are responsible for approximately 90% of all exports; and they constitute a major proportion of our tax base. Because of a poor indigenous sector we need these multi-national companies – both the current ones operating and any new investment the IDA may be able to entice into the country (if only to replace the ones that are leaving).

As one example of over-reliance, let’s look at tax revenue. The yield from the foreign-owned sector is considerable – more than 10 times that of the Irish-owned sector. In fact, recently figures came to light showing that a mere ten companies paid nearly 25% of all corporate taxes. What strikes one is not how little revenue we get from the corporate sector, but how little we get from the indigenous sector.

And herein lies the crux. ICTU’s Paul Sweeney, an articulate spokesperson for the proposal to increase the tax rate, argues that

It is asserted that many MNCs come here primarily because of the low CT rate. The world of foreign direct investment is far more complex than tax rates, and while they do affect such investment decisions, firms locate here for many other reasons. In many discussions with the finance directors of MNCs, I . . . have been surprised at the number who say they are unable to persuade their head office to locate profits here to take advantage of the low rate, while others say that their MNC tax planning is so complex that they do not require the low rate.

But another progressive economist, Frank Barry, arguing that any reduction of foreign investment would not, in the short-term, be compensated by indigenous enterprise, stated that:

What we need to do, if we fear divestment, is to build a stronger indigenous sector before this occurs. How to do this is one of the deepest, hardest and most important questions in Irish economic development . . it seems to me crucial that some such framework be put in place and be seen to be working before we begin to think of raising corporation tax substantially. Otherwise, that colourful phrase about cutting off one’s nose to spite one’s face would appear apt!

Messrs. Sweeney and Barry are ultimately in agreement. Both argue for a more pro-active enterprise strategy to create a credible indigenous sector. Both agree that the current rate is inequitable. Both agree that future policy cannot be premised on low-tax policies. Where they diverge is on the short to medium-term effect of increasing the CTR. I’m inclined to side with Mr. Barry. Mr. Sweeney may be right – that the effect on raising the CTR would have only a minimal effect on our ability to win and retain FDI. But if he is wrong (and you don’t have to be wrong by very much) then untold damage could be done – to job and wealth creation.  The real problem is that we can’t know for sure.

But we do know that we are facing greater tax competition. A number of countries are reducing their corporate tax rate to win foreign investment – that is, to divert it away from Ireland. For a country so dependent on foreign investment, this is potentially worrying. In 2004 Ireland’s FDI stock was over 150% of GNP. The OECD average is approximately 30%. We could raise the CTR but his could invite the perverse result that revenue is weakened as FDI weakens (even a small rise in the CTR might be interpreted by global players as a precursor to more increases). Is this risk worth arguing for – especially as there is little empirical evidence one way or another?

This dangerous, irresponsible over-reliance on foreign capital and a low-tax rate is the result of right-wing policies that have overseen the continued degraded state of indigenous enterprise, that have eschewed the successful models of social market economies. The Left is not responsible for this state of affairs but we will have to deal with it.

At root, increasing the CTR misses the main point – there aren’t enough export-based, internationally competitive indigenous enterprises paying taxes, employing people, innovating and investing into the economic base. The Right would like to take us on on the issue of tax rates. It is their ground (as we saw in the election campaign). What they don’t want, and what they can’t survive, is a concerted attack on their enterprise strategies. For the Left, that is the ground we should be arguing, the ground we should be claiming as our own. This is not about being ‘business-friendly’; this is about progressive policies to make indigenous business ‘socially and economically friendly, responsible and relevant’.

And for those who are rightly concerned about the inequity of low tax rates, don’t worry. There is still the 5:40 club – or the 1:34 elite: those small sections that own a disproportionate of wealth in our society. A range of measures to redistribute wealth and income remains for the Left to exploit without damaging FDI or undermining future enterprise development. Eventually, the CTR will have to be raised. But it should only be done once, as Mr. Barry says, we have an indigenous base that can take up any slack that may occur if and when FDI weakens.

But that’s eventually. For now, let’s focus on the real prize – policies that can convince people that it is only the Left that can create a dynamic economic base. The current CTR is not an impediment to that goal. The Right’s ideological approach to enterprise development is. And when that goal has been achieved – under the aegis of a progressive economic policy – then people will be more willing to receive, and the economy better able to sustain, our policies on increasing the Corporation Tax rate.

That is the end-game, not the opening move.