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The Summer of Big Numbers

Posted on September 15, 2016 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

And what a summer it has been. It was the summer of the ‘big numbers’. There was €13 billion in claimed back tax from Apple. There was an undisclosed large sum of money possibly running into billions in relation to vulture fund tax avoidance planning (referred to as ‘Section 110’ tax).  The ultimate big number was €40 billion in GDP that we didn’t realise we had in 2015 but now have thanks to an extraordinary statistical revision made by the Central Statistics Office in June (compare here and there). Yet, the pre-budget debate has been dominated by much smaller numbers like the €1 billion in ‘fiscal space’ or the €100's of millions in debated spending or revenue measures in the draft Budget 2017 to be unveiled next month.

(I say draft Budget because, strictly speaking, all budgets of EU member states are subject to approval by the European Commission as the civil service working on behalf of member states.)

The landmark opinion delivered by the European Commission in late August on the tax owed by Apple has dramatically changed the landscape for the Republic of Ireland. In a rush of 'unpatriotic' sentiment while nobody is watching not a few in Ireland have secretly been cheering on Margrethe Vestager and Pierre Moscovici in their very clear statements about these matters in recent times. Yet, the judgment of the Commission, which has not been published in full yet, seems by all accounts entirely justifiable and correct whatever the reasons connected to it (the Commission’s main argument is not about low corporate tax but about selective state aid to one enterprise). The Republic of Ireland may not be a ‘tax haven’ in the strict definitional sense used by the OECD but it surely has been a conduit for tax avoiding behaviour and quite possibly in the last 18 months as the OECD Base Erosion Profit Shifting (BEPS) has given some corporations an incentive to relocate or reclassify some activities from tax havens to near tax havens. What an irony that BEPS may have boosted tax avoidance relocation activity in the case of Ireland.

The EU ruling is simply that Ireland, in the interests of a level playing pitch, should have stuck with the 12.5% headline rate for ALL companies and not a near zero rate for some highly questionable entity or entities.  The EU Commission has targeted not only Ireland but other countries including Luxembourg, Belgium and the Netherlands (see Fair Competition and a level playing field).

In the domestic fuss which followed the EU opinion, it is important not to confuse three issues:

  1. Foreign direct investment (very good especially in terms of jobs, wages, productivity).
  2. Low headline corporate rate at 12.5% (this is not the issue right now but it is debatable in the long-run if we really want to be part of the European Union rather than passengers of convenience).
  3. Tax at less than 0.005% on carefully constructed and ‘located’ business entities (definitely not good).

Claims that mix up the three do not help to enlighten the debate on corporate taxation. Moreover, they deflect from a fundamental challenge in relation to enterprise development more broadly – a point I discuss below.

The notion that large multinational corporations can use Ireland or another other jurisdiction to avoid paying tax is quite simply morally repugnant. To hide behind claims of legality is unconvincing to taxpayers in Germany, France or the USA (or Ireland).  Companies like Apple have made major a huge contribution to humanity by way of technology and innovation (though it must be pointed out that it was in no small way assisted by US government basic research and application as well as grant assistance for specific technologies that enter into the Iphone). Apple’s manufacturing presence in Ireland and its contribution to employment and income for thousands of workers is most welcome and is vital not least to the Cork area where thousands of workers and their families benefit from good employment at the Apple manufacturing plant in Knocknaheeney in Cork city not to mention the wider spill-over impacts on the national and regional economies.

But, what is the common thread behind the summer of big numbers?  For over 50 years the Republic of Ireland has traded on a strong reputational calling card – ‘Ireland is open for business and businesses can invest in Ireland taking advantage of many favourable conditions including not least of all a very low and competitive corporate tax rate’. Foreign direct investment has been good for Ireland – North and South. In the case of the Republic it has been a major factor in making Ireland look more like an advanced economy than say Portugal, Croatia or Greece. Inward investment has also been very much associated with the opening up of trade before and after accession to the EEC in 1973.  However, lying behind the huge GDP numbers of recent times as well as the extraordinarily high average productivity in industry and services is the reality of a dual economy.

A large-scale dependence on inward investment and export share – especially in leading sectors such as Pharmaceuticals and IT services leaves the economy of the Republic highly exposed to sudden downturns or medium-term trends in investment location.  What worked by way of global tax strategy in the recent past may not work in the medium-term.

It is clear from an examination of national accounts data released by the Central Statistics Office that lurking behind the huge share of corporate profits in total income is the position of multinational companies and a few very large ones at that.  While a very significant part of the profits earned here by foreign based enterprises are ‘repatriated’ more of them remain in the State either as retained earnings or for reinvestment or for distribution. It would be no exaggeration to claim that there are, in reality, two economies in the Republic of Ireland:

-        a very high-productivity (at least as statistically measured), relatively low-labour intensive, highly export orientated and highly profitable economy on the one hand; and, on the other

-        a relatively low-productivity, high-labour intensive, domestically orientated and, in some cases, relatively less profitable economy.

Clearly, matters are not so black and white but this depiction captures some key differences relevant to any ‘single country’ analysis of trends in productivity, employment, exports or profits.  It is understandable that the CSO do not and cannot readily disentangle these two economies. The closest they come to it is in reporting aggregate statistics for ‘traditional’ industry and ‘modern’ industry. Separately, data are available from the CSO and Eurostat on Irish-owned and foreign-owned enterprises (increasingly difficult to interpret information given the re-domiciling of enterprises).  Included in the latter are pharma, ICT and similar sectors. It is evident that some 50 enterprises account for over 40% of total Gross Value Added (close to but a different measure to that of GDP) and over 60% of Gross Operating Surplus (close to but a slightly wider measure than corporate profits).  Although dated by now, see summary data in a presentation by the Director-General of the CSO at the NERI annual Labour Market conference in May 2014 here. For more recent data on levels of output and growth rates see here.

During The Great Recession of 2008-2011 the larger ‘modern’ enterprises saw little decline in output or production. This explains the relative stability and even growth in wages in firms and sectors associated with the ‘modern’ sector as measured by the CSO. The story in the ‘traditional’ sector is entirely different where job losses, wage cuts and recruitment freezes were the order of the day.  Outside the ‘traditional’ and ‘modern’ industrial sectors, the public service fell to the ravages of wage cuts, programme cuts and voluntary departures.  It should come as no surprise to anyone that the Republic of Ireland was enabled to recover quickly from about 2012 onwards due in no small part to the role of the ‘modern’ sector. The situation in other parts of the economy tended to reflect a rising tide in the modern sector (but not evenly or at the same pace by any means).

In the next ten years we are likely to face stiff competition from other countries in areas such as corporate tax and other incentives. Whether the EU succeeds in implanting a common consolidated corporate tax base (I hope it does) is not the main point. It is highly questionable that Ireland inc. can rely at all as much as in the past on the single main calling card of low corporate tax.

The game is up and the time is running out. 

A cynic might comment that if only the public authorities, here, were as passionate and diligent about resisting EU ‘encroachments’ on our fiscal and banking policy in 2008-2013 as it is now about facing down the EU commission on an issue clear global tax justice - whatever the legal, technical and political arguments) then we would be in a better position. The real game is not what worked in the past or even now. It is the need to develop a strong, export-oriented, high-productivity, high-skill and resilient domestic enterprise sector. Notwithstanding spectacular successes in a number of sectors and firms we are still left with what I call the weak link in Irish capitalism – the dominance of low-productivity enterprises with a limited capacity to capture world market niches in areas such as food, energy and business services. Turning this situation around and adopting a plan B enterprise strategy to see us through the first half of this century will take years of work, preparation, capacity-building, mind-set adapting and changes in the way enterprises are run. This is the boring year-in year-out stuff and is much less newsworthy than the latest big numbers scandal or upcoming marginal budgetary changes within some notional fiscal space that could evaporate as quickly as GDP bounces back or forward with one company re-shoring its intellectual property.

Whether or not Ireland will retain the magical €40 billion in value added that suddenly turned up in 2015 is uncertain. Nowadays, national and even international statistical conventions along with taxation policies are not able to catch up with large multinational corporations where manufacturing, knowledge patenting and generation, sales and pricing are so intricately related that national boundaries hardly matter. This is the new world of global capitalism – in all its complexity, sophistication and ambiguity. Only inter-governmental cooperation can tackle corprate tax avoidance.

Whether the Republic of Ireland will see all, some or none of the €13 billion claimed by the EU commission is a moot point. As of 2015, we cannot measure national income in any satisfactory way. The statistical rules are rules to stay. GNP or Gross National Income is corrupted as well as GDP as a result of re-domiciling of corporate activity. Hence, ‘hybrid’ measures combining GNP and GDP are meaningless. Net National Product might help but only to a limited extent on one dimension of the problem. In reality, there is no one statistical measure that can capture total ‘national’ income/output/expenditure. In a way this is no bad thing. At least we might start thinking seriously about how to measure sustainable development and all economic activity and not just those bits measured by paid work and the market.

In the meantime, the international lawyers are likely to be much better off courtesy of Irish taxpayers. And Apple is only one case.  Expect more.

Posted in: Taxation

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