Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

Are you right there, Michael? Knowing when no deal is better than a bad deal

The rumour mills were buzzing over the weekend that, despite the Government’s stance that the country’s corporate tax rate was off the table, a deal was being discussed between Ireland’s Minister for Finance Michael Noonan and some of his European counterparts. The “deal” in question was a swap of sorts: in return for Ireland budging on corporate tax, there would be a one percentage point cut in the interest rate on the European part of the IMF-EU loan.
The arrogance on the part of Ireland’s European partners is flabbergasting. It is not even the case that the concession being offered to Ireland recognises the very different position Ireland is in, compared to countries like Greece and Portugal.
Greece and Portugal are in need of loans from their closest partners because of profligate Government spending for a generation. Ireland’s track record on fiscal policy has been far from ideal, but nothing like the problems faced in Greece or Portugal. Ireland’s problem was not about how much revenue the Government raised and spent, but how it did this.
For example, when 2008 rolled around, the ratio of the national debt to the size of the Irish economy was about 30%. In Portugal, the figure was 70%, while in Greece – as in Italy – it was over 100%. A bit like Spain (40%), Ireland’s government had mismanaged the economy but did so in a low-debt way, at least during the good years.
No, Ireland has had to borrow at punitive rates from its closest allies because it made the decision to protect those who had lent to Irish banks… principally banks based elsewhere in Europe. The two-year banking guarantee should have been used as a period for winding down insolvent banks but instead Ireland found its banks stuffed to the gills with ECB funding so that existing bondholders could escape, which they by and large have.
The result is that Ireland’s taxpayers have taken a banking bailout bill of €70bn, in the name of European solidarity. The payback from those who benefited elsewhere on the continent? Nothing at all. In fact, Ireland is giving more: each of the countries lending to Ireland will do so at a large profit, so taxpayers elsewhere not only take no hit on their banks’ dodgy lending to Irish banks but actually make a profit.
That was a bitter enough pill for the Irish taxpayer to stomach. But now, in addition to having their banks bailed out by Irish taxpayers and making a profit on the whole thing, Ireland’s closest partners – in particular France and Germany – want to go a step further and meddle in Ireland’s sovereign fiscal affairs.
Late last year, there was much talk of Ireland’s sovereignty having been lost, as the IMF came into town and set out a plan for the next few fiscal years. But the IMF’s plan was one obvious to anyone with a passing interesting in fiscal sustainability: it involved improving Ireland’s deficit by setting out a plan for cutting spending while normalising those one or two areas of taxation that are out of step – in particular overly generous income tax credits and the lack of an annual property tax.
What France and Germany want to do is completely different. For a start, it is economically illiterate and hypocritical. It is economically illiterate because available evidence suggests that raising corporate tax rates reduces inward investment. Ireland is a hotbed for inward investment and so has much more to lose, from lost jobs and exports to lower government receipts due to income and consumption foregone. Raising Ireland’s corporate tax rate will not improve investment into France or Germany – countries like Switzerland and Singapore will gain – but such a move will worsen Ireland’s deficit and – ironically? It’s hard to tell any more – make it more dependent on loans from allies.
It is also hypocritical, because countries like France hide effective corporate tax rates as low as 8% under much higher headline rates while they want to punish Ireland for having effective rates similar to the headline rate of 12.5%. The message from the EU seems to be clear: countries in the EU are less sovereign than US states like North Carolina, New York and Delaware, who can all set their own corporate tax rates.
Perhaps most importantly of all, though, a “corporate tax rate for interest rate” swap is just a bad deal for Ireland when you add up the amounts involved. Ireland’s EU partners are lending €45bn as part of the EU-IMF deal. Suppose all of that were drawn down now. What would one percentage point gain Ireland? €450m a year – an amount that is largest in real terms in the first year and will gradually shrink in importance, due to inflation and growth.
And what would such a move cost? Well, Ireland’s currently attracts about 10,000 new jobs a year through foreign direct investment. Suppose a move on tax was either a five point increase in the rate (to 17.5%) or a move through some Consolidated Corporate Tax Base scheme that had a similar effect. OECD evidence from 2008 suggests that this could put up to a quarter of Ireland’s new FDI at risk.
What economic impact would this have over five years? Let’s be very generous to our EU partners and leave aside entirely revenues raised from corporate taxes – in effect, let’s assume the new changes don’t really affect existing FDI, just new FDI that Ireland would like to attract. Ireland currently hopes to attract 50,000 new jobs through FDI by 2016. If one quarter of those do not happen, that’s about €625m in salaries that the Irish economy is out of pocket.
Indeed, using the rule of thumb that ten new jobs from investment create a further seven new jobs indirectly, it’s more likely that the Irish economy would be €1bn less well-off per annum by 2016. The government would alone miss out on more than €450m, through foregone tax revenues on income and consumption.
And whereas the benefit of a lower interest rate would fall in real terms over time, the costs would rise, as each year the new pot of FDI coming into Ireland is smaller than it would otherwise be. This is shown in the graph above.
If you were in charge of the Government’s coffers, would you pay €1bn for something worth less than €500m? You don’t have to be the Minister for Finance to figure out that’s a bad deal!

The rumour mills were buzzing over the weekend that, despite the Government’s stance that the country’s corporate tax rate was off the table, a deal was being discussed between Ireland’s Minister for Finance Michael Noonan and some of his European counterparts. The “deal” in question was a swap of sorts: in return for Ireland budging on corporate tax, there would be a one percentage point cut in the interest rate on the European part of the IMF-EU loan.

The arrogance on the part of Ireland’s European partners is flabbergasting. It is not even the case that the concession being offered to Ireland recognises the very different position Ireland is in, compared to countries like Greece and Portugal.

Ireland is not Greece or Portugal

Greece and Portugal are in need of loans from their closest partners because of profligate Government spending for a generation. Ireland’s track record on fiscal policy has been far from ideal, but nothing like the problems faced in Greece or Portugal. Ireland’s problem was not about how much revenue the Government raised and spent, but how it did this.

For example, when 2008 rolled around, the ratio of the national debt to the size of the Irish economy was about 30%. In Portugal, the figure was 70%, while in Greece – as in Italy – it was over 100%. A bit like Spain (40%), Ireland’s government had mismanaged the economy but did so in a low-debt way, at least during the good years.

No, Ireland has had to borrow at punitive rates from its closest allies because it made the decision to protect those who had lent to Irish banks… principally banks based elsewhere in Europe. The two-year banking guarantee should have been used as a period for winding down insolvent banks but instead Ireland found its banks stuffed to the gills with ECB funding so that existing bondholders could escape, which they by and large have.

The result is that Ireland’s taxpayers have taken a banking bailout bill of €70bn, in the name of European solidarity. The payback from those who benefited elsewhere on the continent? Nothing at all. In fact, Ireland is giving more: each of the countries lending to Ireland will do so at a large profit, so taxpayers elsewhere not only take no hit on their banks’ dodgy lending to Irish banks but actually make a profit.

That was a bitter enough pill for the Irish taxpayer to stomach. But now, in addition to having their banks bailed out by Irish taxpayers and making a profit on the whole thing, Ireland’s closest partners – in particular France and Germany – want to go a step further and meddle in Ireland’s sovereign fiscal affairs.

Hypocrisy and economic illiteracy

Late last year, there was much talk of Ireland’s sovereignty having been lost, as the IMF came into town and set out a plan for the next few fiscal years. But the IMF’s plan was one obvious to anyone with a passing interesting in fiscal sustainability: it involved improving Ireland’s deficit by setting out a plan for cutting spending while normalising those one or two areas of taxation that are out of step – in particular overly generous income tax credits and the lack of an annual property tax.

What France and Germany want to do is completely different. For a start, it is economically illiterate and hypocritical. It is economically illiterate because available evidence suggests that raising corporate tax rates reduces inward investment. Ireland is a hotbed for inward investment and so has much more to lose, from lost jobs and exports to lower government receipts due to income and consumption foregone. Raising Ireland’s corporate tax rate will not improve investment into France or Germany – countries like Switzerland and Singapore will gain – but such a move will worsen Ireland’s deficit and – ironically? It’s hard to tell any more – make it more dependent on loans from allies.

It is also hypocritical, because countries like France hide effective corporate tax rates as low as 8% under much higher headline rates while they want to punish Ireland for having effective rates similar to the headline rate of 12.5%. The message from the EU seems to be clear: countries in the EU are less sovereign than US states like North Carolina, New York and Delaware, who can all set their own corporate tax rates.

Perhaps most importantly of all, though, a “corporate tax rate for interest rate” swap is just a bad deal for Ireland when you add up the amounts involved. Ireland’s EU partners are lending €45bn as part of the EU-IMF deal. Suppose all of that were drawn down now. What would one percentage point gain Ireland? €450m a year – an amount that is largest in real terms in the first year and will gradually shrink in importance, due to inflation and growth.

Costs and benefits of an interest rate-corporate tax swap
Costs and benefits of an interest rate-corporate tax swap

And what would such a move cost? Well, Ireland’s currently attracts about 10,000 new jobs a year through foreign direct investment. Suppose a move on tax was either a five point increase in the rate (to 17.5%) or a move through some Consolidated Corporate Tax Base scheme that had a similar effect. An OECD review from 2008 suggests that this could put up to a quarter of Ireland’s new FDI at risk.

Deal or no deal?

What economic impact would this have over five years? Let’s be very generous to our EU partners and leave aside entirely revenues raised from corporate taxes – in effect, let’s assume the new changes don’t really affect existing FDI, just new FDI that Ireland would like to attract. Ireland currently hopes to attract 50,000 new jobs through FDI by 2016. If one quarter of those do not happen, that’s about €625m in salaries that the Irish economy is out of pocket.

Indeed, using the rule of thumb that ten new jobs from investment create a further seven new jobs indirectly, it’s more likely that the Irish economy would be €1bn less well-off per annum by 2016. The government would alone miss out on more than €450m, through foregone tax revenues on income and consumption. And whereas the benefit of a lower interest rate would fall in real terms over time, the costs would rise, as each year the new pot of FDI coming into Ireland is smaller than it would otherwise be. This is shown in the graph above.

If you were in charge of the Government’s coffers, would you pay €1bn for something worth less than €500m? You don’t have to be the Minister for Finance to figure out that’s a bad deal!

  • Stephen Hamilton ,

    Well said Ronan. Our so called European partners really need to fess up and explain the situation properly to their citizens. Far too much politics at play in France and Germany.

    Have the IMF considered lowering the rate on their part of the loan? Perhaps it would be a better tactic to get their rate down first and then hopefully France and Germany will be so ashamed of themselves that they will follow suit.

    • Fergus O'Rourke ,

      Yes, but …

      My sense is that the dissatisfaction with our tax arrangements really stems from the “second-order” stuff of which transfer-pricing is only the most obvious (and easiest to explain).

      And my (hopeful) guess is that the Government is thinking of that area of possible gesture, rather than the rate.

      • Ronan Lyons ,

        @Fergus
        Countries have been looking for ways to stop transfer pricing for decades, to the best of my knowledge. If the Irish government was able to come up with something on that, I think there’d be a lot of interest internationally. Perhaps, though, the Irish government just needs to convince the Dutch to close off the”Dutch Sandwich”, thereby keeping a lot more profit in the EU. (Ireland could easily, however, be one of the largest beneficiaries of such a move, much to the annoyance of France and Germany!) The Germans would probably be happy if they got a concession on royalties on financial products – I believe Ireland has none.

        • Eamonn Moran ,

          Hi Ronan. I think you have left a rather important line from your graph. Gains from increasing the corporate tax rate. If corporate tax rate goes from 12.5% too 17.5% then one presumes the exchequer will gain more income. Last years corporate tax was 4 Billion. Using the same source as you did for showing Frances effective rate at 8% Irelands effective rate was 11% we took in 4 Billion in corporate tax at that rate. If we assume an effective rate of 16% when it is 17.5% that would lead to an increase in corporate tax by well over 1.5 billion in year one. Even if that started coming down over time it is still way too big of a number to just omit. Or as is very possible have I missed something?

          • Ronan Lyons ,

            @Eamonn
            Thanks for the comment. This is the great unknown about this exercise. As I wrote above, I am assuming that there is no net effect on corporate tax income. In other words, the corporate tax foregone by greater outflow and smaller inflow of FDI is offset by more tax paid by those who stay/survive in Ireland.

            I think it’s important to remember that domestic corporate tax is not free money, it is money taken at the expense of income to workers, shareholders and consumers. So even if the FDI issue did net off, we would face higher prices, lower wages and smaller dividends domestically which would of course have an impact on employment and government receipts from the domestic economy. None of that is factored in above – as I said, I thought I would be generous to the counter-argument and say that this didn’t happen.

            What you are arguing is that these effects would be smaller than the effect of increased tax take from FDI companies who remain and from Irish companies who survive and thus that I am being generous to my own argument! Given that we talking about possibilities and counterfactuals, that’s a fair point. I will have to leave it up to readers to judge which effect might dominate.

            Ronan.

            • FERGUS O'ROURKE ,

              Ronan,

              The practical impossibility, apparently, of doing much about transfer-pricing need not be an obstacle to a “political gesture” in that area 🙂 !

              In fact, though, what I had in mind was some of the more abstruse stuff utilising “double-dips” and the like, which understandably gets up the nose of the tax collectors in the big EU states whose tax-bases are eroded thereby.

              And the infamous CCCTB would, I suspect, be seen in a different light in Ireland if the MNC profits were being reported in “France & Germany” due to dodgy transfe-pricing.

              All of which, for some reason, prompts me to wonder, yet again, why the companies dominating food retailing in Ireland *still* get away with hiding their financial results. We can’t blame CJH & Ben Dunne for ever.

              • Michelle ,

                Question: If they offered to forgive all of our debt, and in return they controlled our interest rate; would that be worth taking?

                • Niall Hurley ,

                  What would be ideal would be if the government said that if we are willing to commit to reducing Irish welfare (fraud) by 1bn euro per year would they lower the interest rate. In any corporate context if a company cut costs to it’s credit spreads to tighten. cutting social welfare payments and reducing fraud and motivating people to work has a multiplier effect. raising the tax rate does not. it would be a shame to see our politicians give in on this point. i think this would cause significant unrest in ireland and rightfully so.

                  • Eamonn Moran ,

                    “Let’s be very generous to our EU partners and leave aside entirely revenues raised from corporate taxes – in effect, let’s assume the new changes don’t really affect existing FDI” Hi Ronan, I dont think you are being very generous at all. You are assuming that if there was an increase in Corporate tax rate from 12.5 to 17.5% there would be a zero net effect. I am saying that in year one there would be an increase of about 1.6 billion in corporate tax that would likely reduce over time as FDI decreased( and we would also have to factor in the costs to workers and shareholders and consumers which I think would be very small). Your assumption is that it would reduce the full impact of the increase immediately which I think is unlikely.

                    • Laura ,

                      Transfer pricing and repatriation of profit to take advantage of lower taxes isn’t really Ireland’s call – its ultimately up to the “home” countries who permit these profits to shift offshore. France and Germany should therefore be lobbying the US and UK, not Ireland.

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