Ever since Ireland was forced off international capital markets for protecting European banks, there has been a lot of discussion at European level about its corporate tax rate. UK blogger Duncan Weldon, for example, wanted any funding to be contingent on changes in corporate tax. The chatter hasn’t died down and if anything, with restructuring for Greece looking inevitable, the debate may be intensifying. BusinessInsider reported in the last few days that French Finance Minister, Christiane Lagarde, is going to dig her heels in on this issue: no help for Ireland until it gives up its sovereignty on corporate tax.
For context, France has a headline rate on corporate tax of 33%. Ireland’s headline rate is just 12.5%. Whereas Ireland sees its rate as central to competitiveness and job creation, France sees it as a cheap trick that diverts economic activity, rather than creates it. Or is it that simple?
Corporate tax: just part of taxes on profits
Global business services firm PwC release a report every year entitled Paying Taxes. Its aim is to understand the true cost of taxes, by focusing firstly on the actual rates paid and secondly on the administrative burden that taxes impose, through for example filling out forms. Their most recent report is out and has a wealth of information on practically every country in the world (erm, except Eurozone member Malta, for some reason). PwC find that in the typical country, their “case study” company pays nearly half of its profit over in various different taxes, spending seven weeks of the year dealing with its tax affairs and making a tax payment every 12 days.
Among their ten key findings are two very relevant for the corporate tax discussion. Firstly, corporate tax typically only accounts for about two fifths of the total tax burden faced by firms – in the EU in particular, employer taxes on labour such as social security contributions are much more important. Secondly, the headline rate of corporate tax is – and let’s quote verbatim here – “not a good indicator of the amount of tax a company pays”.
Instead of using headline rates, PwC calculate the true “Total Tax Rate” paid by companies on their income. This is the sum of (1) the effective corporate tax rate, (2) taxes on labour and (3) other taxes and fees. The graph below shows the effective corporate tax rate across the Eurozone (the blue line) and also the headline rate (orange). What is instantly striking is that France (and Belgium) have the two highest headline rates of corporate tax but two of the lowest effective rates, significantly lower than the effective rate in Ireland.
The effect of high tax rates
The model adopted by countries like Ireland and Cyprus is: set a tax rate and charge it. This transparent, open model is one that encourages new business to set up by virtue of its simplicity. You can’t really game the system, but you don’t need to. As simple as it sounds, it is practically revolutionary when compared to the model adopted by countries like France and Belgium. Such a system bears all the hallmarks of an insider-outsider set-up, where insiders know how to pay very low rates of corporate tax but investment by new business is hampered, because outsiders won’t know all the tricks.
Whatever about the effects of a large gap between the headline rate and the true rate, what about the economic impact of changing the rate? If Ireland is digging its heels in pointlessly on an issue that could genuinely help it close its deficit, maybe sovereignty isn’t as important as a bit of cop-on.
It turns out that there are very real risks associated with increasing Ireland’s corporate tax rate. In a study that uses PwC’s data on the true rate of corporate tax, rather than the headline rate, a group of authors including Andrei Shleifer (the world’s top academic economist, according to RePEc), found that increasing the true corporate tax rate by ten percentage points has a range of detrimental effects on an economy:
- It decreases total investment, by 2.2 percentage points [pp] of GDP, and in particular foreign direct investment (by 2.3pp).
- It reduces entrepreneurial activity, with a 10 pp increase in corporate taxes associated with a fall in new business registrations by a fifth on average.
- In truth, it probably doesn’t reduce entrepreneurial activity so much as push it into the black economy, whose share of economic activity rises by nearly two percentage points.
- Lastly, it makes companies more dependent on debt, than on equity, raising the debt-equity by 40 percentage points.
Given all of that, it is more important than ever that our Government is armed with graphs like the one above when they go into discussions about Ireland’s corporate tax rate. Increasing Ireland’s corporate tax rate in response to French pressure:
- Flies in the face of the sovereignty enjoyed even by constituent States of the USA, let alone fully independent members of the European Union.
- Is to give in to hypocrisy on the part of the French, who actually tax profits less than Ireland does.
- Runs the risk of lowering economic growth by reducing investment and enterprise.
- Is a self-defeating measure as by lowering growth and jobs, it would widen the Government deficit and may Ireland more dependent on French and German loans.
Particularly if the French are all while flaunting their low rates to attract overseas business, the message from Ireland on corporate tax must be clear: just say “non”.
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Postscript: Can we trust PwC’s figures on the effective rate? To judge that, it is necessary to know a little about the methodology. The methodology was developed by the World Bank and PwC. To produce any information from the muddle of tax systems worldwide, they used a standardised company in each country. The standardised company is a limited liability company with 60 employees, start-up capital of 100 times average income and turnover of 1,000 times average income. What the methodology accounts for is very specific (and has to be to produce like-for-like comparisons): the company produces ceramic flowerpots at a gross profit margin of 20%, is domestically owned, does not trade internationally and operates out of the country’s largest city. There are also specifications for what it owns and leases (land, machinery, trucks, etc.). It does not qualify for any incentives or tax reliefs other than those it can get due to its age or size.
Eoghan O'Briain ,
Hi Ronan,
Great article as usual and I agree with the thrust of the arguments you make. What I think is open to debate is that ‘Ireland sets a tax rate and charges it’.
As you acknowledge the PWC figure is based on a very specific firm. Given the small army of tax professionals employed by MNCs in Ireland, I am sceptical that Ireland’s tax regime is as simple as this.
However, if it really is the case, then the Government could knock this argument with Ms. Lagarde on its head by releasing the data it collects on effective corporation tax rates paid by IDA clients. Something tells me that this transparency is unlikely to materialise. Either way, it should be forcefully making all the arguments you outline.
Ronan Lyons ,
Hi Eoghan,
Thanks for that. You have a valid point, and it would be good to know. The more data, the better, in my opinion!
My only counterpoint would be that MNCs do this everywhere, not just in Ireland. Indeed, they are legally obliged to do so, if they are publicly listed companies, otherwise they would be in dereliction of their duty to shareholders. So whereas Irish-based MNCs might, by using loose Dutch tax treaties, be able to get their tax rate down from 12% to 8% in Ireland, that might be even larger in other countries. Even if Ireland did have a larger gap than other countries, the blame may lie elsewhere, e.g. the Dutch sandwich!
R.
John Mack ,
When you surrender your currency you surrender your sovereignty.
Ronan Lyons ,
Hi John,
While I totally agree on the lack of adaptation in the Irish system in response to a life in the eurozone, I disagree on the sovereignty issue. In the USA, states, counties and even small towns still have “sovereignty” over taxation issues.
R
Fred Logue ,
Very interesting analysis. I think it is worth noting that in Belgium the “insiders” have a very good deal in relation to tax. There is no CGT and rent is earned tax free. In addition senior employees are allowed incorporate to take advantage of the lower corporation tax rates, avoid social security payements and benefit from expense deductions.
On the other hand the outsiders which includes regular employees, civil servants and small businesses are crucified by high income taxes, social security and VAT rates.
In addition it costs at least €2K to set up a private company in Belgium, compared with €100 in Ireland.
Another point in relation to our tax rate relative to our economy is well made by TCD academic Frank Barry where he traces the history of our corporation taxation policies from the their origins in the 1950’s. He even shows that for a period leading up to our joining the EEC we had zero tax for manufacturing exports and that the 12.5% across the board was only phased in between 2000 and 2003.
Barry also cites research that finds that the level of FDI in Ireland is 70% higher than it would be if were to have the next lowest tax rate in the EU and that 80% of our FDI would disappear if we raised our rates to the EU average.
http://www.tcd.ie/business/staff/fbarry/papers/export%20platform.pdf
Donal O'Brolchain ,
Thanks Ronan for setting out the case for saying NON.
In support of this policy, I refer you to the presentation given by Simeon Djankov, Bularian Deputy Prime Minister and Minister of Finance at the IIEA recently here
http://www.iiea.com/events/corporate-tax-investment-and-entrepreneurship-in-europe
In summary, he pointed out that the Bulgarian way of managing the insider-outsider issue in the post Communist era means that they now have a 10% tax rate on corporate profits, dividends and personal income tax.
re. France.
In July 2009, I attended the launch of a Forfás future scenarios report as I had taken part in some of the preliminary work.
(http://www.forfas.ie/media/forfas090713_sharing_our_future_press_release.pdf)
Among those presenting was Jean-Loup Loyer, (Project Manager, France 2025, Centre d’Analyse Strategique)who spoke about a similar exercise in France. As I remember it, one of his slides made it very clear that France wanted a higher corporate tax rate throughout Europe.
At the time, I regarded it as a “shot across our bows”.
Among the three next steps identified in the Forfas exercise was
“We should develop institutional capacity to anticipate and prepare for future
challenges, trends and opportunities.”
I just hope that in 2025, we will not find the same inertia, smugness and complacency on the part of our governing elites in their response to Ireland joining the €uro
“In the past decade, Ireland’s approach to fiscal policy, prices, costs and financial
regulation were not sufficiently adapted to the disciplines of a single currency.“
(Press Release from National Economic and Social Council (NESC) on a report “The Euro: an Irish Perspective” 17th August 2010. NESC is 30-person social partnership body made up of representatives of government, business, trade unions, agriculture, community and environment. The Secretary General
of the Government chairs NESC. Among the seven Government nominees are the Secretaries-General of five Government Departments.
http://www.nesc.ie/dynamic/docs/The%20euro%20MEDIA%20RELEASE%20from%20NESC.pdf)
For some ideas on what we can do to work ourselves free of this, see my contribution to the Dublin City Business Association 10-point Manifesto Towards a Second Republic from p. 57 here
http://www.dcba.ie/static/doclib/Towards_a_Second_Republic.pdf
AdamS ,
I get the impression that France, Germany, etc, aren’t really that bothered about what Ireland charges its local flower pot makers, but are far more bothered about their loss in revenue when companies that primarily do business in their countries pay tax elsewhere.
Therefore, the levels of company taxes applying to *local* businesses is irrelevent to some extent; the fact is that cases exist where millions of euro of profits are being routed through Ireland purely for tax reasons and the French & German revenues are losing out.
This doesn’t seem to be happening in the opposite direction, whatever the reports say.
Damian T ,
Ronan – interesting sentiments – but I would be far more critical of the methodology used.
Schleifer is a leading economic theorist, but not a policy maker (few academics are).
PWC is an accountancy/tax consultancy – secrecy is their trade! US data that I have seen for 2007 from the US side suggests that the average US non-financial affiliate employs about 170 employees and has capital investments that thankfully don’t relate to flowerpots!
For that year Revenue data suggest that US companies paid some 1.7 billion euro in corporate tax (the largest single contributor) – a quick back of the envelope calculation would suggest that even if all the above was paid by the same non-financial affiliates (of which data is most readily available) the simple effective tax would be about 3.6%.
I would think that the Department of Finance know these figures, and can probably be rest assured that they would never be crazy enough to publish them! Where I would agree with you is that if we charged what we said we did (or perhaps even less) both our fiscal and negotiating strategy would be far stronger. Who knows, we could be the shining light in the murky world of corporate taxation!
Eoin Ryan ,
It’s very relevant that PWC have chosen a farcical type of company to do this analysis.
A company that only trades nationally? What use is that in a debate about EU corporate tax laws, since we’re all trying to attract FDI and as such companies that only trade nationally are irrelevant.
Since PWC makes so much money from giving advice on how to avoid paying tax, it’s in their interests to frame this debate with a simple data-set. They can be fairly confident that most people that see the main graph/conclusions of the study (i.e. don’t increase corporation tax) will not dig down into the methodology in the way that Ronan did.
I think that corporates must dig a little deeper, like the rest of us. There is a case for a small rise in the corp tax rate, 1 or 2%.
We can consider it a PR success for companies like PWC that our entire cabinet is resolute against increasing corporation tax, in the context of all personal taxes increasing.
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