How Ireland’s corporation tax rate is sinking the economy like a stone

“A low rate of corporation tax on export-orientated activity has been a cornerstone of our industrial policy since the 1950s and the 12½% rate is now part of our international ‘brand’. The contribution from  the corporate sector will be made through the maintenance and creation of high value employment.”

So said the National Recovery Plan 2011-2014, issued on 24 November 2010 by the Fianna Fáil/Green Party and which received glowing approval from the EU, IMF and the ECB.

In an interview with the Wall Street Journal towards the end of 2011 Taoiseach Enda Kenny was asked if it was true that the reason so many tech firms set up European headquarters in Ireland was because of Ireland’s low corporate tax rate. Kenny gave an emphatic no to that. But, the interviewer wanted to know, if that was the case, why then was the rate defended to vigorously?

“Foreign investors like decisiveness” he said. 'There isn't any confusion about Ireland's corporate tax rate: it is 12.5%. End of story.' He then added 'but that is not why major corporations come here. It is a cornerstone undoubtedly of why companies might invest in Ireland. But no matter what the business is, it is always about people that can actually develop it and grow it.'

See what he did there? As an indication of how different the Fine Gael/Labour government’s industrial policy is to that of the previous regime he just moved the word ‘cornerstone’ from Ireland’s policy to a company’s rationale. But there can be no doubt that the thinking is exactly the same.

This attempted fudge acknowledges the widely held view that any government that has made various tax reliefs the ‘cornerstone’ of its industrial policy for 50 years is an admission of its failure to develop. In short, reliance on a low rate of  corporation tax is evidence of a failed state: tax relief can be part of the first phase of industrial development, not the cornerstone 50 years later. And it has failed spectacularly - despite the vast amount of money that moves through Dublin’s docklands - to produce anything other than good jobs and handsome incomes for tax advisers and middle managers with good tax accountancy skills. This failure was accentuated by the introduction of the 12.5% corporation tax. In the 5 years when corporation tax was 40%, according to data from the National Income and Expenditure Accounts, the average annual growth rate was over 7%. However, in the 8 years since the rate was reduced to 12.5%, average growth was little more than 1.5% per annum.

History of Ireland’s corporation tax relief

Ireland’s history of providing tax relief on exports began with the introduction of the Export Profits Tax Relief (EPTR) by John A. Costello in 1956. The relief provided a 'remission of 50% income tax on profits of a manufacturing industry derived from increased exports' to be used 'for the expansion of the industry'. As a Department of Industry and Commerce note in 1950 suggested: ‘It is possible that the granting of the concession may induce foreign enterprise to establish in this country industries capable of exporting goods to the dollar area.’ This is the establishment of the ‘cornerstone of Ireland’s industrial policy’.

It was not until the 1970s that the IDA started to overtly market low taxation to attract FDI. Measures offered in the mid-70s included a fifteen year tax holiday for exporting firms, full depreciation and total tax relief on earnings from royalties and incomes from licenses patented in Ireland. These generous reliefs clearly did little to avert the problems for Irish economy in the 70s and 80s.

Once Ireland entered the EEC, however, such tax incentives were judged to be discriminatory, and a change was required, although plenty of time was allowed for them to be implemented. This lead to a broad10% tax rate for manufacturing in 1981, although a 32% corporation tax remained for other sectors. In the 1998 budget however, Minister for Finance Charlie McCreevey announced that he would bring forward legislation for a phased introduction of a new regime of corporation tax. On 1 January 2003 the 12.5% rate of corporation tax came into existence.

Reducing the rate does affect FDI - negatively

At the time the new rate was justified on the grounds that the EU, once again, considered the dual rates to be ‘discriminatory’. But it was also regularly stated that the rate itself would create jobs and bring on prosperity. The defence of it since then has remained the same. In a March 2011 debate on corporation tax in the Dáil, the freshly appointed Fine Gael Minister of State Brian Hayes suggested that the wording of the motion being debated in the chamber should be changed to “Dáil Éireann recognises that the 12.5% corporation tax rate will support Irish economic recovery and employment growth by attracting foreign investment.” The nostrum is that the sacrosanct 12.5% rate itself is responsible for attracting and maintaining this investment.

But what actually happened when the rate was introduced was a significant increase in the FDI leaving Ireland. Economist Michael Burke examined the inflow and outflow of FDI from 1998 to 2010 and found that after the rate was cut in 2003 'there have been many quarters with a net outflow of FDI and the annual average total was an inflow of just €2.3bn. Before the rate was cut that annual average inflow was €17.7bn, and there was only one quarter of net outflow in FDI.'

That the outflow of direct investment should increase after the rate was reduced would not surprise those aware of the wide number of studies which show that firms involved in direct investment consider other factors to be more important than the corporation tax rate when choosing where to invest. Perhaps the most important of these is the availability of a high quality workforce. One reason for the rise of direct investment prior to 2003 is revealed in the Eurostat data for the percentage of the 20-24 year old population in EU countries who achieved at least an upper second level education. Ireland has the highest. The point is obvious, even to large MNCs, a country that lowers its rate will be less able to pay for investment in infrastructure, transport links and education.

Another aspect of the change in the corporation tax rate that gets very little attention is the boost that it gave to Irish banks and certain domestic firms to whom it applied (the vast majority of Irish firms do not earn enough to be liable for corporation tax). This moved their corporate tax liability from 32% to 12.5% overnight. The resulting profits however, were not invested back into businesses, but into property speculation.

Drop in direct investment, rise in financial investment

Dr. Jim Stewart, lecturer in Finance in Trinity College Dublin, has also found that direct investment, which is associated with manufacturing and creating jobs, reached a peak in 2003 and has since fallen. Foreign investment, however, in the form of portfolio and other investment such as the financial assets of banks and financial services in the IFSC ‘continued to rise until 2007 and fell in 2008 reflecting the financial crisis. In 2008 IFSC investment was over 13 times the size of foreign direct investment and approximately 11 times the size of GNP.’

However, this ballooning of investment is just the movement of capital in and out of the country. As Keith Walsh, an economist with the Office of the Revenue Commissioners, wrote in a report titled The Economic and Fiscal Contribution of US Investment in Ireland and published at the end of 2010, ‘much of the inward IFSC investment involves the movement of capital by multinational companies to subsidiaries in the IFSC that is re-invested overseas.’ In September 2010 the Irish Times published a report on internal briefing material drawn up by Revenue officials which showed that: ‘there has been a significant rise in firms transferring the residence of their main holding companies to Ireland or are considering doing so. The very limited amount of tax paid by some of these firms indicates they do not have any meaningful presence here in terms of investment or jobs.’

One of the essential components of this movement is not the 12.5% rate, but our loose regulatory tax regime and Ireland’s membership of the Eurozone. Richard Murphy of Tax Research UK, in a report prepared for ICTUNI on the proposed cut in Northern Ireland’s corporation tax rate to 12.5%, shows data from a UNCTAD report which looks at the FDI flows of selected countries in 2009-2010. He noted that in ‘five quarters in 2009/10 Ireland had inward investment of $31.1bn. Outward investment in that period was $31.0bn. In other words, Ireland is not the location in which foreign direct investment is taking place.’ The attraction of using Ireland as an entry point for US corporations’ investments in Europe is that it reduces the foreign exchange risk considerably compared to locating those investments and sales in a sterling zone, Murphy added.

The IFSC: The cornerstone of the shadow banking system

The reality is that the IFSC is at the core of the international ‘shadow banking system’. As Jim Stewart has shown, many of the banks that fell victim to the problems of subprime lending had subsidiary banks in the IFSC. ‘Ireland hosts over half of the world’s top 50 banks and half of the top 20 insurance companies; in 2008 it hosted about 8,000 funds handling €1.6 trillion of assets; the Irish Stock Exchange hosts about a quarter of international bonds.’ In addition ‘The IFSC along with Luxembourg are the two main centres for administering hedge and other funds in Europe.’ The attraction of the IFSC for managing hedge funds is that the regulatory requirement of these funds having a stock market quotation can be met. Up to August 2011 the Irish Stock Exchange claimed it had ‘standards of regulation to stockbrokers and listed companies which are acknowledged to be among the highest in Europe.’ Yet in spite of these standards many of the funds that were at the centre of the collapse of liquidity in 2008 were listed on the exchange. Significant losses occurred at subsidiaries of two German landesbanks (Sachsen Bank and WestLB) as well as IKB, located in the IFSC. However, as Jim Stewart points out ‘the largest and potentially most serious losses occurred at Depfa Bank, an Irish-registered bank located in the IFSC which became a subsidiary of Hypo Real Estate in 2007. Losses at these banks required large amounts of state aid from the German government.’ Hypo Real Estate is now the largest German bad bank and the recipient of the biggest bailout in German banking history. Depfa Bank is not expected to be re-privatised until 2015.

It is the lack of regulation used as a selling point to attract investment that is the cause of these difficulties. But Ireland’s reluctance to provide legislation to gather tax is at the core of the tax regime here, and while the IFSC is not officially a ‘tax haven’ it still has many of the characteristics of one. This is particularly clear when you see how it allows companies to use the Irish regime in tandem with recognised tax havens. One example is Ireland’s treatment of holding companies.

Here’s how it works: foreign multinationals set up holding companies in Ireland with subsidiary companies located in a tax havens like the Cayman Islands. The intellectual property of these companies (pharmaceutical companies’ patents or the registered trademarks of major brands like Google, for example) are registered in the tax havens with royalty income then being paid by the holding companies to those subsidiary companies.

The tax revenue authorities in many countries are aware of this practice and argue that at least some of the income earned from these transactions with tax havens belongs to the country where the parent (or holding) company resides. In the UK and many other countries they have ‘controlled foreign company’ (CFC) legislation that lets them deem a tax haven subsidiary of a parent company to be resident for tax purposes in the country.

Ireland doesn't have any CFC legislation, a fact that is widely advertised by the Irish branches of international accountancy firms that offer tax advice to foreign multinationals. As Richard Murphy says: ‘The decision by Ireland not to have CFC legislation cannot be chance: it must be deliberately designed to attract FDI. And it does. There can be no doubt that this form of tax relief adds immensely to the attraction of Ireland to tax minimising IT and pharmaceutical companies in particular.’

This is revenue that Irish Revenue is simply not interested in collecting. Allowing companies to avoid tax in this way would suggest that the Irish legislature is simply a branch of one of the major four accountancy firms that offer tax advice to clients who wish to set up business in Ireland.

There has been plenty of debate about effective tax rates, with perhaps the most notorious being Google, which, according to Bloomberg, was able to reduce their overseas tax rate to 2.4% through various mechanisms available in Ireland, in tandem with tax havens like Bermuda. There are plenty of other examples, however, such as Boston Scientific which had an effective tax rate of 0.54% for 2001 – 2003; Forest Laboratories had an effective tax rate of 6.2% for 2005-07; Jansen Pharmaceutical had an ETR of 8.2 for 2003-05; between 2004-5 Symantic had an effective tax rate of zero.

12.5% corporation tax rate supports employment growth?

The unemployment rate now stands at 14.3% of the labour force. The massive increase since 2007-8 is due to the collapse of the construction and retail sectors. However, FDI, even job-bearing investment, has never supported substantial employment growth in Ireland. There was virtually no change in foreign-based industrial employment between 1983 and 2006 and in 2007 the total for direct employment by foreign direct investment in Ireland was 152,267, or 7.25% of the workforce.

The IFSC is also not a source of employment growth. 39 of the 46 treasury management firms out of the over 400 located at the IFSC that Jim Stewart surveyed in 2008 reported no fixed assets and had a median employment of zero. yet they were highly profitable and had median financial assets of €643 million.

One of the strongest features of the collapse in employment since 2007-8 has been the fact that most of the job losses have occurred in working class occupations. Employment for those with third level education has remained relatively stable and most who have become unemployed have been able to return to the workforce within six months. In contrast, the fall in employment of those in working class occupations has led to a significant rise in long-term unemployment. The employment that FDIs provide, with the exception of some manufacturing, are mostly middle class, professional occupations – those high value employments that the government believes Ireland needs more of, even though historically the level of employment has remained static. It is telling that when calculating the taxable income from MNCs, the Revenue Commissioners include tax on income from wages earned by those employed by FDI companies.

The failure of the 12.5% rate

This use of one of the most significant weapons in a government arsenal in order to maintain the employment and income levels of a fraction of the workforce without any corresponding plan to bring on industrial development and employment elsewhere in the economy is an indication not only of its specific class-interest focus, but its ultimate failure as an industrial policy. The attraction is solely to companies who are more mobile, who come and go with relative ease, leaving very little residual skills in their wake. In the case of businesses operating out of the IFSC they are even exempt form Dublin council rates. So the sewage and water services provided to their offices comes free of charge.

The policy has also lead to a decline in real investment, and it has failed to prevent those who domestically benefited from an income boost ploughing their increased profits into useless property speculation. It has failed to increase employment and failed to improve the tax returns available to a government which could use them to develop indigenous industry and the means of creating a sustainable and successful economy.

Increasing the rate and closing off avenues by which companies can avoid tax, in line with other jurisdictions such that stalwart of neoliberalism, the UK, would allow for increased investment, in schools, infrastructure, transport and health, all of which would boost additional inward investment and create jobs. It certainly would be a more successful way of solving Ireland’s economic difficulties than imposing austerity. But then again, Ireland’s comprador/corporate advocacy/ tax consultant/banking/political class won’t allow that. {jathumbnailoff}

Originally published in Look Left.

Image top: Grunge Textures.