Ireland needs to tackle the corporate tax issue or become global bad boy
The rise of the multinational corporation is among the world's most significant economic developments since the middle of the last century. Multinationals have driven the globalisation process and their foreign direct investment is now far more important than trade or any other factor in integrating national economies.
They has brought great benefits. Apart from knitting the world more closely together, multinationals operating in many markets can bring prices down by exploiting economies of scale on a global basis and they accelerate the pace of innovation thanks to the vast budgets they can devote to research and development.
But mega-companies also have many critics. And this is not surprising. Quite apart from those who are instinctively anti-business and profit-hating, there are plenty of valid criticisms the unprejudiced can make of giant, globe-spanning companies. Proven examples of sharp practice, malfeasance, exploitation and plain law-breaking are not hard to come by. Big pharma, big finance and, more recently, big tech have all earned much warranted criticism.
If the anti-globalisation movement is simply wrong when it claims that globalisation results in a "race to the bottom" (health, safety and environmental laws are getting stricter on average and public spending continues to trend upwards), the one hard piece of evidence it has is corporation tax. As the chart on the left shows, the headline rate is falling in most countries, and by sizeable amounts. The reduction is in large part designed to keep indigenous companies at home and lure foreign ones as capital becomes increasingly mobile.
But as this process has gathered pace, companies have become better at using loopholes in the global taxation system. The manner in which corporates spread across multiple jurisdictions manipulate their accounts to avoid paying corporation riles even those who are pro-business. And even though there has been no fall in the overall contribution corporations make to national coffers, as the chart on the right, illustrates, the avoidance issue is now the focus of the world's most powerful policy-makers.
This weekend, finance ministers from the G20, the club of the world's biggest economies, are considering ways of clamping down on the practice at a meeting in Australia. Informing their discussion is a series of reports on multinational taxation published last week by the OECD, a Paris-based think tank.
For very good reason, these reports were much commented upon in Ireland. At base, that is because of how central FDI is to our economic model. In fact, it is simply not possible to exaggerate the importance of foreign multinationals to our standard of living. In no other economy has the net benefit of FDI been so significant.
The Irish economy went from being an economic laggard in Western Europe from independence until the 1990s. In the final decade of the last century, globalisation really took off, fuelled by flows of FDI, which rose almost sevenfold worldwide.
Ireland was in the right place at the right time with the right set of FDI-attractive policies. It was the flood of FDI into Ireland that, far more than any other factor, caused average Irish incomes to surge past most other countries in Europe in less than a decade.
And even if one contests the centrality of the foreign sector in transforming the Irish economy, one simply cannot question the unique role it plays in national well-being.
In no other OECD economy is a larger share of services-sector jobs accounted for by foreign companies. In no other OECD economy is a larger share of manufacturing jobs accounted for by foreign companies. In no other developed economy in the world are 90pc of exports accounted for by foreign companies (that fact is so important that it is worth putting another way - Irish companies account for only one tenth of exports from this economy).
Ireland has come under an unwelcome spotlight in recent times owing to the level of multinational activity and how those companies use, misuse, or are allowed to misuse the corporate tax regime.
As readers of these pages will know well, the valid criticisms of the regime centre not on the relatively low rate, at 12.5pc, but the loopholes that exist within the system. Headlines in the international financial press saying large multinationals are paying corporate tax rates as low as 1.5pc due to domiciling in Ireland raise heckles in other countries and add to resentments in continental Europe, where even the 12.5pc rate is viewed as undermining solidarity.
Last Tuesday's OECD report, which is part of its Base Erosion and Profit Shifting (BEPS) project, looks to curb cross-border tax avoidance via methods such as deductions from top line of a single expense in several jurisdictions.
Among the most infamous examples of these practices with regards to Ireland are tax arrangements called the Double Irish and the Dutch Sandwich, both of which take advantage of rules which currently allow Irish-based companies to avoid taxation by paying royalty expenses to subsidiaries based in full-blown tax havens, such as the Cayman Islands.
As schemes such as the Double Irish are tax avoidance schemes, ending them would not mean a large loss for the Irish exchequer - we cannot lose tax revenue from profits that have avoided tax. However, it may lead to a reduction in the number of companies that chose to locate their headquarters in Ireland solely for tax purposes.
But the really hard decision is not about these companies, it is about companies which have big operations here and use tax loopholes. The question is whether they would downsize their operations, often involving thousands of employees, if they could no longer use the loopholes. If they were to do so the losses of jobs, exports and taxes could be big.
For Ireland, there is a choice of roles to play from here: either resist the international moves, and attempt to maintain the current arrangements for the longest possible period; or take the lead on pro-actively closing tax loopholes, accepting the short-term costs of doing so.
If Ireland takes the initiative on changing the corporate tax rules that are used to avoid tax, it will have the advantage of being able to make those changes on its own terms, rather than have terms imposed from outside, while also enhancing its international reputation.
The most urgently required change is the closing of the Double-Irish loophole. This method of tax avoidance has pretty much been killed by the OECD BEPS. Also, as the OECD recommendations are targeted globally rather than at any particular country, it is very unlikely that Ireland could be disadvantaged by another country starting to offer something similar to the Double Irish.
If we do not proactively address the problems that have arisen under the current regime, we risk being labelled a bad global citizen and could face some censure from the United States, as well as from the more usual suspects in continental Europe.
In his Budget speech in October of last year, Michael Noonan said ".. increasingly tax reputation is also a key factor in winning mobile foreign direct investment. Let me be crystal clear - Ireland wants to be part of the solution to this global tax challenge, not part of the problem." He will present his 2015 Budget in just over three weeks' time. The timing could not be better for the Department of Finance to show how much of a solution to the global tax challenge Ireland is willing to be.
Sunday Indo Business