Thursday 21 February 2019

Budget exit tax move has reduced risk of damaging 'reverse leprechaun' effect

Finance Minister Paschal Donohoe introduced a measure in Tuesday's Budget that reduced the overall risk to corporation tax receipts. The unexpected introduction of an 'exit' tax of 12.5pc on corporate assets that are moved out of the country could be significant.. Photo: Niall Carson/PA
Finance Minister Paschal Donohoe introduced a measure in Tuesday's Budget that reduced the overall risk to corporation tax receipts. The unexpected introduction of an 'exit' tax of 12.5pc on corporate assets that are moved out of the country could be significant.. Photo: Niall Carson/PA

Comment: Dan O'Brien

There is surely no country anywhere in the world in which tax on company profits is discussed more than it is in Ireland. The rate of corporation tax; its legions of international critics, from French presidents to leftist activists; the amounts of it that is paid into the state's coffers each year; and the reasons those revenues might dry up are just some of the issues that are constantly discussed.

With Budget 2019 unveiled last Tuesday, profit tax has been in the news over the past seven days and more. Before Budget week even started there was corporation tax bombshell. Late on the Friday preceding last Tuesday's publication of the fiscal plan for 2019, the Department of Finance announced it expected a €1bn windfall to land in its lap over the coming weeks. How timely. It filled a large hole in the Government's finances.

Overruns in public spending have become large and engrained in recent years. Expenditure ceilings have become largely meaningless. The Government will not face down parts of the system that refuse to stick to budget constraints. Those in the system, and particularly in the health system, know that the Government will cave in rather than allow yet another 'crisis' to emerge.

It doesn't even matter if the additional money is not well spent, or even wasted. What matters for the Government is to be seen to be doing something. In Ireland, that always involves throwing more taxpayers' money at problems.

Most taxpayers don't appear too unhappy with this state of affairs - politicians rarely get harangued on doorsteps about efficiency - so it will continue to happen.

The pressure for more spending can be seen not only in spending overruns. It can also be seen in the annual - always upward - revisions to the amounts the government plans to spend in the future.

In the budget of three years ago the widest measure of state expenditure, and the one that is calculated on an EU-standardised basis to avoid any political funny business, was targeted to rise to €76bn in 2018. After repeated upward revisions and spending overruns, the Government currently estimates that this year's spend will turn out to be €5.25bn higher. The end result will almost certainly be higher again.

The accompanying graphic covers the projections for General Government expenditure over four budgets. As is clear, each year the amounts pencilled in keep rising. By 2021, total expenditure by all branches of the State is projected to reach €91bn, according to last week's Budget projections. That is almost €13bn more than was projected three years ago.

If that is not enough to show that the if-I-have-it-I'll-spend-it instinct is alive and well among the political class, the scale of the underlying is actually much bigger.

Unexpected and very large falls in debt servicing costs mean that non-interest expenditure rose by even larger amounts.

Three years ago the forecasters in the Department of Finance thought that servicing the national debt would cost almost €7bn this year. It is now on target to come in at closer to €5bn.

This unexpected windfall has been matched by another on the revenue side. Ever-topical corporation tax has not just delivered the recent surprise €1bn, but annual revenues from this source have more than doubled in just a few years. Compared to most other countries, they account for an unusually large share of all government revenues.

As is well known, these huge sums are accounted for mostly by a small number of foreign multinationals. Much of the discussion around risks to these revenues focuses on something happening to one or a few of the big companies.

One of the tech giants could, for instance, leave Ireland, be disrupted out of existence or be broken up by politicians out of fear that it has too much power. These are important points. A multibillion euro-sized hole could appear in the public accounts for any of these reasons.

But much less discussed is the universally volatile nature of profit tax revenues. Companies make most money when economic times are good. In slumps, their profits tend to slump too. Often, they make losses. All of this means that tax revenues from profits are much more volatile than the other big revenues streams, personal tax and VAT.

If the Government has been unwise in not treating a good chunk of these revenues as windfall gains, it did take on measure in Tuesday's Budget that reduced the overall risk to corporation tax receipts. Although it got limited attention, the unexpected introduction of an 'exit' tax of 12.5pc on corporate assets that are moved out of the country could be significant.

A measure of this kind was due to come into place in keeping with the EU anti-tax avoidance directive. But it was not expected in Budget 2019. Nor had there been an indication that it would come into legal effect on Budget night. So why did it happen? My guess is to prevent a 'reverse leprechaun'.

That needs a little explaining. Back in 2015 Ireland's GDP jumped by 26pc. This made headlines around the world and was dubbed 'leprechaun economics'. It happened because multinationals moved massively valuable intellectual property assets to Ireland.

The addition of billions of euro to the capital stock boosted GDP. Exports of pharmachem products also rose by €13bn in that year, an increase that was probably explained in good part by the shift in intellectual property assets.

There was always the possibility that clever accountants in these firms would move the assets again if they found a more efficient way to minimise their worldwide tax liabilities.

If that were to happen, Irish GDP could record a big fall. That, in turn, would make the government's debt position look much more precarious (the measure markets look at most closely is debt as a percentage of GDP).

This weekend, the risk of a 'reverse leprechaun' has been reduced.

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