Wednesday 20 February 2019

Sarkozy's grandstanding on our corporation tax misses the point

Whatever funds we got from the EU are rapidly being funnelled back to private European banks, writes Colm McCarthy

President Sarkozy's attack on our corporation tax rate last Thursday was grounded in his perception that Ireland is the fortunate beneficiary of fresh financial aid from Europe's taxpayers.

This, he feels, should be reciprocated through Ireland altering a long-established domestic taxation policy, a prerogative unambiguously reserved to the member states under the European treaties and the subject of an explicit commitment at the time of the second (successful) Lisbon referendum. He went on to assert his respect for the independence of his 'Irish friends', a group likely to have dwindled over the last few days.

From an Irish perspective, what looks to him like financial assistance from Europe could as readily be characterised as a bailout of European investors foolish enough to lend to Anglo Irish Bank and other insolvent banks, courtesy of the Irish taxpayers. The markets having declined to finance this commitment on top of the Irish sovereign debt, our European friends have kindly provided 'assistance' in the form of loans at a mark-up of three per cent on the cost of funds. That Irish and French perspectives can diverge so sharply is testament to the extent of the muddle and indecision in dealing with the European banking crisis.

The EU Commission has brought forward some fresh proposals involving an enlarged European capacity to bail out member states excluded from the sovereign debt markets. Just two, Greece and Ireland, have succumbed thus far but the addition of Portugal, and even more decisively Spain, would exhaust the available resources at European level.

The commission's proposals, however, are for an intensification of existing policy and many commentators have already questioned the efficacy of kicking even bigger cans down the road. The commission, and several member states, have also been offering proposals for a new policy regime to deal with future banking and sovereign-debt crises after the present arrangements run out in 2013.

Meantime the current crisis rumbles on into its third year and has yet to be addressed convincingly. The focus on better arrangements for dealing with future crises will serve only to unsettle the markets unless accompanied by decisive action to deal with the crisis that has been festering since mid-2008.

The crisis in Europe can be characterised as an interacting loss of credit-worthiness by both banks and sovereign borrowers against the background of the diminishing risk tolerance of bond investors these last few years. Some of the sovereign borrowers have accumulated un-financeable debt burdens through failures of budgetary discipline, without any great contribution from banking sector losses absorbed by the state.

Others, including Ireland, could arguably finance their sovereign debts but have been unable to shoulder as well the guarantees extended to those who lent to insolvent banks. A feature of the European response to date has been a failure to distinguish these cases and to prescribe a one-size-fits-all bailout formula. In the Irish case, it appears that the IMF team who visited in November were lukewarm in their support for the European approach, notwithstanding ritual expressions of solidarity.

The essence of the problem is the distinction between liquidity and solvency, two concepts which are often difficult to disentangle at the level of either banks or sovereign states. The inability to borrow may be temporary and suited to a temporary bailout, with clear sight of an exit strategy and return to the markets. Or it may be that liquidity has dried up for the very good reason that the borrower is unlikely to be able to exit in the foreseeable future, and is insolvent. In the latter case, the only satisfactory resolution is a composition with creditors.

A principal source of Ireland's current dilemma is the Government's belief, in September 2008, that the problems in the Irish banks were essentially about liquidity and that a wide-ranging state guarantee would be enough to afford them the chance to re-attain access to credit in the markets.

The European authorities are making the same mistake in the case of the sovereign bailouts of Greece and Ireland, neither of which, in the assessment of the markets, have sight of an exit strategy. When people accuse the EU Commission and the European Central Bank of kicking the can down the road, this is what they mean. With a distressed borrower, any solution which does not offer a realistic prospect of a return to normal functioning is a temporary fix, and will have to be re-visited. This principle is a feature of corporate re-structuring codes around the world, is built into best-practice bank resolution regimes and is the default operating procedure for the IMF when left to their own devices.

Current French and German official attitudes to Ireland seem to be coloured by the perception that this country has been the recipient of substantial EU transfers over the years, which is true; has managed its affairs poorly in recent years, which is also true; and is now receiving yet more handouts, which is not true at all. Ireland is no longer a net recipient of EU transfers, nor should it be. Over the entire period from 1973 to 2009, Ireland's net receipts from the EU budget totalled about €41bn, of which no more than about €20bn could be classified as in any sense discretionary. It is entirely possible, under the no-bondholder-left-behind policy, that this sum and more is being routed from Irish taxpayers to European private creditors of Irish private banks. Indeed, a substantial portion has already been paid over, to be replaced with sovereign debt. Further payments to these creditors will be funded with bailout money at double the cost of funds to our self-satisfied benefactors.

The beneficiaries of the Irish Government's imprudent guarantee of Irish bank liabilities are not the banks or the developers. They are the creditors of Ireland's insolvent banks, including bond and wholesale money market investors who, in the main, are not Irish. Many of them are French and German. The banking system which borrowed so lavishly was poorly managed and poorly supervised, unambiguously our fault, but the same is true of the banking systems which were permitted to acquire dud assets on such an enormous scale, in the United States as well as in the European periphery. There are two sides to every transaction, and the large creditor countries, with the interesting exception of the UK, appear to many in Ireland to have insisted on some economic variant of victors' justice.

Unsustainably high interest rates in the Greek and Irish bailouts were justified, in a quote from an unnamed EU official during the week, in terms of avoiding 'moral hazard'. This is economics jargon for making sure that those who make mistakes pay for it, so bailouts must be at punitive terms the better to discourage the next would-be miscreant. But imprudent lenders to Europe's banks are to be made whole, regardless of the considerable moral hazard thus created. This is hopelessly confused as well as impractical, since the debtor/taxpayers in some countries may end up in sovereign default. Is it wise, as a matter of European policy, to risk imposing sovereign default on member states through insistence on meeting debts which did not enjoy sovereign status when contracted?

None of this is to argue that the Irish politicians and officials who negotiated the bailout held a strong hand of cards. Threats of economic suicide are not credible. But any financial rescue package which fails to afford a plausible exit strategy to the distressed borrower is a temporary arrangement and this game is not over. A difficulty for Ireland is that private debt (the bank bonds) is being steadily paid off and substituted with official IMF and EU debt. From an Irish standpoint, the sooner matters come to a head the better. The trigger could be the need for bailouts in other peripheral countries or the results of the next round of European bank stress tests, which apparently are to be more realistic than those conducted in July last. The key variable becomes the rate of interest on official debt as the pile of outstanding bank bonds gets paid off.

Political attitudes in France and Germany are now so negative towards Ireland that one of the assumptions of EU membership, national autonomy in tax policy, is under attack. Tax competition between member states is, unless and until a new treaty is agreed, a core value of the EU, not a target of opportunity for French and German politicians. There is no area of international economic diplomacy more vulnerable to grand-standing and hypocrisy than corporate tax policy.

Colm McCarthy lectures in Economics at University College Dublin. He has headed an expert group examining state assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, aka An Bord Snip Nua

Sunday Independent

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