This is the second of two articles exploring in depth the question of the impact of Ireland’s tax strategies on developing countries. The first article appeared yesterday.
In the first article in this series, I described the dominant tax consensus, and how Ireland has played the game of tax competition to attract multinational investment through the Celtic Tiger years. This article describes the impact of those policies on developing countries.
Ireland competes with low tax rates, a wide network of double tax treaties, tolerance of transfer pricing and incentives to multinationals to create intellectual property in the country. Recently, developing countries, desperate for investment, have also begun to offer tax incentives in an effort to attract FDI. If they are unsuccessful, the costs of such competition are high. They include investment in inappropriate infrastructure in an attempt to draw in investment (the equivalent of Ireland’s advance factories of the 1980s), erosion of political power and accountability when non-transparent deals are made with multinationals far more powerful than the governments themselves; increases in taxes on individuals to compensate for the low corporate rates with a resulting increase in domestic tax avoidance as highly taxed individuals seek to reduce their tax burden; an increase in indirect taxes such as sales taxes and VAT which apply in a regressive manner to the most vulnerable in society, and a risk of corruption as government officials negotiate with powerful international companies. There is also a risk to indigenous industry, as the corporate tax system may become skewed towards foreign-owned firms.
Negotiating from a position of weakness in terms of perceived lack of stability or infrastructure, developing countries often agree to very low corporate tax rates. Citizens are often unaware of tax deals struck with multinationals, which is a constraint on the accountability of the government. In sub-Saharan Africa, the practice of offering tax incentives to multinational firms combined with high levels of tax avoidance has curtailed the ability of African government to take advantage of the commodity boom in 2008 which, if managed correctly could have created great wealth for many African countries.
There are also immediate costs to those who have been successful in attracting foreign direct investment. Transfer mis-pricing techniques can be used to shift income to even lower tax jurisdictions such as Ireland. Due to the lack of transparency of intra-group transfer pricing, the impact of any mis-pricing is difficult to ascertain. However, Christian Aid estimates that, between 2005 and 2007, abuse of the trade pricing system resulted in a total amount of capital flow from non-EU countries into the EU and US of €850.1 billion. If developing countries had been able to tax this capital it would have exceeded the global aid budget, and gone a long way towards the now-neglected Millennium Development Goal of halving world poverty by 2015.
The inherent instability of tax revenue based on tax competition, even in rich countries also has a knock-on effect on developing countries in terms of aid. Ireland is a good illustration of this. When the economy was booming, in 2006, Ireland was reluctant to meet its obligations of .7% of GDP to the Millennium Development Goals on the basis that this was too high, since the country’s GDP being boosted by superprofits in multinational firms. Now that the economy has begun to shrink, the Irish Aid budget has been slashed and it seems very unlikely that we will even seek to meet out obligations under the Millennium Development Goals. This costs the partners of the Irish Aid program, not just in terms of skewed tax systems and increased tax avoidance, but in terms of health, education, life expectancy and infant mortality. This costs lives.
Besides this, there is the impact on developing countries of the primacy of intellectual property in tax law, brought about in part by R&D anchoring strategies such as those used in Ireland. Tax has succeeded in assigning huge value to intellectual property and incentivising private ownership of knowledge despite the fact that the science often originated in public institutions. A good, if extreme, example is the sale of anti-retroviral medicines. Most agencies active in the field of HIV Aids, such as the Aids Foundation of South Africa, agree that the roll-out of by the South African government in 2003 is the single most significant recent step towards alleviating the pandemic. However, such anti-retrovirals were for many years unaffordable in sub-Saharan Africa. The high price at which they were sold there reflected in part an effort to recoup costs associated with the patent of the drug. The point is, the tax rules create an incentive for companies to classify as much cost as possible as research and development, inflating the supposed cost to be associated with the patent. This in turn increases the royalties to be paid when it is sold, and makes the underlying product less affordable. In the case of life-saving drugs, this is indefensible. The process may be considered almost accidental – states such as Ireland set out to anchor inward investment rather than to damage the lives of vulnerable communities affected by HIV/Aids – but it is undeniable that taxes designed to retain inward investment here inadvertently contribute to the unaffordability in other countries of goods produced or designed here.
Tax competition clearly presents a number of short term benefits to nation states and multinational firms including increased employment for financial workers, inflows of capital to domestic banks which increases lending ability and attraction of international business who bring new skills and technology. But as shown above, it also creates serious problems, not only for developing countries but also within “successful” protagonists at the game of tax competition, such as Ireland. So what is to be done?
Ireland competes with developing countries for investment, yet Irish people have been particularly generous in supporting development NGOs and charities in Africa and Asia. Ireland needs as a nation, to make the connection between this generous impulse and the damage caused by its aggressive competition for foreign investment. Developing countries can learn from the Irish experience, and avoid short-termism in their planning. They need, where possible, not to settle too quickly with multinationals, not to give away too much in terms of tax rates and other operating conditions. They need to foster spillovers where possible by encouraging foreign firms to trade with local suppliers. They need to take care when attracting inward investment not to neglect the indigenous sector, or to drive up personal taxes to the level which would encourage evasion. Critically, they need to review their tax treaties, and consider negotiating them on a multi-lateral basis with other countries in the region, on terms favourable to them.
A long-term solution can, however, only be found beyond national borders, and involves several key changes. Taxing authorities need to cooperate and exchange information, even where it does not seem to be in their immediate, short-term interest. Tax avoidance and tax paid needs to occupy a central role in Corporate Social Responsibility. We, as consumers, need to recognize as responsible those firms which pay their fair share, and denounce as irresponsible those which do not. Country by country reporting of income earned and tax paid would help in this regard. Tax has for centuries been a national question, but now business is global. Tax needs to become international, and be the concern not just of governments and companies, but of all citizens in the world.
Dr. Sheila Killian is a senior lecturer in Accounting & Finance in the Kemmy Business School, University of Limerick. She writes regularly on tax justice issues, tax and public policy and corporate social responsibility.
Latest posts by Sheila Killian (see all)
- “Easy Option”, Hard Consequences - November 21, 2011
- Collateral damage? The impact of Ireland’s Tax Strategy on Developing Countries (Part II) - July 23, 2009
- Collateral damage? The impact of Ireland’s Tax Strategy on Developing Countries (Part I) - July 22, 2009