FDI is not attracted by low corporate tax rates but by investment in education and infrastructure
In mid-January the Department of Finance issued a press release which stated that in “a private submission to taxation commissioner Algirdas Semeta” it argued that plans to implement “a common consolidated corporate tax base (CCCTB)” would “dim the lustre of Ireland’s generous business tax regime”.
The CCCTB plan, due to be implemented in March, is designed to reallocate the collection of taxes to countries where revenues are received, a measure that would curtail the practice in Ireland of companies maximising the profits that they record here.
The Department of Finance analysis of the impact of this move was very bullish:
“The Irish economy could contract by between 1.5 per cent and 2 per cent, employment could fall by some 1.5 per cent and foreign direct investment could fall by 5 per cent.”
This suggests that the Department believes that the attraction of FDI to Ireland is based on its low corporation tax regime. However, in a very interesting Socialist Economic Bulletin post economist Michael Burke provides considerable evidence that this is not the case.
Based on a recent FDI Barometer survey and an analysis of the movement of FDI into and out of Ireland before and after the move from 32% to 12.5% in 2003 Michael shows that in the majority of cases FDI is not interested in the corporate tax rate, and often are actually deterred by it.
What does attract them through is the availability of a skilled workforce. The reason why low corporation tax would act as deterrent is because they “know that low-tax economies do not have the resources to pay for investment in infrastructure, transport links and above all education- the factors that actually attract FDI.”
You can read the full post here, but I am adding in the section relating to the Irish economy.
——————————
Corporation Tax Cuts Don’t Lead To Prosperity
FDI, in common with all investment, is driven by prospective rates of return. Some factors, such as geographical location are outside policymakers’ hands. But the quality of road, rail, air and port infrastructure are not. Likewise, the size of the market is outside policymakers’ hands, except over the very long run, but economic growth rates are not. In particular, studies repeatedly show that it is the quality and skills of the workforce that is the main policy-driven factor in attracting FDI.
Ireland, with the lowest corporation tax rate in the OECD, demonstrates this reality. It is an article of faith for the Dublin government and its supporters that the 12.5% rate is the key to attracting FDI. Both the Taoiseach Brian Cowen and the Finance Minister Brian Lenihan have taking to describing it as “our international brand”. In the 1998 Budget (introduced in December 1997) their predecessor as Finance Minister, Charlie McCreevey, introduced the legislation for a new regime of corporation tax that led to the phased introduction of the 12.5% rate of corporation tax from 1 January 2003 - down from 32%.
Figure 1 below shows what actually happened to FDI in Ireland before and after the cut to 12.5% corporation tax. In the period since the corporation tax was slashed there have been many quarters where there was 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.
Figure 1
If FDI were measured relative to either the level of GDP or as a proportion of total investment, the before and after contrast would be even starker.
Clearly, low corporate tax rates did not leads to higher inflows of FDI, and are not responsible for it. But over a prolonged period the Irish economy has had a much greater share of world FDI inflows than would be suggested by the small size of the domestic economy.
Figure 2 below shows one of the main reasons why that is the case. It shows the percentage of the 20-24 year old population in EU countries who achieved at least an upper second level education. Ireland comes out top.
Figure 2
This also helps to explains why FDI investors don’t relish tax cuts. They aren’t fools. They know that low-tax economies do not have the resources to pay for investment in infrastructure, transport links and above all education- the factors that actually attract FDI. Low corporate taxes therefore do not attract, even deter FDI, as the London survey and the Irish experience demonstrate.
Michael will be talking at the Left Unity Conference in the Gresham on the 5th of February.
Image of George Osborne inspired by his decision to cut corporation tax from 28% to 24% thereby losing out on the same amount of revenue expected to be gained by the hike in VAT.
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Comment by: LeftAtTheCross
Jan 24th 2011 at 15:01
Is there a breakdown of “FDI” into categories which might split say between companies which invest here in order to produce goods and services for export, and those which establish minimal operations in the IFSC etc (head quarters & finance dept’s) to avail of transfer pricing (or whatever the correct term might be) to route their regional revenues and profits through Ireland in order to avail of the 12.5%. Intuitively one would expect the first category to have a longer-term view and an interest in the intellectual raw material of their workforce, whereas the latter category are here for the tax breaks alone.
Comment by: simon
Jan 24th 2011 at 17:01
Interesting piece. But you say that education is the most important factor for companies not low tax. And that Ireland is the highest in achieving second level education (i suspect the science numbers are more relevent).. But that highest achievement comes in the time of lower taxation. So would we come even more first in education with higher taxation?
Companies do not come to ireland for the education not the low taxation. As they do not need to be in ireland to get their tax breaks. What the effect of the higher corpo taxation would be the fact that the IFSC would empty. Resulting in all these companies not paying taxation in ireland.
To prove your case i would like to see a pre and post the change corpo tax revenue from the gov.
Comment by: Denis O\'Connor
Jan 24th 2011 at 19:01
A silly piece of nonsense! Bad statistics: FDI numbers from the Central Bank are largely meaningless. For example something like 20 billion Euro of FDI was reported for 2010 but where are the “facts on the ground”, where are there physical plants/factories that were built? There was almost none. The numbers reflect movement of billions in and out of pseudo Head Offices for tax reduction reasons.
Look at the IDA publicity “Why Ireland”
http://www.idaireland.com/why-ireland/tax/
The IDA people are not eegits. They know the game they’re in. They also know what they are now up against. The game (so successful for 50 years or so) is now up. The EU wants to revise the corporate taxation system so that the Multinationals can’t play off one state against another.
One question for the “Left” is: Why should Socialists defend the existing system when the main winners are the tax minimizing Multinationals? Where’s our Internationalism when it comes to competing with other European states, many much poorer, with our low tax rates? Surely if the EU could come up with a harmonized system whereby all member states could have approximately equivalent corporate tax systems, the Left would regard that as a GOOD THING? Or maybe some of the poorer E. European states would be allowed a decade of two of low taxes to help them develop?
Denis
Comment by: Conor McCabe
Jan 24th 2011 at 20:01
Denis, have you even read the article?
Comment by: Jacob Gill
Jan 24th 2011 at 21:01
Was the corporate tax ate for manufacturing not 10% since the 80s? Was it not 12.5% since 1987 for those working out of the IFSC? Presumably manufacturing made up a significant amount of FDI in the boom years?
Can anybody point to infomation on what proportion of FDI did not fall under either of the above categories prior to 2003?
Can the drop in FDI from 2003 be extricated from the eastward expansion of the EU & the provisions of Accession Treaties & full membership of our Eatern brothers? I’m just trying to get my head around all this. Even so, prior to Accesion Treaties other agreements were forged with future members, including Free Trade Agreements. I’d be interested to know exactly what access these agreements gave inward FDI to the Single Market. Perhaps profitable use can be made of these circumtances to bolster your case?
All the best
Comment by: Denis O\\\'Connor
Jan 24th 2011 at 22:01
Re: FDI stats: Take a look at this article from the Central Bank that shows how disconnected from the “real economy” the FDI numbers can be:
http://www.centralbank.ie/data/QrtBullFiles/Signed%20Article.pdf
Denis
Comment by: Donagh
Jan 25th 2011 at 09:01
Irish Examiner, Oct 2002
The point of the piece was to highlight Michael’s evidence which was presented in light of the argument made in the UK and here that lowering corporation tax is key to attracting FDI. That is the only argument made by FF/FG and Labour for keeping it at its current rate. What he has shown, and what is confirmed in the Central Bank paper is that FDI outflows increased after the corporation tax was lowered. Why?
The enlargement of the EU occured officially on 1st May 2004. To me, its a bit of a stretch to say that the outflow of FDI so soon after the 2002 budget change was down to the expansion of the EU. Take Dell as an example.
I’m a little puzzled why there is so much resistance to the idea that the basis of the arguments supporting low corporation tax is wrong. Why not be pleased that the reality, that increasing investment in education is what attracts productive investment has been demonstrated? Unless of course all FDI is evil.
Comment by: michael burke
Jan 25th 2011 at 12:01
Denis
You are right there is a big disconnect between ‘FDI’ and real capital investment in the economy. This is because FDI is internatonally defined as any investment which seeks control of capital and is contrasted with ‘portfolio investment’, where less than 10% of the existing capital of a firm is purchased. As a result, FDI is an ideological construct as it lumps together both the acquisition of exsting capital and genuine ‘greenfield’ capital formation (new plant, machinery etc.)The data on greenfield investment is far less systematic.
But the FDI data certainly aren’t meaningless. If any foreign capital is attracted to any economy it may be used in that economy. To facilitate that requires policies to transform it into ‘greenfield’ investment, strong growth, high quality infrastructure, leading R&D and above all high quality, mass education.
To simply offer low taxes and no investment provides no incentive for the investment to remain and hence a revolving-door approach to FDI- which is what has happened since 12.5% was introduced.
Comment by: Peggy Olsen
Jan 25th 2011 at 21:01
If education is the primary pull factor attracting FDI, its the education systems of other countries.
Its an open secret in the HR functions of top notch multi-national tech companies, such as Google and Amazon, that they have become increasingly dependent on the willingness of foreign talent to re-locate here, because graduates with the skills required are simply not being produced in sufficient numbers nor quality here.
The problem is that this willingness to re-locate will start draining away, as the tax burden on these folks is stedily increased, while their quality of life is compromised by retrenchment in already poor public services.
Its time to stop fooling ourselves about our supposedly world class education system. Because we’re longer fooling any else. And unless the insiders with a vested interest in maintaining the status quo are shaken out of their smug complacency, we have no hope of maintaining an advanced economy here.
Comment by: Peggy Olsen
Jan 25th 2011 at 21:01
Jesus, I could do with a smug complacent insider to check over my typing before I hit post.
I meant …
Because we’re no longer fooling anyone else.
Comment by: simon
Jan 26th 2011 at 10:01
Anything on the Tax take?