Corporation Tax Cuts Don’t Lead To Prosperity

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Today in Berlin our “Taoiseach-elect” Enda dealt in a most business-like fashion with the German Chancellor Angela Merkel, described as the most powerful politician in Europe at the moment. A bullish Enda said after the meeting was over:

“I made it perfectly clear to the chancellor that, from our point of view, the corporation tax and the consolidated tax base are of absolute fundamental importance to Ireland and that we could not concede any movement on those”.

Wrong. It’s not of fundamental importance to Ireland, but it is to IBEC who do not require the sort high infrastructural investment, such as high educational attainment, efficient broadband, an excellent health service, or high quality port facilities paid for through higher taxes to do business.

The Irish Times today champions Enda’s mission to Berlin in an emphatic editorial:

“What began in the mid-1950s as a tax exemption on export sales profits, which was designed to encourage foreign direct investment in Ireland, has become a cornerstone of economic progress. For decades this low-tax regime has given Ireland a competitive edge in the battle to lure mobile multinational companies.

Wrong. A readily available young well-educated workforce was much more of a boon.

An article last week in the Irish Times by Colm Keena titled “Corporation tax: unravelling the myths“, manages to create some new ones.

“The Irish effective tax rate, at 11.9 per cent, is very close to its actual rate. This reflects Ireland’s desire to make its corporate tax regime as simple as possible, again so as to attract foreign direct investment.”

Wrong. Because of Ireland loose tax laws we have an effective tax rate of around 3% or less.

Below I’m posting Michael Burke’s very important post from Socialist Economic Bulletin, which shows that the lowering of corporate tax rates did not lead to higher inflows of FDI, and is not responsible for it. In the post Michael looks at what happened to FDI when the 12.5% rate was introduced in full in 2003, and in comments shows that before that “in the 4 years 1978-1981 average annual FDI inflows were US$300mn (World Bank database), while in the 4 years subsequent to the 1981 10% tax rate FDI averaged US$235mn.”

As Priya Rajasekar said in an opinion piece also in today’s Irish Times, when highlighting the fact that political parties are ignoring immigrants who are now eligible to vote in this election:

“Ireland places a huge premium on its corporate tax, blind in the belief that it is solely the lower rate of tax that attracts the world’s best companies. This, despite the fact that a few have openly admitted that the presence of skilled workers from across the globe is an all-important component. The covert racism that stunts the career growth of thousands of skilled immigrant workers has to end. Moreover, the redressal begins with the recognition that this malaise exists.”

Michael’s post shows that Fine Gael and the rest of the political establishment are wrong to say that the 12.5% corporation tax is of absolute fundamental importance to Ireland and that our “low-tax regime has given Ireland a competitive edge”. Increasing it would provide much needed additional tax revenue to pay for the education and R&D infrastructure that actually does attract FDI.

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In George Osborne’s Budget in June 2010 it was announced that the rate of corporation tax will be cut in a series of steps from 28% to 24%. This was part of a series of measures which, it is claimed, would boost growth. In fact they comprised part of a series of tax cuts for companies and the highly paid which amount to a giveaway of £12.4bn in 2014/15, almost exactly equal to the yield from the VAT hike of £13.45bn – which in contrast will come overwhelmingly from the pockets of the poor.

But, just as the package of tax measures are not about deficit-reduction at all, but a transfer of incomes from the poor to the rich, so the claim that lowering tax rates will lead to growth is also incorrect. The claim is that lower taxes increase the flow of Foreign Direct Investment (FDI). But the recent FDI Barometer produced by Think London, the agency that promotes FDI in London, shows that overseas investors are less likely to invest in London, not more likely because of recent developments in UK economic policy. In a survey of over 300 executives responsible for making FDI allocations, 60% said the lower tax rate would not change the attractiveness of London as an investment destination, 13% said it would make them more likely to investment, but 22% said it would make them less likely to invest. Therefore a net balance of 9% said lower corporate taxes would make London less attractive to investors!

In fact those surveyed were much more agitated about racist immigration policies – with 48% opposed to the Tory-led Coalition’s cap on non-EU immigration.

This is because FDI is not driven by corporate tax rates. At one end of the scale the highest corporate tax rates in the OECD are imposed by the US and Japan at 39%. Germany has a 30% rate. The lowest rates are in Iceland (15%) and Ireland (12.5%), which should be more a warning than a model!

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.

But George Osborne is a long-time fan of his fellow Thatcherites in Ireland. In fact the current Dublin government has far more fans in Downing Street than in Ireland, with its opinion poll rating dropping to 14% even before the latest resignations of nearly half the Cabinet. Determined to emulate the effects of Ireland’s Thatcherite economic policymaking, the Tory-led government has set out a course to lower corporate taxes. This will not attract FDI, but it does have the effect of allowing established companies to retain a greater proportion of their profits- and lowering wages and increasing capital’s ability to generate profits remains the essence of government policy. Reality shows there will be no increase in FDI to Britain due to lower corporate taxes.

Reproduced with permission. The photo, though, from the Irish Times today showing Enda in Berlin was not.

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Donagh is the editor of Irish Left Review. Contact Donagh through email: dublinopinionAtgmail.com
 

6 Responses

  1. William Wall

    February 15, 2011 7:21 am

    If we reduced our corporate tax rate to zero would we create an infinite number of jobs? Over and over again we hear CEOs of incoming companies saying that the ‘quality of the workforce’ is crucial in their decision. Present policies are driving the workforce abroad.

  2. Small Girl

    February 15, 2011 10:29 am

    At the moment I’d say the minimum wage is more significant for companies looking at investing in Ireland.

    Company CEOs know we have a low corporation tax rate and an educated workforce eager to work so without the support of a really good infrastructure these are Ireland’s hygiene factors to use a business term, they’re the must haves. Our government is protecting these.

    But given that the yardstick has been moving away from the ‘going-rate’ that a person gets paid in a particular industry (not the high techs), Government hasn’t protected that other standard that CEOs look at, minimum wage, the basic measure of the cost of labour in an economy. They’ve driven it downwards. Obviously IBEC and the Chambers of Commerce are pleased with this. I’m sure that along with the other hygiene factors, €6.75p.h. makes Ireland look a little more attractive for investment than it did.

    Nice bit of debunking Donagh.

  3. Donagh

    February 15, 2011 3:19 pm

    Absolutely William.

    Small Girl, I’m not sure exactly sure what you mean, but you might find Aidan Regan‘s post on IBEC and their and other business group’s campaign to cut wages, including their lobbying for a cut in the minimum wage, useful.

    Given the liberal market orientation of Irish capitalism employers are incentivised to bring down labour costs rather than invest in new technologies, long term growth, production or highly skilled labour. This is why IBEC, ISME, SFA, Chambers Ireland and a variety of sectional interests want to cut the minimum wage, the REAs and the EROs. They are focused on short term measures in the domestic economy and don’t know any other strategy. Similar to neo-classical economists they know very little about the real operation of markets as institutions. They assume that by cutting the minimum wage, registered employment agreements (REAs) and employment registered order (EROs) that Irish business will somehow start investing their surplus profit in more labour and create more jobs.

  4. William Wall

    February 15, 2011 3:39 pm

    …”to bring down labour costs rather than invest in new technologies, long term growth, production or highly skilled labour”. That’s such a damning indictment of our indigenous capitalists. It’s bad enough that the country is run for the capitalist class, but it’s worse that they’re shit capitalists as well!

  5. Small Girl

    February 15, 2011 5:35 pm

    Hi Donagh, I’m about as clear as a politician!

    I suppose what I mean is that Ireland is very purposely promoted as being investment-attractive for our low corp tax rate and our skilled/educated workforce and our proximity to financial markets. Our political movers and social analysts have always talked about these factors from different perspectives. You’ve demonstrated that the corp rate doesn’t actually attract foreign investment, rather it’s the skills base in the workforce. But the majority of our politicians don’t want to take a chance on changing the corporation tax rate. And what did they did take a chance on changing? The pay rate. It’s not unreasonable that lowering the cost of labour generally (and eventually skilled labour) would make Ireland ‘look’ a little more attractive to investors. It adds another hygiene factor to the FDI mix. Yes it’s a concession by the political class to the capitalist class and yes it’s based on short-term vision and no it doesn’t take account of all the citizens who actually do most of the wealth generating.

  6. Molly W.

    February 21, 2011 4:35 pm

    Not a single political party, even Sein Fein, has the courage to stand up against the foreign captains of industry. It is regretable that virtually all these foreign companies operating in Ireland are not even paying the statutory 12.5% tax rate. In 2009, Google paid just 3% of its pre-tax earning in Ireland….definitely not the 12.5% tax rate! Small domestic companies have little or no resources to hire expensive tax accountants and legal counsels to exploit legal tax avoidance opportunities. What is needed in the first step is the immediate cancellation of “double Irish”, “Dutch sandwich” and other transfer pricing tax-avoidance schemes for all companies operating in Ireland. Higher tax rate is not necessarily a deterrent to economic development. Compare Finland with about the same educated population mix as Ireland; it has a statutory corporation tax rate of 29% for many years. By correcting this unfair, but legal, tax avoidance pathway in our country, the enormous economic burden to be shouldered by the people for the next few decades will be shared rightfully by the pampered foreign companies operating in Ireland.