When Rehn Was Right: Increasing the Corporation Tax Rate Increases Revenue
It’s strange how certain things stick in your mind. I remember very well reading the newspapers while on a weekend away in early October last year. It was during that bizarre time in the lead-up to the IMF/EU/ECB fiscal kidnapping and just after Olli Rehn had announced that Ireland was a low tax economy, and that we’d have to increase our corporation tax if we want to cut the deficit. Rehn was making a perfectly good point but to read the papers you would think that he had called for the outright destruction of the Irish economy. It showed the degree to which a line of argument can be shut down in this country, even when that argument is coming from a source that in all other respects is deferred to completely.
What Rehn was saying is that if you increase corporation tax you will increase government revenue, which will help deal with the collapse in transaction taxes that had been relied upon completely prior to our economic crisis. The response that such a move would virtually destroy Foreign Direct Investment came from business groups and those now in government:
“The American Chamber of Commerce in Ireland has reacted strongly. “At a time when the economy is in deep recession, nothing which would impact on the continued investment in Ireland by our existing base of multinationals, or would deter new investment in Ireland can be countenanced. The Taoiseach needs to send a very clear message to the multinational community that there will be no increase in corporation tax rates,”
Enda Kenny at the time agreed on the need for this message to be clear:
“The Taoiseach’s ambiguity and evasiveness about the future of the low rate of corporation tax is unhelpful, to say the least.” Mr Kenny said Fine Gael wanted the rate to remain, contending any increase would be a disaster for investment.
In office, Kenny is not for turning: in fact, it’s a change he wouldn’t even contemplate.
The pressure from the EU for a change has not relented however, and with Ireland’s increasingly difficult banking crisis is now almost permanently on agenda at EU meetings. The comment that the corporation rate is considered ‘sacrosanct‘ is appropriate, because there has been very little evidence-based discussion about what an increase would mean.
It is worth reading, therefore, Michael Burke’s post on the 12.5% rate on Progressive Economy. I’ve highlighted Michael’s evidence on this before, but this post is very comprehensive and deals specially with the objections to a move within the context of the Irish economy. Michael looks at the ‘relocation argument’, which says that a rise would drive investment elsewhere. He examines the fiscal impact of an increase and finally at what actually drives FDI to invest in a country in the first place.
On relocation there is an essential point that is never made but should be patently obvious:
“Most of IBEC’s members cannot relocate anywhere- they service demand in this economy. Likewise for foreign MNCs here to service domestic demand; Tesco’s is the biggest foreign employer in Ireland and its profit rate is higher in Ireland than anywhere else. Tesco’s is going nowhere. By contrast, the US Chambers of Commerce speaks increasingly for companies who have no activity and no employees in Ireland- apart from tax specialists - and who pay an effective rate as low as 1% or less.”
On the fiscal impact, even if it MNC’s were to flee as a result of an increase Michael points to a fact that is always completely ignored, we will still gain more tax on those MNCs that remain:
“If the tax rate was hiked to 17.5%, on the OECD’s central estimate FDI would fall by 18.5%. On an extreme assumption that 18.5% of existing MNCs will flee as result (which no-one seriously suggests) then the remaining 81.5% of MNCs would then be paying 40% more in tax (the ratio between 17.5% and 12.5%), with a higher tax take of €1.37bn resulting.”
And it would increase the tax take from the indigenous sector
“….which provides the remaining 70% or nearly €2.8bn of corporate taxes. The tax take from them would also rise by 40%, to €3.92bn. The combined total in corporate tax revenues from both MNCs and domestic sources is therefore just under €5.3bn, a rise of nearly €1.4bn. Of course, all these are taxes on profits which remain abundant in this economy, and by definition cannot be ‘unaffordable’.”
On what drives FDI, Michael shows that a survey of the literature shows that of all the factors that drives FDI none mention the tax rate as a criterion for investment.
What is important is Total Factor Productivity, “because TFP determines the total return on investment, not just the tax rate on that return”.
An FDI Barometer survey taken after the UK government announced a cut in its corporation tax found that “the net response was the investors were less likely to invest following the announcement of lower taxes”.
The point about TFP and the survey which showed that lowering the corporation tax puts off investors are related, Michael argues:
“Since TFP is actually the main determinant of FDI in advanced economies, it is the factors affecting TFP which determine its flow. Productivity derives from investment and the government component of that usually includes education, transport, communications, infrastructure, etc. Lower tax rates leads to lower tax revenues and a diminished capacity to invest in those areas. Declining relative productivity follows, deterring FDI, not encouraging it.”
And this corresponds directly with Ireland experience, if we look at FDI investment following changes in our corporation tax rate:
“The chart below shows World Bank data for Irish real GDP and net FDI as a percentage of GDP.
12.5% tax rates were introduced in 2003. 2004 to 2006 saw outright falls in FDI, which also fell again in 2008. Including the surge in 2003, the annual average growth in FDI since is just 1.5% of GDP. From the time of the McCreevy 1998 Budget announcement average FDI net inflows have been substantially higher, but clearly that trend has gone into reverse.”
Again, as always I would encourage you to read the whole thing.
However, one final point. Ronan Lyons suggests that an increase in the corporation tax would cost us in FDI investment but ignores the potential revenue earned by the huge majority of MNCs that would remain (using the OECD briefing paper’s numbers). He uses the rule of thumb that “ten new jobs from investment create a further seven new jobs indirectly”. Using the briefing paper, and Michael’s point, an increase on the tax rate would lead to an increase of €1.27bn in tax returns from both MNCs and the indiginous sectors based on 2010’s corporation tax take. So, this could then, using Lyon’s rule of thumb, create 100,000 direct jobs and another 70,000 indirectly.
But the fact remains strange: the only time that the Irish government are willing to stand up to the demands of the EU is when it comes to protecting the low level of taxation enjoyed by the most dangerous trade union in the world.
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