What happens when our corporate tax regime is kicked into touch?

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By Cormac Lucey

What does a sports team do if its star player gets injured and is unable to play or, even worse, is forced into retirement? The simple answer is that the coach needs to anticipate such eventualities and develop a pipeline that could replace the star.

The Ireland rugby coach Joe Schmidt (pictured above) has managed two great achievements in the last year: he presided over Ireland winning the Grand Slam for only the third time in our history; and he blooded a host of new players, some of whom — notably Dan Leavy and James Ryan — made critical contributions to winning the tournament.

However, Team Ireland’s star player is the 12.5% corporate tax rate strategy that has transformed the country’s economy. It has been the key ingredient that has brought so much foreign direct investment (FDI) and high-productivity, high-paying jobs to Ireland.

Two generations ago, living standards here were more than 20% below the western European average; today they are more than 20% above it. Half a century ago, people in Northern Ireland enjoyed higher living standards than those in the Republic; more recently those roles have been reversed.

The problem is that Ireland’s star player is being targeted by our rivals — and I’m not referring to Johnny Sexton receiving pre-match trash talk from England coach Eddie Jones. It is our corporation tax strategy that is under threat. As far back as the 2013 Lough Erne summit, the G8 declared: “Countries should change rules that let companies shift their profits across borders to avoid taxes.”

In 2017, the EU economic commissioner Pierre Moscovici asserted: “We are in a new world where people want transparency and want the multinationals to pay their fair share of tax where they profit. We are really, I think, not trying to act against national tax sovereignty, but to create a European sovereignty.”

Last September, Seamus Coffey, the head of the Irish Fiscal Advisory Council, said corporation tax harmonisation plans across the eurozone posed a bigger threat to Ireland than the departure of the UK from the European Union.

So if Ireland’s economic strategy gets kicked into touch by our rivals, what is our substitute? The answer is Ireland’s small and medium-sized enterprise (SME) sector. Alas, its performance is weak — Ireland’s economic performance would take a big hit if we could no longer rely on FDI-induced growth in the future and had to rely totally on our indigenous SME sector.

In June last year, the Irish Tax Institute produced an important report: A Future Tax Strategy to Grow Irish Indigenous Exports. Some of its findings were sobering, such as the fact 20% of Irish manufacturing companies export just one product, and close to half of them export fewer than five.

The indigenous sector is also focused on a narrow range of export markets. About a quarter (27%) of Irish firms export to just a solitary market, in most cases the UK. This position would be threatened by a hard Brexit.

Nine of the top 10 products exported by Irish-owned firms are food products. The agribusiness sector is most vulnerable in the event of a hard Brexit and the imposition of World Trade Organisation tariffs.

Furthermore, while the IT sector represents almost 14% of total services exports, Irish IT firms are mainly domestically focused, exporting less than 2% of their sales and accounting for just 0.5% of total exports.

The Irish Tax Institute concluded that Ireland’s tax policies did not match the needs of the indigenous sector and would not drive the shift in behaviour required.

While our 12.5% corporation tax rate is valued by many Irish businesses, we have a pattern of sustained high rates across a range of other taxes that are critical for growth, coupled with tax reliefs that are either unavailable or inaccessible to Irish SMEs.

The poor export performance of the indigenous sector is matched by poor productivity. According to recent data from the Organisation for Economic Co-operation and Development, locally owned manufacturing improved its productivity by 25% between 2006 and 2016, but the FDI sector increased it by 66% over the same period and, in 2016, was six times as productive as its native rivals.

Locally owned services saw their productivity fall by 4% between 2006 and 2016, while the foreign-owned sector boosted its productivity by 17% over the same period and, at its end, was 3.5 times as productive as its domestic rivals.

A final problem facing the indigenous SME sector is access to finance. The Central Bank of Ireland’s most recent SME market report reveals that new lending to non-financial, non-real estate SMEs in the third quarter of 2017 was 24% higher than a year before.

The stock of credit outstanding to SMEs dropped 10% from the third quarter of 2016 to the third quarter of 2017. In other words, new lending is growing but is still lower than repayments of old loans, and thus the volume of SME loans outstanding continues to contract.

According to the Central Bank, credit demand is low, with the share of SMEs applying for bank loans at 21% in September 2017, according to an European Central Bank survey. Funding working capital is the primary purpose of financing. More SMEs in Ireland are reducing their debt-to-assets ratio than increasing it.

A possible reason is that interest rates for business loans of less than €250,000 stood at 5% in July 2017 — higher than in comparable countries where the average was below 3%. The SME lending market is highly concentrated, with fewer banks holding an ever larger market share. This holds both in terms of outstanding credit and new lending flows.

If the external assault on our corporation tax regime were to succeed and weaken Ireland’s FDI appeal, the indigenous SME sector would be most unlikely to take up the resulting slack. In my opinion, there is no greater economic challenge facing Ireland today than to change that state of affairs.