One of the sad conclusions about today's Irish bailout is that despite numerous lies to the contrary, the country's corporate tax rate, that staple which has allowed so many corporations to skirt the record US corporate tax rate, is about to be hiked. The bailout ink on Irish pre-foreclosure mortgage note was not even dry (and you bet Bank of America is not going to lose this one) and already the European Commissioner for Economic and Monetary Affairs Olli Rehn showed the now insolvent island who's boss: "When asked in an interview with RTÉ News if the corporate tax rate was now off the table for good, Mr Rehn said that by Ireland's ceasing to be a low tax country this did not imply specific measures, but 'it is likely unfortunately to imply tax increases." Ironically, the biggest losers in this transition to a higher tax rate would be various multi national corporations, as was observed yesterday, while the biggest gainers would be other European states, which would be on a more competitive footing with Ireland when it comes to attracting foreign direct investment and new business domiciles. And since banks such as Bank of America and Citigroup would be among some of the legal tax evasion losers, it was only a matter of time before Citi provided the following reasoning for why Ireland would either not allow a corporate tax hike (we are confident this is inevitable), or why any benefits from such an action would be de minimis (this appears far more reasonable).
First, here a chart showing comparative tax rates among the OECD countries. It becomes obvious why the Irish tax rate is its primary trump card when it comes to attracting foreign business:
Next, Citi's Michael Saunders lays out his case why a corporate tax increase in Ireland would not be pursued.
Ireland’s corporation tax rate is currently 12.5%, the lowest among OECD countries. Despite (or perhaps because of) the lower corporate tax rate, corporation tax revenues in Ireland (3.4% of GDP in 2007, before the recession) are not low as a share of GDP, but similar to the OECD average (3.5% of GDP) and above Germany (2.2%). Of course this comparison is also affected by the scale of deductions and allowances. But, it appears that corporate tax revenues gained from the expansion of FDI and the ‘headquarters’ industry in Ireland roughly offsets the revenue lost from the lower rate, even before one counts the other extra tax revenues (income tax, VAT, etc) that flow from the high level of inward FDI. Of course, other high-tax EU countries doubtless are aggrieved at the erosion of their own tax revenues as companies shift to Ireland. But, we doubt that Ireland’s corporate tax revenues would rise much, if at all, if Ireland’s corporation tax rate were to rise significantly because of the risk that Ireland’s high level of inward FDI would suffer. The pressure from other EU countries for a higher corporate tax rate in Ireland seems to be an attempt to use the current crisis to stem leakage from their own tax systems rather than a genuine attempt to restore Ireland to fiscal sustainability.
Citi continues with a largely irrelevant empirical analysis of why a tax hike makes little sense from an overal economic standpoint:
Tax is not the only factor that affects FDI decisions. But it is an important factor. The World Bank “Doing Business” study ranks Ireland as the 9th most attractive business location in the world for companies (and the only euro area country in the top 12). Ireland is ranked as the 7th best country in terms of a business-friendly tax system. The next highest EU country is Denmark, at 13th. In turn, the stock of inward FDI equals 83% of Ireland’s annual GDP, the thirdhighest among EU-15 countries, exceeded only by Belgium and Luxemburg.
In our view, it is not at all clear that a higher corporate tax rate would help return Ireland to a sustainable fiscal path. This is not to deny that the tax burden probably has to rise, including perhaps the corporate tax burden. But, in our view, the emphasis should be on measures that do least long-run damage to Ireland’s growth prospects – because without a significant pick-up in growth amidst fiscal consolidation, the country’s medium-term fiscal prospects will worsen.
In other words, based on empirical evidence and a rational analysis, a tax hike will not lead to an improvement in Ireland.
Well, of course. To claim that what is happening in Ireland is in any way following the "book" is beyond naive. Which is why we completely disagree with Citi's (conflicted) opinion: after all MNCs such as Citi would be the first who will have to come up with novel ways to avoid paying Uncle Scam a tax that is closer to what the US peasants pay. Citi of course is correct that in the long-run all the policies now pushed upon Ireland by its new continental master will be destructive, but what is new? Once again, we believe the biggest impact will be felt by corporations such as Google, which are now faced with two choices: i) repatriate cash back to the US and take an immediate ~30% hit or ii) spend material capex (for non-US expansion) to relocate elsewhere. Either of these options will have a negative outcome to corporate cash flows and EPS in the short term, and in the case of i), to the balance sheet as well (in the case of Google potentially costing the firm up to $100/share in embedded benefits as discussed elsewhere). We are just surprised that so far the market has been rather oblivious to the possibility that Ireland will have to ultimately cave the interests of its new banking overlords.