The flipside to Ireland’s low taxation and its open economy are it creates ‘huge volatility’ in tax revenues and leaves the country ‘susceptible to being gamed by multinationals,’ says University of Limerick lecturer Stephen Kinsella.
When you put two recent news items - the sharp rise in Greece’s new unpaid taxes in May, and the staggering 26 percent growth rate Ireland is supposed to have posted in 2015 – side by side it is easy to come to the conclusion that the Irish system of low taxation is the only way forward. It is a little more complicated than that, though.
Clearly, the latest tax increases adopted by the government will be damaging for Greece’s economy, likely acting as a brake on the slow-turning wheels of recovery. Roughly 1.9 million of Greece’s 6 million total taxpayers are facing an income tax bill this year that will be some 1,300 euros higher on average, the top rate of value-added tax has been increased from 23 to 24 percent and the corporate tax rate was increased by 3 percentage points to 29 percent.
There is concern that these measures will backfire by encouraging tax evasion or driving firms out of business or abroad, where tax conditions are more favourable. Greece’s corporate tax rate, for instance, is well above the European Union average of 20.5 percent, according to accounting firm KPMG. Greece also outstrips the EU average of 20.1 percent in indirect tax. Furthermore, its average individual tax rate is roughly eighth percentage points above the EU’s, which is 37.2 percent.
There are already indications that the government’s hopes of bringing in more revenues via tax rises so it can meet the fiscal targets agreed with Greece’s lenders might not be fulfilled. Reports suggest that VAT revenues from tourist resorts are lower than expected, likely due to some business owners failing to issue receipts, while the amount of new tax arrears created in May jumped to 1.25 billion euros from less than 700 million a month earlier. The total new unpaid taxes for the first five months of 2016 stands at just under 6 billion euros, which is 6.7 percent up on the same period last year. When this is added to the legacy, or pre-existing, arrears the total reaches a mind-blowing 89 billion euros.
Of course, it should be noted that a large part of this legacy debt is never likely to be collected, such as the 12.3 billion euros owed by companies that have gone bankrupt, and that the process of collecting the remainder is painfully slow. For example, by the end of May, the Finance Ministry had collected 1.2 billion euros in legacy debt. Although this seems a small amount in relation to the total that is owed, it is just over 60 percent of the collection target for the whole year.
Nevertheless, it is clear that high taxes in a struggling economy, with a state whose collection capabilities are limited do not make for a successful recipe. Can Ireland, and its apparently pulsating economy, provide an alternative model, an example to follow? Greek leaders coveted the development achieved by the “Celtic Tiger” in previous decades and its current corporate tax rate of 12.5 percent certainly seems an appealing antidote to the repeated tax hikes in Greece. And, as if any more proof were needed, the Irish economy grew by 26 percent last year (revised up this week from the 7.8 percent first estimated) to underline that the country is following a successful strategy.
This, though, is where a word of caution is needed. When you delve deeper than the headline figure for Ireland’s growth rate, it’s clear that the balance between being a tax haven and a country whose real economy benefits from attracting business via low tax rates is a fine one. Economists and analysts have pointed out that the dramatic jump in Ireland’s growth figures was partly driven by companies transferring their productive assets to the country. For instance aircraft leasing company Aercap moved its fleet it Ireland, while Apple also transferred some of its intellectual property rights there. There have also been balance sheet reclassifications through corporate inversions, which involved smaller Ireland-based companies buying bigger, mostly American, firms and headquartering the resulting entity in Ireland. While such actions have a considerable impact on economic data, their effect on the economy itself is limited.
Stephen Kinsella, a senior lecturer in economics at the University of Limerick, told Kathimerini English Edition that the drawbacks of Ireland’s low taxation and its open economy are that it creates “huge volatility” in tax revenues and leaves the country “susceptible to being gamed by multinational companies.”
“The real lesson Ireland teaches is that openness has positives and negatives,” he said. “When globalisation is flourishing, and the financial aspects of globalisation are flourishing, then small open economies are going to boom because of inflows of foreign capital. When those flows stop, then countries like Ireland, Iceland are in big trouble.”
Beyond this warning, Kinsella also points out that Ireland’s economic upsurge in previous decades derives from a number of factors that have been in play over a long period of time. In other words, it is not a model that can be transposed simply, nor can implementing one element (the low corporate tax rate, for instance) guarantee success.
“Ireland began opening its economy up in the 1950s, cutting corporate taxes was a part of that move,” he said. “Perhaps more importantly was the creation of agencies whose only job was importing foreign capital, creating a business-friendly climate, and pushing indigenous sectors to export more. Ireland also has geography and language on its side.”
The other factor that means Greece and Ireland are worlds apart in terms of aligning their tax regimes is that Athens still has to carry out a significant fiscal adjustment. Given that public sector wages and pensions, which have been cut substantially since 2010, account for more than 80 percent of public spending, the easier political choice is to allow the revenue side to pick up as much of the slack of possible. As long as Greece is chasing this targets and the economy is not showing significant enough levels of growth to boost revenues, then taxation will remain high. Speaking to Skai TV on Thursday, Prime Minister Alexis Tsipras indicated he will not be able to consider lowering taxes until the economy is growing.
“Within the confines of the Euro, the adjustment process Greece is undergoing through the wage channel is unstoppable, unless those in power in Brussels relax the fiscal targets,” said Kinsella. “One of the reasons Ireland was able to grow its way out of austerity was the very disconnection between the domestic and multinational/export-facing parts of the economy.”
It is clear that any suggestion there may be a quick fix out there for Greece’s economic travails through a system of lower taxes will have to be set aside for the time being.