14/10/2014: Budget 2015: Of Double Irish and Tax Non-Reforms

This Budget was supposed to be about giving working families something back. In the end, it was not.

The core asymmetry in Irish tax system has been, since the onset of the crisis, increasing burden of State on ordinary incomes. This remains.

2014 projected income tax take is EUR17.18 billion out of total tax take of EUR41.04 billion. 2015 projected income tax at EUR17.98 billion against total tax take of EUR42.3 billion.

Corporation tax: 2014 projection for EUR4.525 billion and 2015 at EUR4.575 billion.

So as a share of total tax take, income tax continues to rise, corporation tax continues to fall.

There is no re-balancing of tax system. Households pay. Full stop.

Of core measures, announced, corporate tax reforms are the biggest. As predicted, 12.5% headline rate is here to stay. Minister Noonan sounded like a politician cornered by someone with a bit more power (Germany? US? EU? UK? all of the above?) on the topic. And he stayed his ground (absent visible opponents).

But the 'non-tax-haven' tax loophole of the Double Irish was abolished, as predicted. For new companies coming into Ireland - starting with 2015 - all companies resident here will be resident here for tax purposes too. For existent companies, the new provision comes into force at the end of 2020. Transition period will see more tax optimised activity being booked through Ireland as corporates embark on building up cash reserves. This firmly puts any risk of economic activity falloff after the full abolition of the Double Irish out into next Government, so should FF or SF or both win next elections, they will bear the weight of any disruptions. Before then, however, more will flow through Ireland on the way to real tax havens.

It is worth reminding that in October 2012, Minister Noonan steadfastly claimed that abolishing Double Irish provision was not within his remit.

Minister Noonan also set out some sketch of the forthcoming tax reforms. These will:

1) Remove completely any base year consideration in application of R&D tax credits. The measure will take hold from January 1, 2015 and will create more incentives to book R&D spending into Ireland. Whether this will tangibly increase actual R&D activity here remains to be seen, since R&D investment is even harder to price than transfer pricing in the services sector. Suppose a lab located in, say, New Hampshire develops a formula for new drug. But final preparation is registered into Ireland. All R&D investment, save minor expenditure on lab operations, can be billed into Ireland, in exchange for having a 'token' small lab of formula preparation team here. make a key scientist fly into Dublin for a couple of meetings and you have magic R&D activity here that can easily exceed activity in the actual lab. The “knowledge box” will, presumably, tax corporate profits generated as a result of patented innovations in a way similar to so-called 'patent box' structures already in place in the Netherlands and the UK. UK 'box' has a tax of 10% , Netherlands' one has 5%, and Minister Noonan promised Irish equivalent will be 'the best in class', so it will need to undercut the already existent ones. Which means that the above-mentioned example of an 'investment' will book profits into Ireland as payments on R&D-generated IP and these will be taxed at a reduced rate.

2) Aim to deliver even more 'competitive' environment for 'intangible assets' domiciling in Ireland. In other words, the fabled IP pushed through the fabled 'Knowledge Development Box', aka black box tax system that leaves IP outside tax net. This should sweeten the removal of the Double Irish for MNCs, especially in the IP-intensive ICT services sector. But it will also mean preciously little in terms of incentivising real activity on the ground here. Instead of shifting profits to Bahamas to get them off the tax hook, MNCs can just book payments into Ireland as payments on IP, making them basically tax free too.

3) To facilitate internationally trading sector, Budget 2015 enhances Special Assignee Relief Programme

4) To address future criticisms of the new system as being unfair to our trading partners, the Revenue will get additional resources to act as a 'competent authority' in enforcement and monitoring of corporation tax matters.

Gas bit is: the EU Commission is already investigating if 'patent-knowledge' box schemes constitute illegal state aid.

One simply cannot assess the full impact of the new changes on the economy. We have no data on specific activities by MNCs here. We have no data on operating tax structures. We have no data on how MNCs can re-arrange their activities here to address the challenge. It is, however, safe to assume that none of existent MNCs will be rushing to do much before 2020. And it is also safe to assume that by 2020, when the Double Irish fully bites the dust, the OECD-led BEPS reforms will be already known.

This, in effect, will mean that Ireland's Double Irish abolition today is a preemptive move that preempts nothing but bad PR. Reputational gain. Opportunity of real reforms for now remains a distant hope.

14/10/2014: Budget 2015: Economic Forecasts a Bit Optimistic

Here's my take on economic side of the Budget 2015 projections:

Gross current expenditure for 2015 will be just over €50 billion. This figure represents an increase of €429 million over the 2014 Revised Estimates. Note: in H1 2014, Government spent EUR35.567 billion which is EUR1.255 billion more than in the same period 2013. As unemployment fell, social benefits rose from EUR13.823 billion to EUR14.016 billion. General Government Deficit has fallen only EUR307 million y/y in H1 2014. These numbers are not consistent with strong economy or strong fiscal performance. Meanwhile, the state took out of the economy EUR1.893 billion more in taxes and social contributions in H1 2014 compared to H1 2013. Where did this increase of funding go?

Government deficit target for 2015 is 2.7% of GDP under ESA 2010 classification. Which means that going back to Troika programmes-comparable measure (ESA 1995 classification), the target deficit is closer to 3.2% of GDP. This is ahead of 3% target and shows how much debt we owe not to smart management of resources, but to accounting rules changes.

Here's a set of economic puzzles courtesy of the Department of Finance:

Real growth is slowing down from 2014 levels, but employment generation is rising. A puzzle. Especially as domestic demand is expected to grow at same rate in 2015 and growth rate is expected to fall in years after.

As compared against other organisations forecasts:

Added puzzle: IMF projections for Irish economy real GDP growth are: 2015 3.045% - full 0.85 percentage points lower than DofF, 2016: 2.538% which is full 0.87 percentage points below DofF, in 2017 : 2.649% or 0.75 percentage points below DofF… and so on.

And another kicker in the teeth… the promise of fiscal rectitude and 'no going back to boom-and-bust cycles':

All of the above is rather academic, since the Department of Finance refuses to forecast Gross Voted Current expenditure of the Exchequer beyond 2015, setting all of it at EUR50.075 billion for each year 2015-2018. Which means the estimated effects on deficit and on borrowing are based on assuming zero growth in spending and continued growth in tax revenues. Happy times roll, even though Haddington Road agreement is about to expire.

Still, as you can see, debt/GDP ratio is expected to fall, courtesy of higher GDP, including the new classification effects that came into force this year. But debt itself is not expected to fall. Instead, from EUR 203.2 billion, Government debt is expected to rise to EUR 215 billion in 2017 and basically stay there in 2018.

So on the balance: a bit too much optimism, especially past 2015. Not enough risk cushion. May the numbers turn out this well in reality...

14/10/2014: Expect the Expected: pre-Budget 2015

Pre-Budget Budget... what to expect based on leaks so far:

Big Items:

1) Corporate Tax Regime changes: we can expect some phasing out to be announced for the notorious Double-Irish Tax Scheme.

This is one of the most criticized parts of the Irish tax code. Double Irish a complex corporate structure whereby a multinational can channel revenues to an Irish subsidiary, which then pays royalties on Intellectual Property to another company resident in Ireland, but tax resident in a tax haven, e.g. Bermuda.

To close the loophole, we can expect the Government will announce that all companies registered in Ireland will be automatically deemed tax resident in Ireland. Such a change will make Irish tax law fully aligned with the US and UK systems.

Since MNCs employ around 160,000 in this country, or roughly 8.6 percent of our workforce, the impact can potentially be significant. Which means Minister Noonan will have to be careful in closing the loophole. It is expected he will off-set the impact by expanding the R&D and Intellectual Property taxation benefits.

It is worth remembering that in October 2012, Michael Noonan solemnly declared that changing the Double Irish 'situation' was not within his remit. Direct quote: "Mu understanding of the "double Irish" is that while it exists, it cannot be remediated by changes in Irish tax law".

2) Households: Budgets 2009-2014 have lifted tax (direct and indirect) take by EUR11.7 billion. Meanwhile, on spending side, all years of austerity have basically meant that our Government spending (excluding banks measures) stayed relatively flat on pre-crisis levels.

There has been re-allocation of some spending from services to paying interest on our massive debt, which or course means there were cuts to some specific services. But we had no significant improvements in public sector efficiencies and we had no significant changes in how the State does business:

• Semi-state companies continue to inflate their books by charging higher and higher prices, blessed by captive regulators;
• State employment, pay and promotion policies remain detached from productivity;
• State pensions remain unfunded, private pensions becoming de-funded;
• State health system continues to crumble, while private subsidy to this system is being eroded;
• Management in public services remains excessively bloated and inefficient, compared to front-office staff which is getting worked harder.

All of which means that 'austerity' years have shifted the burden of state even more directly onto ordinary income earners.

Now, with the economy expected to grow by 4.7 percent in 2014 and deficit expected to fall thanks to the national accounts reclassifications and booming MNCs tax arbitrage, Minister Noonan has some room for minor giveaways.

We can expect that he will cut income tax burden, possibly by lowering the top 52 percent tax rate or raising the income threshold for that rate. Another possible target is much despised USC which currently hits workers on earnings from €10,036.

Keep in mind, whilst the Government will claim credit for any tax reductions and austerity easing, these were made possible, primarily, by the EU-mandated changes in our National Accounts. On the other hand, keep also in mind that the Troika-demanded water charging is introduced as double-taxation measure on foot of Government-own design.

To appease trade unions and other 'Social Partners' pivotal to the Labor Party electoral base, he could also announce the hiring of more teachers and increase some benefits. One point he will probably address is the kick backs to taxpayers and vocal interest groups in terms of reduced cost of water provision. Rumour has it, he will:

• Create additional EUR100 credit for the elderly for water services; and
• Announce tax relief on water charges.

Net outcomes: We are some 18 months away from elections and the Government desperately needs to test waters to see what response from electorate they can get if they start 'McCreeviasing' their Budgets. Over months to come, the Government will be closely watching changes in opinion polls as a function of Budget 2015 'easing' of the austerity. Which is all about one thing: instead of 'stimulating the economy', the Government is attempting to gauge the extent of the Budget easing stimulus on electorate.

Still, keep in mind: Budget 2015 is likely to cut spending and raise revenues by some EUR800-900 million. So small giveaways will mask still substantial austerity. Which means that Budget 2015 is going to be about reallocating once again the burden on budgetary adjustments. Pensioners (already massive winners during deflationary period in the economy and low on debt burden courtesy of the previous property boom) are going to gain. Special interest groups are going to gain. General economy, ordinary working households are going to lose.

'McCreevization' by one half, then...

Little pesky details: Budget 2015 is, in part, going to be based on some non-trivial economic assumptions. In best practice terms, these should be conservative, rather than optimistic. But in Irish reality, the champagne of big 7.7% headline GDP print in Q2 2014 is starting to hit some heads in the Department of Finance. Government's forecast for 2015 Budget is for 3.6% GDP and 3.3% GNP growth. Seems conservative compared to H1 2014 figures, but is it conservative enough? Underlying these, there is a forecast for exports growth of 5% y/y in 2015. Again, might be a tad optimistic. And we also have forecast for accelerated jobs creation over 2015 +2.2% growth) compared to 2014 (+1.8% growth), despite the fact that the Government is forecasting slower economic growth in 2015 (3.6% GDP and 3.3% GNP) than in 2014 (4.7% GDP and 3.1% GNP).  Interestingly, in SPU 2014 (April 2014), the Government estimated employment growth to be 2.2% in 2014 and 2.0% in 2015. This is now revised down to 1.8% for 2014 and up to 2.2% in 2015. Labour force growth was penciled in at 0.5% in 2014 and 0.8% in 2015, but by Budget 2015 it was revised down to -0.1% in 2014 and up to 0.9% for 2015.

Past optimism is being reloaded forward? Or did someone miss their cup of milk before going to bed?