2/7/2013: Sunday Times June 23, 2013: G8 and Ireland

This is an unedited version of my Sunday Times article from June 23, 2013


As G8 summits go, the latest one turned out to be as predictable as its predecessors – an event full of reaffirmations of well-known conflicts and pre-announced news. In terms of the former, the Lough Erne meeting delivered some fireworks on Syria. On the latter, there was a re-announcement of the previously widely publicized Free Trade pact between the US and Europe. Another pre-announced item involved the EU, UK and US push for corporate tax reforms.

The two economic themes of the Logh Erne Summit agenda are tied at the hip in the case of our small open economy heavily reliant on FDI attracted here by the opportunities for tax arbitrage. As such, the G8 meeting agreement poses a significant threat for Ireland's model of economic development. Although it will take five to ten years for the shock waves to be felt in Dublin, make no mistake, the winds of uncomfortable change are rising.


The trade agreement, first announced by the Taoiseach months before the G8 summit, promises to deliver some EUR120 billion in net benefits for the EU economy. Roughly 90% of these are expected to go to the Big 5 economies of the EU, leaving little for the smaller economies to compete over. Behind these net gains there are also some regional re-allocations of trade that will take place within the EU itself.

In the short term, Ireland is well-positioned to see an increase in exports by the US multinationals operating from here and to some domestic exporters. The uplift in trade flows between Europe and the US may even help attracting new, smaller and more opportunistic US firms' investments. While tens of billions in trade for Ireland, bandied around by various Irish ministers, are unlikely to materialize, a small boost will probably take place.

However, over time, the impact of the EU-US trade and investment liberalisation can lead to sizeable reductions in MNCs activity here. Under the free trade arrangements, longer-term investment and production decisions will be based on such factors as cost considerations, as well as concerns relating to access to the global markets, and taxes.


Consider these three drivers for future trade and economic activity in Ireland in the context of the G8 summit and other recent news.

On the cost competitiveness side, we have had some gains in terms of official metrics of labour productivity and unit labour costs. Major share of these gains came from destruction of less productive jobs in construction and domestic services. Increase in revenues transferred via Ireland by some services exporters since 2004-2007 period further contributed to improved competitiveness figures.

Once when we control for these temporary or tax-linked 'gains' Ireland is still a high cost destination for investors compared to the majority of our peers.  As reflected in Purchasing Managers Indices, since the beginning of the crisis, Irish producers of goods and services have faced rampant cost inflation when it comes to prices of inputs. Earnings and wages data for 2009-2012, released this week, show labour costs rising across the exports-oriented sectors. Lack of new capital, R&D and technological investments further underlines the fact that much of our productivity gains are related to jobs destruction and transfer pricing by the MNCs.

When the tariffs and other barriers to EU-US trade come down, some multinationals trading into Europe will have fewer incentives to locate their production in Ireland. This effect is likely to be felt stronger for those MNCs which trade increasingly outside the EU, focusing more on growth opportunities around the world. Based on experiences with other free trade areas, such as NAFTA and the EU, this can lead to increased on-shoring of FDI back into the US and into core European states, away from smaller economies that pre-trade liberalization acted as entrepots to Europe.


The tax dimension of the G8 agreement will be the most significant driver for change in years to come.

The G8 clearly outlined the reasons for urgency in dealing with the issues of both tax evasion (something that does not apply in Ireland's case) and tax avoidance (something that does have a direct impact on us). These are structural and will not dissipate even when the G8 economies recover.

All of the G8 economies are struggling with heavy public and private debt loads and/or high domestic taxation levels. All are stuck in a demographic, social security and pensions costs whirlpools pulling them into structural insolvency. In other words, not a single G8 nation can afford to lose corporate revenues to various tax havens.

In line with the longer-term nature of the drivers for tax reforms, G8-proposed agenda can also be seen in the context of quick, easier to implement changes and longer-term structural realignment of tax systems.

The first wave of tax reforms outlined in principle by the G8 Summit will focus on tightening some of the more egregious loopholes, usually involving officially recognised tax havens. On the European side, this will spell trouble for the likes of Gurnsey and Jersey. The first round will also target easy-to-spot idiosyncratic tax arrangements, such as the Double Irish scheme and similar structures in Holland. Shutting down Double Irish will impact around a quarter of our trade in services, or roughly EUR13-15 billion worth of exports – much more than the EU-US Free Trade Agreement promises to unlock. The cut can be quick, as much of this trade involves electronic transactions - easy to shift and costless to re-domicile.

Over time, as changes in tax systems bite deeper into the structure of European tax regimes, losses of exports and FDI are likely to mount. To raise substantive new tax revenues, the EU members of G8 will have to severely cut back tax advantages accorded to countries like Ireland by their competitive tax rates.

Free Trade zones are notorious for amplifying the role of comparative advantage in determining where companies choose to domicile. Thus, to achieve a level the playing field for trade-related investments within the EU, either the effective tax rates will have to be brought much closer to parity across the block, or the basis for taxation must be redistributed more evenly across producers and consumers of goods and services.

Forcing all EU countries to harmonise the rates of tax would be politically difficult. Instead, there is a ready-to-use solution to the problem of redistributing tax revenues available since 2009 - the Common Consolidated Corporate Tax Base (CCCTB).

Under this mechanism companies selling goods and services from Ireland into European markets will report separate profits by each country of sales. These profits will then be reassigned back to the countries where each company has operations on the basis of a complex formula taking into the account company sales, employment levels and capital structure on the ground. The re-allocated profits will then be subject to a national tax rate. The end game from the CCCTB for Ireland will be effective end to the transfer pricing that goes along with the current system.

The EU Commission analysis claimed that with full cooperation, the enhanced CCCTB implementation will lead to an 8% rise in tax revenues across the EU. The main beneficiaries of these gains will be the Big 5 member states. The total net impact of CCCTB on all EU member states is expected to be nearly zero.

This suggests some sizeable reallocations of economic activity and tax revenues away from the smaller member states, like Ireland, in favour of the larger member states. January 2011, study by Ernst & Young for the Department of Finance concluded that Ireland can sustain one of the largest drops in tax revenues in the euro area due to CCCTB implementation. The estimates range up to 5.7% Government revenue decline, with our effective corporate tax rate rising to 23%, GDP falling by 1.6%-1.8%, and employment declining by 1.5%-1.6%.

The Ernst & Young report was compiled based using data for 2005. Since then, Irish economy's reliance on services exports grew from EUR 49.5 billion or under 31% of GDP to EUR90.7 billion or close to 56% of GDP. With services exports being a prime example of a tax-sensitive sector in the economy, we can safely assume that the above estimates of the adverse impact of CCCTB on Irish economy are conservative.

The CCCTB matches nearly perfectly the G8 Action plans relating to the issues of tax avoidance. It also fits the objectives of the OECD plan on addressing taxation base erosion and profit shifting which the OECD is preparing for the Finance Ministers and Central Bank Governors of the G20 in July.

While much of the impact of this week's G8 summit remains the matter for the future, there is no doubt that the G8 push toward curtailing aggressively competitive tax regimes is real.  In my view, Ireland has, approximately between five and ten years before our competitive advantage is severely eroded by the EU and the US efforts to coordinate the effective rates of taxation and consolidate reporting and payment bases for corporate profits. We must use these years wisely to build up our technological capabilities and develop a skills-based high-value added and highly competitive economy.

Box-out:

The latest data on the duration of working life (a measure of the number of years a person aged 15 is expected to be active in the labour market over their lifetime) shows that in 2000-2002, on average, European workers spent 32.9 years in employment or searching for jobs. This number rose to 34.7 years by 2011. In Ireland, the same increase in duration of working life took Irish workers from spending on average 33.3 years in labour market activities in 2000-2002 to 34.0 years in 2011. The increase in years worked in the case of Ireland was the third lowest in the euro area. In 2011, duration of working life ranged between 39.1 and 44.4 years in the Nordic countries and Switzerland – countries with much more sustainable pensions costs paths than Ireland. The significance of this is that given our pensions, housing and investment crises, Irish workers can look forward to spending some four-to-five years more working to fund their future retirement. Aside from a dramatic greying of our working population this means that even after the economic recovery takes hold, there might be no jobs for today's younger unemployed, as the older generations hold onto their careers for longer.

6/6/2013: Domestic Economy v MNCs: Sunday Times 26/5/2013

This is an unedited version of my Sunday Times column from May 26, 2013



Over recent months, one side of the Irish economy – the side of aggressive tax optimization and avoidance by the Ireland-based multinational corporations – has provided a steady news-flow across the global and even domestic media. While important in its own right, the debate as to whether Ireland is a corporate tax haven de facto or de jure is missing a major point. That point is the complete and total disconnection between Ireland’s two economies: economy we all inhabit in our daily lives and economy that exists on paper, servers and in the IT clouds. The latter has a mostly intangible connection to our everyday reality, but is a key driver of Ireland’s macroeconomic performance and the Government PR machine.

Take a look at two simple sets of facts.

According to our national accounts, Ireland’s economy, measured in terms of GDP per capita, has been growing for two consecutive years expressed in both nominal terms and inflation-adjusted terms. Real GDP per capita in Ireland grew over 2010-2012 period by a cumulative 2.38% according to the IMF. Accounting for differences across the countries in price levels and exchange rates (using what economists refer to as purchasing power parity adjustment), Ireland’s GDP per capita has risen 5.7% over the two years through the end of 2012. Over the same period of time, Ireland’s GNP per capita, controlling for exchange rates and prices differentials, has grown by 3.3%.

Sounds like the party is rolling back into town? Not so fast. The aggregate figures above provide only a partial view of what is happening at the households’ level in the Irish economy. Stripping out most of the transfer pricing activity by the multinationals, domestic economy in Ireland is down, not up, by 5.2% between 2010 and 2012, once we adjust for inflation and it is down 2.7% when we take nominal values. With net emigration claiming around six percent of our population, per capita private domestic economic activity has fallen 4.2% over the last two years.

All in, Irish domestic economy is the second worst performer in the group of all peripheral euro area states, plus Iceland. Sixth year into the crisis, we are now in worse shape than Argentina was at the same junction of its 1998-2004 crisis.


What the above numbers indicate is that the Irish domestic economy, taken at the household level, has been experiencing two simultaneous pressures.

While aggregate inflation across the economy has been relatively benign, stripping out the effects of the interest rates reduction on the cost of housing, Irish households are facing significant price pressures in a number of sectors, reducing their real household incomes just at the time when the Government is increasing direct and indirect tax burdens. At the same time, rampant unemployment and underemployment have been responsible for lifting precautionary savings amongst the households with any surplus disposable income. By broader unemployment metrics that include unemployed, officially underemployed, and state-training programmes participants, Irish unemployment is currently running at 28% of the potential labour force. Adding in those who emigrated from Ireland since 2008 pushes the above broad measure of unemployment to close to 33%.

Lastly, the households are facing tremendous pressures to deleverage out of debt, pressures exacerbated by the Government-supported efforts of the banks to increase rates of recovery on stressed mortgages.

In this environment, real disposable incomes of households net of tax and housing costs are continuing to fall despite the increases recorded in GDP and GNP. The Irish Government, so keen on promoting our improved cost competitiveness when it comes to the foreign investors is presiding over the ever-escalating costs of living at home.

In 2012 consumer prices excluding mortgages interest costs stood the highest level in history and 1.2% ahead of pre-crisis peak of inflation recorded in 2008. Much of this is accounted for by the heavily taxed and regulated energy prices.

Sectoral data reveals the story of rampant annual inflation in state-controlled parts of the economy. Of ten broader categories of goods and services, ex-housing, reported by CSO, all but one private sectors posted virtually no inflation over 2012 compared to the average levels of prices in 2006-2008 period. Food and non-alcoholic beverages prices declined 1.4%, clothing and footware prices are now a quarter lower, costs of furnishings, household equipment and routine household maintenance are down 13%, and recreation and culture services charges are down more than 2.7%. Restaurants and hotels costs are statistically-speaking flat with price increases of just 0.4% on 2006-2008 average. The only private sector that did post statistically significant levels of inflation was communications where prices rose 3.5% by the end of 2012 compared to pre-crisis average. But even here postal services charges lead overall inflationary pressures.

In contrast, every state-controlled and heavily taxed sub-sector is posting rampant inflation. Alcoholic beverages and tobacco prices are up 12.3%, health up 13.4%, transport up 11.4%, and education costs are up 30.4%. Energy costs are up 32.5% and utilities and local charges are up 14.9%. While energy costs rose virtually in line with increases in global energy price indices, the state still reaped a windfall gain from this inflation via higher tax revenues, and higher returns to state-owned dominant energy market companies: ESB, Bord Gais and Bord na Mona.

The state extraction of funds through controlled charges and taxation linked to these charges is rampant. Over 2009-2012 period, indirect taxes, state revenues from sales of services and investment income – all linked to the cost base in the underlying economy rose from EUR 24.8 billion in 2009 (44.3% of total state revenues) to EUR 25.2 billion in 2012 (44.5% of total state revenues). This was despite significant declines in imports and consumption of goods in the domestic economy and declines in government own consumption of goods from EUR 10.4 billion in 2009 to EUR 8.56 billion in 2012. For those who think this extraction is nearly over now, let me remind you that IMF forecast increases in Government revenues for Ireland over 2014-2018 are set to exceed revenues increases passed in all budgets since 2008.


The price and tax hikes on Irish households leave them exposed to the risk of future increases in mortgages costs. Government controlled prices are sticky to the downside, which means that the once prices are raised, the state regulators and policymakers are unwilling to adjust prices downward in the future, no matter how bad households budgets can get. The reason for this is that semi-state companies reliant on regulated charges have significant market and political powers, especially as they act as prime vehicles for big bang ‘jobs creation’ and ‘investment’ announcements that fuel Irish political fortunes. At the same time, the state uses revenues obtained directly via dividends payouts and indirectly via taxes on goods and services supplied by the semi-state companies as substitutes for direct taxation. Absent deflation in state-controlled sectors, there is very little room left in the private sectors to compensate households for any potential future hikes in mortgages by reducing costs of goods and services elsewhere.

And mortgages costs are bound to rise over time. In 2008, new mortgages interest rates averaged around 5.2% against the ECB repo rate average of 3.85%, implying a lending margin of around 135 basis points. Since January 2013, ECB rates have averaged 0.7% while Irish mortgages rates averaged around 3.4%, implying a margin of 270 basis points. At this stage, we can expect ECB rates to revert to their historical average of around 3.1% in the medium-term future. At the same time, according to the Troika, Government and Central Bank’s plans, Irish banks will have to increase their lending margins. Put simply, current average new mortgages rates of 3.4% can pretty quickly double. Ditto for existent mortgages rates.

Based on CSO data, end of 2012 mortgages interest costs stood at the levels some 14.5% below those in 2007-2009 period and 29.6% below pre-crisis peak levels.  Reversion of the mortgages interest rates to historical averages and adjusting for increased lending margins over ECB rate would mean that mortgages interest costs can rise to well above their 2008 levels, with inflation in mortgages interest payments hitting 50%-plus over the next few years.


The dual structure of the Irish economy, splitting the country into an MNCs-dominated competitiveness haven and domestic overpriced and overtaxed nightmare, is going to hit Ireland hard in years to come. The only solution to the incoming crisis of rampant state-fuelled inflation in the cost of living compounding the households insolvency already present on the foot of the debt crisis is to reform our domestic economy. However, the necessary reforms must be concentrated in the areas dominated by the state-owned enterprises and quangos. These reforms will also threaten the state revenue extraction racket that is milking Irish consumers for every last penny they got. With this in mind, it is hardly surprising that to-date, six years into the crisis, Irish governments have done nothing to transform state-sponsored unproductive sectors of the domestic economy into consumers-serving competitively priced ones.

Chart with Argentina: GDP per capita adjusted for PPP differences (prices and exchange rates)

Box-out: 

Remember Ireland’s ‘exports-led recovery’ fairytale? The premise that an economy can grow out of its banking, debt and growth crises by expanding its exports has been firmly debunked by years of rapid growth in exports of goods and services, widening current account surpluses and lack of real growth in the underlying economy. Recent data, however, shows that the thesis of ‘exports-led recovery’ for the euro area is as dodgy as it is for Ireland. In 2010-2012, gross exports out of the euro area expanded by a massive 21.4%. Over the same period GDP grew by only 2.8%. Stripping out positive contributions from the private economy side (Government and household consumption, plus domestic investment), net exports growth effectively had no impact on shallow GDP expansion recorded in 2010 and 2011. The latest euro area economy forecasts for 2013 across 21 major research and financial services firms and five international economic and monetary policy organizations show a 100% consensus that while exports out of the euro area will continue to post positive growth this year, the euro area recession will continue on foot of contracting private domestic consumption and investment. Median consensus forecast is now for the euro area GDP to fall 0.4% in 2013 on foot of 2.1% drop in investment, 0.8% contraction in private consumption and a relatively benign 0.3% decline in Government consumption. The same picture – of near zero effect of exports on expected growth – is replayed in 2014 forecasts, with expectations for investment followed by private consumption expansion being the core drivers for the euro area return to positive GDP growth of ca 1.0%. Sadly, no one in Europe’s corridors of power seem to have any idea on how to move from fairytale policies pronouncements to real pro-growth ideas.

26/05/2013: Ireland Hard at Work on Troika & Tax Haven Fronts

Several recent points raised in relation to the work being done by Minister Noonan are worth a quick consideration.

Point 1: Ireland, allegedly, is the best-performing 'Troika programme' in the 'periphery' (forget the semiotics of a country being a programme and 1/3 of the EZ being a 'periphery'). We are fulfilling all programme requirements and are even ahead of schedule on some (namely - issuance of bonds we don't have to issue). If so, then can Minister Noonan explain:

• Why have we needed all the material alterations to the programme, obtained in conjunction with 2011-2012 Greek 'rescues' (term extensions and rate reductions on loans), the restructuring of the promo notes, etc. If we are satisfying the programme requirements, then why do we constantly attempt (and succeed) in changing the programme?
• If, as a part of well-functioning programme, Ireland has already recapitalized its banks and if the measures - approved by the EU and the Troika - to rebuild Irish banking sector are working, then why does Minister Noonan constantly 'working' on finding ever more convoluted ways to shove more funds into them? As in using CoCos as here: http://www.irishexaminer.com/business/noonan-examining-ways-to-capitalise-banks-232186.html or tapping ESM as here: http://www.foxbusiness.com/news/2013/05/21/ireland-still-hoping-to-refinance-bank-debts-through-esm/

Point 2: Ireland, allegedly, is not reliant in its adjustment on beggaring its neighbours via asymmetric tax regime, when it comes to corporate tax rates. Per Minister Noonan (see: http://www.irishtimes.com/news/politics/oireachtas/us-senate-committee-quoted-incorrect-tax-rates-for-apple-activities-here-d%C3%A1il-told-1.1404834): "The ability of multinational companies to lower their global taxes using international structures reflected the global context in which all countries operated." 

But then, "Mr Noonan said ... “some multinational corporations, with the assistance of legal practitioners and tax advisors, have exploited the differences in these systems to their own advantage”." So, wait a second here: it is down to 'some' MNCs - with help of legal & tax advisors - to 'exploit' tax system to their advantage. "The Minister said tax management was an international business. “Very clever accountants and very clever lawyers are involved in it and they basically try to get into an unspecified space between the tax laws of two jurisdictions." 

Ok, we get the point - bad advisors and bad companies are exploiting good Irish regime or global regime. Were it not for this 'exploitation, one can assume things would have been different, right? Wrong: “Operating in that space, they find ways of avoiding the tax that otherwise would not have been payable.”

Come again? Apparently, some multinationals just love hiring expensive advisors to avoid tax that would not have been payable even absent these advisors. You see, per Minister Noonan, Ireland's reputational problems of being branded a tax haven stem from utter stupidity of some MNCs that are so dim, they hire useless but very clever advisors to devise complicated and clever schemes to avoid that which doesn't exist. 

Seems like Minister Noonan has been exposed to too much logic lessons as of late.