Congratulations to my former colleague at TCD Economics, and my thesis supervisor from years back, Professor Philip Lane on his appointment. Here is a good summary of my view why the Irish Government has made a good choice, via Central Banking
Tuesday, October 20, 2015
20/10/15: New Governor of the Central Bank of Ireland
Congratulations to my former colleague at TCD Economics, and my thesis supervisor from years back, Professor Philip Lane on his appointment. Here is a good summary of my view why the Irish Government has made a good choice, via Central Banking
Sunday, October 18, 2015
18/10/15: Is Ireland a Euro Periphery Outlier? Some Historical Data
How unique is Ireland within the club of euro peripheral countries? Well, historically, rather unique. Alas, sometimes for the reasons not entirely in our favour.
The following are excerpts from the recent ECB paper titled “Fiscal policy adjustments in the
euro area stressed countries: new evidence from non-linear models with state-varying thresholds”.
Quote: “Fiscal policy authorities of Greece, Ireland, Portugal and Spain are shown to have, on average, historically followed a "spend-and-tax" model of fiscal adjustment, where government spending is decided by the political process, and the burden of correcting fiscal disequilibria is entirely left to the tax instrument.”
Of course, ‘historically’ here means over the period 1960-2013 for all countries, with exception of Spain (1970-2013).
But before then, what were the pre-conditions (thresholds) for taking action? “During the 1960-2013 period for Greece, Ireland and Portugal and during the 1970-2013 period for Spain, we find that the threshold estimate for the budget deficit-to-GDP ratio, which led to different fiscal correction regimes, was on average 4.90% for Greece, 5.10% for Ireland, 3.22% for Portugal and 3.12% for Spain.”
In other words, Ireland had the greatest tolerance - over the entire period - for deficits, opting to wait until average deficit as % of GDP would hit above 5.1%, well above Greece (4.9%) and the rest of the peripheral states.
So now, let’s tackle the more recent period, from the start of the Euro: “When considering the period after 1999, this overall picture worsens for Greece and Portugal and improves for Ireland. Moreover, the results for Ireland and Spain are driven by the financial crisis period. In particular for Ireland, the decoupling dynamics of the government spending reflects the support to the financial sector. In fact, when considering the pre-crisis EMU period between 1999 and 2007, the threshold for fiscal adjustment in Ireland and Spain are estimated to be positive; namely, the regime change took place when the budget balance was in surplus. Conversely, the fiscal deficit-to-GDP thresholds estimated at 5.32% for Greece and 4.08% for Portugal remained rather high.”
The above basically boils down to the following: since 1999, growing economies of Ireland and Spain allowed two countries to substantially reverse pro-cyclicality of deficits and significantly reduce thresholds for budgetary actions. This did not happen in Greece and Portugal. While Ireland gets a pat on the back for pre 2007 period, it is hardly unique in this achievement.
But despite the gains of the 1999-2007, things did not change all that much within the structure of deficits and adjustments. So per ECB paper “Looking at the effects of the economic cycle, we find that fiscal deficit-to-GDP ratio was not reduced in Greece, Ireland and Portugal with the improvement in economic activity. Consequently, during the contractionary times, fiscal corrections became more costly, as tax adjustments became a priority in an attempt to restore fiscal discipline.”
In other words, we were not unique in the way we handled the underlying structure of public spending imbalances, despite having substantially reduced the fiscal action thresholds.
But may be during the peak of the crisis we widened up? Indeed, ECB offers some positive evidence in this direction, but it also argues that the same took place in Spain and Portugal. “The results also suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed in Ireland and Spain, while it was reduced in Portugal. By relaxing the fiscal deficit-to-GDP threshold (in an attempt to stave off deep recessionary pressures) Ireland and Spain relied on business cycle improvements to raise tax revenues. Given the tendency by Portuguese authorities to improve the fiscal imbalances during a financial crisis, these figures make sustainability concerns for Ireland, Portugal and Spain less of an issue compared to Greece, in an historical perspective.”
Which, once more, does not really identify Ireland as a ‘unique’ case amidst the imprudent (but learning) peripherals.
“The results …suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed from 5.10% to 6.99% in Ireland and from 3.12% to 4.00% in Spain, while it was reduced from 3.22% to 1.92% in Portugal.” In other words, Irish Government thresholds actually worsened in the financial crisis, albeit most of that worsening is attributable to the Government decision to rescue Irish banks.
Overall, as table below illustrates, Ireland has managed to perform best during 1999-2007 period in fiscal adjustment thresholds terms, while Spain was the overall best performer in 1999-2013 period and over the entire sample.
This completes the arguments about Ireland’s alleged uniqueness as an outlier to the group of peripheral states: with exception of the period during which our property and financial sectors bubbles were inflating to unprecedented proportions, Ireland was pretty much a ‘normal’ peripheral state when it comes to fiscal management. Celtic Tiger et al…
So let's hope the latest Budget 2016 does not return us back to the historical record track...
Saturday, October 17, 2015
17/10/15: Let’s talk about the Law of Small Numbers
Wonkishly awesome, folks…
Let’s start with a set up
You decide to will flip a coin 4 times in a row and record the outcome of each flip. After you done flipping, you look at every flip that “immediately followed an outcome of heads, and compute the relative frequency of heads on those flips”.
“Because the coin is fair, [you] of course expect this empirical probability of heads to be equal to the true probability of flipping a heads: 0.5.”
You will be wrong. If you “were to sample one million fair coins and flip each coin 4 times, observing the conditional relative frequency for each coin, on average the relative frequency would be approximately 0.4.”
Two researchers, Joshua Miller and Adam Sanjurjo “demonstrate that in a finite sequence generated by i.i.d. [independent, identically distributed] Bernoulli trials with probability of success p, the relative frequency of success on those trials that immediately follow a streak of one, or more, consecutive successes is expected to be strictly less than p, i.e. the empirical probability of success on such trials is a biased estimator of the true conditional probability of success.”
Which implies
So far, pretty innocuous from the average punter perspective. But wait. “While, in general, the bias does decrease as the sequence gets longer, for a range of sequence (and streak) lengths often used in empirical work it remains substantial, and increases in streak length.” In other words, while empirical probability does approach closer and closer to true conditional probability, it does so in trials so large (so many coins flips) that such convergence does not make much of the difference in our, human, decision making.
And that is pretty pesky for the way we look at probabilistic outcomes and make decisions based on our expectations, whenever our decisions are sequential.
Impact on decision making
“This result has considerable implications for the study of decision making in any environment that involves sequential data”. These implication are:
- This provides “a structural explanation for the persistence of one of the most well-documented, and robust, systematic errors in beliefs regarding sequential data—that people have an alternation bias (also known as negative recency bias)… — by which they believe, for example, that when observing multiple flips of a fair coin, an outcome of heads is more likely to be followed by a tails than by another heads;
- It also helps resolve “…the closely related gambler’s fallacy…, in which this alternation bias increases with the length of the streak of heads.”
- “Further, the result shows that data in the hot hand fallacy literature …has been systematically misinterpreted by researchers; for those trials that immediately follow a streak of successes, observing that the relative frequency of success is equal to the overall base rate of success, is in fact evidence in favor of the hot hand, rather than evidence against it.”
And tangible applications are
So the realisation that “the empirical probability of success on such trials is a biased estimator of the true conditional probability of success” helps explain why “…the inability of the gambler to detect the fallacy of his belief in alternation has an exact parallel with the researcher’s inability to detect his mistake when concluding that experts’ belief in the hot hand is a fallacy.”
But there is more. Per authors, “the result may have implications for evaluation and compensation systems. That a coin is expected to exhibit an alternation “bias” in finite sequences implies that the outcome of a flip can be successfully “predicted” in finite sequences at a rate better than that of chance (if one is free to choose when to predict).”
They offer the following example of this: “suppose that each day a stock index goes either up or down, according to a random walk in which the probability of going up is, say, 0.6. A financial analyst who can predict the next day’s performance on the days she chooses to, and whose predictions are evaluated in terms of how her success rate on predictions in a given month compares to that of chance, can expect to outperform this benchmark… For instance, she can simply predict “up” immediately following down days, or increase her expected relative performance even further by predicting “up” only immediately following longer streaks of consecutive down days.”
Going back to the first example with coin flipping, the law of large numbers implies that as your sampling size (number of coin flips) rises, “…the average empirical probability of heads would approach the true probability. The key to why this is not the case, and to why the bias remains, is that it is not the flip that is treated as the unit of analysis, but rather the sequence of flips from each coin. In particular, if [you] were willing to assume that each sequence had been generated by the same coin, and [you] were to compute the empirical probability by instead pooling together all of those flips that immediately follow a heads, regardless of which coin produced them, then the bias would converge to zero as the number of coins approaches infinity.”
What this means is that “…in treating the sequence as the unit of analysis, the average empirical probability across coins amounts to an unweighted average that does not account for the number of flips that immediately follow a heads in each sequence, and thus leads the data to appear consistent with the gambler’s fallacy.”
Per authors, “the implications for learning are stark: to the extent that decision makers update their beliefs regarding sequential dependence with the (unweighted) empirical probabilities that they observe in finite length sequences, they can never unlearn a belief in the gambler’s fallacy…”
Overall, we have
To sum this up, the authors found “a subtle but substantial bias in a standard measure of the conditional dependence of present outcomes on streaks of past outcomes… The mechanism is a form of selection bias, which leads the empirical probability …to underestimate the true probability of a given outcome, when conditioning on prior outcomes of the same kind. The biased measure has been used prominently in the literature that investigates incorrect beliefs in sequential decision making --- most notably the Gambler's Fallacy and the Hot Hand Fallacy.”
The two fallacies are defined as follows:
- “…People believe outcomes alternate more than they actually do, e.g. for a fair coin, after observing a flip of a tails, people believe that the next flip is more likely to produce a heads than a tails. Further, as a streak of identical outcomes increases in length, people also tend to think that the alternation rate on the outcome that follows becomes even larger, which is known as the gambler’s fallacy”.
- “The hot hand fallacy typically refers to the mistaken belief that success tends to follow success (hot hand), when in fact observed successes are consistent with the typical fluctuations of a chance process.”
After correcting for the bias, the authors show that “the conclusions of some prominent studies in the literature are reversed.” Awesomely wonkish...
Full paper: Miller, Joshua Benjamin and Sanjurjo, Adam, Surprised by the Gambler's and Hot Hand Fallacies? A Truth in the Law of Small Numbers (September 15, 2015). IGIER Working Paper #552. http://ssrn.com/abstract=2627354
17/10/15: ‘Dream Wedding’ Fairy Tales
Working through some papers, I just came across this now nearly classic, but still recent study that I wanted to share with you ages ago, but somehow forgot. So here it is - a brilliant example of empirical economics at its most interesting edge:
The paper evaluates “the association between wedding spending and marriage duration using data from a survey of over 3,000 ever-married persons in the United States.”
Stats informing this study objective are frightening: “In 2014, wedding industry revenues are projected to exceed $50 billion in the United States. According to a national survey conducted annually by the top wedding website TheKnot.com, the average wedding cost was $29,858 in 2013… In 1959, Bride’s recommended that couples set aside 2 months to prepare for their wedding and published a checklist with 22 tasks for them to complete. By the 1990s, the magazine recommended 12 months of wedding preparation and published a checklist with 44 tasks to complete.” Presumably, humanity lost count of months and tasks required to execute a fairytale wedding since then. But, “in 2012, total expenditures on diamond rings were roughly $7 billion in the United States.”
But is any of this ‘happiness industry’ working? “Overall, we find little evidence that expensive weddings and the duration of marriages are positively related. On the contrary, in multivariate analysis, we find evidence that relatively high spending on the engagement ring is inversely associated with marriage duration among male respondents. Relatively high spending on the wedding is inversely associated with marriage duration among female respondents, and relatively low spending on the wedding is positively associated with duration among male and female respondents. Additionally, we find that having high wedding attendance and having a honeymoon (regardless of how much it cost) are generally positively associated with marriage duration.”
Per authors summary: “The wedding industry has consistently sought to link wedding spending with long-lasting marriages. This paper is the first to examine this relationship statistically. We find that marriage duration is either not associated or inversely associated with spending on the engagement ring and wedding ceremony.” Or in other words, you might be able to buy your way into marriage, but you are unlikely to buy your way into a happy union.
Full paper: Francis, Andrew M. and Mialon, Hugo M., ‘A Diamond is Forever’ and Other Fairy Tales: The Relationship between Wedding Expenses and Marriage Duration (September 15, 2014): http://ssrn.com/abstract=2501480. Note, the paper has been since published in the Economic Inquiry (Volume 53, Issue 4, pages 1919–1930, October 2015).
Friday, October 16, 2015
16/10/15: Euro Area Inflation, via Pictet
An interesting chart highlighting the poor prospects for inflationary expectations in both Euro area and the U.S. via Pictet:
Here’s Picket analysis (comments and emphasis are mine): “In September, headline inflation in the euro area dipped back into negative territory (-0.1% y-o-y) for the first time in six months.
"This weakness must be put into context though as it is primarily due to the steep slide in energy prices. If volatile components (food and energy) are stripped out, core inflation was steady at +0.9% y-o-y. Furthermore, prices of services, which better reflect domestic conditions, rose.
"Nonetheless, falling commodity prices, coupled with the rise in the euro’s trade-weighted value, caused the inflation outlook to worsen. Long-run inflationary expectations, as measured by the break-even swap rate, have been softening steadily since early July and have now reached their lowest level (1.56%) since February this year.
…In parallel, findings from economic and business surveys (PMIs, European Commission surveys) for the third quarter showed decent resilience despite the worries about the Chinese economy. They point to GDP growth of around 0.4% q-o-q in Q3 and Q4.”
Picket projects growth of 1.5% y/y for 2015, “led by domestic demand” that is expected to “continue to benefit from normalisation of the jobs market, subdued inflation, the gradual revival in consumer confidence and an upturn in lending to the private sector.”
In short, sensible view of inflation - low inflation, per Pictet is helping, not hurting the euro economy.
16/10/15: IG Conference: Markets Outlook
My speaking points on the topic of the Markets Outlook for yesterday's IG conference:
Short themes:
Theme 1: Markets pricing in advanced economies:
- EV/EBITDA ratios signal overvaluation;
- EBITDA/Interest Expenses ratio is at below 2010 levels (below 14%) despite extremely cheap debt.
A handy Bloomberg chart:
- Global debt cycle has turned – sovereigns are not leveraging as fast or deleveraging, but corporates leveraged up.
- Much of pricing today reflects migration from equity to debt
- In this environment – long only allocations are problematic.
Theme 2: Emerging markets, especially BRICS
- Idea of 3rd Wave – Goldman’s thesis – is based on two drivers: duration of the crisis (‘this can’t be going for so long…’) and firewalls (‘this can’t spill into the developed economies…’) both of which are
- There are no fundamentals to support robust recovery view
- Again, allocations are highly problematic.
So short-term summary is poor when it comes to hard numbers:
- World economic growth for 2015-2017 forecast is down from 14.1% in 2012 to 10.9% today
- Euro area economy forecasts are flat: 5% in 2012 and 4.9% today, holding relatively steady compared to the rest of the world solely because Europe is now Japanified
- Advanced economies down from 8.1% to 6.6% - another miserably Japanese-styled performance compared to past averages
- Emerging and developing economies from 19.55 in 2012 to 14.0%.
On inflationary targets and rates: the only way we are going to get to the inflationary expectations consistent with monetary policy normalization, is by literally superficially jacking up prices through Government controlled sectors and/or via regulatory policies. Which is to say that any inflation above, say 1% or so in the Advanced Economies, today, will be consistent with stripping income out of the economy to prime up financials (in the short run) and public purse.
Longer themes:
As much as I love the good story of innovation and technological revolutions, I am afraid to say my fear is that we are heading for the twin secular stagnation scenario:
Supply side stagnation:
- Technological returns (productivity growth and new value added) are tapering out
- Substitutability of labour is rising and with it, risks to economic systems
- Regionalisation of trade and production are gaining ground and markets fragmentation is going to play a disruptive havoc with our traditional market valuations
- So expect more volatility on flatter trend.
Demand side stagnation:
- Demographics
- Savings/investment imbalances,
- Debt overhang – across both advanced economies and, increasingly also, emerging markets, so we have a Myth of Post Financial Crisis Deleveraging (via BAML)
Global Debt to GDP
2010-2015: 220 to 240%
2000-2010: 190 to 200%
1990-2010: 170 to 190%
Or a handy chart
- Wealth and income inequalities, including intergenerational effects
- Rebalancing of economic growth drivers (human capital focus pushes incomes gap wider and deeper, but also clashes with current taxation and political systems)
Key forward is to expect:
- Flatter growth trend and more volatility around that trend
- Higher volatility / instability in higher moments
- Financial imbalances accelerating and amplifying
- Financial imbalances / cycles leading real cycles (Excess Financial Elasticity hypothesis)
- Economic volatility spilling, increasingly, into political volatility (political economy).
Key strategy points:
- Focus on lower debt levels on companies balance sheets
- Focus on companies actually paying attention to core basics, e.g. earnings, sales, profit margins, as opposed to subscription bases, user counts etc
- Focus on companies with strong regional reach (not only in product markets, but in logistics and production bases)
- Focus on companies with revenues linked to multi-annual contracts
- Go defensive, stay defensive in core allocation
- Go speculative with low leverage only and on a small share of total wealth
- Go speculative trades on uncertainty and long 5-10 percentile under-performers
16/101/5: Millennials: A Power Poverty Gap?
Having discussed the plight of the Millennials' Generation in global context on numerous occasions, I am too familiar with the problems faced by the current 'younger' middle of demographic pyramid. Hence, not surprisingly, I found this article http://www.independent.ie/opinion/ireland-forces-young-people-to-delay-lifes-milestones-31599496.html to be quite a reasonable summation of the modern reality in which the current younger generations can no longer expect to have better quality of life (measured by more traditional metrics) than their predecessors.
I will ignore the set of prescriptive policies at the end of the article - some make sense, others largely represent well-intentioned economic sentimentality. But the key issue is an important one.
And here is a counter-part piece on the Millennials trends in the U.S.: http://www.nielsen.com/us/en/insights/reports/2015/millennials-in-2015-financial-deep-dive.html.
16/10/15: Gold and Bitcoin: Adjacency and Hedging Properties
This week, I spoke at a joint Markets Technicians Association and CAIA seminar hosted by Bloomberg, covering two recent research projects I was involved with on the role of Gold and Bitcoin as safe havens and hedges for other assets.
Here are my slides (omitting section division slides):
A caveat to the above, we are seeing increasing evidence that Gold's hedging properties may be changing over time, especially due to increased financialisation of the asset. In this context, it is worth referencing a recent working paper by Brian M. Lucey et al linked here that I also cited at the seminar.
- The 'lumpy' nature of demand around Cypriot banking crisis; and
- Potential effects on data quality reported for Bitcoin from a small number of high profile pricing events, such as technical glitches and supply/demand shifts linked to large exchanges-linked events (e.g. MtGox).
16/10/15: Finance@Google 2015
Few weeks back I was taking part in the Finance@Google 2015 conference covering a range of topics from the future trends in Financial Services to more current / shorter-term aspects of the markets for Financial Services (Banking, Insurance and Online Aggregators, amongst a range of other services).
Here are two videos of my presentations:
First: my presentation "Finance at the End of Old Norms" - link here.
Second: my interview "Excuse the Interruption: Financial Expert in the Spotlight" covering a wide range of questions relating to the evolution of Financial Services - link here.
16/10/15: How to Write Perfect Vacuum
Here is one rare occasion where, simultaneously,
- An academic achieves a certain degree of notoriety laying a claim to authoring just one working paper that no one have seen; and
- An academic achieves completeness of an argument by not publishing the only paper he claims to have authored that no one have seen.
Consider the following posting on the SSRN site:
Can Philosophy Be Justified in a Time of Crisis?
Nathan J Robinson
Harvard University
September 3, 2015
Abstract:
In this paper, I take the position that a large portion of contemporary academic work is an appalling waste of human intelligence that cannot be justified under any mainstream normative ethics. Part I builds a four-step argument for why this is the case, while Part II responds to arguments for the contrary position offered in Cass Sunstein’s “In Defense of Law Reviews.” First, in Part I(A), I make the case that there is a large crisis of suffering in the world today. (Part I does not take me very long.). In Part I(B), I assess various theories of “the role of the intellectual,” concluding that the only role for the intellectual is for the intellectual to cease to exist. In Part I(C), I assess the contemporary state of the academy, showing that, contrary to the theory advanced in Part I(B), many intellectuals insist on continuing to exist. In Part I(D), I propose a new path forward, whereby present-day intellectuals take on a useful social function by spreading truths that help to alleviate the crisis of suffering outlined in Part I(A).
And that's it.
Point (1). There is no paper enclosed. And I cannot locate a paper anywhere on the web. The author does not seem to have written a single published paper / article / book chapter prior to that with exception of a children's book or beyond a handful of non-academic articles on matters of interest and subject depth of the Huffington Post. The author does not seem to have any specialisation in the subject matters covered in the abstract.
Point (2). The abstract is bold. But the abstract is also self-contained: if the unique role of an intellectual is to spread "truths that help to alleviate the crisis of suffering", then the role of an intellectual does not include publication of research on themes unrelated to the topic of "alleviating the crisis of suffering". In other words, to complete his own argument by own example, Mr. Robinson is required not to publish his own paper. Which he does.
And the world is going gaga over a non-published and not-available-anywhere paper... Which is to say, simply, the Huffpo intellectuals go shrill for an abstract.
Chill, folks... it all might just be a student prank, or a poorly executed attempt at discovering the next Theory of Justice, or neither...or it might just be the denouement to intellectualism: a falsifiable statement that no one will ever be bothered to falsify because... err... it is already refuted by the very existence of an abstract in absence of a paper...
But, really, can we have a paper, Nathan?.. Please, pretty?..
Thursday, October 15, 2015
15/10/15: Budget 2016: Tech & Entrepreneurship Perspective
My take on the Budget 2016 from the perspective of tech sector: https://www.siliconrepublic.com/video/dr-constantin-gurdgiev-on-budget-2016-stimulating-consumption-by-taking-credit-card-on-future
And more of the discussion of the Budget from technology sector and entrepreneurship perspective here: https://www.siliconrepublic.com/video/dr-constantin-gurdgiev-on-budget-2016-stimulating-consumption-by-taking-credit-card-on-future
Thanks to @iia for hosting the event and to the Silicon Republic for putting the discussions into broader public domain.
I covered the Budget in broader setting of economy-wide entrepreneurship and start ups formation here: http://trueeconomics.blogspot.ie/2015/10/141015-there-isnt-ireland-without-mnc.html.
Wednesday, October 14, 2015
14/10/15: There isn't Ireland without MNC Inc.: Budget 2016
Budget 2016 went in like a circus convoy entering a sleepy town: all pomp and all the excitement with little substance of change in tow.
Budget 2016 is a political budget and not an economic one. The point of all the smaller taxation measures in it, relating to people working for living, is simple: get those voters, vulnerable to swing Left to stay Centre. Sinn Fein got punched, few independents too; Labor got cookies to hand out. But even on this count, Budget 2016 was a fizzle of a firecracker with mostly smoke to show in the end:
- Much lauded idea of exempting from USC all earners
- Virtually all net gains for low income earners from this Budget do not accrue from Michael Noonan spending tax revenue or Government cash, but from minimum wage increase. Just how exactly does minimum wage hike (a mandated cost imposed onto employers - rightly or wrongly is not the point here) qualify as a fiscal policy measure (aka, Government fiscal management of the economy) beats me. Proper economics have no room on fiscal policy side for the scenarios where Government spends not its own money on stimulating its own votes. Note: Employer PRSI change is virtually immaterial, costed by the Department of Finance at only EUR7 million over full year. Where this might help somewhat is in alleviating pressure on employers to cut working hours.
Besides the above aberrations, the Budget was a net positive for current consumption spending, and was a net zilch for investment. Now, here the Government logic is completely off the charts. We are borrowing money to fund the Budget 2016 measures. And we are channeling this borrowed cash into activities that are not expected to generate a return, since these are non-investment activities. Multipliers for current consumption are miserable - most of the stuff we will be buying with the few quid we got in Budget 2016 is stuff made elsewhere and all we can collect in this economy from it is a small gross payout on labour in the retail and logistics sector. Whatever the social imperatives can be for such a 'stimulus' (and they are quite sound in some cases), it is poor economics and poor strategy.
When it comes to economics: Budget 2016 continues with a well-established theme of doing everything possible to demolish productive entrepreneurship spirit in the country. This time around, it is doing it with a flavour of simultaneously pretending that we are pro-entrepreneurs.
Take the following post-Budget 2016 numbers:
- Income tax: What maters here from entrepreneurship and modern economy activity is the upper marginal tax rate, not the base rate. Why? Because people do not choose to become entrepreneurs to earn EUR34,000 a year. It is that, brutally, simple. So in Ireland post-Budget 2016 we have a 40% upper rate kicking in at EUR33,800. Across the pond, in the UK, this happens at EUR59,900. Get it? Forget entrepreneurs, we are talking about school teachers being high earners according to our tax codes.
- Dividends taxation: You get dividends on your investments (rare, but happens in normal economies). Your upper tax on these is 55% here in Ireland, whilst in the UK it is 38%. Darn, those rich retail investors who carefully select better quality long-term non-speculative shares (majority of which pay dividends). Whack them hard, shall we?
- Capital gains Tax: We are a basket case. We have general rate of CGT of 33% which is higher than UK's 28%. We have now a new measure that allows for some reduced CGT on the first EUR1 million at 20%. Minister Noonan thinks that is a great way to reward successful entrepreneurs. In the UK, they think a reward should involve 10% CGT for such investors. For investment returns of up to EUR13 million 'entrepreneurship Island' reserves an effective (reduced by Budget 2016) rate of 32%. In the UK it is 10%. There is no CGT exemptions for qualifying investors and no CGT rollover for reinvestment in Ireland, whilst both measures are available in the UK. Case closed.
- Capital gains structural incentives: For years Irish policymakers and Enterprise Ireland have been struggling with the fact that majority of Irish entrepreneurs opt for early exits from companies - in other words, instead of building large Multinational Enterprises, our entrepreneurs too often opt for a sale of company early on. It has been an explicit objective for Irish development agencies to stimulate growth of companies beyond certain thresholds in size in the past. And Budget 2016 just created an added (albeit small) incentive to exit earlier, rather than later (the cap on preferential rate being set at EUR1 million). Classic example of incentives contradicting objectives.
- VAT: in Ireland, post-Budget 2016, this stays 23% and the crazy situation of charging VAT on services provided to non-VATable entities remains in place. In the UK, VAT is 20%. Thresholds: in Ireland VAT accrues for traders with revenue of >EUR37,500, but in the UK the threshold is Stg82,000. Get that, all of you self-employed and sole traders.
Of course, there is one, just one, area where Irish Government continues to impress the world: Multinationals-linked Tax Optimisation schemes. Ireland now has a Knowledge Development Box bestowing 6.25% corporate tax rate on... err... we don't quite know what. Promise is - it will apply to 'certain' patents and software copyrights. Which is just a tiny sub-set of actual business innovation and knowledge acquisition. And it is the subset that MNCs dominate. The Department of Finance estimate this measure to cost the Exchequer EUR50 million. Which really tells you just how much real activity this Knowledge Development Box is going to generate (answer is: very little) as opposed to how much of the old tax optimisation loopholes it is expected to absorb (answer is: plenty).
NY Times headline from yesterday says it all, really:
Our Knowledge Development Box is 'boxier' than that of the UK - our 6.25% tax beats their's 10% one. Case closed: MNCs win, and there is no economy beyond that which matters.
Anyone noticing that the world around us and the world inside Ireland is shifting toward supporting human capital-centric growth (yes, not labour or PAYE or specific sector, but Human Capital-centric)? Well, over 40 submissions from various bodies and individual analysts to Budget 2016 did. They also spelled out that this shift entails two key things:
- The need to recognise the risks assumed by workers and entrepreneurs working in this New Economy; and
- The need to recognise the fact that human capital-endowed workers are higher earners (not the rich, but well above the average).
People like myself have been drumming this beat for ages now. Still, Budget 2016 does nothing to resolve discriminatory taxation of human capital under the USC system, discriminatory taxation of human capital in self-employment under the USC system and broader income tax system, and it has done nothing in terms of even considering asymmetric risk loadings that entrepreneurs and self-employed carry compared to PAYEs. The Budget does help by introducing Earned Income Tax Credit to offset, partially (by 1/3rd) the glaring discrimination against self-employed inherent in the PAYE tex credit system. But this is hardly a measure to fully address the problem of the taxation system vastly out of tune with realities of modern economy.
Time to ask that pesky question, thus: Does this Government understand modern economy or do we still have leadership that thinks in terms of early 20th century proletarian world?
The sop of the 'entrepreneurship' measures unveiled in Budget 2016 is illustrative to the above question:
- Corporation tax exemption for start ups for the period of 3 years has been extended. The measure 'costs' the Exchequer EUR2 million per annum (per Budget 2016 estimates) same as the estimate for the measure in Budget 2015. Apparently, even by Department own figures, there is zero growth in uptake of this measure year on year.
- The Knowledge Development Box - which is for all intents and purposes is about useful for entrepreneurs and start ups as the Beats by Dre headphones are to the donkey.
- The EIIS scheme to incentivise investment into start ups has been 'fixed' (by increasing company limit from EUR5 million to EUR15 million). Except, the fix addresses non-existent problem and the real problems remain not tackled. You see, you gotta be a fabled unicorn (in Irish market terms) to raise EUR15 million as a start up. Majority of entrepreneurs need far less capital than EUR5 million. So the old ceiling was not a barrier in EIIS scheme. However, EIIS is excruciatingly bureaucratic and difficult to navigate, which it remains such after Budget 2016. And EIIS is not suitable for raising small funding that majority of start ups really need up front - EUR100,000-200,000. Which, once again, Budget 2016 left unaddressed.
And that's it. Entrepreneurs and the self-employed, high Human Capital-endowed workers, start ups, their directors and advisers, as well as their key employees - all can now send their 'Thank You' cards to the Minister for all the love and support extended to them yesterday. Or they can continue to send their business to the UK and Northern Ireland, where quietly, without labelling themselves to be the 'Best ... Country to Do Business In' the fiscal powers are trying to run a more benign environment for investors, entrepreneurs and start ups.
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