Duncan’s Economic Blog

Ireland: Three Questions and a Red Line

Posted in Uncategorized by duncanseconomicblog on November 22, 2010

Ireland is finally facing a long awaited reckoning. This comes as no surprise.

Rather than run, once again, through the reasons why this has happened, I thought it might be worth setting out some questions – and a red line on which the UK government in particular should be negotiating.

But first, it is worth dealing with one central point: this bail out will not work. Without strong medium near (and preferably near term) growth, there will be no solution to Ireland’s problems and such growth will not emerge against a back drop of severe fiscal tightening, The medicine prescribed by the Irish government, and urged by the UK, will kill the patient.

Three major questions remain. First, what happens after this? Assuming the EU manages to come up with enough cash to keep the economy liquid, what happens next? Do the bond markets now turn on Portugal? And if the EFSF (European Financial Stability Facility) is then used to bailout Lisbon, what if they turn on Spain? The EFSF couldn’t cope with that. What long term planning is being done to come up with a long term, Europe-wide solution? It’s taken a week of leaks and denials to get to this point with Ireland, this bailout has been incredibly badly managed – I doubt much long term planning has been carried out.

Second, what solution will Europe suggest to the Irish growth problem? Monetary policy is tight (in the context of domestic deflation, real interest rates are high) and fiscal policy is off the table. So, presumably, as with Greece the answer will be “structural reforms” and “liberalisation” to raise productivity and the growth potential.  Someone will have to explain to me how Ireland, the poster-child for liberalisation, can be reformed further. Exactly what “reforms” are about to be inflicted on the ailing economy?

Finally, is the UK going to lend to Ireland bi-laterally? Why? Will UK loans have a different place in the creditor queue in the event of default (which will come)? Will they have different conditions attached?

And lastly, the red line: Irish corporation tax. Maintaining a 12.5% corporation tax rate was always predatory, and in mine opinion not in the Irish national interest anyway. It is now indefensible. It was indefensible to not raise it whilst cutting pensions, benefits, jobs and spending on infrastructure and public services. In the Irish case “they are all in this together except foreign corporations”.

The Celtic Tiger was not build on structural reforms and low taxes, it was build on foundations of sand: negative real interest rates and an asset price boom.  

The pulling in of footloose global companies attracted by the lowest tax rate in the Eurozone not only deprived other states of much needed revenues, it also led to a fundamentally unbalanced Irish economy.

We should not support a bailout that doesn’t involve raising that tax rate.

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32 Responses

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  1. [...] This post was mentioned on Twitter by Alasdair Thompson and Duncan Weldon, Duncan Weldon. Duncan Weldon said: Post – Ireland: 3 Questions and Red Line. http://wp.me/pt0AC-jj [...]

  2. Neil Wilson said, on November 22, 2010 at 10:29 am

    “Maintaining a 12.5% corporation tax rate was always predatory, and in mine opinion not in the Irish national interest anyway.”

    Can somebody explain to me why a 12.5% corporation tax rate is allowable under European Law, yet a direct state wide bung of millions of Euros would fall foul of the ‘State Aid’ provisions of the European Treaties.

    What’s the difference?

  3. CharlieMcMenamin said, on November 22, 2010 at 10:37 am

    Morgan Kelly of UCD sees only a mass loss of homes followed by national bankruptcy ahead for Ireland:

    “If one family defaults on its mortgage, they are pariahs: if 200,000 default they are a powerful political constituency. There is no shame in admitting that you too were mauled by the Celtic Tiger after being conned into taking out an unaffordable mortgage, when everyone around you is admitting the same.

    The gathering mortgage crisis puts Ireland on the cusp of a social conflict on the scale of the Land War, but with one crucial difference. Whereas the Land War faced tenant farmers against a relative handful of mostly foreign landlords, the looming Mortgage War will pit recent house buyers against the majority of families who feel they worked hard and made sacrifices to pay off their mortgages, or else decided not to buy during the bubble, and who think those with mortgages should be made to pay them off. Any relief to struggling mortgage-holders will come not out of bank profits – there is no longer any such thing – but from the pockets of other taxpayers.

    The other crumbling dam against mass mortgage default is house prices. House prices are driven by the size of mortgages that banks give out. That is why, even though Irish banks face long-run funding costs of at least 8 per cent (if they could find anyone to lend to them), they are still giving out mortgages at 5 per cent, to maintain an artificial floor on house prices. Without this trickle of new mortgages, prices would collapse and mass defaults ensue.

    However, once Irish banks pass under direct ECB control next year, they will be forced to stop lending in order to shrink their balance sheets back to a level that can be funded from customer deposits. With no new mortgage lending, the housing market will be driven by cash transactions, and prices will collapse accordingly.

    While the current priority of Irish banks is to conceal their mortgage losses, which requires them to go easy on borrowers, their new priority will be to get the ECB’s money back by whatever means necessary. The resulting wave of foreclosures will cause prices to collapse further….

    With a sufficiently low interest rate on what we owe to Europe, a combination of economic growth and inflation will eventually erode away the debt, just as it did in the 1980s: we get to survive.

    How low is sufficiently low? Economists have a simple rule to calculate this. If the interest rate on a country’s debt is lower than the sum of its growth rate and inflation rate, the ratio of debt to national income will shrink through time. After a massive credit bubble and with a shaky international economy, our growth prospects for the next decade are poor, and prices are likely to be static or falling. An interest rate beyond 2 per cent is likely to sink us.

    This means that if we are forced to repay the ECB at the 5 per cent interest rate imposed on Greece, our debt will rise faster than our means of servicing it, and we will inevitably face a State bankruptcy that will destroy what few shreds of our international reputation still remain.”

  4. Paul said, on November 22, 2010 at 11:24 am

    Duncan, Im with you intuitively on the need to demand a corp tax rise, but as a technical point how would you counter the argument that Irish corp tax has contributed as much as other EU countries as a percentage of GDP.

    http://www.ronanlyons.com/2009/06/22/can-ireland-afford-to-increase-its-corporate-tax-rate/

    I’m missing something obvious, I think.

    • duncanseconomicblog said, on November 22, 2010 at 11:45 am

      Paul,

      I’m not sure that’s the best measure – and also remember that Irish GDP and GNP are very different due to the large number of foreign enterprises present.

      The overall tax take is around 35% of GDP. There is certainly room to increase that!

  5. Kris Lord said, on November 22, 2010 at 11:26 am

    What should the rate be? The rate is so out of step with other countries an increase would have to be substantial.

    • duncanseconomicblog said, on November 22, 2010 at 11:45 am

      Kris,

      Yes to bring it in line with European norms would take a large rise, which isn’t practical in the short term. Although I think an immediate increase to 14.5% is do-able, coupled with a long term programme to bring it to 20% by, say, 2020.

  6. [...] other news, Duncan has three questions which partly boil down into one big one: Is Ireland really the place to adopt the mantra that [...]

  7. Rachel said, on November 22, 2010 at 2:25 pm

    Duncan,

    As usual spot on. Would we have given a bilateral loan bailed out under a Labour government? My instinct is that however unpopular and, possibly, wrong that would have been I think we might have done.

    What is the economic case for and against?

    Rachel

    • duncanseconomicblog said, on November 22, 2010 at 2:30 pm

      As I understand it, the Uk and Sweden will lend through the IMF facility and bi-laterally, whilst Eurozone members will lend through the IMF and through the EFSF.

      The UK doesn’t want to be part of the EFSF as we are not Euro members.

      I can very curious as to whether our loans will be on the same terms, same interest rates and (most importantly) were we will be in the creditor queue if there is a default.

      I’d have thought it was easier to lend more through the IMF.

      I am not against taking part in a bailout, but I do think we should demand some pretty strong action on tax – and not insists on more spending cuts at this moment.

      More thoughts to follow tomorrow!

  8. barbertuti said, on November 22, 2010 at 2:55 pm

    Duncan

    I have left a similar comment on Robert Peston’s blog, and one of the good things seems to be that the loan will need to be passed by Parliament which may give us an indication of the terms.

    To your questions I would add: the denominated currency, the term of the loan and and default penalties.

    Finally, what scope there is for public monitoring of the repayments.

  9. Ronan L said, on November 22, 2010 at 3:37 pm

    Hi Duncan,
    So under your proposals, Delaware or North Carolina – as constituents of one country – can set whatever corporate tax rate they like in the USA, but Ireland, Malta, Hungary, Estonia, Cyprus – all as sovereign members of the EU – shouldn’t be allowed to. Presumably this argument applies to all EU member states that have a corporate tax rate you don’t like.

    Incidentally, you might (or might not) be interested to learn that Ireland loses a lot of potential corporate tax revenue from multinationals to tax havens via the Netherlands.

    “Maintaining a 12.5% corporation tax rate … is now indefensible. It was indefensible to not raise it whilst cutting pensions, benefits, jobs and spending on infrastructure and public services. In the Irish case “they are all in this together except foreign corporations”.”
    Wow. Perhaps you spend some time living in Ireland or another small economy. Capital likes being around other capital and labour, hence larger economies can get away with charging a higher corporate tax rate than smaller ones can.
    Great political rhetoric about companies paying their fair share, but it wouldn’t make any headway in Ireland, where the overwhelming majority agree that if it weren’t for the 150,000 or so jobs supported by FDI, pensions, benefits, jobs and spending on infrastructure and public services would be a lot lower.

    You seem to think Ireland was a poster child for liberalisation. It was a poster child for runaway government spending, which almost trebled in the decade to 2008, compared to just a doubling in the UK and typically 50% elsewhere in the OECD. That is what has to be fixed.

    Becuase of a mix of factors – most notably ease of doing business, being the only English-speaking eurozone country, low corporate taxes and a ready supply of skilled labour – Ireland was the most successful country in the world at attracting FDI jobs in both 2008 and 2009, according to the IBM GILD report. All indications are that 2010 will be even more successful. Don’t take that away from a country that needs the jobs.

    • duncanseconomicblog said, on November 22, 2010 at 3:54 pm

      Ronan,

      In my ideal world countires wouldn’t compete with predatory tax rates to draw business from each other, yes.

      But in the specific case of Ireland now, given the large relocations from the UK to Ireland over the past decade, I think the UK and France are entitled to insist that any loan comes with conditions.

      More generally in the context of large cuts to public spending, and a rumoured one euro off the minimum wage, I think insisting that corporation tax also rises is social just.

      The EU doesn’t allow state aid. I don’t see a difference between direct subsidy and a 12.5% corporation tax.

  10. Ronan L said, on November 22, 2010 at 4:00 pm

    You are aware, though, that if you force the same tax rates on corporate income – and then presumably labour income, otherwise competition would just shift to that – you will seriously undermine attempts to ensure some sort of balanced development across regions of the world. In other words, you can’t pretend agglomeration economies don’t exist.

    • duncanseconomicblog said, on November 22, 2010 at 4:10 pm

      Ronan,

      The last thing I want is a race to bottom in terms of corporation taxes and wages across Europe.

      I wish the EU had engaged more seriously on this over the last decade.

      But right now, Irish corporation tax is a totemic issue.

      I can’t seriously believe that any government, especially one facing an election, is prepared to defend not raising corporation tax whilst engaging in otherwise savage tax rises and spending cuts.

  11. Ronan L said, on November 22, 2010 at 4:21 pm

    Quite simply, because hundreds of thousands of jobs in Ireland – a substantial fraction of the workforce in a country as small as Ireland – depend on FDI. If you don’t have these jobs, you don’t have all the VAT revenues and income tax that they produce. As someone pointed out above, Ireland is among the top five in the EU in terms of its corporate tax take as a percentage of GDP. Why on earth would any team trying to *fix* Ireland’s deficit break the one thing that is definitely working, instead of tackling run-away spending?

    The only two areas Ireland’s tax system is deficient, in terms of producing revenue, are (1) lack of a sustainable property tax [€3bn a year], and (2) overly generous tax-free allowances [another €3bn a year]. There is almost universal consensus that the remaining €10bn in savings will have to come from spending, which was fourth largest in Europe last year, if – as you are so keen to do elsewhere – you look at GNP.

    No party in Ireland is contemplating “fixing” corporate tax, with the exception of Sinn Fein, who are economically socialist (even they talk about a rate of 20%), as it would be economic suicide. Most have already gone on the record to reassure workers, voters, companies and markets that for them the corporate tax rate is a deal-breaker. Thankfully, judging from what they’ve said over the weekend, it seems to have been pointed out to Europe’s leaders that:
    (a) if corporate tax is a raging fiscal success, don’t mess with it
    (b) while it is in need of cash for its banking system, Ireland is a sovereign state and should be able to set its own taxes aaccordingly.

    • duncanseconomicblog said, on November 22, 2010 at 4:41 pm

      Ronan,

      I doubt we’ll agree on this one (corporation tax). And I’m not going to rise to the bait of “run away spending”.

      I do think this Reuters article is a balanced read on the corporation tax issue:

      http://www.reuters.com/article/idUSTRE6AI3HN20101119

  12. Ronan L said, on November 22, 2010 at 4:47 pm

    Hi Duncan,

    No worries – no point having a long tit-for-tat in the comments, but perhaps we should see about setting up an online discussion, e.g. irishdebate.com – send me an email if you’re interested.

    In that article, Prof Philip Lane summarises the economics of it all quite well. (Incidentally, EU subsidies are overstated in that article: compared to the effect of EU market access, they were quite a small amount, although steady and very welcome, in the grand scheme of things.)

    On government spending, I am by no means a blinkered anti-spending hack. But trebling permanent spending in ten years *is* at the heart of the problem.

  13. Matt said, on November 22, 2010 at 5:10 pm

    Hi Duncan

    Would it not be better for Ireland, as it biggest trading partner is the UK, to ditch the Euro, replace it with the Pound. In fact, due to this factor, would it not be best for Ireland to join an economic union with the UK?

    • Neil Wilson said, on November 23, 2010 at 10:53 am

      Another Act of Union replaces one currency union with another – and exactly the same problem.

      Our currency union has a concentration of those that are making pots of cash due to the currency being lower than it otherwise would have been (ie the South East of England), while the rest of the union exists on transfer payments.

  14. [...] is a fairly extreme example, with fairly approximare numbers, just to make the point.  In fact, Duncan calls for a more gradual approach, starting with Ronan’s 14% and then moving towards 20%, still at the lower end of the [...]

  15. Luis Enrique said, on November 22, 2010 at 8:33 pm

    Lord knows how you pick yourself up from this. Is there best bet a (relatively) high tax-and-spend, or a relatively low tax-and-spend? Take away the banking disaster, and Ireland does have a reasonbly strong private sector doesn’t it? But I don’t know, can tell stores either way.

    as for the short-medium run pragmatic question of what tax policy will maximize tax revenue … well again I have no insights apart from obvious worry that raising
    corporate taxes too high may cause some FDI to depart. What else are you going to lure them with? Low wages?

    What I’d like to know if who is going to wear the losses from the banking crisis. As ever the priority appears to be protecting the bank’s creditor. If the state has de facto nationalized the Irish Banks then any thing that further impairs the value of Irish assets (like a mass mortgage default) is going to drop the state further in it. Are Euro-area tax payers going to wear the losses by extending loans that are going to get written off? If anybody can point me to some good answers to the question of “who will end up holding the losses” I’d be grateful.

    I shan’t say anything about UK tax receipt trends Duncan.

    • Neil Wilson said, on November 23, 2010 at 11:06 am

      UK tax receipts are irrelevant when demand is as depressed as it is. The UK is monetarily sovereign and therefore tax is nothing more than a thermostat to control inflation.

      Unlike Ireland we don’t have to fund spending financially. Instead we should be concentrating on funding the economy with real stuff, ie getting the 4.8 million people that want a job something to do that is beneficial to us all and making sure they have equipment to do it.

  16. jamiedixon75 said, on November 22, 2010 at 10:15 pm

    Duncan

    I do not accept the line that Ireland was asking for this bail-out. If that were true then why the rush to do it this weekend? I assume it was in the belief that a European banking crisis was imminent without it. In that context this bail-out deal became a no-brainer for all sides and the matter of Ireland’s CT rate became irrelevant.

    The UK is, and remains, captive in all of this. The UK’s national interest is in avoiding a European/UK banking crisis. Adjusting Ireland’s CT rate at this time is just tinkering around the edges by comparison.

    Rather than worrying about Ireland’s CT rate and what hypothetical negotiating the UK might do if the reality were different, I think the most important point you raise is regarding what happens next. The priority should be more contingency planning to deal with the chain of crises that is very likely to be ahead of us.

    Jamie

  17. [...] magic potion and it failed by Sunny Hundal     November 23, 2010 at 8:50 am This is what Duncan Weldon predicted yesterday morning: But first, it is worth dealing with one central point: this bail out [...]

  18. [...] Duncan seems pretty certain that Ireland will default.  Eric’s talking about radical bank withdrawals. [...]

  19. Cian said, on November 24, 2010 at 11:20 am

    On the GDP/corporate tax thing. Prior to the crisis I had a couple of conversations with trade economists who reckoned (back of the envelope stuff) that the GDP was inflated by various tax dodges being run by domiciled corporations in Ireland. If that’s true (and god knows I’m not in a position to judge), then I guess reducing corporation tax might reduce GDP on paper, while having a marginal affect in practice.

    I’ve always had a suspicion that a fair bit of the trade statistical data must be noisy due to the various shell games played by multinationals, but never really known how to check.

  20. crossland said, on November 24, 2010 at 5:28 pm

    What is the reasoning behind the bilateral bit of the bailout ? im no wiser as to what it is specifcally adressing beyond the general point about bank exposure and exports.

    Why hasnt the govt just backed the IMF/ECB ?
    It seems odd that ireland was in line for £80-90 Billion ,yet we are providing £7 billon of that on top of our IMF comitment etc.
    Originally i thought that the bilateral bit would give the UK leverage over something to do with the Irish banks and mitigate the demands of the IMF but as we seem to be contributing what is a small amount compared to the overall deal Im not sure thats the case.
    havent seen any detail , anyone know ?

  21. CharlieMcMenamin said, on November 25, 2010 at 5:42 pm

    Dunc,

    Having given it a few days thought, I’m not so certain that hitting on the CT rate is the key issue here. Yes, it’s unjustifiably low in RoI – but, as you seem to acknowledge upthread, there really haven’t got much room to manoeuvre on this front in the short term at least.

    So I wonder if it is a mistake for the Labour Left, Richard Murphy , La Toynbee et al to major on this particular theme. Harmonisation of tax rates in the EU may be desirable, but the lack of such harmonisation is hardly the immediate cause of the Irish problems. I note that the FT Alphaville blog points out , rather splendidly, quite how interconnected Ireland’s problems are with those of the entire global ‘shadow banking’ system.

    I see that James Meek on the LRB blog has a what, to my mind, is a rather more politically robust line: that, actually, this is another bailout of the British banks in disguise. If this view was more widely promulgated it might undermine the general Tory line that our domestic economic woes are all due to ‘excessive’ govt spending under Labour. As he puts it:

    “It has been depressingly easy for the Cameron administration to hypnotise the British public into forgetting that our current economic plight is a result of reckless lending by the country’s banks rather than reckless Labour borrowing. £7 billion, the government must feel, is a small price to pay to avoid another British banking crisis, and to avoid the country waking up and remembering that we are much more like Iceland than we ever were like Greece.”

    • duncanseconomicblog said, on November 25, 2010 at 6:00 pm

      Interesting thoughts. And thanks for the links.

      I’ve been meaning to post on this again, but work/other commitments have meant a busy week. I’ll try and incorporate some of this.

    • vimothy said, on November 26, 2010 at 10:14 am

      Not just the British banks!

  22. [...] at European level about its corporate tax rate. UK blogger Duncan Weldon, for example, wanted any funding to be contingent on changes in corporate tax. The chatter hasn’t died down and if anything, with restructuring for Greece looking inevitable, [...]


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