Cash & Investment Management

Ireland & Taxation – Q3 2016

Monday 3rd October 2016

The Irish economy is set to register significant growth in 2016 following exceptionally strong performances in 2015 and 2014. However, there is now a considerable contrast between the domestic and external components of growth. With the former, investment and particularly consumption are in the main fuelling present growth rates, while on the external trade side a certain softening of the growth performance is evident. It is now believed that GDP will increase by 4.3% in 2016 with growth moderating somewhat in 2017 at 3.8%. This weakening of the external trade performance is mainly due to two related considerations, the deterioration in global demand, which, in turn, is due to the continuing weakness of the Chinese economy and, secondly, Brexit-related issues.

Concerns about the UK referendum had impacted, marginally, on the Irish economy in advance of the referendum. However since the UK’s decision to leave, high frequency data particularly for the domestic manufacturing sector suggests that the negative impact has persisted. The ultimate long term implications of Brexit will only be evident once the differing trade relationships between the UK, Europe and the rest of the world have been established. This is likely to take a number of years. The release of the recent National Accounts raises a number of important issues for analysts and policymakers alike. Difficulties with interpreting the National Accounts of a highly open, small economy have long been apparent, however these challenges have been exacerbated by recent developments. Very few people believe that economic activity in the Irish economy expanded by 26% in 2015 and while the Central Statistics Office is clearly bound by the accounting criteria mandated by Eurostat (i.e. the ESA2010 standard), it is imperative that a set of National Accounts be published which presents a credible narrative as to developments in the domestic economy.

The figure is mostly explained by the open nature of Ireland’s economy and its attraction to U.S. companies seeking access to a 12.5% tax rate. The Irish economy grew by 26.3% in 2015, compared with the expected rate of 7.8%, after foreign companies that switched their base to Ireland were included in the value of its corporate sector, pushing up the value of the state’s balance sheet. The process of switching tax domicile after a merger or acquisition, known as an inversion, has increased in recent years, and Ireland has become a popular end destination in these corporate manoeuvres because of its low corporate tax regime.

Several US companies, including pharmaceutical companies Allergan and Jazz Pharmaceuticals, security systems provider Tyco and medical technology specialist Medtronic have domiciled in Ireland by buying a smaller Irish-registered rival and inverting into an Irish corporate structure. Corporations with assets overseas of €523 billion were headquartered in Ireland in 2014, up from €391 billion in 2013, according to the statistics office. A surge in aircraft imported into Ireland by leasing companies that send the jets out on loan to airlines was also among the main reasons for the economic growth. Lease operators based in Ireland account for about 20% of the global market, with sales of €7.8bn. In a statement, Finance Minister Michael Noonan pointed out that growth numbers cut Ireland’s debt and deficit ratios. Trouble is, they carry downsides too. For one, tax inversions artificially inflate the size of Ireland’s economy. When the headquarters of a group of companies becomes resident in Ireland, all of its global profits may be counted as part of the nation’s gross national income, according to the ministry.

Since 2008, that gauge has been boosted by about €7 billion thanks to corporate relocations, without accompanying substance or employment, the ministry has said. This in turn drives up the country’s contribution to the European Union budget, which is based on the size of the economy. Also, it leaves analysts and commentators at a loss to explain the state of the Irish economy. Some have looked at indicators like employment growth and tax revenue for a better gauge, and guessed Ireland’s underlying economic growth was about 5.5% last year.

One area where the national accounting issues cause particular difficulties is in generating reliable metrics for evaluating the suitable fiscal and budgetary stance. In using alternative growth estimates, it is believed that the output gap has closed in the Irish economy. This is an important development on a number of fronts and confirms that the domestic economy has mostly recovered from the international financial crisis of 2007/2008. It also indicates that, subject to full indexation of taxation and social welfare bands, the 2017 budgetary policy should be neutral with fiscal policy neither explicitly stimulating nor contracting economic activity. The case for a neutral policy is compounded by the particularly strong increases in personal consumption in 2015. This, along with the continuing increases in retail sales observed in 2016, suggests that economic activity does not need to be further stimulated by reducing personal taxation levels. Additionally, recent research by ESRI researchers, illustrates the relatively stable nature of income tax vis-à-vis other taxation items as a source of Government revenues. It appears that it is important, from a fiscal stability perspective, that income tax remains a sizeable component of the overall taxation take of the State, and that any significant increases in Government expenditure at this point would increase the productive capacity of the economy.