Tax Analysts Blog

Will Indebted Ireland Be Forced to Raise its Corporate Tax Rate?

Posted on Oct 5, 2010

With newly released estimates of the bailout of Anglo Irish Bank the Irish government is staring down the barrel of a budget deficit equal to a whopping 32 percent of GDP. Ireland does not want a Greek-style foreign bailout and it does not want to default or restructure its own sovereign debt or the debt of its failed banks. So the Irish government is pushing to be the most austere of austere European governments. It has announced its intention to shrink its deficit to 3 percent of GDP by 2014. (The U.S. is not close to making any such commitment and its deficit will be double that level in 2014).

In this fiscal and political maelstrom is it possible for Ireland's 12.5 percent corporate tax rate to survive? At first glance it seems absolutely untenable. Why should the country with the largest deficit in western Europe have the lowest corporate rate? How can a country with over 13 percent unemployment ask for more in middle-class income tax hikes, cuts in social services, and cuts in public sector pay without asking U.S. multinationals to share some of the pain? Last week European Economic and Monetary Affairs Commissioner Olli Rehn said that due to damage to Ireland's public finances inflicted by the financial crisis, Ireland can no longer remain a low-tax country.

The American Chamber of Commerce in Ireland denounced the mere mention of a rate increase. Finance Minister Brian Lenihan vowed the rate would remain unchanged. So did the leading opposition party and many other major politicians.

This is absolutely the correct approach. It would be foolish for Ireland to raise its corporate rate. The low rate provides an annual transfer worth billions from the U.S. Treasury to the Irish government. Here's how it works. Ireland's low rates give a huge incentive to shift profits out of the United States to Ireland. This is relatively easy to do under U.S. transfer pricing rules where intangible assets can be transferred to subsidiaries in low-tax countries like Ireland for a fraction of their real value. The resulting excessive profit in Ireland (it's three times the rate of the rest of Europe) gives that country extra corporate tax revenue at the expense of the U.S. Treasury. From Ireland's perspective this is free money. This is one of those rare cases where raising a tax rate would actually reduce revenue.

But that's not the end of the story. Logic could fall be the wayside as political pressures mount. Details of the four-year plan will be announced in November. It will be met with howls of protest across the political spectrum as everybody must share the pain. But even still it is only the beginning --a mere framework. A new budget must be enacted into law in each year. And with each year a new political battle. It is universally agreed that the government headed by Prime Minister Brian Cowan and his Finance Minister Brian Lenihan will be lucky to survive through 2011 and will certainly be out of office by 2012. The two leading parties in Ireland, Fianna Fail and Fine Gael, are center right. Center-left Labour is a distant third but gaining fast. Calls for large profitable foreign corporations to share the burden will undoubtedly get a more sympathetic ear as time goes by.

Even greater will be the external pressure. Large EU countries like Germany and France are sick and tired of Ireland's low corporate rate attracting business to its shores at their expense. Ireland has been able to forestall pressure from the European giants by threatening EU unity. If politics become too populist in Ireland, or if the financial demands are greater than expected (because, as many believe, the government's economic forecasts are too optimistic), the government may have no other option but to seek help from the stability fund created by the EU and IMF earlier this year (and which the Greek government is already tapped into). Ireland's banks are already getting massive infusions of liquidity from the European Central Bank. Ireland wants to retain its sovereignty but it is in fact increasingly dependent on its fellow Euro-area countries.

The bottom line: If Ireland can stabilize itself without external aid, the 12.5 percent rate will almost certainly survive. But if matters start spinning out of control--a very real possibility--and Ireland must borrow from the rest of Europe, all bets are off.

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