Ireland's situation demonstrates that tax breaks are a bad way of stimulating activity
Taxes are something of a sensitive subject to most. Citizens tend to know that they are taxed but are unsure of the direct benefits that they receive from the system.
This conundrum has resulted in many people always trying to reduce their tax burden to the minimum while the state attempts to maximize revenue subject to Jean Baptiste Colbert’s dictum of ‘plucking the goose with the least amount of hissing’.
Ireland’s taxation system has been placed under an international microscope because of the changing nature of the global economy. The conundrum began with the US Congress Permanent Subcommittee on Investigations hearings where Sen. Carl Levin began asking awkward questions about the state of the taxation system between some major high tech companies, the United States and Ireland.
While this was a global discussion there was particular disquiet about the ability for firms to eliminate their domicile globally due to a peculiar loophole, now closed, in the Irish tax statutes.
Ireland subsequently became part of an active discussion about how multinational companies operated globally and how these firms were able to use a combination of technology, global supply chains and tax codes no longer fit for purpose.
Changes made to the US tax code in the 1960s enabled more flexibility for US firms operating abroad and how their profits were treated for tax purposes. This is the bedrock of the international taxation system but these rules were designed for a world of merchandise trade not smart phone apps and intangible products.
In Ireland, and across multinational technology companies, there has been an increased intensity of intellectual property over the last five years. The crucial aspect of this is that the value added in these products exists in intangible form and purchased and possibly delivered in an intangible form.
The value added of products held in their intangible intellectual property and the advent of the ‘internet of things’, has changed the traditional lines of taxation, domicile, residence and ownership.
As such, the taxation arrangements, most of which were drafted between the late 19th century and before the last quarter of the 20th century are no longer fit for purpose.
Even statutes as young as a decade old are no longer suitable for this type of economy. The current Knowledge Development Box, modelled on the UK patent box, attempts to find a way to allow changes in the treatment of intangibles to be ring-fenced into functional taxation regime.
Ultimately what matters most in these circumstances is the behaviour of the US tax code and our double taxation treaty with the US. The Irish Knowledge Development Box is another way of ensuring that firms pay a reduced tax bill for activities that are deemed advantageous by policymakers.
The unfortunate reality is that tax breaks (tax expenditures to policy wonks) are a terrible way of encouraging activity and heavily distort investment decisions and mangle the tax code.
The problem is also multinational. Ireland’s tax code aims to best exploit the situation created by the US tax code, which is generally acknowledged to need radical reform.
While it is politically costly to all politicians the problem will most likely become a live issue in the 2016 US election given the prominent coverage of the Irish Apple case and the response by the US Treasury White Paper to what is seen as Commission aggression to US firms.
The worrying thing is that serious thinkers about the future of the US economy, like Robert Gordon, author of The Rise and Fall of American Growth, state:
“Tax laws, like equipment, depreciate in the sense that they accumulate special provisions called tax expenditures, where corporate income is taxed at different rates for particular companies and industries engaged in specific activities encouraged by the tax code. Once implemented, these special provisions accumulate, and their beneficiaries fight hard to retain them.”
Bad tax laws in the US have reduced US economic growth, plain and simple. The Irish position on this should ultimately be one that allows flexibility relative to the modifications of the US tax regime and work towards policies that make tax avoidance less attractive to US firms.
At the same time Ireland needs to be serious about rethinking industrial policy. Tax has a cornerstone of industrial policy since the 1960s and it is clear that such a policy is reaching its sell-by date.
The vigorous criticism of the Commission’s decision by Irish senior political figures, as well as a clear statement that there would be an immediate appeal, indicate that the taxation structure is still the core industrial policy of the country and that there is no ‘plan b’.
The impact of the European Commission’s investigation into the tax arrangements with respect to Apple during the early 1990s has resulted in a significant cost to Ireland in monetary and reputation terms.
In this changing world, and with the EU taking an increasingly stringent approach, governments (and especially small governments) will be placed under more pressure to make their arrangements with large multinationals as transparent as possible.
Good relations with the European Union will require Ireland to walk a fine line between tax avoidance and industrial development. Ireland needs an environment where all action on the part of corporate taxation must be done in a fashion that will ensure that the EU continues to support tax competition between countries and allow tax sovereignty.
Such a possibility existed with continued UK membership; it is a more remote possibility with their exit. The treatment of multinational firm taxation needs to make reference to the situation of the Irish citizen.
Taxation regimes globally face serious challenges and have not been treated with due care in the past. Distortionary tax statutes induce inequality, rent seeking, and the mis-allocation of scarce resources. They rob the state and its citizens of revenues and incomes that they would otherwise enjoy.
While this may appear a dry subject, it is at the very core of Ireland’s future industrial policy and Ireland’s social fabric.
Charles Larkin is a research associate at the School of Business, Trinity College Dublin
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