Has Obama really bombed us?

The recent proposal by the Obama administration to eliminate deferral, under which US multinationals do not pay US taxes on overseas earnings that are ploughed back into their subsidiaries, has sent our local press into a tizzy. The discussion follows the logic that such a move would increase the effective tax rate paid by subsidiaries in Ireland to that in the US. If these firms are here in large part due to our low tax, this would presumably lead to US-owned foreign direct investment (FDI) leaving Ireland en masse furthering our downward spiral.

While this dire scenario makes for good reading for people who like bad news, there are reasons to question the extent of the shift in economic activity this might cause.

The removal of deferral applies only to retained earnings – that is income used actively (US law already removes deferral for passively invested earnings under the subpart F regulations). Thus, this is only for a subset of the earnings attributed to Irish subsidiaries. Nevertheless, it could potentially lead to an increase in repatriations by US owned firms who no longer find it advantageous to “park” them in Irish investment. What does this imply for the Irish economy? As an indication, a tax change in 2004 created a temporary reduction in the US repatriation tax from roughly 35% to 5%. This led to a massive influx of funds (around $312 billion) returning to the US from abroad. However, economic activity by US owned subsidiaries in terms of location or level of investment does not appear to have changed markedly. In fact, in response to a recent call for such a move again, Senator John Kerry noted that “It did not increase domestic investment or employment. The fact is that many of the firms that benefited from this during that period of time laid off workers after they brought that money back. They passed on the benefits to their shareholders.” Thus there was no shift in jobs back to the US before, making it less than certain it would occur under the proposed change. (You can read more about this debate here).

Why might multinational activity not respond as expected? Eliminating deferral does not necessarily increase the tax burden on foreign income. The recent firm-level study of Barrios, Huizinga, Laevan, and Nicodeme finds that multinationals’ subsidiary locations depend negatively on both the parent and host tax. This is true even for countries that offer deferral. This indicates that deferral-offering parent country taxes are already a barrier. This most likely arises because parents and hosts limit tax breaks to locally-owned, locally-undertaken activities (such as accelerated depreciation or R&D tax credits). Thus, the gap the multinationals face isn’t simply the difference between the US statutory rate of 35% and the Irish one of 12.5%, implying that whatever increase in the effective tax may come isn’t going to be the 200% increase being suggested. In addition, the US operates an income basket method of calculating foreign owned tax. What this means is that it adds up worldwide profits to calculate the US tax liability and worldwide non-US taxes to calculate the US tax credit. Thus, the excess credits earned in a place like Germany (where the tax rate exceeds that in the US) can be used to offset the liability that would be owed in an excess limit place like Ireland. Furthermore, since most US firms are in an excess credit position, they already have a buffer to soften whatever increases may result from deferral elimination. As such, it is not in any way clear that this proposed change would necessarily push Irish subsidiaries into an excess limit position (where they would owe US taxes) leading to a reduction in investment.

But all of this presupposes that taxes are a major force in multinational decision making. Evidence indicates that although taxes are useful in attracting investment on the margin, they are generally of second order performance for most investment decisions. In surveys of multinationals, taxes usually rank around 9th in importance, far behind factors such as labour costs, energy costs, infrastructure, and government stability. Turning to econometric evidence, (see Blonigen for a nice review of the literature) while taxes typically show up as statistically significant, the relatively small differences in effective tax rates across countries compared to, say, labour cost differentials, means that these latter differences are more economically significant when predicting FDI patterns. This then reinforces the survey evidence. Furthermore even the effects of taxes have deeper stories as the sensitivity of FDI to taxes varies along many firm, host country, and source country characteristics. For example, Barrios et. al find that multinationals’ tax sensitivity varies along many parameters including the number of subsidiaries it operates (peaking at 4 subsidiaries). For the US, this could be linked to the income basket described above. Therefore to predict the impact in Ireland, it is necessary to know more about the subsidiaries and their corporate networks than simply where they come from. However, even broad brush stroke predictions suggest that the decline in FDI, although present, will not be the massive outflow being predicted.

Finally, when making a decision, the choice facing a multinational is between Ireland and other location choices. This potential change hits Ireland more than a high tax location like Germany because Ireland has low taxes and benefits more from deferral. But who are we competing with for investment? High tax locations (where our relative advantage might be reduced) or low tax locations (where our relative position will roughly the same)? Given recent headlines, investment leaving Ireland seems bound for low tax Eastern European countries (who not coincidentally have far lower wages than we do). Therefore at first blush, it seems to me this change does little to affect Ireland’s attractiveness relative to our actual competition. The continual focus on taxes as THE central pillar of our foreign direct investment policy is missing the bigger point. To put it simply, taxes are not the only reason for investment in Ireland and they never have been. If they were, we would have zero investment since there are other countries with far lower taxes than we currently have. What needs to be recognized both in this instance and in our overall approach to FDI is that taxes are but one aspect of how firms make decisions. A more balanced approach will leave us far less vulnerable to changes in global conditions and less prone to needless hysteria.

So in the end, has Obama betrayed his Irish roots? To the extent that his proposals affect perceptions, maybe. A quick read of today’s papers leaves one with the impression that the one thing we had going for us is gone. However, this both overstates the change in the taxes firms actually pay and assumes that we are competing with high-tax states for US investment rather than other low-tax countries on the periphery of the European Union. But to the extent that Obama’s proposals will affect actual investment in Ireland, there is still a lot more consideration that needs to be given before Moneygall cancels its plans for an Obama heritage centre.

14 replies on “Has Obama really bombed us?”

I’m reminded of Martin Wolf’s line “Factories do not walk”

But, there is a chance that Ireland might lose it’s position as a wholesale clearing location for US multinationals. If the major multinationals (Coca-cola, Google, Microsoft etc.) stop using Ireland as a distribution/sales centre, the effect on employment may not be catastrophic but the effect on Ireland’s balance of payments might not be so benign.

What incentives are required for re-investment and attracting new entrants, may be different.

In January 2007, the then Microsoft Ireland Managing Director Joe Macri said that the Republic of Ireland’s corporation tax rate was the prime reason why multinational companies choose to remain in Ireland. While access to the EU and the availability of cheap labour were key factors in attracting foreign investment here 20 years ago, these have largely been eroded by rising costs, falling productivity and the enlargement of the EU to central and eastern European countries, he said, adding: “That leaves us with tax.”

Most multinationals do not design their products in Ireland and sales/marketing functions are located elsewhere.

Thanks, Ron. Obama’s plan will not hurt a lot, but they will hurt a little.

Potential investors looking at Ireland will see higher labour taxes and lower public services for years to come, though. That will hurt.

In response to Michael, this statement is exactly what I was driving at. 20 years ago the Irish position had many things going for it relative to the rest of continental Europe, low taxes among them. Currently, in an expanded EU, we do not have those same advantages. But this change will impact the tax attractiveness of Poland (where the 2008 corporate tax rate was 19%) and the Czech Republic (where the 2009 rate is 20%) just as surely as it will affect us. If these other factors matter more (and may matter more to young firms as Michael suggests), perhaps rather than panicking we should use this as an attempt to refocus the Irish approach to attracting foreign investment. To this end, Richard is quite correct that other features of the Irish economy are becoming less attractive (although falling levels of public services and rising labor taxes feature large in our competitors as well). Perhaps this is one place to begin a new dialog.

Mark: Trying to answer that question is a big part of my research agenda. I believe a large part of it is that taxes are a politically easy target to point to. How many politicians in the EU are going to argue that wages (a bigger influence on FDI) should be harmonized between the old EU countries and the new accession countries? None. Pointing to low tax rates overseas provides an easy political scapegoat that can swing votes by placing the blame on “foreign” low taxes rather than “domestic” high costs. This combined with the fact that tax competition even between the high-tax EU countries exists drives the call for harmonization.

Ireland should be a great place for multinationals to recruit over the next few years, which was not really the case during the construction and healthcare boom. There will be plenty of graduates, and numbers doing subjects like computer science are already picking up. Our cost competitiveness should improve too, if the labour market is allowed to work.


The BEA says: “the large affiliate share of value-added for Ireland may be related to US MNCs’ geographic allocation of their income from intellectual property rights (such as patents). A sizable share of the investment in Ireland is in industries, such as pharmaceuticals and software engineering, where intellectual property plays a major role. Affiliates in Ireland conduct substantial R&D work, but it appears that a significant portion of the intellectual property held by these affiliates originated as a result of parent-company activity in the United States, and the property rights were subsequently relocated to Ireland where the tax regime for patent royalties is favorable. The royalty income, much of which is for use of the patents in other countries, is treated as arising from sales of services and is counted as part of the value added of the affiliates that hold them.”

This issue of parking patents in Ireland is likely to be a thorny issue.


The Wall Street Journal article of Nov 2005 on Microsoft:

A law firm’s office on a quiet downtown street here houses an obscure subsidiary of Microsoft Corp. that helps the computer giant
shave at least $500 million from its annual tax bill.

The four-year-old subsidiary, Round Island One Ltd., has a thin roster of employees but controls more than $16 billion in Microsoft assets.

Virtually unknown in Ireland, on paper it has quickly become one of the country’s biggest companies, with gross profits of nearly $9 billion in

The companies were subsequently made unlimited to prevent access to the data.


Ron I think you have the fundamentals correct but I suspect that there are more entities like Round Island One that Michael referred to above and the loss of these, or even the threat that their style of operation might be at risk could result in a significant loss of Irish Tax Revenue if these “parking” operations get wound down. Since it’s gone dark we can’t say what Round Island One actually pays in Irish taxes (or at least I haven’t been able to find out, I’d love it if someone here could throw some light on it) but it was paying in over Euro 500m per annum at one point. Losing that would hurt, even if there aren’t any others on the same scale.

The overall risk to existing productive investment is a lot lower as you say and in addition as Con pointed out we are returning to a position where we have a good supply of well educated\experienced workers. My own personal experience in the tech field indicates that the labour market is already working – wage costs have already dropped by between 5 and 15% as employers have opted to push through permanent reductions in wage levels across the board. That trend hasn’t hit the high profile \ multinational employers yet as they tend to respond to such things more slowly but it will trickle in as they carry out salary surveys and see that the overall labour market rates have declined significantly. Some other pain points for potential future FDI are also improving (energy costs are dropping, congestion is not as bad as it was and is improving, broadband infrastructure is finally starting to improve).

[…] Ron Davies of the Irish Economy correctly notes that many larger multi-national firms will be able to cushion the increased burden due to their existing excess credit position. However, the impact of this mitigating effect is entirely unknown and the US tax liability could increase over coming years. […]

A few thoughts, although they were included in the post above. Obviously, firms that will remain in excess credit position with regards to their US tax liability are fine, but for the rest:

1) Even if we’re not comparatively disadvantaged, doesn’t this measure reduce the rate of return on foreign direct investment for multi-national firms in the US? I presume this was the motivation behind the move, i.e. to make domestic investment less relatively unprofitable. What kind of impact could this have? More generally on stifling investment/expansion too.

2) Considering the large profits recorded by multi-national corporations’ outposts in Ireland relative to the scale of their operations here, doesn’t this imply that the impact of increased tax on profits will be greater than under usual circumstances? I am questioning the validity of the econometric evidence there.

Hi Ron, Although I am not sure whether the recent proposals by the Obama administration involve the elimination of deferral, I would like to comment on your ideas regarding the consequences of such an event. Although I agree with many of your ideas, I believe that some points deserve reconsideration.

You start discussing the effect of a removal of the deferral clause both in terms of the volume of the repatriation by US owned firms and the effect that this will have on the Irish economy. You appear to downplay these effects pointing to the effects of a tax change in 2004. This created a temporary reduction in the US repatriation tax. This led to a massive influx of funds (into the US) but no increase in domestic investment or employment. You conclude that the fact that there was no shift in jobs back to the USA before makes it less certain that it would occur under the proposed change.

I don’t think that the temporary reduction in 2004 can be used to support the argument that permanent removal of deferral will have little effect on the Irish economy. The short term deferral was not designed as a disincentive to shifting jobs out of the USA. It is better interpreted as a move that reduces the main negative aspect (for the multinational company) of the deferral clause in the tax code. The deferral allowed TNCs to bring the profits home. The multinational lobby was quite instrumental in this decision. I believe we are addressing the wrong question. The question is not whether the removal (or temporary reduction in 2004) leads to a shift of jobs back to the US. This can hardly be expected. The removal can at most be expected to make taxation a neutral issue in location decisions. I.e., all other things equal, from a taxation point of view it makes no difference whether you are located in Ireland or in the USA – in both cases you pay the full amount of tax. The removal in itself does not provide an incentive to shift jobs to the USA while many existing projects in Ireland tend to involve sunk costs. The question is: did the deferral clause provide an incentive for companies to shift jobs outside the USA and into countries such as Ireland in the first place? I believe so. The big question than is: would a removal of the deferral clause lead to a reduction of FDI inflows in the future. I think it would.

You also question whether taxes are a major force in multinational decision making. This is partly supported by survey results where taxes rank low in importance, far behind factors such as labour costs, etc. In addition, you point to econometric evidence which suggests that differences in effective tax rates across countries are relatively small compared to say labour cost differentials and that these latter differences are more economically significant in predicting FDI patterns. This is true in general. However, as you point out we have to consider the specific context and the specific location factors involved. Ireland is now competing for high value added FDI projects. Skilled labour is an important factor here. In this respect Ireland experiences competition from countries such as USA, UK and Singapore amongst others. Such countries score equal if not better on the size and quality of the skilled labour pool. In such a context a large difference in tax between relevant counties can suddenly be a very important factor.

Finally you ask the question: who are we competing with for investment – high tax locations or low tax locations? Based on recent headlines about investment leaving Ireland bound for low tax Eastern European countries, you argue that we are competing with low tax locations. I don’t think this is correct. There was a time (from the 1960 to 2000) that Ireland competed with low-wage, low tax, countries, often for medium-skilled projects (although at the end of the period increasingly high-skilled). However, since 2000 Ireland is no longer competing with such countries for such projects. Projects are relocating all right, but we are not competing. Ireland simply no longer stands a chance. We are competing for high skilled projects, with countries that have similar, if not greater skill-pools than Ireland, including the USA itself. In this situation, the reduction of tax advantages can significantly impact on Ireland’s ability to attract new FDI projects

Chris van Egeraat


I’d take this with a large pinch of salt. Firstly, in relation to these surveys, companies have an incentive to play down the tax benefits exactly because they are keen to keep their heads beneath the parapet and not incur the wrath of their home tax authority. Secondly, with regard to labour costs, energy costs, infrastructure, and government stability, which of these do you consider to be a major drawcard in Ireland in 2009?

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