Categories
Competition policy International relations Taxation

The state-aid judgement and stateless income

Next Wednesday the General Court of the European Union will give the first judgement in the state-aid case against Ireland in relation to the taxation of Apple over the period 2005 to 2014.  Yesterday, the OECD published the first set of aggregate statistics from the country-by-country reports (CbCR) that were introduced under Action 13 of the BEPS project.  The data are for 2016.

These are linked as the subsidiaries at the centre of the state-aid case, in particular Apple Sales International, were stateless entities for the period under investigation.  Changes to Ireland’s residency rules for companies introduced from the start of 2015 meant it was no longer possible to have an Irish-registered stateless company. 

The data from the OECD show that in 2016 stateless entities continued to play a significant role in MNE tax structures.  Here is all the data on stateless entities by the jurisdiction of the ultimate parent.

OECD CbCR data for Stateless 2016

While stateless entities are a significant feature of the corporate tax landscape they really only arise from one jurisdiction: the US.  In the OECD data for 2016, 99.8% of the profit linked to stateless entities is linked to companies with their ultimate parent in the US.

Stateless entities are a feature of the US tax code. See the second paragraph of this IRS note on its own CbCR statistics.  As the figures above show stateless entities do not pay significant amounts of tax and the taxation of their profits can be viewed in a number of ways.

From the US perspective, the tax is due to the US and is merely deferred by being located in a stateless entity.  A formal repatriation would have triggered the tax due to the US (with offsetting credits for any tax paid to other jurisdictions).  Under the 2017 Tax Cuts and Jobs Act a “deemed repatriation tax” was introduced and the tax became payable to the US regardless of whether the profit was formally repatriated or not (albeit at a lower rate).  This is one of the reasons Apple’s cash tax payments rose in 2019.

Apple Income Statements 2010-2019

Central to the Commission’s state-aid case is Apple Sales International (ASI).  For the period in question this was a stateless entity with a branch in Ireland.  It had an effective tax rate similar that shown in the aggregate OECD figures for stateless entities (<1%).  The Commission’s state-aid finding was not linked to the stateless status of ASI; it was linked to the allocation of profits between the company’s head office in the US and branch in Ireland.

In a summary of the possible outcomes posted here in early 2016 we said:

Even if these companies are not deemed to be tax resident in Ireland can it be established that their profits should be taxable in Ireland?  Is the presence of a branch enough to deem the profits of the parent taxable here?

There are a couple of ways of approaching this but the key aspect is the agreements granting the rights to use Apple Inc.’s intellectual property outside the Americas to these companies.  All of the licensing and cost-sharing agreements were negotiated and signed in the US, at board meetings which took place in the US, and by directors and key decision-makers who were exclusively based in the US.  None of the key risks, functions and assets that underpin the creation and ownership of the intellectual property had a connection with Ireland.

With the benefit of the subsequent ruling by the Commission we know that all of this is true.  However, there is one qualification that should be added to the above extract – the board meetings where the key decisions were made were not the board meetings of ASI.  And this is the central argument of the Commission’s state-aid finding as set out in this paragraph:

285 The minutes of board meetings provided to the Commission demonstrate that the boards did not engage in any detailed business discussion before the discussions on Apple’s new structure in Ireland, as a result of which, according to Apple, the 2007 ruling ceased to be applied to determine ASI’s and AOE’s yearly taxable profits in Ireland. The summary of the minutes presented in Table 4 and Table 5 illustrates the discussions over the period January 2009 to September 2011 for ASI and December 2008 to September 2011 for AOE. With the exception of one business decision to transfer assets from AOE’s Singapore branch to another Apple group company, those minutes show that the discussions in the boards of ASI and AOE consisted mainly of administrative tasks, that is to say approving accounts and receiving dividends, not active or critical functions with regard to the management of the Apple IP licenses.

And that is essentially the case in a nutshell.  Ireland’s position is that none of the key risks, assets and functions that made ASI hugely profitable were located in Ireland.  The Commission went looking for them but all they could find outside Ireland were the minutes of board meetings where it was decided what bank account to put the profits into.

De facto, the key decisions were made by Apple Inc but they were not documented in the minutes of ASI’s board.  The appropriate allocation of profits would see the profits attributed to the ASI head office attributed to Apple Inc.  This is the view of the OECD.

But Apple Inc. was not part of the Commission’s investigation.  The Commission looked only at the allocation within ASI and determined that “only the Irish branch of Apple Sales International had the capacity to generate any income from trading, i.e. from the distribution of Apple products. Therefore, the sales profits of Apple Sales International should have been recorded with the Irish branch and taxed there.”

The Commission has actually made a pretty strong case (aided by Apple’s poor documenting of decisions) but it only holds if you limit your view to ASI.  If you consider Apple Inc. as a whole you would not allocate 60 percent of the company’s profit to the activities that happen in Hollyhill on the northside of Cork City.

And that is where we are.  If the court limits its view to ASI then the Commission’s state-aid finding probably has a good chance of holding up.  If the court takes the broader perspective of Apple Inc. as a whole then that probability is reduced but remains above zero.  The EU courts don’t have jurisdiction over the actions of the IRS.

Will any of this result in Apple paying more tax? No.  If Apple has to pay more tax to Ireland then the “deemed repatriation tax” due to the US under the TCJA will be reduced by a commensurate amount. 

Robert Stack, former Assistant Secretary at the US Treasury said the following to a Congressional Committee about what would happen if the state-aid decisions are upheld by the courts:

“Now if we were to determine that those payments are in fact taxes and we were to determine that they are creditable under our rules, now when that money comes home from those companies in addition to the credit they got for the tax they originally paid in those jurisdictions they get an extra credit. And that credit to this taxpayer you asked me about means in effect the US Treasury got less money and in effect made a direct transfer to the European jurisdiction that is getting the ruling from the Commission.

So if these turn out to be creditable taxes it is the US taxpayer that are footing the bill for these EU investigations.”

But it was the US tax system that allowed this profit to be deemed “offshore” in the first place through the licensing and cost-sharing agreements provisions of the US tax code.  The IRS has challenged several of these, including Facebook and Amazon, in the US tax courts but has yet to be successful.

The US might be happy to accommodate stateless entities within its tax framework to try and limit the harm of its approach to transfer pricing.  We know that the European Commission has not been so accommodating.  On Wednesday we’ll get a look at what the courts think.

Categories
Economic Performance Macroeconomics

Measuring national income in the time of COVID

National accounts are useful.  Yes, they have their limitations, and, particularly in the case of Ireland, can be subject to distortions but they are useful.

One of those uses is measuring changes in living standards.  If the growth of the inflation-adjusted measure of national income exceeds the growth rate of the population then it is likely that living standards are rising, at least on average.  This is usually taken as the real growth rate of per capita GDP (or another variant).

For Ireland, this averaged around one per cent per annum for the first three decades post independence, it rose by an average of three per cent per annum over the next thirty years and has averaged around five per cent per annum in the period since the late 1980s which is where it was before the current crisis hit.  These are useful summaries of our economic performance, though as is well known, such long-term averages do belie some significant volatility that Irish growth rates have exhibited.

2020 seems set to add to that volatility but let’s consider two things that are likely to muddy the link between the change in real per capita national income (as measured by, say,  GNI*), and the impact of the crisis on living standards:

  • Food consumption and the exclusion of domestic household production from national income;
  • Education and the cost-based approach to including public production in national income.

Food Consumption

Restaurants have been closed for dining in since March.  The CSO’s Monthly Services Index shows that the turnover value of services in Restaurants, Event Catering and Other Food Service Activities was over 50 per cent lower in April than in the same month last year.  The contribution to value added and national income from restaurants will be significantly lower this year.

However, this does not mean we are eating less or even consuming fewer food-related services.  The composition has changed.  The CSO’s Retail Sales Index shows that our retail purchases from Food Businesses were 17 per cent higher in April than in the same month last year.  The food we are not consuming in restaurants and other outlets has been replaced by food we are buying in shops.

In the national accounts, both the food and labour inputs are counted when measuring the value added of restaurants.  For food we buy in the shops the domestic labour input used to turn that food into a meal is omitted from national income, but it still contributes to our living standards.

There’s no doubt there’s more to restaurants than the food we eat and the cooking and cleaning services provided to us.  That is why we are willing to pay more for dining in.  But we are still eating the meal we would have had in the restaurant or cafeteria so someone is still doing the cooking and someone is still doing the cleaning.  It still adds to our living standards, it’s just that it has switched from market production to household production.

The drop in living standards implied by the fall in value added from restaurants in the national accounts won’t be as large as the figures suggest.  We have been forced to move to something that does not have its value added included in the national accounts (nor generate as much Value Added Tax for the government which is also counted as value added when measured at market prices.)

And, separately, the employees who would have been paid from that lost value added have had a large part of their income replaced with government transfers.

Public Education 

For market-provided services the value added is essentially the value of the output produced less than cost of intermediate consumption. 

The value of market output is estimated using the prices people for it.  After intermediate consumption has been subtracted from total revenue, value added is divided between labour through compensation of employees, government through taxes on products, and capital through gross operating surplus.  Net operating surplus remains after a deduction for the consumption of fixed capital (depreciation).  The additional value added that goes to users above the price paid (consumer surplus) is not measured. 

Still, value added is a useful concept and represents a large share of the living standards and welfare benefits of the goods and services we produce and consume in market settings.

This does not hold for publicly-produced services such as education.  These are paid for from general taxation.  We do not have prices and revenues to provide an estimate of the value people place on these services (nor how much they would be willing to buy).  Market prices might be absent but they do contribute to living standards.

The value added for public services in national accounts is essentially the sum of compensation of employees and depreciation, that is, it is the cost not the benefit that is included. 

The value added of education is simply put at the pay bill for teachers and the cost of maintained school buildings.  No benefit above that is included in national income aggregates.

Schools have been closed since the middle of March.  Just like restaurants there has been a switch to domestic production.  Yes, some online supports have been provided but the value of this is unquestionably lower (just as we are only willing to pay lower prices for takeaway meals).  The shift to home-schooling has had a huge impact on living standards.

However, the value added of publicly-provided education services will be largely unaffected.  The fact that the school children aren’t in school doesn’t matter for national accounts; all that matters is that teachers get paid.

Conclusion

The provisional Quarterly National Accounts for Q1 2020 show that constant price gross value added in Distribution, Transport, Hotels and Restaurants was down 10 per cent compared to the first quarter of 2020.  This reflects the forced closure of most of these services towards the end of the quarter.

On the other hand the gross value added in Public Admin, Education and Health was up four per cent compared to the same period a year ago.  This is despite the fact that schools were closed from the 12th of March.

This isn’t necessarily an argument to change the way national accounts are compiled.  Should household production be included in national income? Maybe.  Should the added value of public services be more than pay and depreciation costs? Maybe. For the time being we’ll be satisfied with an understanding of what the figures as currently compiled actually mean.

The drop in value added from restaurants doesn’t mean that we are not eating.  The stability in value added from education doesn’t mean that our kids are being taught.  National accounts are useful and the changes in the aggregates can be a useful proxy for changes in living standards. But not always.

Categories
Uncategorized

Professor David O’Mahony, RIP

Professor David O’Mahony, former UCC Professor of Economics, passed away on March 10th.  He was Professor of Economics in UCC from 1964 to 1988.

A highly-respected scholar, his works include The Irish economy: an introductory description (1964), Ireland and the EEC: political, legal and economic aspects (1972) and The general theory of profit equilibrium: Keynes and the entrepreneur economy (1998) (with Connell Fanning). In addition, he authored several Economic Research Institute (now ESRI) papers, in particular on collective bargaining and industrial relations.     

Professor O’Mahony was widely held in great respect and affection by colleagues and students alike and will be sadly missed.

Funeral arrangements: https://rip.ie/death-notice/professor-david-o-mahony-sunday-s-well-cork/382183

Categories
events

Irish Economic Association Annual Conference 2019

Irish Economic Association Annual Conference 2019

https://iea2019.exordo.com

http://www.iea.ie/

The 33rd Annual Irish Economic Association Conference will be held in The River Lee Hotel, Western Road, Cork City on Thursday May 9th and Friday May 10th, 2019. Seamus Coffey (Department of Economics, University College Cork) is the local organiser.

The keynote speakers will be Dr Asli Demiguc-Kunt, Director of Research at the World Bank, and Prof. Valentina Bosetti, Professor of Economics at Bocconi and a member of the IPCC.

The Association invites submissions of papers to be considered for the conference programme.  Preference will be given to submissions that include a full paper.  Papers may be on any area in Economics, Finance and Econometrics.

The deadline for submissions is Tuesday 5th of February 2019 and submissions can be made through this site.

Categories
Economic Performance Fiscal Policy

Latest Assessment Report from IFAC

The Irish Fiscal Advisory Council has published its latest Fiscal Assessment Report.  The report and some additional resources are available here.

Accompanying the report is a working paper that looks at how a counter-cyclical “rainy day fund” could be incorporated in the framework of the Stability and Growth Pack.  Last week, IFAC published its assessment of compliance with the Domestic Budgetary Rule in 2017 as well as an update of its Standstill Scenario which estimates of the cost of maintaining today’s level of public services and benefits in real terms over the medium term.

A bullet-point summary of the latest FAR:

  • A rapid cyclical recovery has taken place since at least 2014 and this is continuing at a strong pace.
  • Ireland’s debt burden is still among the highest in the OECD.
  • Negative shocks will inevitably occur in future years and there are clear downside risks over the medium term, namely those associated with Brexit, US trade policy and the international tax environment.
  • Improvements on the budgetary front have stalled since 2015 despite the strong cyclical recovery taking place – one that is reinforced by a number of favourable tailwinds.
  • Any unexpected increases in tax revenues or lower interest costs should not be used to fund budgetary measures.
  • The Council welcomes the Department’s publication of alternative estimates of the output gap.
  • The Medium Term Objective (MTO) of a structural deficit of no less than 0.5 per cent of GDP was reached in 2017.
  • The Council sees the fiscal rules as a minimum standard for sustainability and continues to recommend that the Government commit to adhering to the Expenditure Benchmark even after the MTO is achieved.

And on Budget 2019 in particular:

  • The Government should at least stick to existing budget plans for 2019 as there is no case for additional fiscal stimulus beyond existing plans as set out in the 2018 Stability Programme Update.
  • Estimates of the medium-term potential growth rate of the economy and expectations of economy-wide inflation for next year imply an upper limit for increasing the adjusted measure of government expenditure of 4.5%.
  • In nominal terms this translates into spending increases or tax cuts of up to €3½ billion (“gross fiscal space”) as the starting point for Budget 2019.
  • Previously announced measures – including sharp increases in public investment – mean that the Government’s scope for new initiatives in Budget 2019 will be limited.
  • If additional priorities are to be addressed, these should be funded by additional tax increases or through re-allocations of existing spending.
  • Improving the budget balance by more than planned would be desirable, especially given current favourable times, possible overheating in the near-term and visible downside risks over the medium term.
Categories
Economic growth

New publication from the CSO on productivity in Ireland

The CSO have a new publication, which it is intended to update annually, on productivity in Ireland.  It is available here.

The analysis assesses the contribution of labour and capital to growth in Ireland and splits the economy into an MNE-dominated sector and a domestic and other sector.  A breakdown using the standard NACE classifications is also provided.  The first publication covers the period from 2000 to 2016 but the analysis is undertaken for a number of sub-periods, most notably 2000 to 2014, which exclude the dramatic shifts we have seen since 2015.

Here is the summary but the entire publication is well worth a look:

This publication has presented new CSO results for productivity in the Irish economy since 2000. Some key aspects of this publication are set out below.

Irish labour productivity growth averaged 4.5 percent in the period to 2016, significantly for the period ending 2014 the equivalent growth rate is 3.4 percent. This compares with an EU average of 1.8 percent for the entire period to 2016. The contribution of the Foreign sector to labour productivity growth averaged 10.9 percent over the period to 2016 and averaged 6.2 percent to 2014. For the Domestic and Other sectors, the result to 2016 was 2.5 percent to 2016 and 2.4 percent to 2014. This clearly illustrates that the impact from the globalisation events of 2015 are concentrated in the Foreign sector as there is little change in the results for the Domestic and Other sector for the two periods.

Multi-factor productivity (MFP) has played a small part in explaining Ireland’s economic growth over the entire period 2000-2016. However, when the period 2000 -2014 is examined, i.e. excluding the effects of 2015, the picture for multi-factor productivity in the Irish economy improves and this is clearly illustrated in Figure 5.6 and 5.7. Growth in MFP was higher for the Foreign sector than the Domestic and Other sector up to 2014. However, the negative result for MFP in the Foreign sector in 2015 and in the overall economy over the full period is due to the impact of the globalisation events of 2015 on capital services where no corresponding change in labour input occurred. A major aspect of Ireland’s growth, and therefore its productivity story over the period, is the growth in capital.

Ireland’s capital stock per worker has increased from €150,000 to €378,000 per worker between 2000 and 2016, an increase of 152 percent. Capital stock per worker for the Foreign sector increased by an average annual growth rate of 6.9 percent to 2014. When the period is extended to 2016, the growth rate increases substantially to almost 32 percent. For the Domestic and Other sector, the growth in capital stock per worker is around 3.5 percent for both the periods to 2014 and for the entire period to 2016. The EU average annual growth in capital stocks per worker from 2000 to 2016 was 0.6 percent. The rate of increase in capital stocks in Ireland for both the Foreign sector and the Domestic and Other sector was higher than for any country in the EU for which data are available.

As this is the first productivity publication by CSO the results are considered experimental. There is considerable scope for extending the analysis presented in this publication to more detailed presentation by economic sector or to more detailed analysis of labour quality, i.e. gender, education, employment etc and their impacts on productivity. We look forward to a full engagement with our stakeholders to assist in setting priorities for future work in this area.

 

Categories
Uncategorized

Estimating Ireland’s Output Gap

IFAC has published a new working paper from Eddie Casey  on Ireland’s output gap. It is available here.

Categories
Fiscal Policy Taxation

The taxation of profits from intangible assets and Ireland’s contribution to the EU Budget

In last weekend’s Sunday Independent Richard Curran had a piece the start of which looked at a measure passed via Financial Resolution No. 3 on the night of the Budget speech. He says:

Multinationals make very real profits from charging for the use of their IP. In 2015, the trading profit made by multinationals in Ireland on their IP shot up by €26bn. This was completely offset by capital allowances they received - basically reducing their taxable profit on that to close to zero.

To put it in perspective if we had allowed just 80pc of that to be set against capital allowances, we could have taxed 20pc of it at 12.5pc. It could have yielded around €650m in tax.

The measure is linked to the recently published Review of Ireland’s Corporation Tax Code and Richard Curran’s piece throws light on most of the key issues, except one: the link to Ireland’s contribution to the EU budget.  This is referenced in paragraph 9.3.11 of the review:

Figures from the Revenue Commissioners and Tancred (2017) show that there was a €26 billion increase in intangible-asset related gross trading profits in 2015. This was offset by an increase in the amount of capital allowances for intangible assets of a similar scale. These gross trading profits are included in Ireland’s Gross National Income but the use of capital allowances results in a much smaller amount being included in the taxable income base for Ireland’s Corporation Tax. Given Ireland’s contribution to the EU Budget is calculated by reference to Gross National Income, this increase in profits has an impact.

Assessing this impact was beyond the scope of the review but is something which the seven-page note linked below attempts to address.  With lots of moving parts precision is difficult to achieve but the broad elements of the issue should hopefully stand out.

A note on intangibles, the taxation of their profits, and Ireland’s contribution to the EU budget

Update: Here is a bullet-point summary

  • In 2015 intangible-asset-related gross trading profits of multinationals operating in Ireland increased by €26 billion.
  • In the same year claims for capital allowances related to expenditure on intangible assets increased by €26 billion.
  • No Corporation Tax is due on the gross profits offset by capital allowances
  • Using estimates from the Department of Finance implies that these figures have risen to around €35 billion for 2017.
  • These untaxed profits are included in Ireland’s Gross National Income which adds about €200 million to the country’s contribution to the EU budget.
  • A cap on the amount of capital allowances that can be used in a single year is to be introduced for new claims for capital allowances on intangibles.
  • Based on patterns for the past two years the Department of Finance forecast that this will result in €150 million of additional Corporation Tax being paid in 2018.
  • The Revenue Commissioners figures for 2015 and the Department of Finances estimates of the impact of recent onshoring imply that  intangible-asset-related gross trading profits are expected to be around €40 billion in 2018 (with a further €36 million added to the EU contribution).
  • If the cap applied to all claims, existing and new, then the additional Corporation Tax to be collected in 2018 could be up to €1 billion using the 2015 figure published by Revenue and estimates from that time used by Finance.
  • If companies who are expected to move IP here in future years are happy to pay the tax now why doesn’t the same apply for companies who already have IP here?
Categories
Taxation World Economy

Rewriting the rules

From an Irish perspective the most significant announcement made yesterday by Commissioner Vestager was in relation to Amazon not Apple.  The Commission announced that Luxembourg had granted €250 million of illegal sate aid to Amazon.  The structure used by Amazon in Luxembourg is close to a replica of that used by US companies in Ireland.  It is a double-luxembourgish.  Here is the Commission’s description of the Amazon structure:

Categories
Uncategorized

Pre-Budget Statement from IFAC

The Fiscal Council’s offering in advance of Budget 2018 can be read here.

Categories
Economic Performance Macroeconomics World Economy

That 26% growth rate – from startled earwigs to stars in our eyes

Last year we were scrambling around in response to the impact of the 26.3 per cent real GDP growth rate that was the headline from the 2015 National Income and Expenditure Accounts (NIE).  So where do we stand one year on? Long post, with too much mind-numbing detail, below the fold.

Categories
Economic Performance Fiscal Policy

Presentation to MacGill Summer School

Earlier in the week I contributed to a session at the MacGill Summer School on threats to the economy.  My speaking notes for the presentation are here though delivery may have been slightly different.

Conclusion:

We can build 40,000 houses a year, motorways between our regional cities, urban rail connections in the capital, and the roll-out of broadband across the country. We can reduce taxes, increase social transfers and public sector pay. We can spend all the benefits of the surge in Corporation Tax, ultra-low interest rates and the proceeds from the sale of the banks. They are our choices to make. But we cannot do it all and expect the benefits of prudent economic and budgetary management.

No lobby or special interest group sees their request for support as being the one that pushes the economy into the red. And they are right; but we have to watch the totality of what we are doing. If we try to do too much and fly too close to the sun we will fall to earth.

The biggest threat to the Irish economy may not be the decisions of Teresa May or Donald Trump; the biggest threat to the Irish economy are the choices we make ourselves. Let’s make a better fist of getting it right this time.
Categories
Uncategorized

Annual Report on Public Debt

It seemed to slip under the radar but last week the Department of Finance published the first Annual Report on Public Debt Debt in Ireland.  It is a really useful publication and the first report reviews public debt developments since 1995 and particularly the huge build-up of debt since 2008.  The forward-looking analysis is also very good.

The report can be accessed here.

Categories
Fiscal Policy

June 2017 Fiscal Assessment Report

The 12th Fiscal Assessment Report from the Fiscal Advisory Council is now available.  The report has a summary assessment and four in-depth chapters but here’s a summary of the summary to give a flavour of the analysis:

  • The economy is performing strongly and does not require fiscal stimulus.
  • It may be necessary for fiscal policy to “lean against the wind” (i.e be counter-cyclical) to offset overheating pressures and/or prepare for possible downside risks that may materialise.
  • No overheating pressures evident at present but likely if current high growth continues.
  • In the near term, growth may exceed government projections due to momentum from 2016 and possible increase in housing output.
  • Medium-term outlook is uncertain due to external risks such as Brexit, and a “hard” Brexit is used as the central scenario in the latest forecasts.
  • Debt levels remain high and the role of revised debt targets is unclear.
  • Fiscal rules breached in 2016 and likely to be breached again in 2017.
  • Unexpected revenue gains have been used to fund within-year increases in expenditure.
  • In 2016, government revenue (excluding one-offs) grew by 2.7 per cent and primary expenditure by 2.4 per cent; the underlying primary balance was essentially unchanged in 2016 with a similar outcome expected for 2017.
  • Fiscal stance is not appropriate for a rapidly growing economy that is close to its potential, that continues to run a deficit with a high debt levels and that has clearly identifiable risks on the horizon.
  • Fully adhering to the fiscal framework, including to the Expenditure Benchmark after the MTO has been achieved, would go some way towards avoiding fiscal policy that aggravates the boom-bust cycle.
  • The Council welcomes the commitment to develop an alternative to the Commonly-Agreed Methodology for supply-side forecasts.

There is much more detail on all of this in the report.  The report does not contain much about Budget 2018 because the government have not updated their “fiscal space” estimates.  These will be provided in the Summer Economic Statement to be published in a few weeks and will be assessed in the Council’s Pre-Budget Statement.

Categories
Fiscal Policy

The Domestic Budgetary Rule and the Fiscal Stance in 2016

The Fiscal Council published its Ex-Post Assessment of Compliance with the Domestic Budgetary Rule in 2016.  The assessment is summarised in this table:

Main Assessment

The budget condition for 2016 was a structural balance of 0.0 per cent of GDP which was not achieved in 2016 as the structural balance was -1.7 per cent of GDP.

The adjustment path condition required an improvement of 0.6 percentage points of GDP in the structural balance.  This was not achieved as the improvement was 0.3 percentage points of GDP.

The expenditure benchmark is designed to give the real change for an adjusted measure of government expenditure (net of discretionary revenue measures) that corresponds to the required change in the structural balance.  Discretionary revenue measures (including non-indexation of the tax system) amounted to -€0.7 billion in 2016. The assessment is that Ireland was in compliance with the expenditure benchmark in 2016.

This contradiction between failing to achieve the required improvement in the structural balance yet complying with the expenditure benchmark is largely explained by a one-off transaction relating to AIB preference shares that took place in 2015.  As the AIB transaction was not repeated in 2016, the €2.1 billion from that transaction could be replaced with other government spending without breaching the expenditure benchmark.  The outturns show that around half of the €2.1 billion “space” was used for expenditure in 2016 (which will continue in subsequent years).

If this one-off item is excluded from the 2016 assessment of the expenditure benchmark then it would have been breached by 0.4 per cent of GDP.  The breach net of one-offs roughly corresponds to the shortfall in the required improvement in the structural balance (0.3 percentage points of GDP) which does take one-off items into account.

Under the 2012 Fiscal Responsibility Act the Fiscal Council is required to assess the fiscal stance using the structural primary balance.  That is, the general government balance excluding interest costs and one-off items and adjusted for the cyclical position of the economy.

Fiscal Stance

The primary balance itself is relatively straightforward to measure and the figures from the CSO show it to have been +0.7 per cent of GDP in 2015 and +1.7 per cent of GDP in 2016.

To get the underlying changes the impact of one-off items must be removed.  The Fiscal Council assesses that there were three such items in 2015 and 2016.  These were the AIB transaction in 2015, while in 2016 there was the return to Ireland of a pre-paid margin related to borrowing from the EFSF and part of the EU contribution assessed to Ireland that will be non-recurring.  Accounting for these, the table above shows that the primary balance net of one-offs showed close to no change in 2016 – it improved by 0.1 percentage points of GDP.

The structural primary balance depends on the cyclical position of the economy, that is the difference between the actual and potential growth rates of the economy.  The measurement and estimation involved in this are significant.  The CSO put the real GDP growth rate for 2016 at 5.2 per cent while the potential real GDP growth rate estimated using the method set out by the European Commission is 5.1 per cent.

These closeness of these numbers implies that the impact of the business cycle on the government balance in 2016 was relatively small.  The change in the primary balance net of one-offs and the change in the structural primary balance are pretty much the same.  The structural primary balance is estimated to have been unchanged in 2016 which would correspond to a “neutral” fiscal stance.

Your views on the fiscal stance will depend on how appropriate you think the 5.2/5.1 figures are as indicators of the real/potential growth rates of the economy in 2016.  Was the Irish economy growing above its potential in 2016?  What is the appropriate fiscal stance given the cyclical position of the economy? The Fiscal Council will assess these and other issues in its forthcoming Fiscal Assessment Report which is set to be published next week.

Categories
Fiscal Policy Political economy

Interpretation in fiscal space

The suspension of belief is commonly needed for science fiction.  Most space dramas require alien races to speak English or the existence of some form of instantaneous universal translator.  It now seems that something similar is required when moving in fiscal space.  Fiscal space is the money available for new measures while achieving minimum compliance with the rules.   Lots of words are being used to describe this but can we tell what they actually mean?

Categories
Economic Performance Fiscal Policy Macroeconomics

Producing Short-Term Forecasts of the Irish Economy: A Suite of Models Approach.

A new working paper from Niall Conroy and Eddie Casey of the Fiscal Council Secretariat.

Abstract:

The Council’s mandate includes endorsing, as it considers appropriate, the official macroeconomic forecasts of the Department of Finance on which the annual Budget and Stability Programme Update are based. As part of the endorsement process and for the purposes of its ongoing monitoring and analysis of the Irish economy, the Council’s Secretariat produces its own Benchmark macroeconomic projections. This paper describes the short-run forecasting models used by the Secretariat for producing these projections. The general forecasting approach can be described as follows. Equations are used to forecast each component of the expenditure side of the Quarterly National Accounts. Multiple models are estimated for most components, with the simple model average used as an initial input into the formulation of the Benchmark projections. The out-of-sample forecasting performance of these models is assessed at each endorsement round. In addition to these model-based projections, other elements are considered. Discussions with the Council and other forecasting agencies help to guide any judgement that may be applied before arriving at the final Benchmark projections.

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Employment Opportunity: Fiscal Council

The Fiscal Council are seeking to recruit a Research Assistant.  The position is on an initial two-year basis with full details available here.  The closing date for applications is Friday 21st April.  The start date is negotiable, particularly for candidates completing studies.

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The Apple Appeals

We now have summaries of the appeals to be made by Ireland (published in December) and Apple (published yesterday) in the state-aid case.  Ireland set forward 9 grounds while Apple include 14.

On the facts of the case Ireland argue:

The decision also mischaracterizes the activities and responsibilities of the Irish branches of ASI and AOE. These branches carried out routine functions, but all important decisions within ASI and AOE were made in the USA, and the profits deriving from these decisions were not properly attributable to the Irish branches of ASI and AOE.

With Apple’s position being:

The Commission made fundamental errors by failing to recognise that the applicants’ profit-driving activities, in particular the development and commercialisation of intellectual property (‘Apple IP’), were controlled and managed in the United States. The profits from those activities were attributable to the United States, not Ireland.

The readers can identify the difference.  The case continues to attract significant attention and there were two recent opinion pieces in The Irish Times from Liza Lovdahl-Gormsen and Paul Sweeney on the topic.

Apple Cash Tax Paid

Finally, here is a piece worth reading from Martin O’Malloney in the Dublin Review of Books.

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GNI*

The report of the Economic Statistics Review Group, and response of the CSO, are available here. There is lots of detail in both that goes beyond the publication of a modified aggregate measure, GNI*.

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Job Opportunity with the Fiscal Council

The Fiscal Advisory Council are currently looking to fill an economist role.  The position is at AP level and the closing date for applications is Thursday 9th of February. Full details of the post are available here.

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Economic Performance Fiscal Policy

Fiscal Assessment Report

The latest Assessment Report of the Fiscal Council is available here.

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Employment Opportunity at Fiscal Council

The Irish Fiscal Advisory Council are currently looking to fill an economist role within the secretariat.  The closing date for applications is Tuesday 11th of October and full details of the post are available here.

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Competition policy Political economy

The Apple Ruling: What do we know?

It’s just over a week since Commissioner Vestager announced the state-aid ruling on the tax treatment of Apple in Ireland.  We only have the press release and the Commissioner’s statement to go by so it’s still too early to be definitive on what the Commission are actually doing.  It could be months before the full ruling is available here but that doesn’t mean we can’t have a stab at what might be going on.

There has been a lot of reaction to what the ruling means for Ireland’s Corporation Tax regime.  While there has been massive reputational damage (possibly irreparably so) the ruling does not have any implications for Ireland’s Corporation Tax rate or even for any of the rules that Ireland applies to Corporation Tax.

Unlike previous instances the Commission is not looking for any change in Ireland’s Corporation Tax regime.  In this instance looking for changes would likely have been overreach but that is not what the Commission is seeking.  Nor is the Commission seeking to retrospectively impose alternative transfer pricing standards which was a central focus of the recent White Paper from the US Treasury.  If the Commission’s case required a change of rules or the application of new standards it would have had little hope of standing up to an appeal.

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Economic Performance Fiscal Policy Taxation

Forecasting Corporation Tax Revenues

Here is an Analytical Note on the Challenges Forecasting Irish Corporation Tax from staff economists of the Fiscal Council.

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Apple ruling announced

€13 billion. Wow! Nothing to do with transfer pricing. All do with the relationship between the parent companies and their Irish branches. The EC position is that as the ‘stateless’ companies have no substance ALL of the profit is allocated to the Irish branches.  We really are at the races now.

The press release is here.

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Are we there yet? Are we there yet?

The Apple state-aid journey rumbles on.  The scene was enlivened somewhat last week with the publication of a white paper by the US Treasury criticising the approach of the European Commission.  The paper dishes out a good kicking and provides a useful template for a company or country considering an appeal to an adverse ruling.

We know most of the key points the US are making.  They are concerned that the US taxpayer could end up footing the bill (as Robert Stack repeats here) but if the tax payments are legitimately due elsewhere then this doesn’t amount to much.  But the risks, functions and assets that generated Apple’s profits were in the US so, under the current system, the tax on those customers is due in the US.  Of course, a company may decide to move those assets but that is an issue that the country of departure has oversight of.  For the period under investigation in the Apple case it is clear that the main drivers of its profitability were controlled and located in the US.

The US Treasury paper looks at the substance of the EC position – that some transfer pricing arrangements put in place (for mainly US MNCs) were “wrong”.  For the EC is this is a competence they do not have nor one that they should be seeking. If you are intent on saying that something is “wrong” you must be able to state what is “right” – but in transfer pricing there are ranges not precise outcomes.

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Economic growth

That 26% growth rate: two weeks on

The recent publication by the CSO of the 2015 National Income and Expenditure Accounts generated a lot of reaction.  There is no doubt that a 26.3 per cent real GDP growth is bizarre but it was not farcical, false or based on fairy tales.

Many commentators went out of their way to highlight that the figures did not characterise what was happening “on the ground” in the Irish economy.  But this seems like a bit of a strawman.  Instead of being told what the figures were we were been scolded over what they weren’t.  No one said the economy was growing at 26 per cent.  Arguments against using GDP in an Irish context have made for the past quarter of a century.  Even as recently as March, when the first growth estimates for 2015 were provided, there were plenty of people who pointed that the underlying growth rate of the economy was probably around half of the 7.8 per cent growth rate in real GDP shown at that time.

But a 26.3 per cent real GDP growth rate is very very unusual.  And one that deserves understanding rather than dismissal.  However, the discussion of the figures has generated more heat than light.  At the briefing it seems three items were identified as having oversized effects on the national accounts’ aggregates. These were:

  • aircraft leasing
  • inversions and corporate restructurings, and
  • asset transfers to Ireland
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Economic Performance Housing Migration

Preliminary Census Results

The CSO have published some preliminary findings from last April’s Census.

The population was measured to be 4.76 million up from 4.59 million in 2011 giving an increase of 170,000 (+3.7%).  The natural increase was just over 198,000 so the estimate of net migration over the five years since the last census is –28,500.  This is the second consecutive occasion where inter-censal population estimates were out by around 100,000.

The housing stock increased from 2,003,914 to 2,022,895, a rise of less than 20,000 over the five years.  On census night just over 1.7 million units were occupied with 45,000 units where the occupants were temporarily absent and there were 60,000 unoccupied holiday or second homes.  There were just under 200,000 “other vacant dwellings” a drop of 30,000 in this category since 2011.  There is a wide variation in vacancy rates by area.

There is plenty of interesting detail available by following the link.

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Economic growth

Economy expands by 26.3%

Or at least that is what the national accounts tell us.  The CSO have published the National Income and Expenditure Accounts for 2015.  These show that real GDP expanded by 26.3 per cent in 2015 and real GNP grew by 18.7 per cent.  Do these numbers mean anything?  It is hard to know.

Looking at the expenditure approach the big real changes were in investment (+26.7%), exports (+34.4%) and imports (+21.7%).

In nominal terms, exports in 2015 were put at €317.2 billion, up from €219.8 billion in 2014. Exports minus imports was €81.2 billion compared to €34.6 billion in 2014.  We would usually expect most of this to feed through to the outflow of factor payments but net factor income from abroad only went from –€29.7 billion in 2014 to –€53.2 billion in 2015.  That means most of the improvement in net exports also contributed to GNP but the “gross” part of this seems to be important.

The reason is that there seems to be an awful lot happening on the asset side of the national accounts.  The nominal provision for depreciation rose from €30.9 billion in 2014 to €61.6 billion in 2015.  It looks like a large part of the increase in gross value added in 2015 of €60 billion went to cover the depreciation of assets.

The biggest source of the additional value added was in the Industry sector which rose 97.8 per cent in real terms over in the year (and in nominal terms rose €50 billion).  The CSO don’t provide a sectoral breakdown for this (they usually do) but it is probably a safe guess that a large part of it is related to the chemical and pharmaceutical sector.

One explanation is that a number of sectors saw MNCs move intangible assets onshore.  This increases gross value added in Ireland as there are no longer outbound royalty payments.  There is also a once-off increase in investment when the asset moves here (but the growth effect of this is offset by the import of the asset).

It is also worth noting that the increase in value added isn’t necessarily related to goods manufactured in Ireland.  The CSO’s External Trade data, which only include goods that physically leave Ireland, shows €111 billion of goods exports from Ireland in 2015.  Goods exports in the national accounts are done on a different basis (where ownership rather than location matters) and show exports of €195 billion.  A large part of the value added from these exports is accounted for in Ireland.

So we have a large increase in gross value added but this doesn’t fully feed through to increases in wages and/or profits.  Non-agricultural wages and salaries rose from €67.7 billion in 2014 to €71.5 billion in 2015.

The domestic trading profits of companies rose from €52.3 billion in 2014 to €74.4 billion in 2015.  This €22 billion increase roughly corresponds the increased outflow of net factor income.  Profits before depreciation would be up by even more but a lot of that went against the fall in the value of the assets.

But even then the value on onshored assets can’t account for all of this.  Most of the increase in investment can be attributed to research and development which in nominal terms rose from €9.6 billion in 2014 to €21.3 billion in 2015.  It is likely that most of this increase is due to once-off purchases of intangible assets rather than ongoing expenditure on R&D.

There may also be impacts from the aircraft leasing sector.  Although the investment figures show a small decrease in investment in transport equipment in 2015, a balance-sheet effect may have resulted in increased aircraft assets being accounted for in Ireland.  Gross value added in aircraft leasing may be high but depreciation of the asset would again consume a lot of this.

The CSO highlighted this and slide 6 of their presentation on the figures shows that Ireland’s gross capital stock rose by about €300 billion in 2015, from €750 billion to €1,050 billion.  Even with today’s inflated figures this corresponds to an increase in the gross capital stock equivalent to 120 per cent of GDP in just one year. Investment in 2015 was equivalent to just over 20 per cent of GDP so these balance-sheet effects impacted the capital stock to the tune of almost 100 per cent of GDP.

The best we can do to strip out all of this madness is probably to look at net national income which excludes the provision for depreciation from all assets and accounts for net factor income from abroad.

Net National Income at Market Prices grew by 6.5 per cent in 2015 which is probably somewhere around where “the Irish economy” grew at in 2015 rather than the 26.3 per cent that “the economy in Ireland” grew by.