Corporate Tax Saga, May 11 Edition

The saga over Ireland’s request for a reduction in the interest rate on its EU loans continues, with the French continuing to link this issue with Ireland’s corporate tax, a role they swap every so often with the Germans (media stories from today here and here). As Christine Lagarde’s recent comments show, having made such a big deal of the issue, the French are now motivated to achieve the crucial goal that “Everybody will have to save face.”

It is worth noting, however, that the French signed this document “Conclusions of the Heads of State of Government in the Euro Area” on March 11. It stated:

Pricing of the EFSF should be lowered to better take into account debt sustainability of the recipient countries, while remaining above the funding costs of the facility, with an adequate mark up for risk, and in line with the IMF pricing principles.

Note the absence of any mention of corporation tax or renegotiation of deals.

Despite the constant repetition of the line that Ireland is somehow looking to change the status quo, it seems to me that there is a strong case for the opposite position. Having agreed to change the pricing of EFSF loans on March 11, the EU’s principle political leaders have reneged on this agreement for the moment, most likely because the political kudos that come with appearing tough on Ireland outweigh those associated with honouring agreements made at Heads of State level.

Those who believe that Ireland’s situation will end well because European institutions have our best interests at heart may wish to consider how things have played out over the past few weeks.

NI Corporation Tax

The UK Budget was published yesterday. One of the noteworthy changes announced as part of this is a reduction in corporation tax:

“a reduction in the main rate of corporation tax by a further one per cent. From April 2011, the rate will be reduced to 26 per cent with further yearly reductions of one per cent until 2014 when it will reach 23 per cent”.

In addition the UK Treasury has published a consultation document entitled Rebalancing the Northern Ireland Economy, which specifically considers the potential for, and costs and benefits of devolving the power to vary the corporate tax rate in Northern Ireland, potentially reducing the rate in Northern Ireland to the 12.5% that applies in the republic of Ireland.

In the context of the pressure from France and Germany for the Republic of Ireland to raise its corporation tax rate, both the reduction in corporation tax rates in the UK and the potential harmonisation of the corporation tax rate to 12.5% on the island of Ireland are an interesting development.

CCCTB Proposals

The Commission’s new proposals for a Common Consolidated Corporate Tax Base (CCCTB) are available here.

Kenny Returns from Brussels

Enda Kenny has returned from Brussels without any agreement yet to reduce Ireland’s interest rate (Irish Times story here and FT story here). Not surprisingly, Mr. Kenny wasn’t too keen to give up Ireland’s 12.5% corporate tax rate in return for a mere one percent reduction in the interest rate on the EU loans.

To my mind, there is a lot of shadow boxing going on here. The EFSF is an EU institution and it cannot set the terms of its lending on a bilateral basis with individual countries. I’d be surprised if thee tradeoff between these two elements ended up being as explicit as suggested in this weekend’s news stories.

I think the business about interest rates and corporation tax rates has a feel of fiddling while Rome burns. More interesting were Kenny’s comments about the ECB:

“I made the point that for me to conclude a deal here I need to be much clearer in respect of elements related to the ECB,” he said.

“I spoke to president Jean-Claude Trichet and the Minister for Finance will be meeting with him on Monday. He has agreed that I should meet with him before the [next EU summit on March] 24th/25th to discuss a number of issues relating to the ECB and its positions.

“Before the council meets again in two weeks time we hope to be in a much clear position insofar as Ireland’s position is concerned and continue on our progress arising from the mandate that I’ve got about an improvement in the terms of the package for Ireland,” the Taoiseach said.

He continued: “In the next couple of weeks I expect to be in a much clearer position in respect of the state of what we have inherited is in respect of Ireland’s position.

“We’ll have had discussions with the ECB in respect of a number of matters. We’ll have a much clearer picture of what’s emerging from the stress tests and as the principle has now been accepted and implemented of a reduction in the interest rate I . . . would regard that actually as the beginning of a process.”

I reckon they could fill Croke Park if they sold tickets for those discussions with the ECB.

Corporation Tax and the EFSF

There has been a lot of discussion over the past few days about the implications of Commissioner Rehn’s comments about Ireland not being a low tax country in the future. While the comments didn’t explicitly mention the 12.5% corporate tax rate, many have inferred from the comments that the removal of that rate would be part of the price of an EFSF bailout for Ireland.

Two points on this issue seem worth discussing. The first is: What would be the effect of an increase in the corporation tax rate? The take from this tax this year is projected to be €3.2 billion (actually it’s running ahead of target but let’s stick with the original projection.) A purely mechanical extrapolation would see an increase from 12.5% to 15% raise an additional €640 million in revenue while keeping Ireland’s corporation tax rate low by European standards.

Of course, that assumes no negative effects on declared profits. So the €640 million figure may be too high. That said, I don’t think there’s reason to think that 12.5% is a magic Laffer-curve point whereby revenues decline when the tax rate is raised.

Over the longer-term, however, there may be more serious repercussions from a decision to raise the 12.5% rate. Even a small increase would represent a significant departure in policy from the line-in-the-sand approach that has been taken up to now. The real risk may be to that those considering future FDI projects in Ireland (or perhaps making decisions about whether to keep current operations here or consider further investments in them) see an increase to 15% as potentially being the first of a number of increases. Rhetoric about how we’d never change the rate again would not be too credible. On balance, I think the arguments for keeping the rate as it is win out.

The second point worth discussing is whether indeed access to the EFSF bailout would require changing the corporate tax rate. As I understand it from the facility’s framework agreement, the dispensing of funds from the facility does not require each Euro-area parliament to approve. Instead, agreement on a plan must be reached with the Eurogroup of finance ministers.

I’m not prone to anti-European conspiracy theories, so the idea that the Eurogroup finance ministers will be happy to hike Ireland’s corporate tax rate substantially, even if it would have negative effects on our economy and possibly lead to sovereign default, doesn’t strike me as correct. More generally, my sense of IMF-style rescue packages is that the package negotiations usually feature lots of nasty options but that the government can pick which areas it wishes to prioritise for protection. So (and these could be famous last words) I don’t think access the EFSF funds would imply changing the corporate tax rate.