Extra tax paid to EU must not obscure €2bn corporation bonanza

State should save corporation tax windfall and aim to run a budget surplus in 2017

Taxation policy: tourism is booming and hoteliers are making good profits. A rethink of the sector’s VAT reduction should be considered.

Taxation policy: tourism is booming and hoteliers are making good profits. A rethink of the sector’s VAT reduction should be considered.

 

A Department of Finance paper by Kate Levey and Seamus Coffey in 2014 showed that the Central Statistics Office’s figure for profits each year was closely linked to corporation tax receipts. As a result, the bonanza in corporation tax in 2015 suggested that something dramatic was happening to profits.

We now have an explanation: profits rose by 44 per cent last year, primarily because two or three foreign companies relocated to Ireland. These firms had massive profits on which Irish tax was payable and they probably accounted for an increase in tax revenue of about €2 billion in 2015.

Another side of the relocation story that gave rise to this huge tax bonanza, was that gross domestic product, measured according to the UN rules, rose by an incredible 26 per cent. As a result, the Irish contribution to the EU budget will be increased by something under €300 million this year.

This is of course a small fraction of the €2 billion windfall accruing to the Government. The idea that we would begrudge the extra EU budgetary contribution because of an artificial tax bounce seems rather bizarre.

Already, our EU partners are aggrieved at some of the more questionable tax-driven activities in Ireland. While the European budget will get a small part – about 15 per cent – of last year’s increase in tax revenues, it is unlikely to assuage the widespread disquiet among our partners about Irish tax practices.

From an Irish point of view, a major concern is that the windfall is all attributable to one or two companies, and may be volatile. Changes in tax laws elsewhere, or in company ownership, could see this tax revenue disappear overnight and, as we know too well from the 2008 crash, building budget plans on evaporating revenues could trigger a future budget crisis.

So the Government should treat this extra revenue as a temporary gain and save most of it, aiming to run a surplus in 2017.

Last week, the Department of Finance published a very interesting set of tax strategy papers on options for the next budget. Only one of these – the paper on the universal social charge (USC) – attracted much attention. This paper examined options for a €300 million cut in USC, and highlighted the complexity of aiming to achieve all of the Government’s multiple objectives.

It is just not possible to design a change costing €300 million that will simultaneously ensure that those on low incomes benefit most, that nobody experiences a very high marginal tax rate and that nobody loses.

I wouldn’t see reducing USC as a priority for next year. What could make sense is a structural change that would deliver a more integrated and simpler tax system, combining the best features of the USC and the income tax models.

An advantage of USC is that it generally uses a wider base than income tax to assess those on higher incomes, and extending that approach to an integrated tax system would be beneficial. An anomaly, however, is that old age pensions are not subject to USC. It is hard to justify this exemption for those who have substantial income from other sources.

Another of the tax strategy papers looked at the reduced rate of VAT applicable to hotels and restaurants, and points to how different the current environment is to when the low rate was introduced. Tourism is booming, hoteliers are making good profits and some of the VAT reduction is now captured in the capital value of hotels.

A reversion to the old rate would bring in about €600 million in additional revenue, which could be usefully deployed to fund changes in other taxes or increased expenditure. The paper suggests that much of the incidence of such a change would fall on hotel profits and on tourists, and it would have limited adverse economic effects.

In a further paper, analysis by the Department of Finance shows that the benefits of the promised incentives to house purchasers, as proposed in the Government’s housing strategy, will eventually go, not to those buying new houses, but rather to those who own development land. When supply is tight, injecting more money just pushes up prices.

No wonder building industry cheerleaders, who contributed so much to the economic disaster of 2008, are enthusiastic about this proposal.

While the housing strategy has lots of worthwhile measures, the failure to take on board this basic lesson from the last housing bubble is its most disappointing aspect. Let’s not repeat the mistakes that brought so much hardship over the last eight years.

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