Much Progress on Costly and Wasteful Tax Breaks but Radical Change is now Needed.

Paul Sweeney: There has been much progress in getting rid of the most wasteful and destructive tax breaks, but many remain. 

Indeed a radical approach to tax breaks must be taken by government because they are a fierce waste of money. The many references to “Value for Money” by the public service is empty and really should be used unless this issue is seriously addressed.

The issue is that many tax breaks suddenly arise, which were never planned, which cost a fortune and do nothing for the economy or society. 

Ireland – caught in the low corporate tax trap?

Daragh McCarthy and Aoife Ní Lochlainn: In the wake of the Public Accounts Committee in the UK interrogating a trio of multinational executives on the meagre sums of corporate tax paid by many trans-national companies, last Saturday’s episode of the Business on RTE featured a segment on the topic that closed with Feargal O’Rourke of PwC saying that he expected to see these companies pay “a fairer rate of tax” in the coming years. It appears that the pressure for reform is building.

The issue has garnered a significant amount of media attention over the past couple of months—from the storming of Google’s offices in Paris to the naming and shaming of Facebook, Starbucks and Apple in the UK press. Senior government officials in many EU countries are openly voicing their discontent with the increasingly aggressive tax dodging strategies employed by these corporations, and the European Commission is scheduled to discuss the international tax practices of multinational businesses on December 5th. It remains to be seen if this is simply bluster, or if there is a genuine will to devise a coordinated pan-national strategy to reduce tax avoidance.

A recent report by TASC, Tax Injustice: Following the Tax Trail highlighted how the Irish tax system is a key component of a subsidiary-based structure that drastically reduces the overall tax bill of transnational businesses. A friendly tax environment has been a central part of the effort to lure multinational corporations to Ireland. FDI of this nature has been at the core of successive governments’ industrial policy for over half a century, and this policy is generally regarded to have been successful.

Accommodating these companies has come at a substantial cost, however. Contributors to this site have noted the obsessive focus on FDI is likely to have hindered the development of indigenous firms. The contribution made by multinationals to the Irish exchequer has diminished considerably in recent years; currently it is down 2.5 per cent year-on-year. The recent spike in media attention heightens the risk of damage to the state’s reputation. This summer, the US Senate’s Permanent Subcommittee on Investigations sought to establish Ireland’s role in “tax practices that range from egregious to dubious validity.”

However, while much of the media focus of the past few weeks has been on the use of tax loopholes to decrease tax bills in European countries, it remains the case that these countries are still better equipped to address the consequences of such corporate behaviour than countries in the Global South. Tax avoidance by companies and individuals hampers the capacity of these states to develop their economies and pay for much needed public service.

According to Christian Aid, between 2005 and 2007, six Irish Aid programme countries lost nearly €82 million in tax revenue to EU or US – almost 17 per cent of total Irish Aid budget for the countries concerned. A recent report by the Tax Justice Network (TJN) claimed that since the 1970s, 139 low-to-middle income countries have lost a total of $7.3 to $9.3 trillion to tax dodging by the super rich. This vast sum is more than enough to cover the debts of these countries, whose aggregate gross external debts stood at $4.08 trillion in 2010.

The TASC report contains a number of recommendations for tackling tax injustice, including the introduction of country-by-country reporting. However, while increased transparency would help countries better understand the methods of tax avoidance, it will not in and of itself solve the problem and is unlikely to appease many of Ireland’s critics.

Four-Year Plan: Tax Expenditure

Nat O'Connor: I'm going to call the National Recovery Plan "the four-year plan" because I believe we should encourage the next government to publish four-year budgetary plans every year, as part of the opening up and improvement of Ireland's economic and fiscal management.

Having got that point out of the way, this year's four-year plan has a fair bit to say about tax expenditures. And so do I.

While this post is relatively positive towards the plan's actions in relation to tax expenditure, they represent the few positive aspects of a plan that is otherwise weak on jobs and highly regressive on tax measures.

It is to be welcomed that measures in the four-year plan move towards reducing tax expenditure, but significantly more can be done in this area and it can be done quicker.

The decision to standard rate pension tax reliefs is something TASC has called for for years. Tax reliefs at the marginal rate were inherently unfair. An ESRI study shows that 80 per cent of the benefit has gone to the top 20 per cent of earners. The four-year plan estimates that these tax breaks cost the state over €2.5 billion per year. This can be compared to the €6.5 billion spent on the state pensions in 2010.*

* Figure is the rounded sum of the Contributory Pension (€3.4bn), Widow(er)s Contributory Pension (€1.3 bn), Non-Contributory Pension (€0.9 bn), Invalidity Pension (€0.7 bn) and Transitional Pension (€0.1 bn). Source: Revised Book of Estimates 2010.

However, the phasing out of tax relief at the marginal rate will only begin from 2012, so this proposal may yet be changed by the next government. The decision to lower pension tax relief to 20 per cent is (fortunately) also contrary to the recently announced new national pensions’ framework, which advocated relief at an anomalous rate of 33 per cent, so we must be conscious that implementing the move to 20 per cent pension relief will require additional revisions to be made to the national pensions’ framework.

It is important to note that TASC’s objection is not only to the inequality of the pension tax reliefs but to the failure of the system of private pension provision to provide secure incomes for people in retirement. The value of Irish pension funds suffered real losses of 37.5 per cent in 2008, which the OECD (2009) Pensions at a Glance describes as the worst performance across 30 OECD countries. The current system simply does not work, which is why TASC continues to call for the creation of a new social insurance (retirement) fund involving a mandatory defined benefit scheme. Details are available in TASC’s updated pension policy: Making Pensions Work for People.

I note a potentially confusing note in the four-year plan around who benefits from pension tax relief. The plan states: “It is not the case that only those on higher incomes benefit from pension relief. The bulk of employee/individual pension contributions attract tax relief at the marginal or 41% tax rate” (p. 94). The point that many people pay tax at the marginal rate (and can claim relief at that rate) is not in dispute, but the importance of the ESRI study is that it showed that the vast bulk (80 per cent) of the benefits from tax reliefs went to the top 20 per cent of income earners.

It is welcome that the four-year plan acknowledges the risk of abuse, when it states: “Pension tax expenditures will be kept under constant review to ensure that abusive tax sheltering does not take place” (p. 94).

There are other welcome changes to tax expenditure in the four-year plan. Specifically, the plan is to abolish ten income tax expenditures and curtail another six, saving €355 million per annum once implemented.

A further €400 million worth of legacy costs from property-based incentives are also being phased out. I argue that the remaining property-based tax incentives need to be immediately halted in order to avoid last-minute use of the incentives, and consequentially less than €400 million being saved in this area.

There is also a commitment that “reliefs and exemptions from CGT, CAT and Stamp Duty will either be abolished or greatly restricted to ensure that there is an adequate base for these taxes and that all of society makes a fair contribution to the correction of the public finances” (pp. 99-100). A conservative estimate of €145 million is given for this. To date, TASC has focused on tax expenditure on income tax and corporation tax (following available data). But for every tax, there are tax breaks in the Irish system. So changes to CGT, etc are welcome.

The Cost of Tax Expenditure
The four-year plan proposes to reduce tax expenditure by €1.7 billion by 2014 (see pp. 93-97). For reference, the plan states that the cost of pension tax relief is just over €2.5 billion. TASC estimated that tax expenditure on income tax and corporation tax alone cost the Irish Exchequer €7.4 billion in 2009. So, it seems obvious that more could be done to reduce this than €1.7 billion in four years.

The four-year plan is incorrect and misleading in its explanation of the OECD finding that tax expenditure cost €11.49 billion in 2005. The four-year plan states that “80% or €9.72 billion of all the tax expenditures relate to personal allowances / credits / bands, pensions and savings” (p. 95). The OECD’s figures do not include the effects of the income tax bands. In addition, the OECD calculation shows that €7.2 billon from income tax relief came from other sources than basic personal credits (i.e. Single Person’s Credit, Married Person’s Credit and Widowed Person’s Credit). In other words, 62 per cent of the €11.49 billion tax expenditure on income tax came from other credits and allowances, which are not ‘basic’ or part of the ‘baseline’ tax system. TASC explained and replicated the OECD findings with 2006 data in its pre-Budget proposals submitted to the Department of Finance (see pages 28-29).

In fairness, the four-year plan is correct that there is a lack of public understanding about tax expenditure; due in no small part to the inadequate data available on this area. When the €7.2 billion of ‘non-basic’ tax credits and allowances are examined, they contain a wide range of things, including inter alia: the PAYE tax credit, tax relief on private medical insurance and health expenses, the tax exempt status of Child Benefit, relief for investment in films and TV, tax relief for paying third-level fees, approved profit-sharing schemes, and the various pensions/savings reliefs.

The reform of this area is complex and demands a commitment to substantial overhaul of the tax system to make it simpler, transparent and equitable. In particular, the removal of some tax reliefs may require balancing changes to be made in areas of economic or social policy. For example, TASC’s proposals about pension tax relief are not just about removing an unjust relief, but they also put forward a system for ensuring everyone has a better, more secure pension.

Nevertheless, there is a need to look at the overall distributional effects from the combination of the taxation, tax reliefs and the welfare system; it is hard to justify benefits to middle income earners, if the alternative is cuts to payments and services on which more vulnerable people depend.

TASC has proposed that all current and proposed tax expenditure should be subject to an equality audit and economic efficiency audit. In addition, they should all be subject to an annual check and vote by the Oireachtas, as they constitute a major area of public spending. Most developed countries report systematically on tax expenditure every year. The World Bank associates the absence of such reporting with developing and transition countries.

Money for some, just not us

Michael Taft: ‘Folks, the money ain’t there. There is no untaxed honey-pot of rich people to be taxed. Put top rate taxes up to where they were in the 1980s (we are more than halfway there already, by the way) and see how much money we raise. It won’t make a material difference and might just make things worse. Explain to the public sector that they were hired, with the best of intentions, on a premise that proved to be false. The money to pay them just doesn’t exist. That does not mean they are not valued or that they are not doing a superb job in a dedicated way.

The ‘no cash’ constraint is, unfortunately, absolute and binding.’

No wonder the debate over the economy is so degraded - if this is the quality of commentary we are getting from our broadsheet media. Let’s examine this ‘no-cookies-in the-cookie-jar’ argument that Chris Johns, chief executive of Bank of Ireland Asset Management, put forward in the Sunday Business Post.

First, there are cookies for Anglo-Irish - up to €20 billion cookies that will never be repaid.

Second, we will pay (and it is we – through Government guarantee) approximately €50 billion for largely under-performing, if not downright worthless, assets from the banks.

One may argue these expenditures are necessary; or that we could have achieved the same thing for less cost (the Government is already reconsidering the option of closing down Anglo-Irish over the long-term – an option they initially dismissed). One may argue that we had to clean up the banks’ balance sheet (but we could have paid a lot less if we were willing to take larger a stake in the banks). One may argue a number of things – but one thing is certain: the ‘no-cash’ constraint is, in these cases, neither absolute nor binding.

Third, the ESRI estimates the Government will have nearly 30 percent of GDP – or nearly €50 billion – in Exchequer cash balances and National Pension Reserve Fund assets. Yes, we need a large liquid buffer, especially as the Government’s deflationary policies have failed to protect the integrity of Irish sovereign debt. And, yes, some of this money is tied up in bank recapitalisation. And, no, this is not an argument for raiding the cookie jar. What it shows, however, is that there are some free-floating cookies that could be put to use: investing in the economy, generating jobs and growth, increasing tax revenue, reducing unemployment costs and, so, reducing the deficit. We may debate how much; but the ‘absolute and binding’ argument is not so absolute when we lift the cookie jar lid.

Let’s look at the ‘honey-pot’ assertion. The Commission on Taxation, to take just one small example, stated that of the €700 million spent on mortgage interest relief expenditure (in essence, a cash subsidy), nearly half went to the top two income deciles which, according to the EU Survey on Income and Living Conditions, averaged €140,000 in gross income. A question arises: if ‘the money ain’t there’, why are we subsidising high-earning households to the tune of over €300 million a year?

Or take the current exemption from the Health Contribution Levy enjoyed by rental and dividend income; Fine Gael estimates this subsidy costs €89 million. This, again, is likely to benefit the top income deciles – at a time when the ‘money ain’t there’.

Or take Labour’s proposals to limit the tax relief for pension contributions for high income groups. They estimate this subsidy costs €350 million – a lot of money to be paying those on high incomes there ain’t no money.

So the money is there – through these subsidies – for certain folk. It just depends on one’s priorities.

Probably the most disturbing thing about this analysis is its rejection of investment as a tool for growth and revenue generation. For instance, the Irish Times reported on an internal HEA report:

‘The HEA report says an investment of over €4 billion will be required to upgrade dilapidated buildings and provide space for a 30 per cent surge in student numbers.’

Clearly, this would be a wise investment – not only in our future knowledge capital but in getting people back to work now on productive activity. What if we were to take that money in just those three examples I’ve used (there are lots, lots more – see TASC’s report on tax expenditures) and redirected it into upgrading our third-level institutions? A back-of-the-envelope multiplier calculation indicates that it would boost tax revenue by nearly €900 million over a six year period while employing thousands of workers directly and creating thousands more jobs downstream. It gets even better when one factors in reduced unemployment expenditure.

From just this one small example, building on small examples, we see how redirecting money that is being foolishly spent (and subsidising high-income groups in a recession is about as daft as you can get) into productive investments exposes arguments based on ‘no cookies in the cookie jar’.

The fact is that money is there. It depends on priorities. We can argue the toss over how much and how best it should e spent. I’m sure Mr. Johns would agree that state investment in Bank of Ireland is a good investment based on the probability of return and the protection of our banking system. Clearly, Mr. Johns would say that the ‘no-cash constraint’ is not absolute and binding in this case.

If so, then how much more the case for the economy and growth and employment.

Guest post by Anne O'Brien: Reconstructing the Tourism Economy

Anne O'Brien: The volcanic ash crisis is not the only problem facing the Irish tourism industry this summer. Other, less dramatic and less publicly discussed problems exist, which will fundamentally influence if or how the sector recovers following the crisis post-2008.

The twentieth year of impressive continuous growth for the Irish tourism sector was marked in 2007. While in the late 1980s tourism arrivals were at 2.4 million, the industry employed 69,000 people, and revenue earnings were £1,153 million (€1,459 million) (Bord Fáilte, 1992) by 2007 tourist arrivals achieved a peak of 7.7 million, the industry employed 322,000 people and revenue earnings were €6.45 billion (Fáilte Ireland, 2008).

However, in the latter part of 2008 Irish tourism collapsed dramatically. The decline began in the third quarter with 174,000 less overseas visitors travelling to Ireland. In total overseas visits to Ireland decreased by 4% in 2008, despite a growth of 2% in world arrivals. Nonetheless, a total of 7,435 million overseas visitors came to Ireland in 2008 and 8,339 million domestic trips were taken, tourism contributed €1.5 billion in taxes in 2008 of which €1.1 billion was from foreign visitors (Fáilte Ireland, 2008). In 2009 the decline continued and the total number of visitors to Ireland was down by 11.6% to a total of 6,927 million (CSO). Business trips were down 20.5% (and spending down 25%). Overnights in hotels were down 19.7% (Guesthouses and B&Bs 20.6%) Total earnings from tourism were €3,879 million (CSO).

The crash has impacted in particular on the hotel sector, in part because accommodation constitutes a large proportion (28% in 2009) of the tourist spend in Ireland. Also the domestic market was heavily hit by the Irish recession, and the hotel sector had become increasingly dependent on the domestic market in recent years. In 1997 the domestic market accounted for just 46% of all hotel guest-nights, by 2008 this figure had risen to 65% of all guest-nights (Howarth, Bastow Charleton, 2008 & 2009). For hotels, lower demand was thus a problem but this was further aggravated by massively increased room stock capacity, which was at its highest level ever (58,467 rooms in 905 hotels). Since 1997, over 30,000 additional rooms and 480 new hotels had been built, representing an investment of €4 billion, and room stock had increased by 98.7% over the previous ten years (Howarth, Bastow Charleton, 2008).

Investment in the hotel sector grew after 1987 when the Business Expansion Scheme introduced tax incentives for tourism facilities, including accommodation. Between 1996-2006 the number of rooms doubled from 26,000 to 52,000 (Fáilte Ireland). In 2007 “the conclusion of the building boom in hotels brought over 8,000 new rooms to the hotel stock” in that year alone (Howarth, Bastow Charleton, 2008). Since 2003 the number of hotel rooms grew more rapidly than demand but the domestic market maintained occupancy until the crash in 2008 when the level of oversupply became obvious. For over a decade investment in Irish hotels came, not from sound fundamentals within the sector, but from the existence of capital tax allowances.

The Bacon Report in November 2009 outlined how hotel-construction tax breaks had distorted the market, by generating an oversupply of rooms. Accelerated tax allowances had been available for investment in hotels since the Finance Act 1994 and only terminated in 2006. Under the incentives investors in hotel property development could claim 15% of the capital cost of a hotel for each of the first six years of operation and the remaining 10% in year seven, against tax liability.

The Bacon Report details the vested interests that gained from these incentives by outlining a scenario where a developer applies for planning for a mixed development. As part of the planning process planning authorities would request the inclusion of a hotel development – on the basis that tourism is promoted, local employment provided, development levies are paid to the local authority, the hotel is a basis for rates payments to the local authority and the hotel constitutes a facility for local residents. The developer subsequently allocates some land and plans for a hotel with, for instance, 50-60 rooms and a construction cost of €10 million. He or she can maximise the ‘cost’ of the hotel end of the development and in this way get the tax incentive on access infrastructure costs. The developer and some ‘high net worth individuals’ with large tax liabilities for the following 7 years, fund the €10 million. In return the investors will get tax allowances of €4.2 million, and agree to fund the developer €2.1 million. The remaining €7.9 million is funded by borrowing from a bank on an interest only basis (in the investors names but with no recourse to other assets). The hotel is built and leased to an operator, often as part of an international chain franchise. (The lease income is used by the developer to pay the interest on the bank loan). The tourism development agencies support this arrangement because the accommodation base is ‘strengthened’. The exchequer supports it because it raises new taxes. The banks get to provide a loan to ‘high net worth individuals’ ‘secured’ on a property. By 2008-09 the banks had €7 billion in loans to the hotel sector. At the end of the 7 years of tax relief the hotel and loans are transferred back to the developer or sold for a profit. The general idea is that “Unless property prices fall sharply, the sale will raise sufficient funds to pay the loan and provide a profit to the developer” (Bacon, 2009: 39-40).

As Bacon comments “None of these decision makers expect to experience a downside and so none of them examine the fundamentals of the hotel industry in order to question the justification of the investment” (2009: 39-40). The final result of the tax incentives was that there were 26,802 new rooms added to the register in the period 1999-2008, with an estimated total investment of €5.2 billion and debt of €4.1 billion, most new hotels had on average been insolvent since 2002, and the situation was particularly bad in respect of hotels constructed between 2005 and 2008 (These comprise 217 hotels with about 15,600 rooms) (Bacon, 2009:ii- iii). The Bacon Report bluntly stated with regard to tax relief based investment that “it was categorically not driven by the fundamentals of the hotel industry… the investments never made sense from the point of view of operating hotels and would have been insolvent if market conditions had stayed as they were at the time of the investment” (2009:ii- iii).

The Bacon report offers a solution of sorts to this problem, which involves the ‘removal’ of between 12,300 and 15,300 rooms from the market. However Bacon further proposed that ‘barriers to exit’ for insolvent hotels should be removed “without disadvantaging the initial investors… capital allowances that have already been claimed in respect of any hotel should not be subject to any claw back by the Revenue… (2009:iv). While Bacon claims that ‘The costs to the Exchequer of removing this barrier to exit would be zero given the situation that has arisen’ (2009:iv), in a previous post on progressive-economy.ie, Pentony argues that the total potential loss to the Exchequer amounts to a bail-out for developers and adds up to over €1.5 billion. Allowances yet to be claimed have an estimated value of €527 million and allowances already claimed, have a value estimated at €1 billion.

Against this backdrop, as part of the Government’s framework for Sustainable Economic Renewal Building Ireland’s Smart Economy, a Tourism Renewal Group was appointed by government to work on a development plan for tourism for the five year period 2009-2013. The report noted that Irish tourism has the capacity, if supported and developed, to deliver as part of an export-led economic recovery but the Chairman outlined a number of issues and priorities, which needed to be urgently addressed. These included maintaining investment in the brand, cutting access costs, providing access to working capital, maintaining state agencies and acknowledging nationally the role that tourism can play in economic renewal. The report set out a number of different scenarios for recovery and the ‘realistic scenario’ illustrated what could happen if the right steps were taken against a ‘challenging’ background. This Scenario

• Sees overseas tourists stabilising at 2009 levels and returning to growth by 2011 with modest growth of 3 to 4% per annum linked to 7.5 to 7.9 million arrivals by 2013.
• Revenues from these tourists would fall in 2009 and 2010 but would show modest growth in 2011-13.
• With regard to domestic tourism the report sets a target for growth by 2011-12 and a target of 8.3 million trips by 2013.

Mid term actions for recovery focused on key issues such as putting tourism at the heart of government, increasing the knowledge and innovation base of the industry, more marketing, retraining, sustaining investment in the tourism product (strangely investment in accommodation is still included), securing more World Heritage Site designations, more e-commerce, focusing on leisure and business tourism, making access easier for tourists, keeping costs low and easing ‘the burden of regulation’(TRGR, 2009).


While Bacon comments that even if the group achieves its objective the growth signalled will not be enough to maintain many existing hotels, nonetheless there are some grounds for optimism. The UNWTO documents that while international tourist arrivals declined worldwide by 4% in 2009 this can be interpreted as a sign of comparative resilience when compared with the estimated 12% slump in overall exports (2010: 1). Moreover, in the last quarter of 2009 growth of 2% was recorded in international visitor numbers and the UNWTO forecast global growth in international tourist arrivals of between 3% and 4% in 2010. In an Irish context Howarth Bastow Charleton’s Hotel Survey for 2008 noted that effectively targeting business tourism will assist in alleviating some of the difficulties that the industry is facing. The introduction of the National Conference Centre to Dublin in 2010 was expected to create up to €50 million per annum for the economy and €1billion by 2012.

However the TRG report needs to get to grips with some fundamental problems within Irish tourism, which have existed since the early 2000s, and which don’t simply concern volcanic ash. As outlined above, there is a structural issue with the hotel sector - average room occupancy rates have been declining since 2000, and there’s a surplus in supply that needs to be addressed. The political dynamics that underpinned the prolonged use of tax relief to incentivise private sector investment in an overdeveloped hotel sector needs to be examined so that it is not repeated. Cost competitiveness in Irish tourism began to deteriorate in the early 2000s. The industry claims this is due to relatively high labour costs, high domestic inflation and the strength of the Euro against the dollar and sterling (ITIC, 2008:3). Increasingly in media discourse of late the minimum wage (rather than, for instance, profit levels in the sector) is cited as central to the problem. This common misunderstanding continues despite TASC’s report ‘A Square Deal’ which points out that the abolition of wage agreements for restaurant workers will only heighten inequality and depress consumer demand and that removing wage agreements for restaurant workers would mean a reduction of just 61 cent per customer for a meal costing €60 for two.

A more relevant issue is signalled by Fáilte Ireland, which noted that visitor satisfaction with value for money declined consistently since 2000 when 63% of visitors found value for money in Ireland good or excellent, this declined to 45% in 2002 and to 16% by 2007 (Fáilte Ireland 2003 & 2007). A further fundamental problem is that there has been a serious lack of innovation and development of the tourism product in the last decade or two (which was not subject to the same tax incentive scheme as hotel development). However possibly most centrally, there appears to be a problem with the politics of tourism development. It has been generally accepted that the main driving force behind the major success of Irish tourism over the past 20 years was the private sector. And while agencies like ITIC and the IHF were undoubtedly key in the past, there’s a central need now for the state and its agencies to act not merely to protect the sector but rather to redirect its efforts and agencies to more effective ends, namely to generate a developmental growth strategy for the sector- one preferably not premised on the demise of the minimum wage!
Dr Anne O’ Brien is an academic co-ordinator with Kairos Communications Ltd. for Media Studies programmes at the School of English, Media and Theatre Studies in NUI Maynooth

Taxbreak hotels

Sinéad Pentony: The report by Peter Bacon on the Irish Hotel Industry highlights the sorry state of the industry, which has been insolvent since 2008. By the end of that year, there were a total of 59,000 hotel rooms in the country – and according to the Report, a quarter (15,000) of these rooms need to be closed down urgently. The Report also estimates that €1bn of debt in the hotel industry is not covered by assets. Peter Bacon makes a large number of recommendations in the Report that, if implemented, would effectively restructure the industry. However, it is worth taking a closer look at his recommendations in relation to the accelerated capital allowances for hotels (tax breaks), because it would result in a significant bailout of developers if implemented.

The Report on the hotel industry identifies a number of factors that have contributed to the virtual collapse of the industry. In the first instance, it points the finger at hotel tax breaks and the damage they have caused by distorting the market. The tax breaks resulted in the creation of a huge over-supply of hotels whose viability was questionable from the outset. Bacon concludes that the stock of new hotels has been seriously insolvent since 2005, and the analysis shows that in every year since 2002, new hotels on average have been insolvent from the year of their construction. The economic crisis has compounded the situation and has brought the industry to the brink of collapse.

Secondly, the Report highlights the practices of financial institutions and banks in contributing to the problems in the industry. It would appear that the banks and financial institutions are supporting a large number of insolvent hotels to remain in business. Bacon identifies a number of reasons for this in the Report, including “... the need of hotels to remain open for seven years to allow investors to avail of capital allowances and to avoid the creation of a tax liability due to a clawback of allowances that have been claimed already; the reluctance of banks to realise losses and write off loans granted to hotels with no prospect of recovery because of the additional pressure this would place on the capital adequacy of their own balance sheets; and the reluctance to act in advance of the introduction of NAMA.”

The result of these factors is that the insolvency problem is being spread through the industry, and solvent hoteliers now find themselves having to compete against ‘zombie’ hotels, many of which were created specifically to take advantage of tax breaks, and this is threatening to destroy fundamentally sound businesses. At the same time, the reluctance of banks to provide sufficient working capital is leading to liquidity problems that further undermine the businesses of solvent hotels. Peter Bacon points to the possibility that the banks have less incentive to keep viable hotels with relatively low levels of debt open, than is the case for hotels with high levels of debt, for the reasons stated above – having to realise losses and write off loans.

So how do we solve this problem? The recommendations contained in the Report outline the restructuring that needs to take place within the industry, to put it back on the road to solvency and viability. One of the key recommendations relates to the issue of over-supply and removing 15,000 rooms from the market – it goes on to specify that the reduction of excess capacity should be facilitated by the adjustment of tax regulations concerning tax allowances for new hotels.

Incredibly, the Report recommends “...that a special provision be introduced in the Finance Act 2010 to allow relevant hotels to exit the industry without disadvantaging the initial investors in terms of capital allowance. It is further recommended that an accompanying provision be introduced to the effect that capital allowances that have already been claimed in respect of any hotel should not be subject to any claw back by the Revenue should that hotel exit the industry within seven years”.

Essentially, the Report is recommending that developers who took advantage of tax breaks to build hotels that were never going to be viable should not be subject to the clawback of those capital allowances - because they won’t have an incentive to close these hotels but rather, keep them open for the seven years, which will further undermine the hotel industry. There are two questions that arise here: the first is an economic question, and the second relates to how insolvent hotels continue to be financed.

We live in a market economy and the Report clearly demonstrates the detrimental consequences of market-distorting tax breaks. The economic logic would see the removal of the tax breaks and, if the hotel ceases trading within seven years, tax allowances would be clawed back. The tax breaks for hotels have been discontinued along with other property-based tax incentive schemes. However, the Commission on Taxation Report 2009 notes that many live on for existing projects and “for pipeline projects”, as in the case of hotel accelerated capital allowances (tax breaks).

The recommendation contained in the Report in relation to the treatment of the claw back can only be described as a further market distortion and raises serious questions in relation to ‘moral hazard’, whereby failed investors are in fact freed from the consequences of their actions. If implemented, this recommendation can only be described as a bailout for hotel developers, when they should, in fact, be subject to the same rules as everyone else who operates in a market economy. This leads us to the second question.

How can struggling developers and investors afford to keep insolvent hotels open? The answer is - the banks. The Report identified the actions of banks as being “particularly damaging” because they are avoiding the need to realise losses due to bad loans on hotels that are not viable by providing a “drip feed of working capital”. Meanwhile, hotels with low debt levels and viable businesses are experiencing liquidity problems because they are having difficulty in accessing sufficient working capital. The Report recommends that the banks need to fully recognise bad loans within the hotel sector and face any capital adequacy issues which might follow.

John Power, CEO of the Irish Hotels Federation, in an interview on Drivetime on the 5th January clearly articulated the problem with the banks keeping insolvent hotels open and the detrimental effect this is having on the industry as a whole. But how can the banks, which have such serious liquidity problems afford to keep these insolvent hotels open – when we hear countless stories of viable businesses going into liquidation because of credit restrictions?

We can only assume that part of the capital that has been injected into the banks from the State (€11bn to date) is being used to keep insolvent hotels open, so that they can be transferred to NAMA and/or to prevent the developers from incurring tax clawback liabilities, should the hotel be forced to close within 7 years of being built.

The Report puts the costs to the Exchequer of removing this barrier to exit the industry at zero. Hotel-related capital allowances which remain to be claimed have an estimated value of €527 million to investors. More importantly, allowances already claimed, which potentially could be clawed back by the Revenue, have a value estimated at €1bn. The total potential loss to the Exchequer adds up to over €1.5bn.
The Finance Bill is due to be published in the coming days, so we will have to wait and see if hotel developers are next in line to be bailed out by the taxpayer. Hotel developers would not be able to keep these hotels open were it not for the support of the banks, who in turn, have questions to answer - in relation to continuing to finance insolvent hotels and the extent to which capital injected by the State is being used to support this activity. It would appear that the taxpayer is being used to prop up the whole system and is keeping the banks, speculative developers and other vested interests afloat.

But who is propping up the tax payer?
Sinéad Pentony is Head of Policy at TASC

Budget 2010: landlords 1, SW recipients nil

in 2010, the savings made by cutting Social Welfare will be almost exactly the same as the spend on tax breaks for landlords (SW saving = €809 million in a full year, landlords tax breaks = €782 million in a full year). You can read the full details in TASC's post-Budget analysis, available here.

Congress tax menu

While a number of papers and submissions have been analyed in the media and elsewhere during the past few weeks, one paper seems to have escaped journalists' attention.

Last week ICTU published a list of 'Areas where taxes can and should be raised in the Budget' - essentially, a menu of taxes which could be levied in Wednesdays 2010 Budget. ICTU estimates that these taxes could raise over €2 billion in total.

Among their recommentations is the suggestion that more be raised from those who currently pay least, by raising the minimum effective rate on those who utilise the tax "incentive" schemes schemes. ICTU suggests that the minimum effective tax rate be raised from 20% to 35%, and that the threshold be reduced to those earning over €100,000 utilising these schemes but that the scheme be applied to pensions too.

The document is available for download here.

Tax Breaks

Nat O'Connor: TASC has estimated that tax breaks ('tax expenditure' to use the technical term) on personal income tax and corporation tax will cost €7.4 billion in 2009 in lost revenue. Tax breaks benefit the better off, whereas social welfare cuts will increase the number of people at risk of poverty. TASC argues that the Minister for Finance should cut tax breaks. You can read TASC's full submission here.

In this blog post I want to explore our (the broad public's) complicity in our tax break regime and what we can do next to make it economically and socially beneficial.

The OECD's Economic Surveys: Ireland reports that in 2005 (which is the latest full data) tax expenditure on personal income tax in Ireland cost three times as much as the average of 22 other EU countries. Tax expenditures on corporation tax costs seven times as much. In total, in 2005, tax expenditure cost €10.7 billion (not including personal credits).

Some questions:
1. What's the problem?
2. How did this happen?
3. What do we do about it?

Some answers:
1. There are three problems. Firstly, economic inefficiency. Secondly, inequality. Thirdly, the resulting non-progressive tax system.

An example of economic inefficiency was shown by the Goodbody and Indecon reports on property- and area-based tax breaks published as annexes to Budget 2006. They showed considerable deadweight - that is, people benefiting from tax breaks for investments that probably would have happened even without the tax breaks. This inefficiency was accepted by Government and these tax breaks are being discontinued.

An example of inequality is that high earners have disproportionately benefitted from pension relief (see this recent post).

The non-progressive tax system results because better off households can use more tax breaks. There is probably an income/wealth threshold after which it is cost-effective to pay a tax advisor, which in turn opens up more possibilities to avoid tax. Hence, we have a theoretically progressive tax system, with a higher rate for higher earners, but the reality of income tax paid is more like a curve. Low earners pay little of their salaries in income tax, middle earners pay a higher proportion, but higher earners pay a lower proportion.

Both the inefficiency and the inequality stem - in part - from a lack of caps and limits being placed on tax breaks. Whether or not you think that tax breaks are a valid and useful tool for Governments to use to encourange economic activity, it seems that successive governments were inexpert in designing and implementing tax break schemes. They may not have been concerned about equality, but is there evidence to show that successive Ministers for Finance signed off on tax breaks that would deeply harm the economy in order to benefit a small number of wealthy people?

2. There are probably a number of suggestion for why tax breaks grew in number and cost. Paul Sweeney, for example, has suggested they were seen as "costless" by some ministers. They certainly dovetailed with a low tax ideology. Maybe in the past ministers found it easier to persuade their colleagues to grant tax breaks, rather than increase departmental budgets.

It has been suggested that tax breaks permitted State supports to enterprise that would have been more difficult or forbidden under EU rules.

Many specific tax breaks are a response to the demands of specific sectors, such as construction, farming, mining, fund management, etc.

Tax breaks were also introduced to achieve parity with tax concessions or spending in other sectors. So more tax breaks were created to even out markets that had been distorted by other tax breaks. One cannot escape the classic image of someone sawing off the ends of table legs with increasing fervour in order to correct a relatively minor original imbalance.

3. The remaining problem is that many households, on low and middle incomes, benefit from tax breaks. Although this is nothing like the extent to which high net worth individuals have benefitted, an immediate cut of tax breaks (such as mortgage interest tax relief) would represent hundreds of euro per month taken out of many households' net incomes. The prices people paid for their homes were in turn inflated by the distorting effect of mortgage interest tax relief in the housing market, so cutting the tax break immediately would be a double blow. Nevertheless, we really do need to make major cuts in tax breaks.

One immediate solution is for the Government to impose strict caps and limits on the full range of tax breaks - including the many tax relieving measures that the Commission on Taxation identifies as part of the benchmark tax system. Strict caps will means that low to middle income households will not suddenly face a few hundred euro less in their net incomes (which is significant). Higher income households will benefit less. Over the following few years, more and more tax breaks can be cut completely, to lessen the shock to any particular part of the economy (except tax advisors).

Tightening up on tax breaks should also be more efficient than increasing income tax, as the amount of tax actually paid is much more effected by breaks than rates.