The OECD ramps up plans against corporate tax avoidance

Sheilla Killian:Following yesterday’s primer on the landscape of multinational taxes, this post reviews today’s brand-new OECD report on their plans to address multinational tax avoidance.

What’s in the report?
This report, Addressing Base Erosion and Profit Shifting, is a good contribution to the area in three ways. First, it reviews the existing studies well, pointing to a number of indirect indicators of multinational tax avoidance. As one example, it notes that the top locations for affiliate employment (the UK, Canada, Mexico, China, Germany) barely match the top locations for gross profits (the Netherlands, Luxembourg, Ireland, Canada, Bermuda). Another indirect measure cited is the ratio of profits of US-controlled firms to the GDP of the countries in which those profits are booked. For G-7 countries the ratio ranges from 0.2% to 2.6%. It rises to 4.6% for the Netherlands, 7.6% for Ireland, 18.2% for Luxembourg and up to 35.3% for Jersey. FDI flows are perhaps the clearest sign that something is amiss: In 2010 the British Virgin Islands (with a population of 23,500) were the second largest investor into China (14%) after Hong Kong (45%) and a long way ahead of the United States (4%).

The report is also useful in that it details a number of aggressive tax planning structures involving the use of royalties, debt, hybrid instruments such as convertible bonds and cost-contribution agreements. A simplified example is the use of convertible bonds by, for instance, a French company0. This hybrid instrument is a bond which at the end of its term converts into a share. If a French company invests in a foreign subsidiary using convertible bonds, the return on that investment will generally be regarded as tax-deductible interest in the host country of the subsidiary. However in France, the income will come in as tax-free dividends, creating an obvious motivation to ramp up the interest rate as a way of shifting foreign profits home, tax free.

Most significantly, though, this report is a declaration of intent. It flags a marked change in the way in which the OECD will approach the question of multinational tax avoidance. While it has focused in the past on harmful tax competition, tax havens and transfer pricing, it now intends to look more holistically at aggressive tax planning, taking in a far wider range of practices, and setting about removing the tax advantages associated with them.

So what are the plans?
The aim is essentially to neutralise the aggressive tax schemes by removing their tax advantages. So how might the OECD achieve this? The focus is shifting to corporate practices rather individual countries, reflecting the international nature of the problem. One possibility on the table is to replace the 3,000+ double tax treaties in existence worldwide with a single multi-lateral tax treaty, applying the same rules and the same treatment of income in all countries. This would be effective, for example, against the convertible bond structure highlighted above. It would be a political challenge, however, particularly in a world where not all countries follow the OECD model treaty.

They plan to improve and clarify transfer pricing rules, with a particular focus on the intangibles at the heart of the Double Irish, the Dutch Sandwich and a host of other well-known and well-sold structures being peddled to multinational firms. Rules on financial transactions between related companies and on the location of digital services are being considered. The OECD plans work faster than usual on this, and to report with detailed recommendations within two years.

The new focus is far less on tax havens; they are adamant that they are not targeting particular countries. They do acknowledge that what they diplomatically describe as “conduit countries” - countries through which royalties, interest and other payments are channelled away from the tax net - might not be immediately advantaged by the process. They insist, though that since the ultimate aim is to ensure that large companies will pay more tax overall, there will be more tax to go around. So even if Ireland, for instance, were to get a smaller slice of the tax pie, the pie itself will be larger.

Will this work out in practice? Well it depends on why companies are locating here. If their motivation is commercial, or even primarily to avail of the low corporate tax rate in generating profits here, they (and we) should be fine. Those few companies or divisions of companies which are here to abuse the tax system may find that choice less rewarding in the future, and so may move on. In a way, this will be an acid test of who we are hosting, and should result in more stable FDI for the country in the long term.

The report stops short of overt consideration of unitary tax, country by country reporting, and a host of other recommendations of such NGOs as the Tax Justice Network. However, it is a significant report, and marks a departure from the long-held OECD brief of working to avoid double taxation. They now seem more serious about tackling double non-taxation, the backbone of international tax arbitrage.

That really matters. It's important to remember in all of this that tax "saved" by aggressive corporate tax avoidance comes at a cost to the revenue stream of countries, often in the Global South where such revenue is very badly needed. If these structures were broken, not only might the pie become bigger, but also more equitably distributed, which would be a good thing for millions living in developing countries.

The full OECD report is available here. The next interim report comes in June – well worth keeping an eye on.

Sheila Killian
@islandtotheleft

Multinational tax avoidance and international responses (1 of 2)

Ahead of tomorrow’s release by the OECD of what promises to be an interesting report on their plans to address multinational tax avoidance, this post is a primer on the issue and on the role of the OECD. I’ll follow up tomorrow with some analysis of the report itself.

What’s the issue

Multinational Corporate Tax avoidance: the perfectly legal but shockingly complex process of arranging special purpose companies and capital flows in artificial ways so that the group as a whole pays as little tax as possible worldwide. It’s a huge problem – the IRS figure for profits offshored by US corporations is 1.7 trillion dollars - and that’s just American firms. The problem is that while taxes are imposed by individual countries, multinational firms roam the world in search of advantage, setting up a management firm here, a registered office there. Individual tax authorities find it difficult to see the whole picture. These days too, most of the value in large companies comes from intangible things like brand and intellectual property, which are far harder to trace than physical sales or factories.

Avoiding tax is a game as old as tax itself, but lately opposition to multinational tax avoidance has gathered momentum and political support.

Why is this a problem ?

That $1.7 trillion kept offshore by American firms is not just a loss to the US exchequer – profits it might reasonably have expected to tax. It also makes an uneven playing pitch for American companies. The bigger multinational ones can avoid tax more easily than smaller, domestically-centred firms. That gives them an immediate advantage that biases against entrepreneurship, growth, and all the things needed to kick-start the economy.

A wider problem is that it’s not just the US that is losing tax: as discussed here, the loss in relative terms to countries in the global south is even greater. A recent Action Aid report details the case of a Zambian sugar company routing interest and dividend payments through Ireland and the Netherlands in order to avoid tax in Zambia; this in a country where 45% of children are undernourished, and 90% of rural dwellers live in poverty. Lives are, quite literally, at stake here.

It’s hardly surprising in this context that US President Obama harks back again and again to the need for corporate tax reform. Indeed, politicians the world over are excited about this issue now. South African leaders have spoken out about this for years. It’s debated in the UK parliament, makes primetime news in France, home of the OECD. This media coverage drives more political debate, which in turn puts pressure on the big international bodies to do something about this.

So who are these international bodies?

In this part of the world, the three international bodies shaping international tax are the European Commission (EC), the UN and the OECD. The EC has been working for the last seven years on the Common Consolidated Corporate Tax Base (CCCTB), of which more here.  Basically, this is a way of allocating the taxing rights on profits earned in the EU across the member states, depending on where the company has located its assets, its employees or its sales. It’s an idea that bubbles steadily under the surface, but for now, and as long as unanimity is required for big tax changes like this, it is not an immediate prospect.

The UN is obviously the most representative of the three bodies. It’s also the most focused on the global south, and last October produced a detailed Practical Transfer Pricing Manual for Developing Countries.  Like the OECD, its focus is on the tax rules in place between countries – tax treaties and transfer pricing arrangements. The UN models tend to favour developing countries by allowing tax to be withheld on royalty and interest payments of the kind documented in the Action Aid report mentioend above. However, while the UN may have the mandate, and the EU the immediate proximity, the OECD has the resources, and now, spurred on by increased political pressure, is developing new strategies to tackle the issue.

What has the OECD been doing so far?

The OECD is the body behind the dominant model tax treaty, which forms the basis for most bilateral treaties negotiated worldwide. It has fairly standard clauses on who has taxing rights in cross-border transactions, and aims at eliminating double taxation. They started looking at tax havens, or harmful tax competition in the 1990s. They developed a three-part test whereby a country with low or zero tax rates ring-fenced to a subset of companies and with a general lack of transparency would be regarded as a tax haven. The penalty effectively was to lose the benefits of the tax treaty network. Around this time, Ireland’s switch from a 10% rate in Shannon and for manufacturing, to a 12.5% rate for all neatly sidestepped the new rules. We have a low tax rate, but we’re not a tax haven as defined because we have no ring-fencing of the low rate to a particular subgroup of companies.

As well as identifying countries with harmful practices, the OECD focuses on transfer pricing, of which more here. Simply out, a transfer price is the price at which goods are sold between sister companies. It can be abused as a way of shifting profit from high-tax to low-tax locations by manipulating the prices or more commonly the level of royalty or management charges paid. Such transactions should be at “arms length”, meaning that the same rates and conditions should apply within a group of companies under common ownership as between unrelated firms. This is straightforward enough to police if you are looking at the selling price of something tangible, like cars or computers. It’s virtually impossible in the case of royalties for which there is no benchmark price outside of the group.

As if this wasn’t challenging enough for taxing authorities, there has been a raft of new and very complex tax structures adopted and mimicked by multinational firms in recent years. The best known locally is The Double Irish.  As reported by Bloomberg , this is a now-infamous means used by large US firms to channel royalty payments through Ireland on to Bermuda, reducing their overall tax bill to negligible levels. Ireland is not the only country whose tax system is used in this way. Even without a detailed knowledge of the particular techniques used to shift profit, there are signs plainly to be read: the number of companies now headquartered in The Netherlands, for instance; the levels of investment flowing in and out of Luxembourg. The issue is enormous, complex and difficult to tackle. How do you establish an arms-length price for something which is only sold to one related company? How can you determine where a company has operations if its product or service is as nebulous as the very cloud in which it hosts its files?

The way in which business is done by multinational firms has changed dramatically, and tomorrow the OECD reports on how it will change its approach to multinational tax evasion in response. A blog post here will analyse their new approach, and some of its implications.

Sheila Killian

@islandtotheleft

Open Budgets: Time for Ireland to join the rest of the world

Today, the World bank is hosting a live blogging event on the results of the International Budget Partnership's 'Open Budget Survey'. The survey, produced every two years by independent experts, measures and compares budget transparency and accountability in one hundred countries across the Global North and South. The 2012 survey found that 77 out of these countries failed to meet "basic standards of budget transparency".

Unfortunately, unlike some of our fellow EU member states, Ireland is not included in this survey. If Ireland was included where would we stand?.

The Department of Public Expenditure and Reform has an impressive reform agenda, from whistleblower protection to the establishment of a system of regulation of lobbyists. Part of this reform agenda includes reform of the budgetary procedures. While much of the commentary on the preparation of the budget has focused on the role of the Economic Management Council and whether or not it weakens the role of the Cabinet, outside of NGOs, relatively little attention has been paid to the decrease in information provided by Budget 2013. Apologies for the repetition, but as Nat O'Connor noted in this blog in December 2013:

"The current Programme for Government agreed by Fine Gael and Labour is full of commitments to openness and transparency. Not least, on page 23, the pledge that “We will open up the Budget process to the full glare of public scrutiny in a way that restores confidence and stability by exposing and cutting failing programmes and pork barrel politics.”

Yet, for the first time in years, we were not given a full break down of spending decisions to the level of expenditure programmes and organisational budgets for a number of Departments. What might have been three or more pages of detail in a previous budget for some of the key departmental blocks of voted expenditure was reduced to just one page per vote block in the Budget 2013 Expenditure Report. The votes affected were: Gardaí; Prisons; Courts; Justice and Equality; the local government fund under Environment, Community and Local Government; Education and Skills; and Agriculture and Food. Only Social Protection and Health provided the same break down of sub-heads as last year.

What this means in effect is that some publicly-funded organisations are no wiser after the budget about what level of change has occurred in their individual budgets for next year, which begin in a few weeks’ time. It also means that policy analysts and journalists cannot give people in Ireland as full a picture on what promises and policies are implemented or not through the decisions made by each Minister on how his or her budget allocations will be spent".

Minister Howlin has announced his intention to bring proposals to Government on joining the Open Government Initiative established by President Obama in September. Part of this initiative requires a commitment to "Fiscal Transparency". Hopefully Budget 2013's backward step in terms of transparency will be reversed by budget 2014. In the meantime, you can watch the live blog of the Open Budget Survey here, and hopefully by the time of the next Open Budget Survey, Ireland will have joined the rest of the world.

The €64 Billion Question

Nat O'Connor: In 1955, the $64,000 Question was a 'big money' quiz in the early days of American TV (Wikipedia). Six decades later Ireland's bank debt question is one million times bigger! That's €64,000,000,000.

The Congress of Trade Unions has organised a national protest for Saturday (9th February) and Fintan O'Toole discusses a petition website in today's Irish Times. There are already more than 7,000 signatures on an Avaaz petition against the repayment in Match.

For those who would like to know more about the technical detail, the NERI is holding a special seminar on Wednesday (6th February, 10:30) that will propose some options.

More technical detail can be found in the various blog posts on this site by TASC economist Tom McDonnell:
- A powerpoint presentation here: The Promissory Notes
- Link to another briefing papers here: Karl Whelan's briefing paper
- Link to NAMA Wine Lake's analysis on a deal: Any old deal won't do

New CEPR paper on the contribution of IMF recommendations to the ongoing crisis in Europe

The Center for Economic and Policy Research (CEPR) in Washington D.C. has published a paper examining the policy recommendations made by the IMF to European Union Countries for the years 2008-2011.

  Under Article 4 of its Memorandum of Understanding, the IMF is charged with "(i) overseeing the international monetary system to ensure its effective operation and (ii) monitoring each member's compliance with its policy obligations." (IMF) As part of this 'surveillance', the fund continually monitors the economy of member countries, including country visits and consultations with stakeholders. It also makes policy recommendations.

The CEPR paper examines the advice given by the IMF over four years and finds a consistent pattern of policy recommendations, "which indicates (1) a macroeconomic policy that focuses on reducing spending and shrinking the size of government, in many cases regardless of whether this is appropriate or necessary, or may even exacerbate an economic downturn; and (2) a focus on other policy issues that would tend to reduce social protections for broad sectors of the population (including public pensions, healthcare , and employment protections), reduce labor's share of national income, and possibly increase poverty, social exclusion, and economic and social inequality as a result." (CEPR)

  Its is unsurprising, perhaps, that this is the path chosen by the IMF. However, as the paper points out, the IMF is overwhelmingly influenced by European governments through its governance system and these same European governments also subscribe to broader European Union goals, such as those articulated in the Europe 2020 strategy of a sustainable and inclusive economy. The paper points to the tension between these goals of a reduction in social exclusion, an increase in research and development and climate change goals, and the fiscal consolidation and cuts to social expenditure as advocated by the IMF.

The paper recommends that the IMF engage in an Independent Evaluation Office (IEO) review of its policy advice in Europe, which might enable it to "play a constructive role in Europe's recovery" and "demonstrate the IMF's commitment to the goals of accountability and transparency in its role as 'trusted advisor'". (CEPR)

  The paper can be accessed here.

Guest post: Potential of Government Shares held in the ‘Viable’ Banks

Guest post by Gearóid Ó Cosgora: A subject that deserves an airing, if only to tease it out, is the potential of utilising the government’s partial share ownership of the ‘viable’ banks (AIB, BoI & PTSB) to counter the current economic circumstance. I am also suggesting an improvement to the government debt profile, a recommencement of the social economy programme with 150,000 new jobs, and I discuss how the EU bank resolution programme could be self-financing.

A potential benefit of this partial share ownership is the hope (or probability) that the ‘viable’ banks will ‘turn the corner’ in the medium-term and that the eventual gains, when they arise, can be put to good use.

One good use would be to set off these potential gains against the IBRC promissory note upfront. Because the already agreed promissory note timeframe, 2011-31, is substantial, a revised cash-flow within that timeframe could potentially be met in full by directed dividends and capital gains arising from the share ownership in the viable banks.

There are certain values to be met, of course, like ‘none of this was our fault’ and ‘Ireland must be included fairly in the EU’s banking resolution initiative’. Straight off, I’m happy with a break-even, a break-even where the bailout is bailed back with interest included. I’ll even be happy with a ‘nearly’ break-even, as would most other people, I would say, given the bad situation. I’ll be glad to see any combination of actions that brings about the resolution.

As for realigning the promissory note to the government share ownership in the viable banks: If realistically projected to be sufficient, and with measures to deal with an under/over, then the weight of the promissory note would be ended. The costs associated with the ‘viable’ banks would be zeroed as well, i.e. fully recovered. The full banking bailout cost, therefore, of €64.1bn would be lifted and gone (not just deferred); policies for a much quicker economic recovery could be undertaken and issues such as jobs and debt could be addressed seriously and fast. The ‘stressed’ – long-term unemployed, excessively indebted, struggling businesses – could be targeted in an achievable national recovery plan commencing immediately.

A topic likely to be raised is whether government ownership into the post-medium-term period will hamper economic recovery. I don’t think so; two pillar banks and one ‘smaller’ bank, neither wishing to be outdone; public-v-private. I think they would be nicely set up, with an incentive to get the better of each other. As for the requirement of maintaining market share, there is nothing obvious on the horizon that suggests otherwise.

The backdrop is summarized as follows: Firstly, the level of annual profits in the ‘viable’ banks in 2007 was €4.2 billion. Secondly, this figure is allied to the averaged weighted level of government ownership in these banks, around 60%. Thirdly, the Balance Sheet equity ‘net worth’ as reported in the most recent accounts, June 2012, is €19.9bn (with government capital loans & preference shares shown as liabilities). Fourthly, the downsizing of the loan book has been mostly completed – from €318bn in 2007 to €210bn in June 2012 and to around €203bn currently (noting bank management statements issued in November), with a target of €190bn, but probably leveling out at above that, say €195bn.

EU Negotiations: This strategy would augment whatever partial write-off is achieved in the current negotiations with the ECB on the promissory note. Although it is currently suggested that no write-off will be achieved, merely a deferral, it should be noted that the ECB could agree to transfer part of the loan to the ESM where a partial write-off could be agreed as part of an EU-wide bank resolution policy. I wouldn’t throw in the towel yet. If achieved, this would make the above suggestion even more viable. The case for similar treatment for all banking resolution issues, from 2008 onwards, is solid. Also, the bank resolution process as cash-flowed over time will likely be of a break-even nature. Although times are difficult now for parts of EU banking, there will be better times. Things will likely balance out over time, so a break-even is achievable.

If the bank resolution programme is self-financing over time, the programme will attract political agreement more easily.

The income side of that cash-flow will likely include gains on bank shares, as well as bank levies and probably smallish government contributions directed from other areas. It may be possible for the ECB to channel gains from its Securities Market Programme to the banking resolution effort, a fact that was referred to at the recent Joint Oireachtas Committee on Finance (Jan 16) in discussion with Professor Patrick Honohan, Governor of the Central Bank of Ireland. It is thought that around €19bn of Irish Government bonds were purchased by the ECB at distressed prices well below par. The ECB profit on this transaction has been estimated (Barclays Capital Report) at between €3-5bn. It is within that ‘cash-flowed over time’ structure that the promissory note write-off could be included, bearing in mind that the Irish government would be left with the balance of the promissory note. All in all, there would be greater fairness across the EU or Euro area. The ECB can play a huge role also as provider of finance at negligible interest rates.

So what are the ‘viable bank’ figures that are relevant to a projection of future equity net worth? The ratio of after-tax profits to loan book in 2007 (the basis figures are above) was 1.32% (4.2/318). I project a marginal improvement in this ratio, if only because of the newly-found caution of bank regulators, bank management, governments and shareholders. Say 1.5%. If we project the loan book upwards at a cautious 2.75% cumulatively from its €195bn start-point at the beginning of 2014, we reach €266.7bn by 2025, yielding an after-tax profit of €4bn for the year, based on a 1.5% net profit rate. This is a very moderate suggestion, based on an 18-year cycle (2007-25) of market correction, surely erring on the side of caution. Leaving dividends out of the calculation, for the moment, the Balance Sheet ‘net worth’ would have increased by (say) an average of €3bn per annum for the years 2014-25, that’s €36bn, but less further losses during 2012/13 of (say) €5.9bn. The new figure is €50bn (19.9 + 36 - 5.9).

However, the ‘value’ of the equity increases to a level above that because the value of its sustainable profits is added, bringing the ‘value’, as distinct from its ‘net worth’, to a higher figure. Take the following example: Balance sheet net worth, steady at 10% of loan book, sustainably earning 15% after-tax per annum (100% of loan book @ 1.5% net after-tax profit), and where the cost of the purchasing capital is 5% per annum: The balance sheet net worth is attributed the first 5% of after-tax profit to match up with purchaser’s cost of capital. An additional purchase cost above balance sheet net worth is factored in. This represents the value to the purchaser arising from the extra 10% annual contribution (over cost of capital) plus any projected growth in that contribution. The purchaser might anticipate recovery of this extra purchase cost within (say) 5, 7 or 10 years. In the case of Allied Irish Bank (AIB) in 2007 the market value at €21bn was around €12bn over balance sheet net worth, i.e. close to 6-times after-tax profits. This ratio was replicated elsewhere before the banking crisis.

I am applying a figure of 5 times profits (€4bn), equal to €20bn. This is added to the balance sheet net worth after the dividend pay-out is factored in. If the balance sheet ‘net worth’ is pared back to bank capitalisation requirements, around €26.7bn (10%), with a dividend pay-out of €23.3bn, then the ‘value’ is projected at €46.7bn. The dividend contribution at 60% of €23.3bn is €14bn.

The equity cost, including the non-recoverable special capital contribution of €6.054bn to AIB, is €19.8bn. When deducted from the sale contribution, €28bn (@ 60% of €46.7bn), a capital gain of €8.2bn is shown, giving a total gain (with the dividend) of €22.2bn. To which we can add the gain from the government’s bank guarantee scheme plus part of the surplus earned by the Central Bank from the banking crises (excluding the promissory note interest cycle). This should be circa €7bn. (Alternatively, we could set off the special capital contribution of €6.054bn to AIB against these gains and be done with it.)

Significantly, the remainder of the bank recapitalisation of the ‘viable banks’, now at €7.3bn (following a recent €1bn sale), can be recovered from within their asset/liabilities, i.e. without recourse to the revenue reserves. The €1.3bn purchase cost of Irish Life can also be recovered. That completes the non-AngloNationwide banking bailout.

If we factor in a partial write-off from the ECB/ESM, (say €11.6bn, one/third of AngloNationwide principal cost) and if we elect to continue ownership until the promissory note end-date, 2031, then a decent kitty could be anticipated which could be targeted upfront to fund strategic capital projects and to augment a very major jobs programme, such as via a very substantial social economy programme (see below) in conjunction with the Dept of Social Affairs. Continued equity-holding in the ‘viable banks’ for 2026-31 could yield a further €16bn, allowing for inflation. Capital projects that could be undertaken include the Spirit of Ireland energy project, which could underpin our quest for a comfortable time into the future.

By these projections the full cost of the AngloNationwide bailout plus net interest is exceeded. Such projections are of no importance when compared to the principal of a proper buy-in by the EU in the resolution of AngloNationwide debt as part of its amendment, effectively, of the EU Euro Treaty. The ‘successful’ projections shown here are important as part of good solid democratic debate, and as part of the ‘glass half-full’ approach. The NPRF is an obvious recipient of surplus.

Resetting the Promissory Note: So how could we turn the potential of the government equity in the ‘viable banks’ against the cost of the promissory note. We could do this by coming to an agreement to reset the promissory note within its timeline, 2011-2031, with a revised cash-flow. A special share would be issued, linked to the reset promissory note, directing dividends & net capital gain from the equity held by the government in the ‘viable banks’, instead of the payments from the exchequer. This would be a new fully legal agreed alternative to the current method of funding the promissory note, a method that removes it from the general government debt.

What to do with government debt: We could agree on a realisable working assumption that the equity held in the ‘viable banks’ would hold par value in the medium term. When the promissory note debt and the unused borrowing amount is removed from the General Government Debt, the amount at 2012 year-end is thought to be around €138.1bn. When the AngloNationwide bailout contributed directly by government (€7.1bn) is excluded, the figure is reduced to €131bn or 80% of GDP.

However, against this it is possible to allocate the task of loan interest payment to the available government assets. The National Pension Reserve Fund (NPRF), with its bank ‘investments’ now valued at par, and with all the remaining exchequer funding of banks (€6.5bn) assigned to it, would have a value of €28.5bn, (i.e. €6.5bn less allowance for the €3,771m contributed by the NPRF as part of the €6,054m non-recoverable special capital consideration allocated to AIB, and less allowance (€1.05bn) for previous sale of Bank of Ireland equity shares, July 2011, which were paid directly to exchequer).

The remaining exchequer funding of banks are listed as follows: €2bn Contingent Capital, €1,3bn Irish Life, €2.3bn PTSB, €0.875bn EBS; the revised NPRF value is €26.8bn (current) + €1.7bn = €28.5bn.

The remaining commercial state assets plus the Central Bank – with a combined value of €10.4bn – would complete this loan interest assignment government asset. Combined, the asset group would undertake to meet the loan interest costs of a selection of debt, matching the asset group value, €38.9bn (say €40bn). The loan portfolio selected would be taken mainly from the low interest end of the loan book. The interest paid by this asset group would be approximately €1.5bn, based on an average rate of 3.75%.

Two difficulties arise requiring a solution. 1) The Central Bank payment would be channeled via the exchequer as normal, and 2) the income forgone by the exchequer would be recovered by means of tax buoyancy and interest savings. The government debt would now stand at €93bn, or 57% of GDP. The government asset group would continue to fund the loan interest until 2025 when the NPRF becomes operative, or earlier if the gross national debt had fully stabilised.

The net government debt, the banking crisis aside, has moved from around 13.5% of GDP to a little over 63.5% of GDP in the 5-years, 2008-12, i.e. 10 percentage points per year on average. It has cushioned the crisis somewhat. But now is the time, with the banking debt off our backs, to steady it to not more than what it is at.

Social Economy Programme: The improved economic circumstance arising could be directed to quickly develop a voluntary social economy programme with 150,000 places, thereby countering the very high unemployment rate. I don’t see any difficulty in rolling out this programme, based on the 2000-2002 model. A leaner model, perhaps, with management from within the participants, with strong voluntary involvement undertaking tasks such as financial management, support for management, marketing and training. A leaner model would better sustain the roll out. It would require a ‘GRAND’ plan, big and brash, closer to full-time than the one week on, one week off of earlier times. And funding: Premises funded by local authorities (funded directly from property tax) but utilising empty space; Materials & consumables budget funded by savings re above suggestions; Labour costs funded by current unemployment assistance/benefit and other linked funding; Social Economy project earnings contribution averaging 25% of costs. Pay: Social welfare payment + €50 per week. Some working from home factored in.

Mortgage debt: The figures seem to be roughly as follows: Households with no mortgage, a low mortgage or who are paying a social housing economic rent: equal to 50% of households. Renting by young or mobile: equal to 10% of households. Long-term renting: equal to 10% of households (mostly small units). Renting by ‘settling down’ households: equal to 10% of households. High mortgaged households: equal to 20% of households. Some of the high mortgaged households have mortgage-security extended to non-household funding, including struggling or lapsed businesses; many high mortgages are on temporary interest-only payment systems.

I mention mortgage debt because, as these rough figures suggest, the issue can be solved and the above measures would undoubtedly hasten that solution.

Household debt: At €178bn (3rd Quarter, 2012), it is a serious drag on the economy. If the portion of it that is ‘business balance-sheeted’, i.e. that is part of a business balance sheet that ‘could’ be earning some return (perhaps not in the immediate short-term) – such as buy-to-let property, some of, and secured business loans – was being repaid from business activity, or at least where there might be repayments in the medium-term, then that would reduce the severity of the overall figure.

Also, as a measure of the problem, some account should be taken of the cost of an alternative to mortgages, i.e. controlled or uncontrolled rents. The aggregate cost of housing in Ireland may still be less costly than in countries with a practice of mainly letting.

The combined effect of all these measures in unison would be to speed up the needed resolution to the crisis effecting the economy, jobs and debt. It would be like handing the economy a €64.1bn boost or stimulus. But unlike a Keynesian multiplier stimulus, there is no cost, no borrowing and no circling of the multiplier effect.

The loan balances across the six banks bailed out by the government in September 2008 are now down by around a half, €403-203bn (plus the NAMA/IBRC balance of around €42bn, now not in the system); the suggestion above, if successful, would show the government debt at very manageable levels; but the household debt would remain an issue, except that the improved economic outcome would facilitate a substantial easing. The social economy initiative, if successful, would put a far better shape on the unemployment rate and restore work dignity to a considerable number of people.

It is a proposal of speeded-up economic recovery directed at the ‘stressed’ – long-term unemployed, excessively indebted, struggling businesses. A slow-crawl recovery, as per Japan (since the nineties), would serve most of the population well, but not the stressed.

Gearóid Ó Cosgora is proprietor of Salthill Bookkeeping and Accountancy. He held management roles in community initiatives such as Leader, ADM Partnership, and community cooperatives and was involved in both the pre-development and operational stages of the social economy programme, 2000-02.

Financialisation

The most recent issue of the Economic and Social Review has a symposium on the politics of financialisation, including papers on the US, a comparative analysis of financialisation and inequality in the OECD and my own paper on”The Crisis of Financialisation in Ireland”.

The table of contents, with links to papers, is here: http://www.esr.ie/vol%2043_4/ESRTOC43_4.htm

The abstract of the Ireland paper is below:

Comparison of EU Bank Bailouts

Michael Taft uses Eurostat data here to compare the 'direct' impacts on General Government Deficits caused by the EU's numerous bank bailouts. In some cases these figures dont even capture the full cost of the bailouts as, for example, in the case of Ireland the €20 billion taken from the National Pension Reserve Fund is not included in the Eurostat figures.

Promissory Notes: Any old deal won't do

Tom McDonnell: There is a real risk that any old deal in advance of the 31 March payment will be hailed as a victory after the failure to get a deal on the promissory notes last year. No matter how bad the deal actually is.

In that context Nama Wine Lake provides a quick overview here of what would and wouldn't constitute a deal. Just eleven weeks to go.

Launch of NERI Quarterly Economic Observer/Facts

The NERI has published, today, its fourth Quarterly Economic Observer (QEO) along with the latest Quarterly Economic Facts (QEF). A link to the full QEO together with a short summary of key points is contained here.

The QEF may be accessed here.

Later today staff of the NERI will present these publications at a special seminar at 3pm (earlier time than normal NERI seminars) in Dublin. All are very welcome to attend. Details are here.

The next (Spring 2013) QEO will be focussed primarily on the Northern Ireland economy while retaining the NERI's all-island mandate in the publication itself.

What is the matter with Europe?

Tom Healy: It is time to think deeply about the European project especially as Ireland assumes the Presidency for the coming six months. While I don't necessarily share all of the premises and conclusions in this article(written in mid-2012) by Prof Ray Kinsella and Maurice Kinsella the reader has reason to pause and think and think again. The authors assert that there is an alternative to current economic orthodoxy with a 'new economics based on solidarity'. They are trenchantly critical of the move away from the founding principles of European solidarity, subsidiarity and respect for fundamental human rights including economic and social. I was particularly struck by the following:
"The policies offend against justice in that in Spain, to take one example, almost 50 per cent of those under twenty-five are now unemployed. No amount of economic sophistry based on 'flexible labour markets' can detract from the reality that this generation has been cut off from the right to work, and to give expression to their talents and their capacity to support a family. Whole new segments of society have been cast into poverty and this offends against justice and the shared values which once animated the European ideal."
Incidentally, the same edition of Working Notes (produced by the Jesuit Centre for faith and Justice) has very interesting articles by economist historian Kevin O'Rourke, TASC economist Tom McDonnell and Robin Hanan of the European Anti-Poverty Network

The effect of marginal tax rates

It has sometimes been suggested that marginal tax rates in Ireland are too high, and that raising them would harm growth. They may affect the incentive to work. It is true that they are 10th highest, of the 34 countries in the OECD. Also the marginal rate hits in relatively low (affecting average earners). Helpfully, the OECD provide the data here.


However, what is the link between marginal tax rates and the economy?

 

As can be seen in the above graph there is no negative relationship between GDP per capita and marginal tax rates. In fact it is slightly positive. Of course this is not conclusive evidence of a positive link, but the evidence certainly does not support the hypothesis that high marginal rates harms GDP.

But does it affect the incentive to work?

No relationship is found between unemployment rates and marginal tax rates in the OECD.

High tax rates are not the problem. In other countries, such as the Nordic countries, high tax rates are used to fund social services such as child care, which make it easier for people to work in the market economy.

Open debate on paying the promissory notes - the long countdown

Tom McDonnell: Various official sources (including Ministers) have been making the claim in recent days that the 2012 promissory note to the IBRC went unpaid. Sadly this is untrue.
The ECB insisted all along that it receive its ELA repayment from the IBRC on time on 31 March and this is exactly what happened.  The repaid money was then destroyed/deleted/burned/expunged on time and as scheduled.

It is true that the money promised to the IBRC was initially paid to the zombie bank by the state-owned NAMA (in exchange for a 13 year government bond given to IBRC by the Irish State) rather than by the exchequer. Nevertheless it was paid using 'our' money - we own NAMA after all. Following a series of subsequent exchanges the bond is currently held by Bank of Ireland.

A slightly irritated ECB watching the shenanigans merely acknowledged that it got paid on time as expected and that it had observed certain transactions betwen various Irish state institutions.

That the promissory note was paid (by issuing a sovereign bond) is stated clearly in the Department of Finance's Medium Term Fiscal Statement. Much of the confusion may stem from the media's general failure to accurately report and explain what happened on 31 March - understandable given the byzantine nature of what occurred. Fortunately not everyone in civil society has been taken in by the official line. For example the Debt Justice Action group has a letter in today's Irish Times which draws attention to this issue.

The government's next payment to the IBRC will not be made for 108 days. There needs to be an open and honest public debate about the subsequent promissory note payments to the IBRC. All options have to be on the table.

TASC's more detailed response to Budget 2013

Nat O'Connor: TASC's more detailed response to Budget 2013 is here.

Budget Transparency Pledge Weakened by Lack of Detail

Nat O'Connor The issue of budget transparency is so important that it deserves special mention.

With the possible exception of elections, there is no other single most influential event in our democracy than the national budget. The budget is where all is revealed in terms of the values and priorities of the current government and it is often when it comes to spending money that promises made in manifestos are fulfilled or broken.

While the Government is moving towards some important reforms, like the strengthening of the Freedom of Information Act, there were some major surprises in the dilution of the quality and depth of information provided in the Budget 2013 documentation.

The current Programme for Government agreed by Fine Gael and Labour is full of commitments to openness and transparency. Not least, on page 23, the pledge that “We will open up the Budget process to the full glare of public scrutiny in a way that restores confidence and stability by exposing and cutting failing programmes and pork barrel politics.”

Yet, for the first time in years, we were not given a full break down of spending decisions to the level of expenditure programmes and organisational budgets for a number of Departments. What might have been three or more pages of detail in a previous budget for some of the key departmental blocks of voted expenditure was reduced to just one page per vote block in the Budget 2013 Expenditure Report. The votes affected were: Gardaí; Prisons; Courts; Justice and Equality; the local government fund under Environment, Community and Local Government; Education and Skills; and Agriculture and Food. Only Social Protection and Health provided the same break down of sub-heads as last year.

What this means in effect is that some publicly-funded organisations are no wiser after the budget about what level of change has occurred in their individual budgets for next year, which begin in a few weeks’ time. It also means that policy analysts and journalists cannot give people in Ireland as full a picture on what promises and policies are implemented or not through the decisions made by each Minister on how his or her budget allocations will be spent.

For example, we know that in Vote 24 (Justice and Equality) there will be a 20 per cent reduction in programme expenditure to ‘promote equality and integration’ (line item D). That’s a €5.8 million reduction in that programme.

The equivalent information in Budget 2012 was part of item G: ‘equality, integration and disability’. However, in last year’s document the amount of money going to 10 different line items is shown, such as ‘grants to women’s organisations’, ‘equality proofing’, ‘Traveller initiatives’ and so on, with the specific changes to each area open to scrutiny.

Such missing detail means that people in Ireland have far less clarity on what is being done with their money and in their name. This lack of transparency is a retrograde step from the point of view of Ireland’s democracy.

TASC's initial response to Budget 2013

Nat O'Connor: TASC's initial response to Budget 2013 is as follows. (PDF available here).

Lost opportunity to provide a pathway to an equitable economic recovery
Continued pensions inequality and cuts to investment underline the need for a process of equality proofing and economic impact assessment to improve Budget process

In an initial analysis of the measures introduced in Budget 2013, TASC Director Nat O’Connor welcomed the introduction of the local property tax, but expressed concern at the likely damaging effect of others measures on economic equality and on job growth.
“As TASC highlights in its own pre-budget analysis, property tax is shown by international evidence to be the least damaging form of tax on jobs and growth.” Dr O’Connor noted. “Likewise, the introduction of deferred payment options makes sense from an equity perspective, whereas a bad precedent was set by the waivers given to those who can afford to buy an empty house in the next three years, as that waiver will be paid for by many people who cannot afford to buy.”

“It is surprising and disappointing that, despite a range of announcements in Minister Noonan’s speech, the Government has not in fact made any real change to Ireland’s pension tax breaks for 2013. All that has been substantively announced is that the Government will consider changes in future years. Pension tax reliefs favour better off sections of society and those subsidies are paid for by other taxpayers who will never enjoy those benefits. The ESRI has shown the 80 per cent of the benefit of pension tax reliefs goes to the top 20 per cent of earners. It is a missed opportunity that TASC’s proposal of reducing relief to the standard rate was not adopted, as this would have raised €500 million that will instead be found through less progressive tax measures and cuts to public services that people on lower incomes rely on more heavily.” Dr O’Connor concluded.

Commenting on the overall Budget package, TASC economist Tom McDonnell expressed serious concern at the cuts to capital expenditure. “The disproportionate cuts to capital expenditure are a false economy and represent a failure of economic policy, which will undermine our medium-term growth potential. All the international evidence shows that an economy’s capacity to grow depends on productive investment. Yet Ireland is projected to have by far the lowest level of investment (gross fixed capital formation) of any country in the EU for the coming years, which is highly likely to mean a weaker growth going forward.”

“The PRSI changes made in the budget represent a highly regressive form of tax increase on earned income that will almost certainly worsen economic inequality in Ireland. TASC has repeatedly emphasised the need for equality proofing of budget measures in advance, in order to ensure that Ireland’s budgets reduce rather than increase inequality.” Mr McDonnell concluded.

Lessons from the UK

Nat O'Connor: The UK's Chancellor of the Exchequer, George Osborne, gave his Autumn Statement early this afternoon, as the UK too examines its debt and deficit levels. One striking feature is that he cited at length the independent Office of Budget Responsibility, which generates the growth forecasts used by the UK Government instead of the civil service predictions used in the past.

Despite presumably being disappointed by those independent forecasts (including the prediction of UK GDP decline of 0.1%), the Chancellor nevertheless praised the independence of the OBR. Given the history of optimistic growth forecasts by the Irish civil service in recent years, there may be a lesson for us in the value of having independent growth forecasts.

The OBR notes that problems in the Euro zone will "constrain growth for several years to come" in the UK. The Chancellor (citing the IMF and others) laid the blame for the UK's low economic growth on the problems abroad. Limited growth in the UK likewise affects Ireland greatly, as they remain our major trading partner. Of course, Ireland's woes are part and parcel of the Euro zone's problems and our growth will be even more constrained than the UK's until strong action is taken to repair the institutional weaknesses in the Euro zone.

The UK is not cutting spending in its Revenue service, but is instead clamping down on tax evasion and avoidance, including measures to close hundreds of tax loopholes and tax breaks, including pensions tax relief (which in Ireland has been described by the IMF as tax relief for richer sections of society).

The UK government is also increasing capital spending by a modest amount (£5 billion GBP) to improve economic infrastructure, which is exactly what is needed to foster long-term growth. Another lesson for Ireland there, as our capital expenditure has been slashed in recent years.

The UK is also creating a new business bank to ensure lending to SMEs. The lack of credit from Ireland's dyfunctional banks is currently killing businesses in Ireland.

The UK has capped rail fare increases for the next few years, unlike in Ireland where they continue to rise - including Dublin Bus's recent fare increase of c.18 per cent following a rise of around c. 15 per cent earlier this year!

Not that I'd agree with a lot of the Chancellor's other measures or rhetoric. Some bad moves include limiting welfare increases to below inflation (which will lower aggregate demand), tax incentives for shale gas extraction (which will be environmentally damaging) and ruling our further property taxes (which are less damaging to job growth than any other tax increases). But it will be interesting to compare the measures taken by the UK coalition with our own coalition budget later today.

The deficit and debt repayments

Nat O'Connor: The brief ten pages of the 2013 Estimates include the stark reminder of just why the Government is set on €3.5 billion of tax increases and spending cut today. Receipts in 2012 were just under €41 billion, wheresas spending was around €56.5 billion. That's a gap of €15.5 billion.

The actual deficit in the General Government Balance is slightly less, at €13.4 billion (Table 1a in the same document).

The gap shows the growing importance of the national debt interest repayments in making the public finances unsustainable. Servicing the national debt cost us nearly €6.5 billion in 2012 and is set to rise to €8.1 billion in 2013. That's nearly as big as the entire education budget (€8.7 billion in 2012). The details of public spending can now be seen at DoPER's databank.

This point is graphically illustrated on page 12 of the Medium Term Fiscal Statement, which is the other document currently on budget.gov.ie. A copy of that image is below:

The debt interest burden is projected to peak at 16 per cent of all Government revenue in 2014.

A serious concern with these projections (and the assumption that the deficit and debt interest payments will stabilise) is that projections of economic growth have repeatedly been over-optimistic. The IMF now calculates that austerity in developed economies means that for every €1 taken out through tax or cuts, between €0.9 and €1.7 will come out of economic output (GDP) - see page 43 of IMF's World Economic Outlook. There is a real risk that even this grim picture of debt interest repayments may be over-optimistic.

At any rate, it is certainly the case that a major win on reducing the bank debt part of the national debt (and annual debt servicing costs) needs to be achieved.

#Budget2013

Nat O'Connor: As the new era of budget transparency dawns (or should that be New Era?), the Government's official information service (MerrionStreet.ie) will be tweeting budget soundbites to the nation, via hashtag #Budget2013

For more conventional information, official documents will be made available on the Government's Budget website budget.gov.ie as the day progresses.

Clamping Down on Tax Injustice—Sharing the Price of Austerity

Daragh McCarthy: On Wednesday, the EU’s tax commissioner will outline a set of proposals aimed at reducing the level of tax evasion and aggressive tax planning in the EU. The Commission estimates that tax dodging, in all it's various guises, deprives Member States of almost €1 trillion every year.

Reports suggest that the plan will detail the need to agree a concrete, shared definition of a "tax haven", and to create a blacklist of jurisdictions that match the definition. It is hoped that this measure will make it easier to tackle tax evasion and to take action against jurisdictions that fall outside the norms governing the taxation of cross-border corporate transactions.

The Commissioner's report will look at ways of closing-off access to loopholes that facilitate the development of aggressive tax avoidance structures. To this end, it has been suggested that states adopt "general anti-abuse" legislation that would allow tax authorities to disregard any corporate arrangements deemed to solely serve the purpose of tax avoidance. In addition, the Tax Commission will outline the need for countries to insert a clause into their double-tax agreements specifying that one country is precluded from taxing income only if that income is taxed in the other contracting state. It is hoped that is would prevent double non-taxation of income.

Efforts to extract a greater tax yield from transitional businesses must address several challenges. TASC's report highlights the difficulty of assigning a market value to transactions between subsidiaries of the same parent company. By making it hard for officials to identify and place a true value on intra-group deals that purely facilitate tax reduction, multinationals retain the capacity to substantially reduce the potential effectiveness of some of the measures being proposed. The 2006 European Court of Justice ruling in favour of Cadbury Schweppes established that putting subsidiaries in low-tax countries was not necessarily tax avoidance—so long as the activity carried out by the operation was not "wholly artificial"—which makes legislating for reform more problematic. Finally, Feargal O'Rourke recently argued that the increasing prominence of online business is reducing states' ability to collect tax from corporate entities, though it's difficult to establish the extent of the hindrance that this creates.

Effective regulation of the problem requires enhanced international co-operation. It's a well-worn argument, but aggressive tax code competition between countries results in jurisdictions that unilaterally decide to take a harder line with regard to taxing transitional subsidiaries being punished through the loss of foreign investment. Ireland's model of industrial development is, however, largely predicated on enticing multinationals to the jurisdiction on the basis our low-tax regime, so, in the medium term, the proposals represent a potential threat to economy. If the Commission's ideas gain traction—and the EU moves closer to the creation of a Common Consolidated Tax Base—pleasing the multinationals while remaining a full-fledged member of the EU could become an increasing precarious balancing act.