Is tax avoidance at the heart of Ireland’s economic miracle?

Coming out of the economic crisis Ireland was one of the best performing economies, with GDP growth rates of 8.5% in 2014 and an extraordinary 26.3% in 2015. But how much of this economic activity was real, and how much a fiction created by Ireland’s tax haven status? A new paper by Heike Joebges of the University of Applied Science in Berlin considers the evidence.

While the European Commission has praised Ireland for its remarkable economic rebound after the crisis, Professor Joebges concludes that this recovery might not be as impressive as thought.

Firstly, much of the statistical economic boom in  Ireland over the last couple of years has been the result of a change in the way national accounts are calculated. But even if we strip out the accounting changes, Ireland would still have shown GDP growth of 5%, an impressive improvement. However, here there are some issues too.

A foreign dependency

Ireland is an economy dominated by foreign companies. According to official figures foreign controlled affiliates provide almost 50% of employment in the country and 80% of exports (90% of manufacturing exports). This, combined with Ireland’s status as a tax haven, makes Irish GDP figures particularly vulnerable to profit shifting.

Because of Ireland’s low tax regime it is advantageous for companies to try to report profits in Ireland. Through transfer pricing, which involves the Irish subsidiary overcharging other parts of the company based elsewhere for goods and services, profits can be moved from the rest of the world to Ireland.

However, this kind of internal profits shifting does very little for the domestic workforce. Indeed, in some cases headquarter companies based in Ireland may not be employing anyone at all. Wages do not increase because the Irish subsidiary is making more money. Instead profits declared in Ireland are quickly taken out of the country again. As Heike describes in her paper:

Employment creation by foreign affiliates in reaction to increased demand is lower than for domestic companies (Department of Finance 2014), and some foreign companies may not at all offer employment opportunities: Re-domiciled Public Limited Companies (PLCs) may be legal entities without any economic activity in Ireland. The term refers to companies that relocate their headquarters back to Ireland, typically in order to avoid tax payments in other countries and benefit from low taxation in Ireland. Their only contribution to the Irish economy are tax payments.

Who benefits?

The paper goes on to to demonstrate how in Ireland, FDI driven growth has done little to benefit the domestic workforce. Employment has still not reached pre crisis levels in Ireland. This is despite the fact that the country has been experiencing net emigration, which should decrease the work force. Wages have still to reach 2008 levels also. The wage share, that is the amount of national income that is paid out as wages, has declined severely. What this means is that the economic costs provoked by the financial crisis have been borne by workers, not investors.

Why this matters

All of this matters because Ireland’s economic recovery has been celebrated by many economists around the world as providing a case study for other countries. The European Commission has attributed Ireland’s recovery to structural reforms which led to a more ‘competitive’ labour force. But if the recovery is mostly illusory, and the results are not reflected where it matters most, in jobs and growth of the real economy, then is Ireland really the example that others should follow? Indeed is it even possible for countries to follow the Irish development model, which relies on freeloading off profits earned elsewhere?.  As Professor Joebges summarises:

“This result puts the Irish role as a blueprint for other countries into question. Ireland’s strategy of attracting foreign owned companies by low corporate taxation rates can be seen as a beggar-they neighbour strategy, increasing downward competition for taxation in the EU. The strategy is not even clearly positive for Irish citizens, at least not for those relying on wage income. Therefore, it is surprising that the government seems to be willing to continue to compete for foreign owned companies by low corporate taxation rates, as a series of publications of the Department of Finance (2014) seems to indicate as well as the discussion of having to accept tax payments of Apple (CNBC Sep. 7, 2016)”

The full paper can be read here.