Maybe Ireland has discovered the magic formula on taxes

For at least half a decade now there has been no shortage of warnings that the State is becoming overly reliant on a few big multinational companies for its tax revenues. Add in the income tax paid by the employees of these companies and you find a tax system where a lot of cash is based on narrow foundations. The risk of something going wrong is obvious. After all, we have been bitten before, when property related revenues collapsed after the financial crisis, leaving a massive crater in the public finances.

But the surge in tax revenues just keeps on going. What if this is all sustainable? What if Ireland has found the magic formula which has moved revenues to the State onto a different level?

Something interesting happened as the economy emerged from the pandemic. Not only did corporation taxes keep on beating forecasts, there was also a big increase in income tax which jumped 17 per cent last year and are rising strongly again this year. The jobs market is booming. And because better-off employees pay a lot more tax than those on lower earnings, it is clear that the high wage sectors are doing particularly well.

There is new evidence of the earnings boom is getting, well, boomier, in the high-tech and associated sectors. A paper by Kevin Timoney of the Irish Fiscal Advisory Council this week estimated that employees in the top five sectors in terms of earnings account for about 22 per cent of hours worked in the economy, earn 33 per cent of the wages and pay 40 per cent of the income tax and PRSI. Since the economy recovered after the financial crash, earnings in this group have moved sharply ahead of the rest of the economy – and jumped again in 2021, based on higher employment, rising wages and bonuses.

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The IFAC is not known for its happy-clappy optimism. Its job is to take a cautious view. But the paper concludes that while there are the obvious risks – for example a big hit to economic growth cutting hours worked and pay levels – the official income tax forecasts from the Department of Finance could actually be too conservative.

Corporation tax has been the other big performer, with annual revenues rising from just over €4 billion in 2015 to a forecast of €14 billion this year – again likely to be well exceeded. With over one in every five euro collected in tax coming from this source, Ireland is well out of line with international averages, or historical experience. Hence the regular warnings that by bedding in extra spending on the basis of what may be a transient revenue the country is storing up trouble for the future. But for now corporation tax returns just keep heading higher.

Investment

Where has this all come from ? The big move of investment to Ireland after the international tax rules changed in 2015 seems to have changed the game. Many multinational companies moved their intellectual property (IP) assets to their Irish branches – the patents, licenses and copyrights to the international sales of things such as the iPhone and many key pharma drugs are now owned from Ireland. Crucially, multinationals have build new physical investment in tandem with this, creating jobs, more profits and tax revenues. And the tax paid on profits earned directly by the IP assets may rise in the years ahead as initial tax write-offs run out – provided of course the IP is not moved off elsewhere.

Here we come to the first risk to our tax bonanza – the exposure to decisions made in a few big corporate headquarters. What boardrooms in California give, they can also take away. But while we have seen a few warning shots from restructurings recently, the momentum of investment remains positive – for now anyway.

The second risk is that external factors move against us. The OECD tax reform process – now heavily delayed – will cost Ireland revenue, though the associated increase in the corporate tax rate will earn some of it back. The impact of the war in Ukraine on international investment trends also needs to be watched – combined with the fall-out from Covid, the talk is that full-on globalisation, from which Ireland has benefited, may be on the wane. Businesses may want shorter supply chains, closer to home, even if they cost a bit more.

The third risk is a big international recession as a result of the war in Ukraine. Already this has led to a cost of living crisis and things could get worse if, for example, gas supplies from Russia were disrupted. This would have a broader impact on investment, employment and taxes across the board.

And the fourth risk is that Ireland starts to lose ground in the fight for foreign investment. Already there are warnings about the impact of house prices and rental costs – a key barrier to bringing staff here. And Ireland’s energy security – or lack of it – and the need to develop clean energy sources will be a key competitive issue. As IBEC boss Danny McCoy has warned, the extraordinary growth of investment here puts pressure on the State to increase its activities in a whole host of area – housing, planning, energy provision, transport and so on.

So there are reasons for caution. And a clear case to keep putting cash aside in contingency funds given the huge uncertainties ahead. But Ireland also needs to focus on policies to keep the major investments producing all the revenue here and building their Irish presence. The big surge in taxes has gone on too long to be some kind of once-off fluke. The growth of revenues is surely unlikely to continue at the rates seen over the last half a decade – but there is something here worth fighting to hold on to.