Apple's tax woes as Irish conventional wisdom fails again
There is a sense of déjà vu about the seismic shock experienced by the Irish establishment following the European Commission's finding that Ireland provided illegal state aid to Apple Inc. when it issued advance tax opinions in 1991 and 2007 — while the impact is not on the scale of the bursting of the property bubble, the latest failure of Irish conventional wisdom has much in common with 2008.
In the 2011 report on the Irish banking collapse that was commissioned by the Government, Dr Peter Nyberg, a former senior official at the Finance Ministry of Finland highlighted "groupthink and conformism", "herding", "everybody expected a 'soft landing' at worst", "the media and the political system take a supportive rather than a challenging role", and "barring only a handful of identified vociferous contrarians, may have made it easier for institutions to accept toning down the application of vital, tried and traditional prudential practices."
Dr Nyberg could make similar observations about the current tax debacle.
Last Tuesday's announcement that Ireland has been instructed to demand Apple to pay about €13bn ($14.5bn) + interest in back taxes came six weeks after the announcement that Irish GDP (gross domestic product) in 2015 had been revised up to a world-beating 26.3% — Bloomberg News reported: Ireland Stuns World With 26% Economic Growth Rate, and Paul Krugman, New York Times columnist and winner of the 2008 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, sent a tweet (see below) calling the news "Leprechaun economics."
The 2015 stunning growth revision and Apple's tax woes are directly related.
John Kenneth Galbraith (1908-2006), the Harvard economist, coined the term 'conventional wisdom' in his book The Affluent Society (1958). He wrote:
Because familiarity is such an important test of acceptability, the acceptable ideas have great stability. They are highly predictable. It will be convenient to have a name for the ideas which are esteemed at any time for their acceptability, and it should be a term that emphasized this predictability. I shall refer to those ideas henceforth as the conventional wisdom.
Galbraith made clear that it's not other ideas that defeat conventional wisdom as facts do not often change entrenched views: "The enemy of the conventional wisdom is not ideas but the march of events."
The Irish establishment was sanguine until May 2013 that Ireland's facilitation of massive tax avoidance by giant US companies was not a threat to Ireland's key enterprise policy.
Ireland had a veto in Brussels on changes in corporate tax (CT) policy and gridlock in Washington DC was likely to prevent the enactment of corporate tax reform.
The Irish Government said in 2013 that it does not know how many Irish non-resident companies existed and a multi-billion dollar invoice charge from an Irish shell company with an address at for example a law firm in Bermuda to a US affiliate in Ireland, typically would not raise any alarms in Dublin among auditors or the Irish Revenue, nor did Apple's secret designation of its Irish entities as stateless — the directors of less prominent indigenous companies using similar devices would likely have risked imprisonment.
The impact of tax avoidance on key economic indicators is not officially recognised and in 2014 Ireland's Department of Foreign Affairs said in a statement: "Ireland is a strong performer in services exports, which now account for over half of total Irish exports. This reflects the growth in ICT and e-business sectors with a number of Irish services companies and foreign-owned multinationals operating and exporting from Ireland."
Google for example was booking 40% of its global revenues in Ireland, Microsoft about 25% and Facebook about 50%, boosting Irish exports.
The CSO said in 2014 that Irish companies had 246,000 working abroad but most of them were in American firms that became Irish for tax purposes>>>>>>
In 2010, the year of the international bailout, President Sarkozy of France was branded a hypocrite for criticising Ireland's headline CT rate of 12.5% when France apparently had an overall effective CT tax rate of just over 8% — which was a distortion. It was also a time in the UK when public protests against tax dodging coincident with austerity would lead to a political focus on tax avoidance in Europe by big multinationals.
The May 2013 report by a US Senate panel containing sworn information on Apple's tax strategy and the disclosure that Apple's key Irish non-resident companies were secretly classified as stateless for tax purposes and used to channel billions in funds tax-free to the United States, was a dramatic development in the battle against international tax avoidance.
In 2015 after President Obama name checked Ireland as a location for US companies, which choose to become Irish for tax purposes, the Irish Government said it did not welcome tax inversions — they mainly benefited Big 4 accounting firms and commercial law firms while increasing Ireland's contribution to the EU budget as GNP (gross national product) was artificially boosted (as is the Current Account).
FDI in Ireland
When the Irish Free State was formed in 1922, the new state had only a third of the industrial capacity on the island.
As in other former colonies, foreign direct investment was mainly from Britain. However, the decision in 1917 of Henry Ford to build a tractor plant in Cork City, 30 miles from where his father had been born, was a big deal. By 1930, Ford was employing 6,000 in Cork.
John A. Mulcahy, another Irish-American and a Pfizer board member, who had sold his Quigley company to the drugs firm in 1968, was instrumental in the decision of Pfizer to open a manufacturing facility in Cork in 1969. It was one of the first pharmaceutical companies to locate in Ireland. Apple opened its Cork factory in 1980 and in 1984 Cork had its annus horribilis when Ford shut its assembly plant, Dunlop shut its adjacent tyre plant on the Marina and downstream in the harbour the Dutch-owned Verolme Cork Dockyard, closed its ship building facility.
T.K. Whitaker (b. 1916), the head of the Irish civil service, in a 1957 memorandum on the failure of economic policy and the general sense of hopelessness in the country, had warned that "without a sound and progressive economy, political independence would be a crumbling facade."
Ireland decided to abandon its protectionist system and it embraced the emerging globalisation that tariff reduction triggered.
November will be the 60th anniversary of the introduction of the Export Profits Tax Relief (EPTR). Originally this provided for a 50% tax reduction on profits from increased export sales, but this was quickly raised to 100% and 1930s era restrictions on foreign ownership were eased.
According to Prof Frank Barry of Trinity College, manufactured exports, which had been flat for years, grew by 18% in 1957 and doubled between 1956 and 1960.
The EPTR was abolished in 1981 (with a grace period of up to 1990 for existing beneficiaries) and replaced with a 10% corporation tax on “manufacturing and internationally traded services.” The standard corporation tax rate was 50% and the 10% rate was extended in 1989 to activities in the International Financial Services Centre (IFSC) in Dublin.
The current 12.5% applied to all companies from 2003 and by 2010 the grace period for the 10% rate ended.
In 2015 there were about 177,000 permanent staff in FDI exporting firms in Ireland (CSO graphic above includes staff in companies such as Tesco) — 9% of the employed workforce.
The indigenous dominant food/beverages sector and the FDI dominant pharmaceuticals/medical devices each employ about 50,000 direct workers. Customs tracked exports (in addition the output of some foreign drugs plants are also booked in Ireland) of pharmaceuticals/medical devices sector are about six times the food/beverages sector, but the latter is more important for the Irish economy.
The effective rate of tax paid or accrued by US-owned Irish affiliates based on data including cash diversions to island tax havens, which was submitted to the Bureau of Economic Analysis, was 2.5% in 2010 compared with the headline 12.5% rate.
Data in 1990 from a Department of Industry and Commerce survey show that foreign companies were taking advantage of tax avoidance.
In 1984 profits before tax as a percentage of sales in Irish industry were at 21.8% for foreign firms and 2.1% for Irish firms. In 1988 the ratios were 23.9% and 3.9%. See here also.
Ireland was the world's most profitable country for US corporations, according to analysis by US tax journal Tax Notes in 2004. In a study by the journal's Martin Sullivan, it was found that profits made by US companies in Ireland doubled between 1999 and 2002 from $13.4bn to $26.8bn, while profits in most of the rest of Europe fell. In his analysis Sullivan termed Ireland a 'semi-tax haven' for US firms, because firms are involved in real productivity in contrast with locations such as Bermuda.
Between 1999 to 2002, US multinational corporations increased profits in countries with no taxes or low rates by 68% while sharply reducing profits recorded in countries where they engaged in substantial business activity, a study published in the journal Tax Notes showed.
Ireland's Central Statistics Office (CSO) does not include diversions to places like Bermuda and the Cayman Islands and it reported in respect of 2012 for all enterprises in the business economy, that 15.6% of turnover was reported as operating surplus (earnings before interest and depreciation). This figure was reduced significantly to 9.6% when the foreign multinationals were removed from the analysis. All large enterprises recorded 20.2% of turnover as gross operating surplus while large indigenous enterprises recorded a percentage of 11.6%.
The 50 largest enterprises in the business economy by GVA (gross value added) accounted for 36.3% of total turnover, 41.6% of total GVA and 60.6% of total gross operating surplus. In contrast, the 50 largest enterprises in the business economy by employment accounted for 20.1% of total turnover, 19.9% of total GVA and 21.1% of total gross operating surplus.
The CSO said industry stands out in terms of its reliance on a small number of high value added enterprises. The 50 largest enterprises in industry by GVA accounted for the majority of all three main indicators within industry at 61.4% of total turnover, 73.3% of total GVA and 85.0% of total gross operating surplus.
Most of the top 50 are likely to have been foreign firms.
In 2004 Finfacts calculated that 40 American firms accounted for two-thirds of headline Irish exports in 2013.
Durable wealth creators
In a February 2014 Sunday Independent interview in 2014, Craig Barrett, ex-CEO of Intel, the US chip maker, was asked could Ireland attract the really valuable Google and Twitter type R&D and innovation functions as well as supplying hewers of wood and drawers of water?
"No," Barrett replied. "I think to a degree it's a matter of numbers. You can have an Intel invested here as a creator of jobs but it's primarily a manufacturing investment."
"Those are good paying jobs and I think the Irish are very happy to have them and Intel is happy to be here. Intel also has engineering applications here with 300 employed in Shannon. But that's small compared to the engineering base it has in Santa Clara or Portland or Arizona, for example, and that's just a matter of numbers.
"The multinationals are going to go where the resources are. And the bulk of resources are not in Ireland because it's a small country of four or five million people. Look at it on the positive side, at least they're putting their HQs here."
In March 2014 in a speech titled 'Irish Exceptionalism in the World Economy,' Prof Patrick Honohan, then Central Bank governor, said:
"One hoped-for element of the policy of encouraging foreign-owned firms is the inward transfer of technology and business know-how including to locally controlled firms. As the decades passed, this transfer does seem to have happened to an increasing extent. But the reliance on foreign-owned firms has lasted a long time. Irish-owned companies have grown and prospered over the past half-century, and the most pessimistic of prognostications have not materialised. Nevertheless, this systemic dependence on foreign capital and know-how has skewed Irish development. In the interests of robust diversification, most Irish economists observers would hope for a greater convergence towards normality in this aspect of Irish economic development, with a stronger emergence of innovative Irish companies alongside those steered from abroad."
More than 300 shareholders and executives at Irish tech firms have become millionaires over the past 15 years through selling their businesses, according to a 2015 report on mergers and acquisitions in the IT sector. However, there have been no significant scaleups — this is a poor return for the Irish taxpayer.
Big companies typically acquire most of their innovations by buying startups.
Policy makers are obsessed with high tech but the sector is not typically a big jobs generator.
Based on research by the Kauffman Foundation, the leading entrepreneurship think-tank in the US, — using Inc. magazine’s 500|5000 list — it found that the fastest-growing companies and entrepreneurs often do not match the stereotypical profile we see portrayed around startups.
In fact, only about 1% of these fast-growing companies are in Silicon Valley, only half of which are in the high-tech industry. Less than one in ten of the fastest-growing companies were venture-backed, while most were funded through bootstrapping, loans, and help from friends and family.
Distorted indicators put Ireland among the top innovators in the world (half the staff in the ICT sector are in administration and high tech exports are boosted by the Double Irish tax dodge) but while Irish indigenous firms have only 93,000 employed ( <5% of employment) and the number of manufacturing firms is second-lowest in the EU, business R&D spending is typically concentrated in manufacturing.
The US Congressional Research Service says that manufacturers have been responsible for approximately 70% of all R&D conducted by businesses in the United States in recent years. This is far lower than in Germany, Japan, South Korea, and China, where manufacturers account for 85%-90% of all business-financed R&D. Conversely, the service sector is relatively more important in undertaking R&D in the United States than in many other countries. The most notable exception is the United Kingdom, where service companies account for three-fifths of all business R&D spending.
Both the UK and Ireland are dependent on foreign firms for the majority of research spending and typically that is not at a high level.
Irish FDI data masks the serious long-term problems facing Ireland: 1) Poor adult skills including younger people according to the OECD; 2) The second-highest rate of low pay among the mainly advanced countries of the OECD Area; 3) Only 40% occupational pension coverage in the private sector; 4) While having poor outcomes, Ireland's public spending on health in 2014 was almost 20% of government expenditure (capital + current) — the highest in the EU while total spending as a ratio of economic output was second-highest to the United States in 2013 5) Ireland has a very low number of exporting firms.
Despite the dominance of FDI, Ireland's indigenous sector is still dependent on the United Kingdom:
Leprechaun economics: Ireland reports 26 percent growth! But it doesn't make sense. Why are these in GDP? pic.twitter.com/h6M0LhQkSd— Paul Krugman (@paulkrugman) July 12, 2016
Finally, Italy has had two lost decades, only growing by 3.3% per capita in 20 years but it's striking that in 2015 its individual standard of living was higher than Ireland's.
Eurostat, the EU's statistics service, reported in June that the average Irish individual standard of living in 2015 was lower than Italy's. Ireland was also below both the EU28 and EA19 (Euro Area) averages. Eurostat compares individual consumption of public and private goods and services in each member country, adjusted for price differences.