Transfer Taxing

The Irish Times reports that President Obama is set to implement sweeping tax changes to treatment of repatriated profits from overseas. The measure might seem politically expedient, but is questionably beneficial for the American economy. Meanwhile, Ireland seems exposed.

During the boom years, much of Ireland’s staggering economic growth can be attributed to Foreign Direct Investment (FDI), most of it coming from the US. Low corporation tax rates meant that profits of multi-national companies, with long and complex supply chains, could be declared in Ireland at great benefit to the firm.

Commentators described this growth as illusory, but it had extremely beneficial side-effects. When these firms were attracted to Ireland and declare profits (a practice known as ‘transfer pricing’), they were obliged to maintain a certain facade by employing workers in their Irish outpost.

In effect, low tax rates subsidised these Irish workers. Although there were obvious benefits to locating in Ireland at the time – which included business-friendly regulation, stable government, limited trade union activity and especially a cheap, well-educated workforce.

However, Ireland’s comparative advantage in this area has been eroded over time. Now, Eastern European countries are competing with us at every level and at lower cost. They are poaching business from Irish workers. Further erosion of Ireland’s few comparative advantages will only hasten the exit of these firms from our shores.

Ron Davies of UCD correctly notes that many larger multi-national firms will be able to cushion the increased burden due to their existing excess credit position. However, the impact of this mitigating effect is entirely unknown and the US tax liability could increase over coming years.

He also claims that Ireland’s comparative position has not changed since the levy would be raised on all locations that we are competing with. However, this ignores the impact that this measure will have on the attractiveness of foreign investment by American firms in general.

In the future, coming out of the current economic turmoil and into recovery, firms will be looking to expand their business. They will be looking at locations domestic and foreign. This measure significantly reduces the return from investment abroad, and at a time when capital for investment is scarce.

The empirical evidence, which he appeals to, would appear to support his claim that firms don’t necessarily value the tax environment. However, consider the substantial profits declared by firms in Ireland relative to their operations in the country. Clearly, this makes the relative importance of decreasing profits much higher for our economy.

Ireland will suffer. To the extent that this is effectively a protectionist policy from President Obama, the American economy probably will too. Hurting US firms will not rescue his fiscal position.

© The Free Marketeer 2009

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