Tuesday October 20, 2020

Comment: Budget 2021 must play to the economy’s strengths

There are a number of measures the Minister for Finance can use to stimulate demand and keep Ireland attractive to investors despite the uncertainty the pandemic has created

9th October, 2020
The budget deficit for the year is expected to be greater than the originally estimated €23 billion but lower than the revised €30 billion

This year’s budget is set at a time when significant uncertainty remains over the level and duration of support needed for many parts of our economy.

On a positive note, exchequer receipts have been holding up relatively well. While total tax receipts to September are down 3 per cent or €1.2 billion compared to last year, they are over 21 per cent or €7 billion ahead of expected receipts. The next few months, however, are big months for corporation tax, income tax and VAT so it will be very interesting to see whether the relatively strong performance seen heretofore endures.

To date, corporation tax has been remarkably resilient, reflecting the concentration of foreign multinationals trading in the ICT, manufacturing and financial services sectors, all sectors that have performed relatively well through the pandemic.

Corporation tax is over a quarter or €1.6 billion ahead of last year. The relative contribution of corporation tax to total tax receipts for 2020 is not yet known. Recent figures released for 2019, however, show corporation tax receipts accounting for 18.4 per cent of total tax receipts which remains well ahead of the OECD average of 9 to 10 per cent. This highlights the importance of the sector to our economy – but is also drawing the attention of the OECD.

Foreign multinationals account for more than three-quarters of corporation tax payments. The top ten companies last year accounted for 40 per cent of all corporation tax payments, down from 45 per cent in 2018, bringing some welcome diversification.

Foreign multinationals are also a major employer, responsible for more than a quarter of all employments and contributing 44 per cent of all employment taxes, reflecting much higher average salaries. Notwithstanding the shutdown of parts of the economy, income tax receipts to date are almost in line with last year, reflecting again the resilience of these multinationals and their outsized contribution. It is therefore crucial that Ireland remains attractive to multinationals.

A worrying trend emerging over the last few years is the progressive fall in research and development (R&D) claims. Claims in 2018 were just over half of those made in 2016. Consideration should therefore be given to additional budgetary measures to stimulate R&D activity.

While we are not expecting much in the budget for corporates, it is very welcome that Ireland will likely defer until 2022 the implementation of the interest limitation rules, an output from the OECD Base Erosion and Profit Shifting (BEPS) 1.0 work.

In this vein, continued attention needs to be paid to the significant work ongoing in Paris at the offices of the OECD on how taxing rights on multinationals should be allocated across countries and at what rate. This work clearly could have a very significant medium to long-term impact on our economic health, and it is important that Ireland continues to reflect the perspectives of smaller nations in these conversations.

While the US has reservations about the impact that these work streams could have on its own economy, there is an expectation that consensus on certain measures will be agreed. It is likely that this will be after the US election at this point, but not too far away. How the EU will implement the recommendations and whether it seeks additional measures also remains an important consideration for Ireland.

In terms of navigating the immediate challenges and funding the disruption, it is increasingly clear that the government is choosing long-dated cheap borrowing as the preferred funding option. This requires a continued positive and accommodative EU mindset. Assuming this, the government’s projected numbers show a pathway to a return to more balanced budgets in the future.

There is clearly not an open chequebook, however, and as a fuller reopening of the economy is going to take much longer than initially anticipated, discretion on spend will be required.

For the economy to recover, consumption is critically important, and while demand may be there, supply has been turned down or completely off in certain sectors, making consumption more difficult. This has, however, led to a very significant surge in household savings over the last few months with additional savings of about €5 billion to €6 billion being seen in the commercial banks. This provides some comfort that there is latent consumption power in the system for when sectors can reopen.

It should not, however, be taken that there is no need to include budgetary measures to stimulate demand, such as a lower VAT rate for the badly affected sectors. Such a measure could also help businesses recoup their Covid losses.

Maximising income available for spend also remains key. In this regard, it has been well flagged that there will be no income tax or USC rate increases or changes to the tax bands. But there are proposals to increase self-employed PRSI which would likely have a very negative effect on many tradespeople, professionals and entrepreneurs. With marginal rates so high and the level at which marginal rates apply relatively low, any future increase in rates could in fact see an overall drop in exchequer returns due to the higher cost of employment in Ireland making investment less attractive.

The profit capture of multinationals here is becoming more dependent on the level and nature of the employment in Ireland. Ireland’s personal tax regime, therefore, needs to compete internationally in order to enjoy continued support from multinational investment and entrepreneurs.

Stimulating investment in the domestic economy will also form an important plank of managing through the pandemic. The Minister for Finance has tools available to him to do this.

It was hoped that we would see a reduction in capital gains tax (CGT). Our CGT rate is very high compared to international norms. People investing and putting cash into businesses have to contend with this high rate of CGT and this acts as a disincentive to people considering investing in Irish business. It also acts as a disincentive to sell assets which could be better served under new ownership.

Between 1995 and 2000, the Irish CGT rate was halved from 40 to 20 per cent. On a static analysis, the Irish exchequer CGT yield ought to have fallen by 50 per cent – instead the yield increased more than twelve-fold (over 1200 per cent) in real terms over that five-year period. A much-needed boost to the exchequer could very well be seen again if such a rate reduction was re-introduced while putting a more investor-friendly framework in place to inject capital into Irish businesses.

The minister has also signalled an intent to continue capital investment. This in itself will generate more economic activity while upgrading the state’s infrastructure. It presents an opportunity to invest more deeply in low-carbon technologies and address in a more meaningful way our emissions reduction target of 51 per cent over the next ten years. Initiatives under consideration are set out in the programme for government and could be accelerated. They could also at least in part be funded by the planned €7.50-per-tonne increase in carbon taxes each year.

So while the minister is grappling with international and domestic challenges in looking to frame a budget that provides the necessary supports for badly impacted businesses and keeps Ireland as an attractive place for investment, there are many strengths in our economy and our people to draw on and measures available to him to achieve this.

Tom Woods is head of tax at KPMG

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