A Bumper Year

Dec 10, 2018

Sunday Business Post, 9 December 2018, It’s tough to make predictions, according to the great baseball player Yogi Berra, especially if they are about the future.

Nevertheless, predictions are critical to the management of a business.  Every business uses budgets and forecasts, and governments do the same.  That’s why the announcement this week that tax receipts in the eleven months to November of this year are substantially ahead of forecast is both good news and bad news.  Good news, in the sense that government will have sufficient funds to meet its expenditure commitments in 2018, and with some cash to spare.  Bad news, in that the forecasting process is so far off the mark.  An under forecast is almost as bad as an over forecast because it prevents the government from allocating funds which might be usefully spent or invested.

The main culprit in the inaccuracy is in the forecast for corporation tax yield – the amount of tax companies paid to the Exchequer on their profits and gains.  The corporation tax yield is running almost 20% ahead of the amounts estimated at the start of the year.  As a consequence, the ratio of corporation tax to all of the other taxes collected is unusually high by the standards of developed economies.  In most OECD economies, corporation tax accounts for about 10% or less of the total taxes collected.  In Ireland, almost one euro out of every five collected this year was paid by a company as corporation tax.

The reliance on Corporation tax has already been identified by the Irish Fiscal Advisory Council as potentially problematic, and the volatility of corporation tax receipts has been a matter of debate for the past several years.  But if companies are preparing their own budgets and forecasts, how is it that this rigour at a business level does not transfer to the forecasts for national tax receipts.  In short, why is Corporation Tax so volatile?

One reason is that relatively few companies in Ireland pay corporation tax in significant volumes.  Most companies in Ireland are small, and are often owned by a number of family members who pay out the company's profits to themselves as salary.  It isn't smart for them to leave profits in the company which are subject to corporation tax, and then suffer income tax on whatever balance remains when it is paid out by way of dividend. 

According to the Fiscal Advisory Council, two in every five euros of corporation tax paid comes more from just ten firms.  If any one of those companies has a bumper year, that will have a disproportionate effect on the nation's tax yields.  How companies calculate their profits is also important.  For instance, this year there were changes in the way companies account for monies they receive under multi-year contracts.  That particular change in the accounting rules seems to be the reason for some of the corporation tax uplift at least.  Less mundanely, there should be a correlation between the numbers in employment and corporate profits.  The significant jobs growth of recent times should now be translating into better company results and therefore more corporation tax being paid.

While the 12.5% rate of corporation tax is low, it is also largely unavoidable despite the bleating of its critics.  For many years companies have been unable to shield taxable profits by investing in their factories and production lines.  The only tax shelters of any consequence available to them is investment in research and development, or investing or developing intellectual property – patents, licences, know-how and the like.  Revenue don’t even wait for the company to earn the money before taxing it.  The larger companies pay tax at six monthly intervals based on estimates of what they will make.  The supermarket chain where you will do your Christmas shopping in the next few weeks may well already have paid its corporation tax on the profits it hopes to make this month.

Then we must take account of the way tax receipts across the economy are estimated.  There is evidence that generally speaking, tax revenues increase in a fixed proportion to economic growth.  This proportion is important, but is more accurate when applied over a period of several years and is therefore not completely reliable when predicting one year.  It is even less useful in in predicting the composition of the tax yield – how much comes in via income tax, VAT and so on. 

The pattern of tax forecasts versus tax outcomes over the past few years suggests that it is easier to get the tax forecasts right in a period of recession than it is during a period of growth.  However this pattern has been broken.  Brexit uncertainty, the doubts over how Foreign Direct Investment will be impacted by trade war posturing, and the effect of the US Tax Cuts and Jobs Act must be added in to the mix of variables.  Economists have a good handle on the links between general economic activity and tax yield, but the impact of tax policy on business decisions (and hence profits and tax receipts) is not well understood.

A few years ago, who knew that the biggest beneficiary of a global clampdown on cross-border asset transfers by companies to avoid tax would be Ireland?  It is indeed tough to make predictions.

Brian Keegan is Director of Public Policy and Taxation at Chartered Accountants Ireland