Tax incentives for embattled SMEs

When the Minister for Finance stood in the Dáil to deliver his budget speech last October, Paschal Donohoe announced that the 2020 scenario was for a no-deal Brexit. As it turned out there wasn't a no-deal Brexit in 2020. Instead we ended up with a no-vaccine pandemic. From the political noises last week, a similarly cautious approach is in prospect for Budget 2021.

There is one big difference however. Last year's budget was formulated on the basis that, as Donohoe put it, “if we do not need it, we will not borrow it”. The Budget 2021 strategy, announced by Donohoe and Michael McGrath, the public expenditure minister, on Wednesday is resigned to borrowing the best part of €20 billion in 2021. This is government business as unusual.

There was some other budget signalling last week too. The Tax Strategy Group is a committee of civil servants from various departments charged with identifying and presenting taxation options which might feature on budget day. Their deliberations for Budget 2021 were published last week but their analysis and commentary on income tax has little enough reference to Covid-19. It runs to over 40 pages, yet has only four mentions of the impact of the pandemic on tax policy.

There are two possible explanations. The first is that the public servants involved in putting together these tax ideas for ministers to decide upon are operating in a hermetically sealed bubble of officialdom. Lending credence to this argument is the emphasis in the income tax paper on withdrawing the meagre flat rate expenses from typically lower paid workers and not reinstating tax relief on trade union subscriptions.

The other explanation is more pragmatic. Perhaps the apparent omission of coronavirus considerations is prompted by a realisation that if something is not broken it should not be fixed.

It is a peculiar feature of the current pandemic that the tax yield has not been as badly affected by the slowdown in all forms of trade across the economy since March. Certainly, Vat receipts have plummeted reflecting the drop off in consumer activity, but income tax and corporation tax receipts have remained relatively stable.

This is a remarkable occurrence, particularly when compared with the situation of our nearest neighbour, Britain. There, revenues from all forms of taxes have fallen off a cliff since the pandemic bit in. By contrast the tax policy emphasis in Ireland on export led industrial incentives – because by definition foreign direct investment is export driven – and an income tax system that primarily taxes higher earnings, is, probably unintentionally, paying off. Few nations routinely design their tax systems to be pandemic proof.

Just because something is not broken doesn't mean that it can't be adjusted. In a presentation included in the tax strategy papers, John McCarthy, chief economist at the Department of Finance, highlighted the falloff of economic activity in our export markets since the pandemic. We cannot rely indefinitely on export buoyancy. Yet the tax strategy group papers are remarkably short on ideas to modify the tax system to foster domestic supply, demand or investment.

This is particularly true for the SME sector. Recent research from the ESRI contains few surprises about how badly the sector has been affected, but it usefully emphasises how well the sector was doing pre Covid-19, providing almost seven out of ten jobs in the country.

Officialdom became scared of tax incentives given how runaway property tax reliefs contributed to the financial crash of 2008, but there is a role again for targeted tax incentives if we are to move this sector out of its liquidity crisis and into recovery mode. One priority should be getting more private equity into small Irish business, particularly those in the services sector.

Currently, tax reliefs for small traders are few and far between, but tax reliefs for the service industry are non-existent. It is possible to get some income tax relief only when investing in a new trading or manufacturing start-up, but not services. This bias continues through the company life cycle as only trading companies are offered a three-year corporation tax holiday.

Privately held service companies must also deal with corporation tax surcharges. Proprietary directors of companies are virtually pariahs within the system, excluded from many of the benefits of being an employee. They only narrowly made the cut for the new employment wage subsidy scheme and are subject to much higher tax penalties.

The only way to climb out of the pandemic’s economic gutter is to garner additional tax revenues by keeping people safe while growing economic activity, and not from charging more tax on the subdued activity that remains.

Even the robustly conservative Irish Fiscal Advisory Council was calling last week for the economic stimulus to be maintained, at least in the short term. The quicker we can bridge the chasm between the levels of government expenditure prompted by the need to bolster healthcare and support industry, and the amount collected in tax, the sooner the borrowing requirement will dissipate.

On the evidence of last week, the political system is getting the message. To judge from the Tax Strategy Group papers, it is not quite as clear if it has landed yet within officialdom.