In an earlier post we went through some of the remarkable improvements for the household sector in recent years. Of course, an outstanding question is: where did the growth come from? We can get some insight into this from the same sector accounts.
Current Account
Here we will look at the Irish-owned non-financial corporate sector which as we will see has been a major contributor to recent growth. First, the current account. Click to enlarge.
Some of the changes here are very significant. Between 2013 and 2019, output of domestic NFCs increased by 55 per cent, wage paid by 66 per cent and gross operating surplus by 83 per cent. Compared to where they were in 2013, last year NFCs produced €53 billion more output, paid employees €18 billion more and generated €12.5 billion more profit.
These have been a significant factor underlying the economy’s recent growth. A useful sectoral breakdown is also provided. Here are the domestic sources of compensation of employees (with domestic financial corporates (NACE K) also included))
The largest relative increase was the 130 per cent rise in employee compensation from domestic ICT companies (NACE J). The largest absolute increase was the €2.6 billion increase in employee compensation from professional, scientific and technical activities companies (NACE M), with mining and manufacturing (B,C), wholesale and retail (G), and administrative and support services (N) as well as ICT also recording increased greater than €2 billion.
Some of the other notable changes in the current account of the domestic NFC sector are the near 1,000 per cent increase the retained earnings of foreign subsidiaries and related entities of Irish-owned NFCs, the 500 per cent increases in dividends received and the 13 per cent increase in Corporation Tax paid.
Two per cent tax rates?
It is surprising to see such a small increase in Corporation Tax paid by domestic NFCs over a period when all performance indictors improved significant. The figures are this item are a significant revision on what the CSO reported this time last year. For example, it was previously reported that domestic NFCs paid €1.6 billion of Corporation Tax in 2018. This is now estimated to be just €0.5 billion.
It is not clear why there has been such a significant downward revision. Nor is it clear that the figure is correct. If we take the figures for depreciation from the capital account we can get the Net Operating Surplus of the sector. This is probably the closest proxy of the tax base for Corporation Tax in the sector accounts and is akin to EBIT (the FISIM adjustment excepted). Anyway, using Net Operating Surplus we can get some effective tax rates.
Those certainly are some eye-catching numbers down at the bottom. Perhaps there is some support for this in the Revenue Commissioners research paper on recent Corporation Tax receipts which shows that non-multinationals (i.e., domestic companies) have the lowest effective tax rates in their data.
However, that conclusion was based on an effective tax rate in 2018 or 7.4 per cent which is almost three times larger than what the national accounts are showing. Differences in definitions and coverage aside that is a large gap to be explained. No explanation is offered here.
Capital Account
We dipped into the capital account with the depreciation figures used above and here it is in full.
Again, we are looking at some large increases over the period. In line with the rise in profits (and seeming absence of a rise in taxes) the annual increase in net worth rose significantly over the period.
Of this, ever more was used for gross capital formation, with the investment spending of domestic NFCs rising from €7 billion in 2013 to €19 billion in 2019. There was no year where this fully exhausted the gross saving available and for each of the past seven years the domestic NFC sector has been a net lender.
That is, after working through the current and capital accounts there was a residual surplus that was transferred to the financial balance sheet. And it could be that some this is going on the financial balance of foreign subsidiaries or related companies given the increase in the retained earnings on FDI shown in the current account.
Financial Balance Sheet
We don’t have a financial transactions account so move straight to the financial balance sheet. As we said last year this has been exploding.
The financial assets of the Irish-owned NFC sector have gone from €167 billion in 2012 to €513 billion last year. On the other side of the balance sheet, financial liabilities have gone from €175 billion to €633 billion. Even with the huge increase in the gross figures, the net financial worth of the sector has been largely unchanged, going from –€108 billion in 2012 to –€120 billion last year.
Such is the scale of the increases across the available categories it’s actually pretty hard to determine what is going on. But for both financial assets and liabilities there has been extraordinary growth in the equity category. Are there some form of circular transactions taking place?
While the balance-sheet amounts are massive we didn’t really see significant distortions in the current account. Yes, there has been a surge in the retained earnings of foreign related entities. This was €3 billion in 2019 and it is possible that some of this should be included in operating surplus.
It would be nice to see the interest figures before the FISIM adjustment but they are only published by Eurostat who do not use the bespoke sectoral breakdown employed by the CSO.
Conclusion
All-in-all it looks like there are two things going on in the domestic NFC sector. The first is a large, and very real, contribution to the growth of the Irish economy in recent years with significant increases in output, wages and profits. This has driven a lot of the improvements that occurred pre-COVID.
The second is some kind of financial engineering on the balance sheets of (some) domestic NFCs. It is possible this involves some sort of circular international transactions with huge increases on both sides of the balance sheet but limited impact on net worth. To the extent, that there are flows which might, for example, reduce the tax base in Ireland, is unclear. And, indeed, the tax paid on the tax base of this sector that remains seems unusually low with an estimated effective rate of not much more than two per cent.
So a mix of the good and the unexplained.
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