Saturday, October 31, 2015

A question on Google

Usually we use Google to answer a question; here we answer a question about it.  Google CEO Sundar Pichai approaches you with the following proposal:

We are looking for someone to run our advertising services outside of the Americas.  What you have to do is provide the logistics and administration and deal with the customers; we will provide the technology from our engineers in the US.

Based on the most recent year we estimate that revenues will be about €18.3 billion.  Of this around €5 billion will go to various websites and organisations who host advertising on their websites.  You will also have to work with customers in the countries to ensure the services provided match their requirements.  It will cost you around €300 million to have these offices around the world.

We want to have the logistics, billing and administration and other functions organised on a centralised basis.  This will probably require around 3,000 staff and significant investment in buildings and facilities.  This will probably cost around €300 million a year.

This gives a cost of sales of €5.6 billion and an operating profit of €12.7 billion.  Obviously we’re not just going to let you keep €12.7 billion which is almost wholly earned from the technology we have created but we’ll split it with you.

We’ll charge you a fee that is equal to 98.5 per cent of the operating profit.  Based on the figures about you will pay us €12.5 billion and you will be left with a profit of €200 million.  If you keep that in a company you will probably pay around €25 million in Corporation Tax to the Irish government.  And for every extra €100 million in profit you generate you get to keep €1.5 million so we think the incentives are pretty balanced.

So what do you say: are you willing to be the servicer of Google’s advertising products outside the Americas in return for 1.5 per cent of the operating profit?

If this was offered it should surely be a question of where do I sign up. The technology is a market leader. OK, running an operation in Dublin with 3,000 people and dealing with offices and customers around the world will be pretty demanding but I will gladly take €200 million of compensation for doing something pretty demanding.

Anyone indicating displeasure at the amount of Corporation Tax Google pay in Ireland can only do so if they would refuse the above offer.  Who in their right mind would refuse the rights to Google’s advertising technology even if they have to pay over 98.5 per cent of the operating profit?

The issue with Google is not the €12.5 billion license fee that is paid out of Ireland.  The issue is where it goes.  The technology was developed in the US and the key decision makers for the technology are in the US yet the payment ends up in Bermuda.  The issue is that the payment ends up somewhere where the company has no substance.  That is what needs to be addressed.  We don’t need faux outrage from people who would all accept the above offer.

Wednesday, October 28, 2015

Cork Repossession Hearings in October

There were five hearings before the Cork County Registrar of civil possession cases in October.  Across the five dates some 369 cases were listed and all bar two of these involved residential property (PPRs and BTLs).  The outcomes are summarised below:

October Repossession Hearings in Cork

Compared to earlier sittings there are now more cases being struck out and this happened to 13 per cent of the cases listed in October.  It is not always stated why a case is to be struck out but some of the reasons given are:

  • the property has been sold or voluntarily surrendered and the legal proceedings are unnecessary.
  • the person is back making full repayments on the mortgage
  • there are legal issues that mean the proceedings must be withdrawn (some of these relate to the Finnegan judgement)

The most frequent outcome when cases come before the County Registrar is for them to be adjourned.  In October, 98 cases were adjourned as per the practice direction of the President of the Circuit Court which requires that possession cases involving mortgages be adjourned on their first date before the court.  Even more cases were adjourned by the lenders themselves with 141 cases adjourned by the applicant banks.

There are many reasons for this.  Some are for legal reasons such as to change the name on the civil bill because the loan has been sold but most are because there is on-going engagement with the borrowers.  The banks can seek time to assess a recently submitted SFS or they can seek time to see if the borrower can adhere to a revised repayment amount for a test period.  Some cases are adjourned generally with no new date given but  the applicant has “liberty to re-enter” if circumstances change, such as the borrower not adhering to an long-term repayment arrangement.

There were 48 cases listed which could not proceed because notice of the case had not been served on the borrower.  This seems to be a combination of borrowers who cannot be found (thus substitute service such as ordinary post or pinning the notice to the property is required) and instances where the lender has issued a civil bill but not formally served notice on the borrower (possibly because some engagement is now taking place).

Cases where service cannot be effected will likely conclude with a possession order being granted (with many of these properties likely to be vacant) while cases were service has been delayed will hopefully be struck out at a future return date (if the borrower can resume payments to the satisfaction of the lender).

There were 27 cases where the lenders proceeded with their application for a possession order.  They were granted two possession orders, of which one was by consent.  In the 25 other cases where the lenders sought an order the case was adjourned against their wished.  About half of these were back to future hearings of the County Registrar with the other half sent for hearing before a judge of the Circuit Court.

All the 91 cases that were on the list for the 28th of October are cases that had previously been heard before the County Registrar.  Of these, 18 had been adjourned by the County Registrar in previous sittings where the lenders had sought to proceed with their application for a possession order. 

When these cases came around again in October the lenders sought to proceed in just five of the cases while the other 13 were adjourned by the lenders as engagement, of some level, was now taking place.  One case where the lender had previously sought an order for possession was adjourned generally by the lender with liberty to re-enter.

Of the five cases where the lender proceeded again with their application for possession four were adjourned by the County Registrar and in three of these this was the third time this year this happened.  In one of these no payment had been made since 2009 and the arrears are over €120,000.  A proposal for a lump-sum payment was made at a hearing back in July but has not yet materialised.  The borrower had legal representation in court who said the lump-sum would be available in May 2016.  The case was adjourned to February with the Registrar requesting that some regular payments be made in the interim. 

One order was granted and that was by consent with the borrower present in court.  For notes on this case from a hearing last July see case #10 on this list.  Typically a stay of three to six months is applied to such orders but the borrower asked for a short stay as they were no longer using the property. It was set at one month.

In this hearing there were nine cases where the lenders proceeded for the first time with their application for a possession order.  All of these cases were adjourned.  In five of them the borrower was present or represented in court and got an adjournment very quickly with very little information provided.  There was more discussion of the other four and the details are summarised below (click to enlarge):

Possession Orders Refused 29-10-15

Of the total of 369 cases heard in October about 310 will appear on future lists for sittings of the County Registrar.  And no doubt will accumulate fees for the legals involved.

Thursday, October 15, 2015

Why are we betwixt and between the fiscal rules?

Ireland is set to leave the Excessive Deficit Procedure next year.  This is the “corrective arm” of our fiscal rules and is based on bringing a deficit that is above three per cent of GDP back below it.  The mechanics of the EDP are fairly straightforward: each year a country is set a headline deficit target with these targets reducing systematically to the three per cent of GDP level.

Once a country gets below the three per cent of GDP threshold it moves to the “preventative arm” of the fiscal rules which are based on reducing any remaining structural deficit.  In theory the “preventative arm” is more flexible than the “corrective arm” where rigid targets to bring the overall deficit below three per cent of GDP must be adhered to.

Under the Excessive Deficit Procedure Ireland had to get the deficit below three per cent of GDP by 2015.  This is a target that was set in December 2010 which is almost five years ago and it was not adjusted in the interim. Is a deficit target that was set five years ago appropriate for fiscal policy now?

In rough terms we had to reduce a deficit that was around €20 billion in 2009 to €5 billion in 2015  – and we achieved that with room to spare.   Ireland over-performed the EDP deficit target each year and this over-performance increased as the economy improved in the past two years or so.

In 2015 all we had to do was return an overall deficit that was below 3 per cent of GDP.  If there had been no changes on top of last year’s budget it is likely this year’s deficit would have been somewhere around 1.5 per cent of GDP. 

Hence, under the apparently more rigid “corrective arm” there was allowable space to introduce supplementary spending for 2015 and this was flagged with around €1.5 billion of supplementary spending estimates included in the White Paper last Friday.  This brought the 2015 deficit back up to 2.1 per cent of GDP so still well below the three per cent of GDP target.

From 2016 Ireland will have left the EDP so the fiscal landscape will be about reducing the remaining structural deficit at a particular pace and, measurement issues aside, the rules have some in-built leeway.

If the economy is doing poorly (negative growth) and is below its potential no effort has to be made to reduce the structural deficit under the balanced budget rule. The fiscal effort can be delayed until the economy improves.  If the economy is showing some growth and is close to its potential then some effort to reduce the deficit is required. This is where the figures published by the Department of Finance back in April put us.

Of course, as 2015 has evolved the economy has continued to improve and all growth forecasts have increased and most of these are now above the potential growth rates of the economy. In rough terms the four per cent plus growth rates for 2016 that most forecasters, including the Department of Finance, are pencilling are above the long-run potential rate of the economy.

The fiscal rules are designed so that countries with a deficit have to make greater effort to reduce that deficit when their economies are growing strongly. And the revised figures published by the Department of Finance this week reflect the fact that the Irish economy is growing strongly.

The original figures published in April put Ireland in a place where the required reduction in the structural deficit must be greater than 0.5 per cent of GDP.

However, the updated figures published this week put us in a position where the required reduction in the structural deficit must be greater than 1.0 per cent of GDP. That is, now that the economy is growing faster we should be doing more to reduce the deficit.

By the letter of the fiscal rules it appears the deficit reduction required is that which corresponds to the April figures. But the Irish economy is a small, open economy that can turn around very quickly and it has.

Should we ignore the spirit of the fiscal rules which requires countries with deficits to reduce them faster in times of economic growth simply because an earlier set of figures allow for a more expansionary budget?

And this is the key point. The key point is not some esoteric discussion about which figures for the output gap and potential GDP growth should be plugged in to a fiscal adjustment matrix

The key point is that at a time when the economy is growing, when we can reduce the deficit without significantly harming the economy, we are choosing to introduce policies that will prolong our borrowing.

This does not mean there cannot be increased spending.  There can be lots of additional spending but it must be matched by equivalent revenue measures.

We were led to believe that the budget would be framed around a fiscal space of €1.5 billion. In practical terms over the past week we have had over €3 billion of expansionary budget measures introduced.

First there was the €1.7 billion of supplementary spending estimates for 2015 that were flagged in the White Paper published last Friday.  On their own supplementary estimates are not unusual and have been a regular feature of public finance in Ireland.  But the public finance practices of the past are part of the reason we got into our current predicament.

As we will still be below the three per cent of GDP target for 2015 these supplemental spending increases become “baked in” and give the starting point for 2016.  One danger is that these permanent increases in expenditure are based on temporary sources of revenue.  And then on Tuesday we had a further €1.5 billion of tax cuts and expenditure increases added on top of that. 

So all told over the past week we have had expansionary measures totalling over €3 billion introduced.  The fiscal rules do not prevent additional spending. They direct that discretionary expenditure increases (such as these supplementary estimates) should be matched by equivalent revenue measures or offsetting savings elsewhere.  Unexpected inflows of Corporation Tax would not count as a revenue measure under the rules. 

This will be the position from 2016.  At the moment we are crossing the threshold from the “corrective arm” to the “preventative arm” and there are gaps in the crossover, particularly for an economy that is growing strongly, that allow this increase in spending under the letter of the rules.  Using these gaps for large supplemental increases in expenditure undermines the budgetary process as expenditure ceilings become meaningless if they can be increased when windfall revenues are available.

Ireland would come well short of meeting the required reduction in the structural deficit if we applied the deficit rule to the 2015 outcomes.  The budget documents show an improvement in the structural deficit of just 0.2 per cent of GDP is expected in 2015.  This is not an issue under the letter of the rules as what is required is for the headline deficit to be below three per cent of GDP and this is easily achieved because of improvements in the economy and the surge in Corporation Tax receipts. 

But the spirit of the rules is that countries with deficits should do more to reduce them in times of economic growth.  And, to repeat, this do not mean there cannot be increased spending.  There can be lots of additional spending but it must be matched by equivalent revenue measures.  Surely our recent history is proof of the benefits of that.  And the rules have some additional flexibility if that spending is for capital rather than current purposes.

If the structural deficit rule and the expenditure benchmark are good rules for 2016, and the budget documents make various positive references to adhering by those rules in 2016, surely then they are also good rules for 2015?  Is it prudent to frame our fiscal policy based on a target set in December 2010 when the notion of six per cent growth in the Irish economy would have been derided?

Fiscal rules are useful but they are imperfect.  They are a guide not a crutch. We have rules of the road for driving but we don’t blindly ignore the conditions around us and drive at the speed limit at all times.  There are many times we hit the brake because of road conditions even though the rules don’t require us to slow down. 

Irish fiscal policy for 2015 was framed based on a target set in 2010.  The economic conditions are hugely different now.  Of course, there are factors other than the economic cycle that drive fiscal policy but that is not our concern here.  Our fiscal stance may adhere to the letter of the fiscal rules but if you think it is too expansionary for the unknown twists in the road that might lie ahead then you are probably right.

Tuesday, October 13, 2015

Permanent expenditure with temporary tax?

Here is the progression of estimates of 2015 Gross Voted Current Voted Expenditure over the past year or so:

  • Revised Estimates (December 2014): €49,612 million
  • Stability Programme Update (April 2015): €49,715 million
  • White Paper (October 2015): €51,040 million

Gross Voted Current Expenditure for 2015 is set to be around €1.4 billion higher than set out in the Revised Estimates published last December.  This is due to Supplemental Estimates that are due to be introduced for various departments in 2015.

The scope to do this was afforded by the over-performance in tax revenue this year which meant that expenditure could be increased while still staying comfortably inside the 2.9% of GDP deficit limit set under Ireland’s on-going Excessive Deficit Procedure.

However, almost all of the tax over-performance is due to Corporation Tax.  If we look at vintages of projections for 2015 Corporation Tax receipts we have

  • Budget 2015 (October 2014): €4,575 million
  • White Paper (October 2015): €6,130 million

Corporation Tax receipts for 2015 are now expected to be €1.6 billion greater than expected at the time of the budget last year with around €6 billion now expected based on the trend that has been seen so far this year.  It is this extra revenue that has allowed the Supplemental Estimates for 2015 be introduced.

Cum Corp Tax

A 33 per cent rise in Corporation Tax is significant.  The Information Notes with the monthly Exchequer Statements have attributed it to “improved trading conditions”.  This was expanded on in today’s budget documents:

All of the major taxes are significantly up in year-on-year terms and ahead of, or broadly in line with, profiled receipts. Of particular note is the very strong performance of corporation tax, which is up €1,209 million on profile at end-September; this is primarily due to improved trading conditions, principally amongst the multinational sector.

Given that 80 per cent of Corporation Tax between 2008 and 2012 was paid by foreign-owned companies it is not a surprise that the extra tax revenue this year is coming from the same sector.  On the difficulties in forecasting Corporation Tax revenues based on relationships that can evolve over time the following is noted:

This is particularly relevant given the performance of corporation tax through the first nine months of 2015, which is up 45 per cent year-on-year, and the fact that over 40 per cent of corporation tax receipts are due in October/November. Given that the May/June receipts earlier this year include the preliminary payment for 2015, the 2015 forecast assumes a continuation of the year-on-year growth. However, given the concentration risks in corporation tax, with the top 10 taxpayers accounting for about a third of overall revenue, this tax head is subject to greater swings than most.

The performance of Corporation Tax in 2015 is surprising but is it permanent? It has been used to finance increases in current expenditure this year but these become “baked in” to the figures for future years.  If the €2 billion increase in Corporation Tax expected this year is permanent then there are unlikely to be difficulties but if this increase is transitory then the permanent expenditure increases will have to be funded from elsewhere. 

Also when the tax data from the Revenue Commissioners with these increased Corporation Tax payments becomes available what impact will this have on the CSO’s GDP estimates? €2 billion of extra Corporation Tax could conceivably be related to an extra €20 billion of Gross Operating Surplus (assuming the extra Corporation Tax is on increased trading profits though CGT paid by companies is also a possibility). 

And this is, apparently, before any of the implications on the national accounts that could flow from an adverse finding by the European Commission in the Apple State Aid case.  Consider the revisions if Apple’s ex-US profits are to be added to our GDP! [though the ECJ are highly likely to overturn any such finding].

Tuesday, October 6, 2015

EconTalks at UCC

Here are the slides for my presentation as part of the EconTalks – School of Economics Public Talks Series 2015-16. Details here.