Explaining the rapid growth in GNI*

When modified Gross National Income, or GNI*, was published by the CSO in July it was welcomed as a step forward in our understanding of the underlying performance of the Irish economy.  There is no doubt it gave a better measure of the level of the Irish economy but there was some disquiet about the growth rates it implied.  The nominal growth rates of GNI* for 2014 , 2015 and 2016 are estimated to be 8.0 per cent, 11.9 per cent and 9.4 per cent which were “too hot” for many tastes.

We poked around this and unsurprisingly the issue seems to arise in the non-financial corporate sector as shown in this table looking at Gross National Income since 2011 making the * adjustments for depreciation on certain foreign-owned assets and the net income of redomiciled PLCs to the NFC sector.

The 9.4 per cent nominal growth rate for 2016 is shown in the bottom right hand corner.  We can see that reasonably plausibly growth rates are estimated for the household, government and financial corporate sector but the 22.5 per cent growth rate for the non-financial corporate sector does not seem right.  Looking a longer series of GNI* for the NFC sector shows how rapid the recent growth has been.

In 2016, nominal GNI* for the NFC sector was twice what it was at the peak of the boom.  It is probably worth noting what is not in GNI*. In rough terms GNI* is got from:

• Value of Output
• less Intermediate Consumption
• equals Gross Value Added
• less Compensation of Employees
• equals Gross Operating Surplus
• plus net factor flows
• equals Gross National Income
• less net income of redomiciled PLCs
• less depreciation on foreign-owned IP assets
• less depreciation on aircraft for leasing
• equals modified Gross National Income, GNI*

So GNI* should not include the profits of foreign-owned MNCs (which will be picked up by net factor flows – distributed profits and retained earnings) and also gross income attributed to Ireland through redomiciled PLCs or the depreciation of certain foreign-owned assets.  GNI* should give a good indication of the gross income of the “Irish” business sector. 

It might be instructive to pull a few measures out of the national accounts to try and see what is going on.  From the national accounts we will look item 4 from Table 1 of the NIE  which is the domestic trading profits of companies (including corporate bodies) before tax and from the Balance of Payments we will take the Current Account outflows of direct investment income on equity.

So in general terms we have the profits (after depreciation but before tax) generated by businesses in the Irish economy and the outflows of profits attributed to direct investors.  We won’t be too prescriptive about what the difference represents but in rough terms it gives us the net profits generated in Ireland that stay in Ireland and, as such, are included in GNP and GNI.  So why has this exploded recently?

The key problem is that of scale and concentration.  Issues in the statistics that would be little more than noise for most countries are amplified in the case of Ireland because of the nature of the MNC presence here.  And for the past few years the issues have all affected the figures in the table in the same direction: they have increased the growth in the difference between them which in turn has increased the growth of GNI*.

The first issue is one of data and coverage.  The Balance of Payments estimates are the result of survey data from the companies while the National Accounts figures come more from administrative date (from sources such as the Revenue Commissioners etc.).

The second issue is the treatment of depreciation.  Both of the figures above are measures of profit after depreciation but the National Accounts use the “perpetual inventory method” as the basis for the depreciation figure used whereas depreciation for Balance of Payments purposes is more closely aligned with the accounting treatment in the companies’ accounts.

Although these could impact the figures in any direction it seems for 2014 they increased the estimated outflows of profits in the Balance of Payments relative to the estimate of profits shown in the National Accounts.  This drove down the level of the difference shown above for 2014.  These data and depreciation issues unwound somewhat by 2016 and the difference moved closer to what it “should” be but this, of course, meant the growth is higher than would otherwise have been the case.

Between 2014 and 2016 the difference in the measures shown above increased by about €18 billion (from €18.3 billion to €36.6 billion).  According to the CSO around €4 billion of this was the result of issues with the data coverage and depreciation methods outlined above but there is nothing systematic about these impacts and there is no reason their impact could not have been in the other direction.

There are two issues that are systematic – the impact of taxation and the treatment of research and development expenditure.

The National Accounts measure shown in the second table is profit before tax while the Balance of Payments gives a measure of the profit attributed to direct investors after tax.  It is only natural that the absolute gap would increase as profits increase due to the impact of Corporation Tax.  This accounts for a further €1 billion of €18 billion change in the difference.  GNI has been growing because we are collecting more Corporation Tax.

The final issue is probably the most serious and results in a systematic error in the figures.  The error arises from the internationally-agreed methodologies rather than anything idiosyncratic that the CSO are doing.  The reasons are not clear but the National Accounts and Balance of Payments methodologies have different treatments for expenditure on research and development activities.

In the Balance of Payments R&D spending is treated as intermediate consumption while in the National Accounts R&D spending is considered a capital item.  The difference is between a cost that reduces profits versus a subsequent use of profits generated for investment.  As a result of this, the Balance of Payments will give a lower estimate of profits compared to that which arises in the National Accounts and if R&D spending grows the difference between them grows. 

So has R&D spending from Ireland on activities elsewhere being growing? Yip. 

The table starts with total imports of R&D from the Balance of Payments.  This figure has been incredibly volatile recently and most of this is due to the lumpy nature of acquisitions of intellectual property products (intangible assets).  We can get the figures for these outright purchases of intangible assets in Annex 4c of the Quarterly National Accounts.  The residual approximates imports of R&D services, that is payments made from Ireland for R&D activities that take place somewhere else.  Almost all of this is undertaken by foreign-owned MNCs.

We can see that this grew by €5 billion between 2014 and 2016 and stood at €11.5 billion in 2016.  This figure is subtracted as a cost from the profit estimate used in the Balance of Payments.  In the National Accounts it is not taken as a cost but appears as a capital item much further down the accounts.  There is a substantial, and growing, difference between the National Accounts and Balance of Payments profit measures.

What does this mean for the figures? Well, go back to the schema for GNI* outlined above.  The estimate of profits generated (Gross Operating Surplus) comes from the National Accounts and the estimate of net factor flows is taken from the Balance of Payments.  So the National Accounts profits generated in Ireland are higher to the extent they don’t subtract R&D spending as a cost and the Balance of Payments outflows of profits to direct investors are lower because they do. 

This means that in 2016 around €11.5 billion of R&D investment was counted as coming from “Irish” income even though it was funded by MNC profits and any resulting profits will not benefit Irish residents outside of any tax that may be collected on them.

It is a hard circle to square.  One approach would be to estimate profit outflows for Balance of Payments purposes before accounting for R&D spending on activities elsewhere, thus making outbound profits higher.  Doing this through retained earnings would lead to an inflow of direct investment in the financial account and those monies could then be treated as been used to fund the R&D spending.  This would have no net impact on the overall Balance of Payments but would reduce the current account balance.  Outbound factor flows should reflect monies that are distributed or available for distribution but that is not the case here as the money is being used to fund R&D activities.

However, it does not seem right that imports of R&D services by foreign companies should be counted as coming from national income but that is what is implied by the current inconsistency between the National Accounts and Balance of Payments methodologies.  This holds for all countries not just Ireland but again scale and concentration amplifies the impact in the case of Ireland. Correcting this anomaly would knock a couple of percentage points of the recent growth of GNI* and would also bring down the level of GNI* (how’s that debt ratio??).  This may happen if the different treatment is as a result of paragraph 1.51(a) of the ESA2010 manual.

1.51 (a) the recognition of research and development as capital formation leading to assets of intellectual property. This change shall be recorded in a satellite account, and included in the core accounts when sufficient robustness and harmonisation of measures is observable amongst Member States;

As well as looking at the growth of GNI* we also had a poke around for an underlying current account balance.  Adding an adjustment for the acquisition of IP assets to the * star adjustments gave us this:

As we said then, this seemed plausible up to 2014 but the improvements since then did not.  Well now we know.  There are some data and depreciation issues having an effect but the biggest issue is the treatment of R&D spending by MNCs.  The figure above shows a surplus of €13 billion for 2016 but included in that was a large amount of MNC profits that were used for R&D spending.  Accounting for that would hugely erode the surplus shown above but there still would be some improvement in the current account as all years would be pushed down.   The macroeconomic position is improving, just not to the extent that the current estimates of GNI* might imply. 

We started off with an €18 billion increase in the difference between profits generated in the economy and those attributed to non-resident direct investors.  What we have seen here is that about two-thirds of that is the result of data and methodological issues, of which the most significant is the treatment of spending on R&D activities. 

That still leaves one-third of that €18 billion as a real increase.  The profits of Irish companies have increased in the past few years and Corporation Tax receipts from all classes of company have increased and these account of maybe €6 or €7 billion of the increase we have been trying to explain.  The impact all this would have on the growth rates of GNI* is hard to tell but real rates of around six per cent would seem likely. Goldilocks would be pleased.

How much tax do GAFA pay?

Google, Apple, Facebook, Amazon.  The debate on corporate income tax in the EU is fixated on.  Earlier this week Dutch MEP Paul Tang, and member of the European Parliament’s TAXE committee, was co-author of a short report which looked at potential tax revenue losses from Google and Facebook.

The conclusions require a complete re-working of existing tax law.  The tax losses are based on estimated customer revenue shares in EU countries and the global profitability of the companies.  That is, if a customers in a country generate 10 per cent of a company’s net sales that country should be able to tax 10 per cent of the company’s total profit.  Of course, that is not how the system works but it is indicative of the approach some would like introduced.

What this report has in common with many other reports is that it is difficult to determine how much tax the companies are currently paying.  If the argument is that something is “too low” surely we should be told what it is and what it should be.  This is rarely shown.

The table here gives the consolidated income statements for Google, Apple, Facebook and Amazon aggregated over the five financial years that ended between 2012 and 2016.

There are a couple of different ways of measuring how much tax a company pays but that one that matters is surely cash tax payments – how much are companies actually paying over to fiscal authorities in corporate income tax payments net of any rebates or refunds received.  This is given in the second last line of the above table.  From 2012 to 2016 Google, Apple, Facebook and Amazon paid $63.4 billion of corporate income tax.

The companies made provisions to pay around $105 billion of corporate income tax over the period but due to a number of issues (mainly the deferral provisions in the US tax code but also the use of previous losses and tax credits carried forward) the actual amount paid was about one-third less.  Still $68 billion is quite a chunk of change.

Of this, the bulk was paid by Apple which is unsurprising as it generates the largest profits.  For financial years ending between 2012 and 2016 Apple made $52.9 billion of net corporate income tax payments.  Cash tax paid was equivalent to 18 per cent of income before income taxes.

On this measure Facebook comes lowest with cash tax payments equivalent to just 7.2 per cent of income before income taxes.  The reasons for this are that Facebook built up substantial losses prior to 2012 and was able to offset these against the positive income it began to generate from 2012.  This have been exhausted and of the $1.9 billion of cash tax paid over the five years over $1.2 billion was paid in 2016 alone.  In the accounts Facebook indicate that tax payments will rise in further years as offsetting losses are no longer available to be utilised.

The lowest tax payments over the period were made by Amazon but the reason for this is pretty straightforward – Amazon had the lowest profits.  Amazon is a prodigious spender on research and development.  Of the five year period Amazon used 34 per cent of its gross margin for research and development.  This compares to a spend of 15 per cent of gross margin across the other three companies.

Do these companies pay enough tax?  That is not what we are trying to answer here.  What we can say is that between 2012 and 2016 these companies paid $68.4 billion of corporate income tax which was equivalent to 16.4 per cent of their income before income taxes.  What tends to be true of most studies of these companies is that the authors want the companies to pay more tax in certain countries which will almost certainly result in less tax being paid in others. 

Who got most of the $68 billion that the companies paid? The US, of course, because that is where most of the profits were generated.  And if the US didn’t allow deferral or have rules that allowed US-source income to be treated as “offshore” it would collect even more.  And no matter what formulas are used the EU will not simply be able to go and take that taxing right.

The annual income statements for the individual companies are reproduced below.

US companies in the business economies of the EU–and the taxation of their profits

Data from Eurostat clearly shows the oversized presence of US companies in Ireland.  The table below gives the contribution of US companies to the business economies of the EU15 in 2014 for profits, pay, employees and investment.  The business economy is NACE B to N excluding K so it reflects the economy excluding the financial sector, sectors dominated by the public sector such as health and education, and the arts. 

For all the categories shown the largest contribution of US companies is in Ireland.  US companies employ 8.3 per cent of all people employed in the business economy (it is c.5 per cent of total employment) and because they pay rates are higher US companies contribute more the 13 per cent of employee remuneration.  Around one-tenth of investment in tangible goods (excluding aircraft) in Ireland is undertaken by US-owned companies.  In all of these measures the UK is next while the figures for Ireland are between three and four times greater than the mean across the EU15.

The stand-out figure is clearly for Gross Operating Surplus with US companies responsible for more than half of the Gross Operating Surplus generated in Ireland.  The next largest is Luxembourg though the relative contribution is three and a half times smaller while the mean across the EU15 is 14 times smaller than that recorded in Ireland.

We would probably prefer Net Operating Surplus (which is akin to earnings before tax and interest) but GOS gives a good approximation of the contribution of US companies to the corporate tax base in each country.  If for some reason Ireland ended up with a contribution of US companies to gross operating surplus close to the EU mean it would represent a loss of close to half the corporate tax base.

Relative to other EU countries Ireland benefits disproportionately from US companies under the headings of staff, pay and capital investment but the largest difference is for profits.  Ireland’s corporate tax revenues are generated by US companies to an extent that no other EU country comes anywhere near.

The following table gives the numbers behind the contributions of US companies in Ireland.  The total for the business economy is given as well as a breakdown by the main sectors: manufacturing, wholesale and retail, information and communication and the rest.  Remember that the financial sector is not included in any of the data used here.

The key figures are €6.5 billion of personnel costs for 103,000 staff and €2.5 billion of investment in tangible goods.  From the €39 billion of gross operating surplus Ireland probably collected in the region of €2 billion in Corporation Tax while something around €4 billion of the total purchases of goods and services would have been made from Irish suppliers.  This gives a total of €15 billion or so.

We can see how this is broken down by the main contributing sectors in the subsequent columns.  The largest sector is manufacturing with about half of the staff, pay bill and profit totals.  Capital investment in Ireland by US manufacturing companies seemed surprisingly low in 2014.  For the years 2008 to 2012, US manufacturing companies undertook an average of over €1 billion of capital investment in Ireland.  The 2014 figure was just one-twelfth of that though capital investment by ICT companies meant the total of €2.5 billion was in and around the annual average since 2008.

The final thing we can look at is the distribution of these contributions from US companies across the EU.  In can be seen that in terms of absolute size across the EU, US companies have their largest footprint in the UK, well for the time being anyway.  Around 30 per cent of US companies profits, staff, pay and investment in the EU are in the UK.

The stand-out figure for Ireland is again for profit.  Just over one-fifth of the gross operating surplus generated by US companies in the EU in 2014 arose in Ireland.  Current rules for allocating taxing rights means that Ireland has approximately one-fifth of the taxable income of US companies in the EU in its tax base.

Alternative proposals to allocate taxing rights are contained in the Commission’s CCCTB proposal.  This would allocate taxing rights on the basis of number of employees, pay bill, tangible capital goods and sales.  Obviously, the allocation will be done by individual company but we can see that in aggregate Ireland has about three percent of the staff measures to be included and maybe around double that for the tangible investment component (or at least for new investment in tangible capital goods in 2014).

We don’t know where these companies sell the goods and services that make up the turnover column but we can get a rough approximation of the size of national markets using ‘actual individual consumption’ from national accounts statistics.  Ireland is about one per cent of the EU market.

Again, the aggregates here don’t provide the granular detail that would go into the calculation at the level of the individual firm but if taxing rights were to be allocated on the basis of employees, pay bills, capital goods and sales, Ireland’s tax base from US companies could fall from the current level of around 20 per cent of profits generated by US companies in the EU using the arm’s length principle to something roughly one-sixth or one-seventh of that under formulary apportionment.  Again this would represent a loss of around half the existing Corporation Tax base.

Who would favour this approach?  Well, just look at France,  Italy and to a lesser extent Spain, in the above table.  France is nearly 16 per cent of the EU market and has around 10 per cent of the employment and capital investment of US companies in the EU.  How does France fare on taxing rights?  Much lower.  Only 3.4 per cent of the gross operating surplus generated by US companies in the EU in 2014 arose in France.  A similar outcome can be seen for Italy with shares of employees, pay bill, capital goods and market size that exceed its current share of the tax base.  Winners and losers.

Remarkable falls in the Live Register

There are better measures of changes in the labour market (with the QNHS being best) but it can be instructive to look at changes in the Live Register and some of the recent changes have been remarkable.

The pattern of the Live Register itself is probably pretty well understood.  Here is the seasonally adjusted total since 2007: rapid rise, level for a period, period of decline.

Let’s look at the rate of change.  Here are the average monthly changes over rolling three-month periods since 2010.

The Live Register has been dropping for five years but the three-month period that has the fastest absolute decline has been the last three months.  The average month fall (seasonally adjusted) across June, July and August has been 5,100.  The next best of the 4,500 recorded for the three months to September last year.

Maybe the seasonal adjustment casts some doubts so lets look at the annual changes in the actual numbers.  Here are annual changes recorded in the unadjusted total on the Live Register each month since the annual declines began around the start of 2012.

The largest annual decline in the Live Register was the month just past, August 2017.  Compared to 12 months ago the Live Register has fallen by 51,762.  Previously, the largest annual decline was the 48,162 drop seen in March of this year.  And again these are the absolute declines which might have been expected to moderate but are doing anything but.