Wednesday, December 19, 2018

SILC confirms the boom in labour income

A previous post looked at the increase in labour versus non-labour income in the CSO’s national accounts statistics.  This week the CSO published the 2017 update for the Survey on Income and Living Conditions and, perhaps unsurprisingly, the income patterns in this granular micro-data reflect what has already been reported in the aggregate macro-data.

Here is a table of weekly average household income since 2012.

CSO SILC Weekly Household Income by Item 2012-2017

The bottom line is that, in nominal terms, weekly net disposable household income is up €136 or 17 per cent since 2012.  And we have to go all the way up to the top to find the item contributing most to this: employee income.  Over the same period, average weekly employee income is up €148 or 27 per cent. 

The figures in the table are averaged across all households so will include households who have no employee income (such as retirees) who will bring the average down.  This can also be seen for “unemployment benefits” under social transfers. 

The average weekly amount here has fallen from €61 in 2012 to €39 in 2017. This is not because payment levels have been reduced but because the number of recipients has fallen.  Many households have moved to have zero in this category and this brings the average down.

But it is not the average, per se, that we are interested in, but the changes in them and we can see that employee income accounts for most of the improvement in household disposable income.

Proportionately, the largest increase has been for gains from self-employment which are up 83 per cent over the period.  The direct income item with the smallest proportionate increase for the period shown is “other”.  From the background notes the CSO tell us that this is:

Other direct income:

    • Value of goods produced for own consumption
    • Pension from individual private plans
    • Income from rental of property or land
    • Regular inter-household cash transfers received
    • Interests, dividends, profit from capital investments in unincorporated business
    • Income received by people aged under 16

This is where the non-labour income that was the focus of the previous post would show up.  The series in the SILC is a bit erratic.  Although it is up 20 per cent compared to 2012, it is actually down slightly compared to 2014 (and going back one year to 2011 would show a 50 per cent increase by 2017). 

Still there is little evidence of non-labour income such as interest, dividends, and most notably, rents outstripping labour income.  At an individual household level, there will be some who are seeing their housing costs rising faster than their income but in aggregate terms employee income is rising by a much greater amount than housing costs.

This table tries to scale up the average weekly amounts shown in the SILC to annual and national terms.  It is very crude.  The weekly amounts are annualised and then multiplied by an estimate of the number of households for each year (based off the 1.7 million figure from Census 2016).

CSO SILC Weekly Household Income by Item 2012-2017 Scaled

In rough terms, it corresponds to what would expect given what is in the aggregate data. A key difference is that the SILC does not include the imputed rent of owner-occupiers as income.  Here is some work from Eurostat on the distributional impact of imputed rents in the SILC.

The scaled-up figures gave an increase in employee income of €15 billion over the period which is in line with what we have seen elsewhere (though maybe levels could be higher).  The amounts for “other” direct income scales up to between €2.0 billion and €2.5 billion each year. 

The boom is in labour income.

Thursday, December 13, 2018

The continuing remarkable improvement in Ireland’s Net International Investment Position

The Net International Investment Position (NIIP) of a country is the balance of external financial assets and liabilities.  In headline terms, Ireland is a huge debtor nation with a negative NIIP of around €420 billion, or around €90,000 for every person in the country. 

While this can put Ireland at the top (or maybe the bottom) of international tables two factors are worth noting: the impact of the IFSC and MNCs on Ireland’s data.  Both of these contribute significantly to Ireland’s NIIP position but these debts will not fall on the shoulders of Irish people so there inclusion in the €90,000 net debtor position is misleading. 

And if we strip them out we get an entirely different picture.  Here is Ireland’s NIIP excluding the IFSC and the non-financial corporate (NFC) sectors using all available data in the latest series.

NIIP ex NFCs Q2 18

It would be nice to see this series extended backwards but it is not a surprise to see that we had a debt position of around €100 billion at the start of 2012.  Since then the turnaround has been remarkable and we have moved to a net creditor position of almost €120 billion.  On a per capita basis we have €25,000 more external financial assets than external financial liabilities.

It could be that stripping out the entire non-financial sector omits some important information.  Stripping out the NFC sector does purge the data of the polluting impact of foreign-owned MNCs but the international position of domestic firms is excluded as well.  However, there is nothing to suggest it would alter the underlying pattern shown above.

It is worth looking at a sectoral breakdown of the above aggregate position.  There are four sectors included in the total shown above:

  • General government (public debt)
  • Monetary authority (central bank)
  • Monetary financial institutions (banks)
  • Financial intermediaries (pension and other investment funds)

Here is the contribution of each to the underlying NIIP shown above

NIIP by Sector Q218

The negative NIIP €130 billion for the government sector is unsurprising and, of course, is linked to the c.€200 billion of debt that the government has, and this NIIP position has been largely unchanged for the past few years.

On the other hand, financial intermediaries has seen a sustained improvement in their positive NIIP, rising from €100 billion at the start of 2012 to €200 billion in the latest data.  This largely reflects the value of private pension and investment funds of Irish households.  This increase will be the result of additional contributions but also revaluation effects, reflecting the rising value of various financial assets through the period.

The NIIP of monetary financial institutions has changed little over the period shown.  It was close to zero in 2012 and had edged up to around +€20 billion by the middle of this year.  One reason for this is that the chart excludes the chaos of the 2008 to 2010 period when the banks ran into huge problems and their external liabilities would have been bouncing around.

We know that during this period the banks repaid almost all of their external creditors and did so by drawing down huge amounts of central bank liquidity which reached up to €180 billion at one stage.  This improved the NIIP of the financial sector but merely transferred the external liabilities to the central bank, at least until the banks were able to repay the central bank liquidity they were using.

And this is can be seen.  At the start of 2012, the monetary authority (the Central Bank of Ireland) had a negative NIIP of around €100 billion.  This largely reflected a liability to the Eurosystem in respect of the liquidity provided to Irish banks to allow them to pay their creditors.

Since then, the banks have been reducing the size of their balance sheets but in terms of the NIIP this shows up through the position of the central bank rather than the banks themselves as they have been using the reduction in loans and increase in deposits to reduce their reliance on central bank liquidity, which in turn reduces the central bank’s liabilities to the Eurosystem.  This is the deleveraging we have been going through for the past decade or so.

And the net result is that, if we strip out the IFSC and MNCs, Ireland has a positive international investment position of almost €120 billion.  It has been a remarkable turnaround.

Of course, this aggregate does not reflect the distribution.  The biggest debtor is the general government sector which, in a sense, is all of us, while the biggest creditor are financial intermediaries which reflect the pension and investment savings of a much narrower subset of households.  And it is also the case that some of the improvement in the financial position has been brought about by the sale of real assets.  Still it’s much better to be talking about the distribution of assets than the burden of debt.

Tuesday, December 11, 2018

Where’s the boom in non-labour earnings?

One of the most notable features of the Irish recovery in recent years has been the surge in employee earnings.  Compensation of employees received in the first half of 2018 was almost 12 per cent higher than in the equivalent period of 2008 (€40.4 billion to €45.2 billion).  The chart below shows this. It is in nominal terms though relative prices between 2008 and 2018 are not hugely different in overall terms.

Compensation of Employees Nominal

But with labour earnings booming it is worth considering what has happened to non-labour income.  The institutional sector accounts allow us to do this. Here is a chart of property income as defined in the institutional sector accounts since 2005.

Household Sector Property Income

The pattern here is very different to the pattern shown in the first chart.  There has been no boom in property income and it remains below the levels seen in 2007 and 2008.

There have been some changes within the total.  Interest received is down 70 per cent since 2008.  The distributed income of corporations returned to its 2008 level in 2017 and has grown 70 per cent since 2013.  It would be useful to get a breakdown of the distributed income of corporations into actual dividends received (which is capital income) and withdrawals from quasi-corporations such as large partnerships (which has some links to employment).  The definitions of the investment income linked to insurance policies and pension entitlements is available here.

One thing to note is that the above chart does not include income earned by households as suppliers as services.  This will include the income of independent traders (the self-employed) and the income of households as a supplier of housing services (landlords).  The only rent included in the above chart is rent on natural resources or land.

To complete our look at earned income we must look at mixed income and gross operating surplus.  Mixed income is the income of the self-employed and the operating surplus of the household income is derived from the provision of housing services.

First, mixed income:

Household Sector Mixed Income

This is still way below the previous peak and is only rising slowly.  This is likely linked to the construction sector and the engagement of contractors.

Second, the gross operating surplus of the household sector:

Household Sector Operating Surplus

OK, so maybe we have a boom in non-labour income after all.  This is the capital income households earn as suppliers of housing services after the deduction of costs for maintenance, repairs, utility charges and property taxes. 

One important consideration here is as most households own their own home it is an imputed income from the housing services they supply to themselves.  Money doesn’t actually change hands but it is the amount as if owner-occupier households were charging rent to themselves.  This imputed rent is based on market rents.

Of course, there are plenty of instances of those owning housing provided housing services to others and charging actual rents for the supply of these services.  It would be ideal if the gross operating surplus shown above was available for actual and imputed rents but it does not appear to be so.

The CSO do provide a measure of net rent of dwellings (i.e. after depreciation) that is divided into actual and imputed rents so this gives a reasonable idea of what has happened.  The net amount for 2017 is around €3.5 billion below the gross amount shown above which reflects the depreciation set against the capital assets.

Household Sector Rent of Dwellings

We can see that since that imputed rents have contributed significantly to the increase in this item of capital income.  Actual rents received have also increased. 

In net terms, actual rents received for housing have increased from €1.8 billion in 2008 to €3.0 billion in 2018.  In fact, the share of actual rents in the above total has increased from 21 per cent in 2008 to 27 per cent in 2017.

An alternative way of looking at this is, rather than look at income, to look at the amount of rent included as consumption.  This is the aggregate amount of housing services consumed so is before the deduction of costs, charges and depreciation.

Household Sector Rents in Consumption

The aggregate amount of actual rents in household consumption expenditure has gone from €3.0 billion in 2008 to €4.5 billion in 2017.  It has gone from 19.5 per cent of household rental consumption to 24.5 per cent.

Anyway, the summary is that the boom in labour income has not been matched by a boom in non-labour income, dwelling rentals and in particular the imputed rentals of dwellings excepted.

Here is a table with the past five years of figures for the main items covered above with a further breakdown of employee compensation by the sectors who pay it.

Household COE Mixed Property Income and Rentals

Since 2013, there has been a €16 billion rise in compensation of employees received and a €3.5 billion rise in the imputed rentals of owner-occupier household to themselves.  The incomes of the self-employed (mixed income) have risen around €2 billion.  After that the changes become even smaller.

In percentage term, the distribution income of corporations paid to households is up 70 per cent and actual rentals paid by household are up 40 per cent though these make relatively small contributions to the overall change in the income of the household sector which has primarily been driven by employee, and to a lesser extent, self-employed income.

The Distribution Impact of Budget Changes

After each budget the ESRI produce excellent analysis on the distributional impact of the announced measures on disposable income.  This tells us whether the budget is regressive or progressive.  The analysis published for Budget 2019 contains the following chart:

ESRI Impact of Budget 2019 changes

It is commonly used to infer the impact the budget had on disposable income.  This is not necessarily true.   The budget did not reduce the disposable income of all households as might be inferred from the above chart.

To understand this it should be noted that these losses shown above are relative to a benchmark scenario, in which welfare payments and tax bands and credits are indexed in line with wage growth.

The chart above shows whether households are better or worse off compared to this benchmark; not relative to their starting position.  In the ESRI benchmark scenario for Budget 2019, wages tax bands and credits and welfare payments are increased by 3.0 per cent.

Let’s try to set up some sample households to see the impact of this.

Example 1
Consider a household with an earned income of 30,000 (and no other income). Assume the single tax rate is 20 per cent and the tax credit is 3,000.

Pre-budget disposable income in 27,000. The benchmark scenario assumes a 3.0 per cent rise in wages and the tax credit. Thus income is assumed to rise to 30,900 and the tax credit becomes 3,090. Disposable income in the benchmark is 27,810 – a rise of 3.0 per cent.

If the budget does nothing to this household (by keeping the tax rate at 20% and the tax credit at 3,000) the distribution analysis will look at the impact of these (non)changes after the assumed 3.0 per cent increase in wages.

Thus, their assumed income of 30,900 will continue to be taxed at 20 per cent with the credit staying at 3,000.  Actual disposable income is expected to rise to 27,720 – a rise of 2.67 per cent

According to the distribution analysis the household is worse off by 0.33 per cent – and that’s even though the budget changed neither the tax rate nor the tax credit they get on their income.

Intuitively we would say the budget has no impact on them, but they are relatively worse off because tax credits did not increase in line with the increase in wages. A greater proportion of their income is now taxed.

The households "effective tax rate" has gone from 10.00 per cent to 10.29 per cent. This is called fiscal drag. They are said to be worse off even though the household disposable income has increased from 27,000 to 27,720. It would have increased to 27,810 if tax credits were increased in line with wage growth. The household are worse off relative to this benchmark by 0.32 per cent but in reality their disposable income has increased by 2.67 per cent (because of the expected wage growth).

Example 2
Consider a household who receive transfer income of 15,600 (and no other income). This one is more straightforward. The benchmark scenario assumes a 3.0 per cent increase in the transfer payment. So the benchmark is a disposable income of 16,068 – a rise of 3.0 per cent.

Let’s assume that the budget sees this family receive am increase in their transfer payments of 6 per week, i.e., an annual gain of 312. This means the household’s disposable income increases to 15,912 – a rise of 2.0 per cent.

According to the distribution analysis this household is worse off by 1.0 per cent – and that’s even though the budget increased their welfare payments by 312. Intuitively we would say that the budget has made them better off but they are relatively worse off because their welfare payment did not increase in line with the increase in wages.

The gap between this household on welfare and a household on wages is now greater (as wages are assumed to have increased by 3.0 per cent). They are said to be worse off even though their disposable income has increased from 15,600 to 15,912.

It should have increased to 16,068 if transfer payments were increased in line with wage growth. The household are worse off relative to this benchmark by 1.0 per cent but their disposable income has actually increased by 2.0 per cent (because of the increased transfer payment).

Distribution Analysis
If our economy is made up of just these two households and we have a budget that does nothing except increase the transfer payment to the household on welfare the distributional analysis where wages are expected to grow by 3.0 per cent is:

  • Welfare Household: –1.00%
  • Wage Household: -0.33%

The budget is regressive and everyone is worse off. Yet the only thing in the budget was an increase in the transfer payment. The budget gave income to the low-income household and did nothing to the high-income household yet is labelled regressive.

This is because the budget failed to offset the impact of the assumed 3.0 per cent increase in wages. It is because of this that the high-income household is relatively better off compared to the low-income household – not because of any changes in the budget.

Before the budget the high/low income ratio was 27,000/15,600 = 1.73. After the budget the ratio is 27,720/15,912 = 1.74 (based on the assumed increase in wages). 

Inequality has increased and we shout at the minister for introducing a regressive budget. The minister looks down at her notes and wonders what sort of eijits is she dealing with as she is after announcing a budget where the only change is an increase in transfer payments to the low-income household. How could that be regressive? It is regressive because income inequality in the economy has increased.

It is also possible that the same budget could be judged as progressive.  If we put in a wage increase of 1.5 per cent the conclusion changes – assumptions matter.  Here is the distribution impact for our simplified scenario with an assumed 1.5 per cent increase in wages.

  • Welfare Household: +0.50%
  • Wage Household: -0.17%

The same budget is now progressive.  This is because the income gap narrows.  The wage household is a little worse off because of the budget, again because tax credits were not increased in line with the expected wage growth (which this time is 1.50 per cent).  The “effective tax rate” goes from 10.00 per cent to 10.15 per cent.  The welfare household have gained because of the increase in the transfer payment and have gained even more relative to wage earners.

By working through the numbers it can be seen that the post-budget income ratio here is 27,360/15,912 = 1.72.  Income inequality has been reduced relative to the starting ratio (1.73).  So the same budget can be both regressive and progressive depending on what initial assumptions are put in.

This might seem like a massive complication of what should be a relatively simple concept – what impact did the budget have on household disposable income. However, a budget is not set in isolation. The impact of the dynamics of the economy (wage growth etc.) have to, or least should, be taken into account when the budget is being formulated so it is right that the impact of the budget is compared to some benchmark of what is expected to happen in the economy rather than the way it is now. We do not live a world where things are static.

This makes the analysis of the ESRI a bit more nuanced to interpret. The key thing we can take from it is whether a budget is regressive or progressive in terms of the income gap between households in a changing economy. Hence the simple contrived example above shows a regressive budget even though all the budget did was give a higher transfer payment to the low income household – it should have given them more to keep pace with the assumed 3.0 per cent growth in wages.

Budget 2019 did not make anybody worse off. Just looking at the measures introduced would show that. What the ESRI are saying is that inequality will increase if the assumed wage growth inputted to the analysis materialises. Hence the budget was regressive – or at least it was from decile three up to decile ten.

This does not mean inequality will rise in 2019. This is because the analysis by the ESRI is micro-based. So, yes, the micro analysis points to greater inequality as a result of government policy relative to a scenario where wages rise by 3.0 per cent.  However, the distributional analysis does not reflect macro factors such as employment growth which obviously has a large impact on inequality – and probably a greater one than the budget measures.

A continued increase in employment in 2019 will likely reduce inequality. A priori, the net effect on inequality between the offsetting micro and macro factors is impossible to determine.  For that we need something like the Survey on Incomes and Living Conditions. SILC 2017 is due to be published by the CSO next week.

Tuesday, October 16, 2018

The household sector accounts make sense again

It’s a well-worn path that Ireland’s national accounts are so heavily distorted by the impact of MNCs that getting any reliable signal from some of the most commonly-used aggregate measures is close to impossible.  The work of the CSO has led to the publication of some bespoke measures from the Irish accounts such as GNI* and CA* that strip away some of the distortions.  These have been welcome additions to the accounts.

Within the accounts themselves the household sector may be a good place to look for underlying trends.  The outcomes for the household sector should reflect many of the underlying trends in economy for incomes, spending, saving, investment and borrowing.

About 18 months ago we did a deep dive and pulled together a coherent narrative from the accounts. In summary, household current spending (consumption) and capital spending (capital formation) was below household income so that the household sector was an aggregate net lender and was using these funds to repay loan liabilities. 

But then, this time last year, the apparent coherence was revised away and the figures at that time reported the household sector to have been a net borrower since 2014.  We returned to this a few times (here, here, here and here). 

At the time we were still waiting to get a clear view of CA* so the net lending/borrowing position of the household sector would have been an important indicator when looking for signs of pressures in the economy.  Except, after last year’s revisions, it didn’t make sense.  But this has now been restored.

If we go all the way to the bottom line we can see the result of the latest revisions.

Household Sector Net Lending Revised Oct 2018

There has been a massive upward revision in the accounts to the net lending position of the household sector.  For the period 2014-2017 in cumulative terms, the household sector has switched from being a net borrower of €1 billion to being a net lender of €16 billion. 

This is much closer to what we would expect given the scale of debt reduction untaken by the household sector in recent years with loan liabilities reducing from over €200 billion in 2008 to under €140 billion now. 

Household Sector Loan Liabilities

It never made sense that the funds for these repayments were coming from the sale of unlisted shares.  That the accounts now show that a large part is coming from unspent income eases any concerns about the build-up of financial pressures in the household sector: the “deleveraging hypothesis” trumps the “overheating hypothesis”, for now at least.  The deleveraging will not continue for ever.

Although not of central concern there may be some interest in looking at where the revisions were entered into the accounts.  Some of it happened in the current account.  There has been some upward revision to the gross savings rate from what was shown this time last year but not massively so.

Household Sector Savings Rate Revised Oct 2018

This has largely been because of an upward revision to household income.  For example, gross disposable income for 2016 has been revised from €95 billion to €97 billion with the result that the gross savings rate is now 1.5 percentage points higher.  The output produced and wages paid by the household sector itself were revised up.

But some of the more significant changes happened in the capital account.  Here are the previous and revised figures for gross capital formation of the household sector.

Household Gross Capital Formation Revised Oct 2018

The 2016 figure for household capital formation has been revised from €8.0 billion down to €5.2 billion.  The main item in the capital formation of households is housing; both the improvement of existing units and the acquisition of new units.  There is even less of this going on then previously thought which is a major reason for the revisions in the net lending shown at the top.

Whatever the reason we now have a set of household accounts that make sense.  The household sector is not spending all its income and is a significant net lender which is what we would expect given the scale of the reduction in household loan liabilities in recent years.  As hinted above this points to wondering what will happen when the deleveraging stops.

Friday, October 12, 2018

The Irish Hare is set to complete its second lap

Here is a chart from Honohan and Walsh (2002) showing Ireland going through a 25-year imbalance cycle from 1975 to 2000.  Internal imbalances are shown through the unemployment rate with external imbalances shown through the balance of payments current account deficit (these are shown using the reverse sign so positive numbers indicate deficits).

Celtic Hare Lap 1

Back in 2009, Honohan pondered whether the hare was heading off on another lap.  He was right (and first raised the possibility with co-author Walsh as early as 2007). 

Anyway, here is an update of the imbalance chart using the modified current account rather than the headline one.  Outturn data from the CSO is used for 2004 to 2017 with figures for 2018 to 2020 coming from the latest Department of Finance forecasts included with Budget 2019.

Celtic Hare Lap 2

The latest lap began with the current account deterioration from 2004 (though it should be noted that the range of the horizontal axis in the second chart is about half that of the first).  The current account did begin to improve after 2008 but this was coincident with the explosion in unemployment (same axis range in both charts) as consumption and, most notably, investment fell. 

Since 2012, we have been closing the loop through rapid falls in unemployment and improvement in the current account.  The current account did deteriorate in 2017 though this may have been an MNC effect related to the acquisition of stocks.  The latest forecasts from the Department of Finance show a continued erosion of the current account surplus from that point as a result of consumption and investment rises.  The forecasts have us getting us back to where we were in 2004 sometime next year or the year after so the final closing of the loop as shown above is still a forecast rather than an outturn.

If it does happen the hare will set a new PB: cutting the the lap time 25 years to 15 years (albeit, as noted by Honohan, the course was shorter this time). What’s in store for the celtic hare? Hard to know.  But let’s hope it takes a breather before heading off on its third lap.

Monday, September 24, 2018

The household sector in the NIE

There are some neat modifications of the tables published in National Income and Expenditure (NIE) accounts included with the 2017 update.  Recent years and have seem improvements in how the household sector is covered in the accounts and this continued with the publication of the full set of tables for the 2017 NIE.  There is a useful information note here.

Here is a table setting out the gross disposable income of households in nominal terms.  This is after tax and transfers with the “gross” referring to depreciation. Click to enlarge.

Gross Disposable Income of Households NIE2017

The main use of disposable income by households is consumption and the main consumption items for the same year are set out in the following table.

Household Consumption Expenditure NIE2017

After consumption expenditure in 2017 households had just over €10 billion available for capital formation (investment) or net lending.  If investment expenditure was more than €10 billion then the household sector would be a net lender as the sum of consumption and investment expenditure could not be funded from disposable income.

We don’t get insight into this from the NIE accounts but we will do so from the Institutional Sector Accounts (ISAs).  The 2017 ISA annual figures will be published in the next few weeks where we will hopefully see the extent to which the household sector is a net lender (i.e. using some of that €10 billion shown above to repay debt). 

Wednesday, July 18, 2018

When can we expect the next wave of IP onshoring?

The 2017 National Income and Expenditure Accounts will be published by the CSO on Thursday.  In a detailed information note the CSO have set out some of the updates and revisions we can expect.  Some of updates relate to the treatment of expenditure on imports of R&D services and tally with a lot of what we said here.

While these welcome updates are likely to be the most significant changes introduced by the CSO they are unlikely to be headline grabbers.  But they will significantly improve the usefulness of key measures of the economy such as the modified current account balance in the Balance of Payments, CA*, and the level and recent nominal growth rates of modified Gross National Income, GNI*. 

It is a bit of a punt but it is possible that for 2017 we will see CA* record a surplus somewhere in the range of 2-4 per cent of GNI*, while the recent nominal growth rates of GNI* may fall in the range of 5-8 per cent per annum.  These are impressive, and plausible, numbers.

But impressive and all as these might be it is likely that more attention will be directed at seeing how this pointer in section 4.1 of the CSO information note plays out:

The CSO’s Large Cases Unit (LCU) continues to work with data providers on their R&D-related activity. As part of this work, additional purchases of R&D-related IP assets have been identified in recent years and will be included as imports of services in the upcoming National Accounts and Balance of Payments results, with offsetting additions to the capital stock in the National Accounts. As a result of these new additions to the stock of intangible assets, the GNI* indicator will also include revisions to its depreciation adjustment for R&D-related IP assets in recent years.

We don’t have a GNI* depreciation adjustment for 2017 so that can’t be revised, thus it could be that these newly-identified onshoring events relate to years up to 2016.  And we do have another data source which now goes up to 2016 where these transactions are likely to make an impact – the aggregate Corporation Tax calculation published by the Revenue Commissioners.

The table below shows the national accounts depreciation adjustment for MNC imports of intellectual property products from last year’s NIE release and the capital allowances claimed for intangible assets under Section 291A of the Taxes Consolidated Act which was introduced with the Supplementary Budget of April 2009.

IP CFC and S291A CA

While these obviously are related concepts the figures do not have to match each other but they are strongly correlated which is best shown by the change in 2015 when both series rose by €25 billion ± €1 billion.  Conceptual differences aside it looks like there is some scope in most years for the national accounts version to be revised up.

This seems particularly true for 2016.  In last year’s NIE the CSO increased their depreciation measure for these IP products by €2.7 billion.  The recently-released aggregate CT calculation from the Revenue Commissioners shows a €6.9 billion increase in 2016 for the amount of capital allowances claimed for intangible assets.  There is a €4 billion difference between the changes.

It should also be noted that the time period covered by each series is different.  The CSO data covers activity that happens in a calendar year; the Revenue data reflects the details in CT returns filed for accounting periods ending during the calendar year.  So, for example, a company with a June 30th year-end will have the figures from its CT return included for one year even though the figures reflect activity that happened in the second half of the previous calendar year. 

This is only a minor wrinkle and should wash out between the series over a couple of years.  But it should be noted that changes in the Revenue data for a particular year could relate to activity that began the previous year and if a June 30th company introduced a change from July 1st 2016 it won’t appear in the Revenue data until 2017 but it could affect the revised 2016 data the CSO is set to publish this week.

So while little more than an enlightened guess we could see a couple of billion added to the national accounts depreciation measure in question here for years up to 2016. 

So what would a €4 billion increase in any year mean for the national accounts?  If we assume a 10-year lifespan then we could be looking at an increase in the capital stock of these intangible assets of around €40 billion.  Given recent developments it is likely that the upward revision to GDP (and GNP) would be around €4 billion.  This could add 1.5 to 2.0 percentage points to the growth rate of each.  GNI* will largely be unaffected as the upward movement in GDP will be offset by the increase in the depreciation adjustment that is subtracted to get this modified measure of national income.

So while the improvements to CA* and GNI* will be main source of added-value from this release they will have to fight for attention if tens of billions of intangibles are further added to the estimates of Ireland’s capital stock of intangible assets.

And, of course, we have absolutely no idea what could be introduced for 2017.  It is possible that the recent wave of IP onshoring was linked to “stateless” companies who would have been impacted by changes introduced to Ireland’s residency rules in the 2014 Finance Act that became effective from the start of 2015 and the implementation via the OECD’s BEPS process of country-by-country reporting by MNCs to the tax authorities in the countries in which they operate.  A country report for “Republic of Nowhere” would probably have raised a few eyebrows.  Maybe we have a few laggards but one would have thought that most of the impacted companies would have restructured before the end of 2016.

Of course, a second wave of onshoring is likely in response to the 2015 Finance Act changes to Ireland’s residency rules which become fully effective at the start of 2021 and, more importantly, proposed changes to Ireland’s transfer pricing rules which would see the latest OECD guidelines based on BEPS Actions 8 to 10 incorporated into Irish legislation. 

This would see royalty payments for IP disallowed as a tax deduction if the recipient of the royalties does not have sufficient DEMPE functions to warrant receipt of the royalties (DEMPE functions are the development, enhancement, maintenance, protection and exploitation of IP).

Up to now Irish legislation has been blind to the location, residence and substance of entities receiving outbound royalty payments but if BEPS Actions 8 to 10 are incorporated into Irish transfer rules (and it has been recommended that this should be done before the end of 2020) then the substance of such entities will matter.  Companies can continue to make royalty payments to them but they would only be eligible as a deduction for Irish Corporation Tax purposes if the receiving entities have sufficient DEMPE functions.  Cash-box entities in the Caribbean are unlikely to satisfy the criteria.

So either companies reroute the royalty payments to an entity that has the required DEMPE functions – such as the parent company in the US that undertakes most of these MNCs R&D activity – or restructure their operations in Ireland.  If recent events are anything to go by this restructuring will involve the onshoring of the IP licenses previously located with the cash-box entities in the Caribbean or other offshore financial centres..

Thus, the taxable income of the Irish operating company will move from being reduced by “renting” the IP and making annual royalty payments for the use of the IP to being reduced by “buying” the IP and claiming capital allowances each year based on the cost of acquiring and maintaining the IP.

Could we have seen a few early movers in 2017 even though such a change could have been delayed until 2021? Maybe, but it seems unlikely.  There was a reasonably-flagged change to S291A that became effective from midnight on the night of Budget 2018.  This saw that amount of capital allowances that could be used in any one year limited to 80 per cent of the relevant taxable income. 

This guarantees that some of the intangible-asset-related profit will be exposed to tax each year though if the cap is binding it means it takes a longer period for the capital allowances to be exhausted as the full amount is still available to be used.  It seems unlikely that a company would have moved in advance of the introduction of this change when they could continue with the royalty-based structure until the end of 2020. 

And it seems even more unlikely when the alternative is a capital-allowances-based structure that is essentially limited by the amount that can be claimed arising from the initial acquisition cost versus the open-ended and virtually unlimited amounts that can be used in the royalty-based structure.

But maybe it would be a consideration with a particular profit outlook and risk appetite. Such risk assessments could include the possibility of an EU State-aid investigation (and maybe the risk appetite of national tax authorities for the same could also be a factor).  If you were a typical US MNC availing of the “double-irish” to defer your US tax liability you might get the heebie-jeebies when reading the full version of the Amazon-Luxembourg state-aid case.

Even with that it is more probable than not that the second wave of IP onshoring to Ireland will not be seen until nearer to 2020.  Although the analysis is preliminary it does not appear that the Tax Cuts and Jobs Act passed by the US Congress last December will significantly change the incentives involved for existing IP that companies have moved offshore.  

And with over €70 billion of outbound royalty payments currently being made from Ireland the potential scale involved is huge. However, section 5.1 of the CSO information note indicates that this will be revised down by some amount but it should be remembered that this is on the basis of a national accounting interpretation of what is going on not a tax interpretation. 

This issue aside it could be that the total value of the assets involved is of the order of something approaching a trillion euro while the associated gross profits / capital allowances could be double the levels seen by the end of 2016 bringing the annual amounts to something around €100 billion. 

Could any of this have arrived in 2017? Maybe.  Just as it’s a possibility that there were some late first-wave movers that only got around to getting their affairs in order in 2017.  As flagged by the CSO there will be changes to the national accounts with revisions to the data relating to onshoring that took place up to 2016. 

At this stage the rest of us really are blind as to what could have happened in 2017.  Maybe the NIE release on Thursday will see us stunned like startled earwigs again, and then again maybe it won’t, but IP onshoring is something we should be expecting to see much more of as we move towards the end of the decade.  Buckle up!

Tuesday, July 17, 2018

Capital Allowances and companies with Net Trading Income that is negative or nil

The previous post went through the overall outturns from the 2016 aggregate Corporation Tax calculation which was recently published by the Revenue Commissioners.  As detailed there the figures for capital allowances are worthy of attention.  The amounts of capital allowances used against gross trading income for the last four years for which we have data are:

  • 2013:  €15,955m
  • 2014:  €18,621m
  • 2015:  €46,153m
  • 2016:  €59,254m

Additional research from staff of the Revenue Commissioners tells us that a large part the increased claims for capital allowances are linked to intangible assets.  Here are the amount of capital allowances claimed for expenditure on intangible assets from 2014 to 2016.

  • 2013:    €2,522m
  • 2014:    €2,652m
  • 2015:  €28,871m
  • 2016:  €35,737m

It is worth noting that capital allowances claimed as shown in above figures is not the same as capital allowances used which were shown in the first set of numbers.  A company may claim capital allowances but unless it has income against which to offset those capital allowances the capital allowances remain unused and can be carried forward as a loss for use in subsequent period when there may be income to use them against.  There is a story here but it doesn’t relate to intangibles which is the focus here and is something we may land on in future.

The CSO host a databank from the Revenue which provides some distributional details of income, deductions and allowances used for Corporation Tax purposes.  The next table shows claims of capital allowances for plant and machinery (which includes intangible assets) by range of net income since 2013.

Plant and Machinery Capital Allowances by Range of Net Income

It can be seen that two income ranges are responsible for almost all the capital allowances claimed: companies with net incomes greater than €10 million and companies with negative or nil net income.  And of these, most of the action is within companies with negative or nil net income.  Since 2014, the amount of capital allowances claimed by such companies has gone from €12.6 billion to €47.5 billion.

The distributional data has been made available much quicker by the Revenue this year and we can put together a rough CT calculation for companies with negative or nil net trading income.  There are some missing items but there enough to allow us to see what is going on.

Corporation Tax Computation for Companies with No Trading Income

The fifth row gives the duck eggs for Net Trading Income (0 0 0 0) but above that we can see that these companies had significant amounts of Gross Trading Profits.  These profits went from €13.5 billion in 2014 to €40.0 billion in 2015 to €49.9 billion in 2016.  These gross profits are included in GDP but it is Taxable Income that matters for CT payments. 

And we see that after the application of losses, and most importantly, capital allowances, the resulting net trading income of these companies with almost €50 billion of Gross Trading Profits in 2016 was zero.  It doesn’t matter what the tax rate is, the tax due on trading incomes of zero is zero.   Some companies in this category do pay Corporation Tax but that is due to Other Income such as rental, foreign or capital gains rather than Trading Income.

The Gross Trading Profits shown in the above table are responsible for a large part of the recent surge in GDP.  But they have no role in explaining the recent rise in Corporation Tax.

The 2016 Aggregate Corporation Tax Calculation

Ireland’s national accounts cannot be accused of being dull and the latest update to the National Income and Expenditure Accounts due this Thursday looks like it will offer plenty to chew over.  Of course, all the CSO are doing is reporting on what is going on.  The main reason for the lack of dullness in the accounts is the corporate sector, and in particular, the impact of foreign-owned MNCs.

We know tax is a factor behind a lot of what goes on so the tax data provided by the Revenue Commissioners is a useful complement to the national accounting data published by the CSO. 

The Revenue have now published the 2016 update of the aggregate Corporation Tax calculation.  This might seem a bit sluggish but the deadline for CT returns is nine months after the end of the financial year to which they apply to CT returns for tax years ending in December 2016 would have been filed up to September 2017 and the process of compiling the aggregate figures means we get the data about half way through the following year.

So, now that we have the aggregate CT calculation for 2016 what does it tell us?  Essentially, we can divided the calculation into two parts:

  1. The determination of Taxable Income from Gross Trading Profits, and
  2. The determination of Tax Due from Gross Tax Due

We’ll start with the determination of Taxable Income.

Aggregate CT Calculation for Taxable Income 2012-2016

In relative terms (i.e. compared to 2015!) the changes in 2016 were relatively modest.  The starting point of the table, Gross Trading Profits, had a massive surge of almost €50 billion (and 50 per cent) in 2015.  The 2016 increase was €15 billion or “just” 10 per cent.

From 2014 to 2016, Gross Trading Profits increased from just over €95 billion to almost €160 billion.  Over the same period the bottom line here, Taxable Income, increased from €50 billion to €71 billion.  This suggests there is a lot going on in between when a €65 billion rise in Gross Trading Profits translates into an increase in Taxable Income of around one-third of that amount.

It also suggests that caution should be exercised when drawing a link between the 2015 surge in GDP and the 2015 surge in Exchequer Corporation Tax receipts.

There is a lot going on and it is almost all due to just one item: Capital Allowances, i.e. the tax treatment of expenditure linked to the acquisition or maintenance and development of fixed assets.  The fourth row of numbers in the table shows what happened.

Back in 2012, firms used €8.5 billion of capital allowances against their gross trading profits (though this could have been affected by lower profits) and by 2016 the amount of capital allowances used had risen to almost €60 billion. Most of this increase has happened in the latest two years for which data is available, 2015 (+€27.5 billion) and 2016 (+€13.1 billion).

The only other notable change in 2016 was the €6 billion or so reduction in Trade Losses Carried Forward used though all this has done is brought this item back to its 2014 level.  There is lots to be learned in the table but when it comes to recent changes, and finding links to developments in the national accounts, it really is all about capital allowances.  The next post will look at these in more detail.  For now we will looks at the second part of the aggregate CT calculation which shows how Tax Due is reached from the starting point of Gross Tax Due.

Aggregate CT Calculation for Tax Due 2012-2016

Applying Ireland’s two Corporation Tax rates shows that the Taxable Income reported by companies for tax years ending in 2016 resulted in a Gross Tax Due amount of almost €9.5 billion. Ireland does have a third tax rate paid by companies, that on capital gains, but these amounts are regrossed based on the difference between the CGT rate on the CT rate of 12.5 per cent and the 12.5 per cent rate is applied to these regrossed amounts to give the amount of tax due.

We can see that the €9.5 billion of Gross Tax Due results on a Tax Due amount of €7.2 billion once we reach the bottom line.  The reduction is due to credits and reliefs available under Irish CT legislation.  These are actually pretty limited in number and we can see that the bulk of the reduction is due to two sets of items:

  1. Double Taxation Relief and the Additional Foreign Tax Credit
  2. The R&D Tax Credit used against tax this year and the Payment of the Excess R&D tax credit.

Between them these factors account for €2.0 billion of the €2.3 billion difference between Gross Tax Due and Tax Due.  Earlier posts considered the impact of these features of Ireland’s CT codes on effective tax rates here and here.  Without them the effective tax rate on Taxable Income would essentially be 12.5 per cent.

Finally, it is worth comparing the figures for Tax Due shown here and the cash receipts for Corporation Tax recorded by the Exchequer.

CT Tax Due and Exchequer CT Receipts

For the five years shown the two series roughly sum to the same aggregate amount (c.€27 billion) but reach the 2016 amount of c.€7.25 billion by difference routes.  As is well known Exchequer CT receipts spiked by almost 50 per cent in 2015.  On the other hand the increase is Tax Due as shown in the aggregate CT calculation is more evenly spread across 2014, 2015 and 2016. 

This suggests there may have been a timing issue at play when it comes to the surge in cash receipts in 2015 with some receipts due on activity that occurred in 2014 delayed until the final CT return was filed nine months after the end of the companies’ accounting periods. 

And, again it highlights, that although the surge in CT receipts may have happened in the same year as the jump in GDP, they are not necessarily directly related.  As with lots of things lately, capital allowances play a central role in this and it is to them that we will turn next.

Monday, June 18, 2018

Who shifts profits to Ireland?

Eurostat’s structural business statistics give a range of measures of the business economy broken down by the controlling country of the enterprises.  Here is the Gross Operating Surplus generated in Ireland in 2015 for the countries with figures reported by Eurostat.

Ireland Business Economy by Controlling Country - Profits 2

In total companies reported around €125 billion of Gross Operating Surplus in Ireland in 2015.  Of this 90 per cent arose in companies controlled from just two countries.  These were companies “controlled by the reporting country” (i.e. Ireland) and companies controlled from the United States.  Much smaller amounts of profits are reported for companies controlled from all other countries.

Although there are problems with it we can get some insight into the profitability of companies by comparing their gross operating surplus to their personnel costs.

Ireland Business Economy by Controlling Country - Profitability 2

Again, there is one stand-out figure – that for the United States.  There are other countries which do seem to have companies in Ireland with “excess” profits (Australia, Japan, Italy and Belgium) but as shown in the first chart the amounts in question are relatively small and some of the high rates are one-offs rather than showing up consistently in the data.

Do these charts show:

  1. Profits being shifted out of large market countries such as France and Germany, etc. or
  2. Profits being shifted out of their source in the United States?

And if it is #1 why is it only US companies that seem to be able to do it?  Why don’t French or German companies shift their profits to Ireland?  Of course, the answer is that the charts actually show #2 to be key issue but that seems unlikely to get a foothold in the debate anytime soon.

Wednesday, May 9, 2018

Why is the Irish “average wage” in the OECD Taxing Wages so low?

A few weeks ago the OECD published the 2018 update of their Taxing Wages publication.  There is plenty in the report worth chewing over but one minor issue that arises is the level of the “average wage” benchmark used for Ireland.

OECD Taxing Wages Average Wage Ireland 2000-2017

It doesn’t really appear to be anything too noteworthy.  It rises fairly rapidly up to 2008 (the figures are nominal so no account is taken of inflation), drops in 2009, has been edging upwards for the past three or four years or so, and is put at €36,800 for 2017.

But what about when we look at it in a comparative context?  OK, an international comparison  isn’t as straightforward as looking at a single country through time but we can overcome some issues if we look at countries that share a common currency. 

Here are the nominal average wages used for 2016 for a group of euro-area countries.

  • Netherlands €50,120
  • Germany €48,300
  • Belgium €46,528
  • Austria €45,073
  • Finland €43,716
  • France €37,906
  • Ireland €35,430

So, we still haven’t adjusted for prices but some of the gaps here are very large.  Is the nominal average wage in Ireland 27 per cent lower than Germany and 29 per cent lower than The Netherlands?

The OECD also has an Annual Wages publication which uses aggregate data from the national accounts to work out an average wage.  As the notes say:

Average annual wages per full-time equivalent dependent employee are obtained by dividing the national-accounts-based total wage bill by the average number of employees in the total economy, which is then multiplied by the ratio of average usual weekly hours per full-time employee to average usually weekly hours for all employees.

So what does this tell us?  Here are the 2016 averages from this dataset.

  • Ireland €51,336
  • Netherlands €46,709
  • Belgium €43,097
  • Austria €41,421
  • Finland €41,209
  • Germany €38,302
  • France €36,809

Of the selected group Ireland has gone from last to first with a 44 per cent rise in the estimated annual average wage as measured using the national accounts versus that used in Taxing Wages.  For most of the other countries the difference is only a few per cent – bar Germany where the national accounts show an average that is over 20 per cent lower.  Still by far the greatest absolute difference is for Ireland.

So,what explains it?  Perhaps it is coverage.  The national accounts cover the entire economy where the Taxes Wages figure is derived from NACE sectors B to N, i.e. the business economy which excludes state-dominated sectors such as education and health. But this coverage is the same for all countries.

The answer lies in the annex of the Taxing Wages report

Table A4 shows the method used to calculate the average wage.  One piece is the type of workers covered.  There are columns which show whether supervisory or managerial workers are included.  There are 36 countries covered in Taxing Wages and 34 of them include both of these types of workers, many of which we can assume would be in the top half of the earnings distribution. 

Which countries do not have them included when the average is calculated? Turkey and Ireland.

Part-time workers are another category that get varying treatment across countries.  Some countries leave them out altogether and only include full-time employees when working out the average.  Other countries include them but do so on a full-time equivalent basis such that their earnings are included but are scaled up as if they were a full-time employee.  There are six countries who include part-time employees in the calculation but do so on the basis of their actual annual earnings as part-time workers.

In their notes the OECD say:

The worker is assumed to be full-time employed during the entire year without breaks for sickness or unemployment.  However, several countries are unable to separate and exclude part-time workers form the earnings figures (see Table A.4). Most of them report full-time equivalent wages in these cases.  In four countries (Chile, Ireland, Slovak Republic and Turkey), the wages of part-time workers can neither be excluded nor converted into full-time workers (for example, an OECD Secretariat analysis of available Eurostat earnings data for selected European countries has show that include part-time workers reduces average earnings by around 10%).

So, the Irish figures used in Taxing Wages exclude supervisory and managerial staff, and include part-time workers on an unadjusted basis. 

What would the Irish figure be if it was estimated in line with the practice for most other countries?  Figures on that basis are available from Eurostat’s Structure of Earnings Survey though it is only available every four years.  The averages (with part-time employees given on a full-time equivalent basis) for sectors B to N are given as:

  • 2002: €33,320
  • 2006: €40,761
  • 2010 : €42,111
  • 2014: €44,700

This would put Ireland pretty much in the middle of the set of countries used above. 

Would it make a difference if the 2017 average wage used for Ireland was €45,000 rather than €36,400?  It probably would.

The OECD show that a single person on the average wage in Ireland has taxes and social insurance deductions of just under 20 per cent of their gross wage.  If this calculation was done using an average of €45,000 then the deductions would be 25 per cent of gross wage. 

This is part of an infographic the OECD used to promote the publication of Taxing Wages

OECD Taxing Wages Infographic

The OECD average is given as 25.5 per cent for 2017 and Ireland is included in the group of “low-tax” countries with tax rates for a single worker on the average wage of less than 20 per cent.  If an average wage was used that better reflected the actual outcomes in Ireland, in line with the methods used for other countries, then Ireland would be pretty much bang on the OECD average and would not be flagged (literally) on such infographics. 

Such a change would probably have limited impact on the estimated progressiveness of the Irish income tax system but it would change the range of values that are currently included in the analysis.  The OECD analysis extends up to earners on 167 per cent of the average wage.  This is around €60,000 with the average currently used but would be €75,000 if that was increased to the value proposed here.

If €45,000 was used for the Irish average wage (which the available data would support) then Ireland would not be down towards the bottom of charts like this.  This calculator puts the tax rate on a single person earning €45,000 in 2017 at 25 per cent.

OECD Taxing Wages Tax Rate on Average Wage

If a more realistic average wage was used, Ireland would pretty much be the same as the OECD average (and rise maybe ten places higher) in the above chart.  So why is such an unrepresentative average wage used for Ireland in this important report?

Why don’t the household sector accounts make sense?

Ireland’s national accounts have their foibles but they don’t seem to be limited to the corporate (MNCs) or financial (IFSC) sectors.  Their are some quirks in the household sector as well though maybe the heading above is a bit of an exaggeration.  The household accounts do make sense just maybe not in the way that we would expect.

The issue can be seen by looking at two outcomes:

  1. The flow of net lending or borrowing of the household sector.  This is essentially the outcome after all current and capital flows (income, expenditure, taxes and transfers) have been accounted for and gives a surplus available for use (net lending) or a deficit to be financed (net borrowing).
  2. The stock of loan liabilities of the household sector.  This is simply the sum of all loans (mortgages, car loans, short-term loans etc.) of the household sector taken at a point in time usually the year-end.

First the annual flow of net lending/net borrowing of the household sector:

Household Sector Net Lending

And the stock of loan liabilities:

Household Sector Loan Liabilities

OK, at first glance both of these are pretty much what would expect.  The household sector went deep into net borrowing by 2007 with loan liabilities rising steeply. The borrowing stopped abruptly in 2009 and the household sector became a net lender and this deleveraging is evident in the drop in the amount of loan liabilities from just north of €200 billion at the end of 2008 to around €140 billion at the of 2016.

So what’s the problem?

This issue is the difference between the amount of resources that the current and capital accounts tell us is available for net lending (such as repaying loans) and the drop in loan liabilities.  Here are the sum of the flows (net lending) versus the change in the stocks (loan liabilities) since 2008:

Household Sector Net Lending v Loan Liabilities

These don’t have to be the same but we would like to be able to explain the difference between them.  From 2009 to 2016 the loan liabilities of the household sector were reduced by around €60 billion.  Over the same period the household sector had cumulative net lending of around €15 billion.  The household sector has significantly reduced its loan liabilities but the resources to do so does not seem to have come from income.

And, as the first chart above shows, for the past few years we can see that the household sector has had a net lending outcome of close to zero (and even been a small net borrower) while at the same time continuing to reduce its stock of loan liabilities by around €8 billion a year. 

Where is the money coming from?

There are a number of ways the loan liabilities of the household sector can be reduced.  These include:

  • making repayments from income
  • selling assets (real or financial) to finance repayments
  • revaluations, write-offs or other stock adjustments.

Can these three factors explain the €60 billion reduction in loan liabilities that has occurred since 2008?  Even if all the available net lending generated from the first was devoted to repaying loans that would still leave €45 billion to be explained by the latter two.

We can get some insight into the contribution of revaluations and write-offs is we compare the flow of loan transactions (net drawdowns versus repayments) to the stock of liabilities.   Again we will take the end of 2008 as the starting point.

Household Sector Loan Transactions v Loan Liabilities

In the five years to the end of 2013 the €34 billion reduction in loan liabilities is closely matched by the minus €33 billion sum of loan transaction, i.e. the reduction was almost entirely achieved through repayments.  Since 2013 though, the reduction in the stock of household loan liabilities has exceeded the amount that can be attributed to loan transactions.  The gap reflects revaluations and write-offs with a €12 billion difference showing in the chart above by 2016.

But we still don’t know where the money came for the loan transactions shown above.  All told they are responsible for €47 billion of the €60 billion reduction in household loan liabilities since 2008.  If every cent of net lending the households generated from their income this could only provide €15 billion over the same period.  Where did the other €32 billion come from?

Maybe it came from deposits. This could be borrowers themselves using deposits. It would also show if an asset (such as a house) was sold with the seller using the proceeds to repay a loan while the purchaser funded all or a large part of the transaction with deposits.  For the household sector in aggregate give rise to a reduction in loans and a reduction in deposits. 

But household deposits have actually increased over the period, from €120 billion at the end of 2008 to €135 billion at the end of 2016.  Of course, this only adds to the mystery.  If, as we would expect, some of the household net lending went to increase deposits then even less would have been available for loan reductions so the gap to be explained is even larger than €32 billion.

How do the accounts explain the gap?

The financial accounts do make sense, i.e. add up, so we can see where it is implied the money came from. And this is the sale of assets – the second of the three possibilities listed above. shares.  What did the household sector sell? The answer apparently is unlisted shares, that is shares in private or family companies. 

However looking at the balance sheet doesn’t reveal that this is the place to look.  Here is the stock of unlisted shares held by the household sector.

Household Sector Unlisted Shares

There has been some reduction since 2009 but only in the order of a couple of a billion.  The stock position was €39.5 billion at the start of 2009 and had declined to €32.75 billion at the end of 2016.  It is not clear from this that the household sector has generated substantial resources from the sale of unlisted shares to fund the level of debt reduction we have seen.  But if we look at the transactions and revaluations behind these end-of-year positions this is what we see since 2009.

Household Sector Unlisted Shares Transactions Table

The stock position might have declined by only €7 billion or so between 2009 and 2016 but the cumulative impact of transactions was almost minus €53 billion, i.e. the household sector had net sales of unlisted shares of €53 billion!  The reason this had such a small impact on the stock position is that there were offsetting positive revaluations and other adjustments of plus €46 billion.  These are big numbers.

But wouldn’t we see some evidence of these transactions elsewhere. For example, selling tens of billions of assets would probably have some Capital Gains Tax implications but CGT receipts for the past few years have been in the order of hundreds of millions and, of course, reflect realised gains on a broad range of assets not just shares in private companies.  There is no evidence of tens of billions worth of transactions in unlisted shares. 

And it is interesting to note when they were added to the accounts.  This table shows the figures as published in different vintages of the Financial Accounts going back to 2012.

Household Sector Vintages of Unlisted Shares Transactions Table

In the 2013 release, the reported transactions for the years 2009 to 2012 summed to –€7.4 billion.  The latest estimates for those years sum to –€26.3 billion.  And it can be seen that the changes have been made in relatively neat amounts.  The 2009 figure has been revised by €5,000 million compared to what was in the accounts originally.  Similarly even figures can be seen for the other changes.

The absurdity of the reported Irish outcomes can be seen if we look at transactions in unlisted shares by the household sectors across the EU15.

EU15 Household Sector Unlisted Shares Transactions Table

No country comes close to having the scale of household sector transactions in unlisted shares to that of Ireland.  The median sum for the period 2009 to 2016 across the EU15 is +0.3 percentage points of GDP.  As can be see the outcome for Ireland is –26.6 percentage points of GDP (and that’s even with an inappropriately large denominator).

So Ireland’s household sector accounts do make sense. The net lending/borrowing shown in the Capital Account is a close match for the net financial transactions shown in the Financial Account. 

Household Sector Net Outcomes CSO 2002-2016

The discrepancy between net financial transactions (B.9F) and net lending/net borrowing (B.9)this is included by Eurostat (as variable B.9FX9) in their sector accounts.  But the relative consistency shown in the chart above, particularly since 2010, is only achieved through the inclusion of massive transactions in unlisted shares which do not make sense. 

As we went through before the CSO and Central Bank views of the financial transactions that are very different.  The Central Bank do not have have tens of billions of net sales transactions in unlisted shares.

So, where do we stand?

Here are the net lending/net borrowing outcomes for the household sectors of the EU15 in nominal per capita terms since 1995.

EU15 ISA Household Sector Net Lending Per Capita

There isn’t much of a surprise in seeing Ireland as the stand-out series up to 2006 and 2007.  But after getting back into the middle of the pack by 2009 we have dropped down through the ranks again in recent years.

And if we go back to the Current Account we can get the gross savings rate which is the share of gross disposable income (with an adjustment for pension funds) that is not used for consumption expenditure.

EU15 ISA Household Sector Gross Davings Rate

Just as with the outcome for net lending/net borrowing which comes after capital spending has been accounted for the gross savings rates show the recent outturns for Ireland to be “low”.

Is any of this important?

It is if trying to gauge the impact on the economy of future changes in the household sector is important.  A "deleveraging hypothesis" would suggest that the household sector has been repaying significant amounts of debt built up during the credit boom and that as these debts are repaid the household sector will have more resources available for consumption and investment as elevated savings to make debt repayments will no longer be required. 

This hypothesis is in line with the huge reduction in debt liabilities we have seen on the household sector's financial balance sheet since 2009.  However, the capital account shows that the household sector is already a net borrower and that there is limited scope to increase consumption and capital formation from existing resources.  This would suggest a stable path for the gross savings ratio over the next few years and forecasts of consumption growth in line with income growth would probably be appropriate. 

But what if household consumption expenditure and/or capital formation grows faster than household income? Should we be concerned particularly if the national accounts indicate that this could only be possible through increased borrowing? 

All this feeds through to expected changes in the current account of the Balance of Payments and informs one's view of whether the level of economic activity is sustainable or not. If activity is dependent on being financed by deficits that activity requires the lending and/or borrowing behavior to continue which, history tells us, is something that can change very quickly.

If the increased activity is being funded through a reduction in gross savings, net lending and/or current account surpluses then reasons for concern should be limited but if it is being funded by increased borrowing and/or current account deficits then at a minimum it should at least trigger an amber warning which may lead to concern being warranted. 

We don't have visible sight of the underlying current account (because of an issue with R&D services imports) and until we do the household gross savings rate and the outcome for net lending/net borrowing take up increased significance.  These would suggest that the financial capacity of the household sector is “tight” and that any rapid expansion should be a cause for concern.

So what to do?

Taking the gross saving rate and net borrowing numbers at face value offers some support for an “overheating hypothesis” and whatever policy prescriptions would follow from that diagnosis.  As the net lending/borrowing chart (the first chart above) shows it is a long way from the dizzying days of 2004 to 2007 but the Irish economy is one in which conditions can change rapidly.  Housing can be a driver of such swings.

But should we take the numbers at face value?  We think there is an underlying current account surplus in the Balance of Payments and that this possibly increased in 2017.   We know that the underlying net international investment position of the economy has been rapidly improving.  We know that the financial position of the household sector has improved and that debt reduction has made a significant contribution to that.  These sit counter to an “overheating hypothesis”.

So maybe just have contradictory signals and none can be taken as evidence of anything. But shouldn’t the pieces of the jigsaw fit together? Shouldn’t we have a coherent story?  In this instance the contradictory signals are in the current, capital and financial accounts of the household sector.

Putting together the national accounts requires a certain amount of estimation and interpolation. Hard evidence will only get you so far and jumps that join the dots are sometimes required.  But putting in tens of billions of sales transactions does not seem credible.

When ranking the hard evidence used for the household sector it is likely that the financial balance sheet would be towards the top of the reliability stakes.  Getting a handle on the loan and deposit positions of the household sector is possible using data from a fairly small number of financial institutions and while there might be some uncertainty around the levels, the direction and magnitude of changes should have greater confidence associated with them. 

These changes point to a €60 billion reduction in household loan liabilities since 2009 and a €15 billion increase in household deposits over the same period.  These figures might be wrong but to be out by tens of billions seems unlikely.

If these balance-sheet changes are considered reliable shouldn’t the rest of the accounts be consistent with them – and in a manner that makes more sense than using absurd transactions in unlisted shares?  It is possible the inconsistency is due to unreported income, in the informal or black economy, not showing up in the current account but one would imagine there is plenty of consumption spending that is not picked up either.

If the accounts are to be more consistent it would require income to be higher, spending to the lower, or some combination of the two.  However it was achieved, the outcome would be a higher gross savings rate and an outcome for net lending more in line with the observed deleveraging.

Of course we actually had that this time last year but such coherence was revised away. Can we have it back please?