A previous post looked at how the current account of the balance of payments can be an early-warning indicator of an economy “living beyond its means”. This is particularly so if the unsustainable income arises via credit expansion. The post concluded, though, by saying that a red flag might not always go up for the balance of payments if the unsustainable income flows through it.
Getting a handle on Ireland’s underlying balance of payments position isn’t straightforward. The CSO have published a modified current account that attempts to strip out many of the distortions, mainly from MNCs, that pollute the headline position.
For our purposes here we are interested in the end result rather than the modifications made. The most recent version of the modified current account is available for the period 2007 to 2017 and here it is as a proportion of GNI*.
As we now now know there was a significant deterioration in the current account up to 2008. Since then, like many economic indicators for Ireland, there has been a significant turnaround.
In the early years of the crisis one factor that contributed to the improvement in the current account was the reduction in imports. We were spending a large amount of the unsustainable, credit-fueled income on imported goods. There was a reason champagne was removed from the Consumer Price Index in 2011 (see Table 1.1).
In recent years, food exports have boosted the underlying position, most notably dairy products for the past two years or so. On the income side, the amount of outbound interest on the government’s debt has been declining.
There is some level of uncertainty about all of these but concerns over volatility do not necessarily translate into concerns of sustainability. One item affecting the current account that generate such concerns are Ireland’s surging Corporation Tax revenues.
And this is what we see if we put Ireland’s revenues in the context of the EU15.
It wouldn’t be usual to link tax revenues to the current account. In general, tax revenues are raised from activities and entities in the domestic economy while the current account reflects the cross-border flow of trade, income and transfers. But Ireland is unusual for the amount of Corporation Tax that comes from foreign-owned companies and unique for the amount that comes from foreign companies which are US-owned companies.
The following table gives the domestic company/foreign company split for the gross operating surplus generated in the business economies of the EU15. Gross operating surplus (GOS) is a relatively useful proxy of the corporate income tax base but some caution is warranted because it is before the deduction of depreciation. For this, and a few other reasons, we will use data from 2014 rather than a more recent year.
The foreign share in GOS is highest in Ireland (69.4 per cent). Luxembourg is the only other country to have more than half of GOS generated by foreign-controlled companies. The median for the EU15 is 24 per cent.
And it is for US companies that Ireland really stands out. After Ireland’s highest share at 56.8 per cent, next is again Luxembourg but this time the gap is all the way to 14.7 per cent. The median for the share of GOS generated by US-owned companies in the EU15 is 3.6 per cent. It was only in the sentence before last but Ireland is 56.8 per cent (or at least was in 2014; it is likely higher now).
The issue is that the surge in Corporation Tax is coming through the current account. The current account looks fine. The deficits built up in the previous boom have been eliminated and there have been underlying surpluses for the past few years. This suggests we could increase our consumption and investment spending from within our existing resources.
However, we need to be mindful of the impact Corporation Tax from US MNCs has on how we measure those existing resources using the current account. These receipts are somewhat of a transfer to Ireland that are boosting the current account – could we compare them to the EU receipts of the late 1980s and early 1990s?
Of course, we don’t know what will happen Corporation Tax revenues over the coming years and it is much better to be receiving €10 billion of Corporation Tax than not receiving it. Our point here is that looking for the current account to provide a red flag for “living beyond our means” - as the previous post did – may not be wholly appropriate. The current account will only reflect any unsustainability in these Corporation Tax receipts when it is too late, i.e. when they are gone.
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