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Friday, August 12, 2011

Ireland's Recent Success Not Built on Low Taxes

As we survey the wreckage of the Irish economy (14.3% unemployment rate in July, average July interest rate of 12.45% vs. Germany's 2.74%), it's worth remembering that not so long ago, Ireland was lauded as a miracle economy we could all learn lessons from. But many people have drawn the wrong lessons from Ireland's success in the 1990s and early 2000s, in particular by claiming that low taxes were a major cause of Ireland's dramatic growth.

One important example of this comes from Sean Dorgan, who was head of Ireland's Industrial Development Authority, now known as IDA Ireland, until 2007. He wrote a “backgrounder” for the Heritage Foundation in June 2006, in which he emphasized free trade, low taxes, and investment in education as the keys to “le(aving) behind” Ireland's “past of declining population, poor living standards, and economic stagnation...”

OK, so the US is currently doing everything possible to reduce investment in education, especially by going after teachers' unions and cutting K-12 and university spending. It doesn't measure up against what was publishable at Heritage just 5 years ago. (And heaven forbid we should adopt Heritage recommendations from the 1980s, like the individual mandate!). At least we've got free trade and low taxes. But what did they do for Ireland?

As I show in my book, Investment Incentives and the Global Competition for Capital, the answer for the first 30 years of low-tax foreign investment attraction (1958-87) was “Not much.” Ireland grew modestly, but it did not grow any faster than the average of the first 15 European Union members (the EU-15). Ireland started out with a 0% tax on foreign multinationals export profits, which of course was virtually all their profits. After Ireland joined the European Union in 1973, it had to get rid of that export subsidy, but replaced it with a mere 10% tax on manufacturing starting in 1983. Yet by 1987, unemployment was 16.8% even though about 27,000 people, almost 1% of the population, were leaving annually (net emigration).

Things started changing in 1987. In that year, Ireland inaugurated a “Social Partnership” of government, capital, and labor, which cut the budget sharply, but also traded lower personal income taxes for wage restraint, leading to after-tax wage gains that were larger than the pre-tax gains. In 1988, the European Union sharply increased the money going into the Structural Funds, which paid for infrastructure, training, and investment attraction. Ireland's allocation equaled 2.5-3.0% of its gross domestic product throughout the 1990s. Several officials I interviewed in March 2009 argued that the EU's “Single Market” program (1985-92) helped the country substantially by giving it better access to the continental European market by reducing other countries' use of subsidies and restrictive government procurement rules.

Then, of course, there was education. Ireland made high school free in 1966; later, the country built several new technological universities. Finally, many observers see Ireland as having gotten lucky by achieving the preconditions for growth just as the world economy began a growth and foreign investment boom in the 1990s.

In the 50+ years Ireland has spent using low corporate income taxes (and high investment subsidies) to attract investment, the country has seen both failure and success. In fact, corporations faced a higher tax rate in the Celtic Tiger years than during the slow-growth era (10% vs. 0). For the very reason that both success and failure accompanied the low tax rates, we can conclude that tax rates cannot explain success: we need something that was present during the boom years but not the slow-growth years. Education, infrastructure, training, and the Social Partnership are the most plausible explanations.

The right lesson to draw in the U.S., then, is that we need to resist the drumbeat for lower corporate income taxes, which in 2008 (the latest year for complete OECD data) came to 1.8% of U.S. GDP versus an OECD average of 3.5% (in most recent years, the difference is smaller, but the U.S. is consistently below average). Similarly, rather than reward corporate tax scofflaws for hiding their money in tax havens with a “one-time” low rate on repatriated profits, we should move away decisively from tax deferral for overseas profits.

I'll have more to say about tax havens in future columns.

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