European Pressure to Increase the Irish Corporate Tax Is Deeply Misguided
The ironies and contradictions surrounding the demand by some European governments that Ireland raise the corporate tax rate as part of a program to address its present financial predicament are breathtaking. They threaten the political underpinnings of the euro area, but also highlight a constructive role for the IMF. Let us count the ironies.
First, Ireland encountered the financial crisis relatively early and came relatively clean. Rather than falsify its statistics and hide the problem, it acknowledged the magnitude of the crisis in its banking system and secured acknowledgement in return from the international community. This is one reason why the attention of officials and the markets had shifted away from Ireland until recently.
Second, regardless of how we might feel about the need for a debt-restructuring mechanism as part of the future architecture of the euro area, the recent proposal of the German government in this respect was responsible in significant measure for destabilizing European bond markets, aggravating Ireland's challenge.
Third, Ireland is being asked to accept a program not because its government needs financing now but primarily because other governments in Europe fear the contagion effects. The increase in the risk premium on Irish financial assets complicates the restructuring of the big Irish banks and these banks face liquidity problems, resulting in overreliance on the European Central Bank. These considerations bring the Irish government to the bargaining table, despite strong domestic opposition. But Ireland engages in these discussions also out of recognition that such matters are of common concern and require cooperation with the euro area partners.
Fourth, tax matters have not been devolved to the European Union; they fundamentally remain the province of member states. There are many governments in Europe that object to the tilt in the tax playing field—which certainly does favor low-tax jurisdictions such as Ireland—and hope to harmonize rates across the membership. But member states have not agreed to a common discipline on corporate taxes and Ireland ratified the Lisbon Treaty on the understanding that its relatively low rate—a key feature of its economic success over the last three decades and a matter of considerable domestic political sensitivity—would not be constrained. To compound the irony, the OECD reports (Key Tables: Taxes on Corporate Income, 2009; figures are for 2008) that Ireland collects substantially more corporate tax revenue as a percentage of GDP (2.7 percent) than Germany (1.9 percent) and about the same as France (2.9).
Fifth, raising Ireland's corporate tax rate would not address the problems of the Irish banking system directly. The Irish government needs to demonstrate that it can stabilize and recapitalize the banking system while consolidating its fiscal position over time. But there are many sources of revenue beyond the corporate tax rate that can address this problem without the same damage to competitiveness.
Sixth, the French and German governments' attempt to secure an increase in the Irish corporate tax rate as part of the financial package (Financial Times, November 19, 2010, p. 1) appears opportunistic in the extreme. The IMF learned during the 1990s that structural conditions in its financial packages for Asian countries backfired politically and were far less important financially than macroeconomic conditionality. It has since pared back such conditions greatly. But European governments wish to reinsert structural conditions into such rescue packages.
Seventh, this is the sort of divisive conditionality that can do real political damage to the Economic and Monetary Union and the European Union more broadly. Having ratified the Lisbon Treaty on a second vote owing in part to promises in the tax area, the Irish electorate would rightly object to concessions in this area that are not strictly necessary to address the financial problems it is confronting. Yet the German government is also advancing a set of reforms to economic governance that would require changes to the treaties. Who would be surprised if Ireland objects to the next set of reforms? We should not, but apparently some officials in the German government would.
Fortunately, Ireland's financial package is being negotiated not only with the European authorities and member governments but also the International Monetary Fund. The European Union and IMF must work together on this rescue and the IMF staff and Executive Board can be a voice of reason on the Irish tax matter. It was precisely to avoid the interference of non-Europeans in resolution of debt and financial problems within the euro area that some European governments originally opposed the involvement of the IMF in the program for Greece earlier this year. But through the involvement of the IMF, the rest of the world can help save Europe's monetary union from the governments of some of its member states.
C. Randall Henning is professor of international economic relations at the School of International Service at American University and a visiting fellow at the Peterson Institute for International Economics. He acknowledges Nicolas Véron, Ted Truman, and Jacob Kirkegaard for helpful comments.