Category Archives: Irish property bubble

6/10/17: CA&G on Ireland’s Tax, Banking Costs & Recovery

Occasionally, the Irish Comptroller and Auditor General (C&AG) office produces some remarkable, in their honesty, and the extent of their disclosures, reports. Last month gave us one of those moment.

There are three key findings by CA&G worth highlighting.

The first one relates to corporate taxation, and the second one to the net cost of banking crisis resolution. The third one comes on foot of tax optimisation-led economy that Ireland has developed since the 1990s, most recently dubbed the Leprechaun Economics by Paul Krugman that resulted in a dramatic increase in Irish contributions to the EU budget (computed as a share of GDP) just as the Irish authorities were forced to admit that MNCs’ chicanery, not real economic activity, accounted for 1/3 of the Irish economy. All three are linked:

  • Irish banking crisis was enabled by the combination of a property bubble that was co-founded by tax optimisation running rampant across Irish economic development model since the 1990s; and by loose money / capital flows within the EU, which was part and parcel of our membership in the euro area. The same membership supported our FDI-focused competitive advantage.
  • Irish recovery from the banking crisis was largely down to non-domestic factors, aka - tax optimisation-driven FDI and foreign companies activities, plus the loose money / capital flows within the EU enabled by the ECB.
  • In a way, as Ireland paid a hefty price for European imbalances and own tax-driven economic development model in 2007-2012, so it is paying a price today for the same imbalances and the same development model-led recovery.

Let’s take the CA&G report through a summary and some comments.

1) Framing CA&G analysis, we had a recent study by World Bank and PwC that estimated Ireland’s effective rate of corporation tax at 12.4%, just 0.1 per cent below the statutory or headline rate of 12.5%. To put this into perspective, if 12.4% effective rate holds, Ireland is not the lowest tax jurisdiction in the OECD, as 12 OECD economies had an effective rate below 12.4% and 21 had an effective rate of corporation tax above 12.4%. For the record, based on 2015 data, France had the 2nd-highest statutory rate at 38% but the lowest effective rate at just 0.4%. I contrast, the U.S. had the highest statutory tax rate at 39% and the second highest effective rate at 28.1%. There is a lot of fog around Irish effective corporate tax rates, but CA&G The C&AG found that the top 100 in taxable income terms companies had a an average effective corporation tax rate at 9.3%, slightly less than the rate applying to all companies (9.8%).

The CA&G findings show some dramatic variation in the effective tax rates paid by the Ireland-based corporations. CA&G report is based on a set of top 100 companies trading from Ireland. Of these, 79 companies paid an effective corporate tax rate of 10-15 percent, and almost 2/3rds paid a rate of 12% and higher. However, 13 companies faced a tax rate of under 1 percent.

Irish corporate tax system is risk-loaded: per CA&G report, 37% of all corporate tax receipts collected by the Irish Exchequer come from just 10 companies, while top 100 firms supply 70% of total corporate tax receipts. This concentration is coincident with rising reliance of the Exchequer on corporate tax collections, as corporation tax contributions to the State rose 49% in 2015 to reach EUR6.9 billion. The Leprechaun Economics that triggered a massive transfer of foreign assets into Ireland in 2015-2016 has pushed corporate tax receipts to account for 15% of the total tax revenues. Worse, 70% of total corporate tax take in Ireland came from only three sectors: finance, manufacturing and ICT. Manufacturing, of course, includes pharma sector and biopharma, while ICT is dominated by services, like Google, Facebook, Airbnb et al. This reliance on corporate tax revenues is the 6th highest in the OECD, based on 2015 figures. Per CA&G report, “Corporation tax receipts are highly concentrated both in terms of sectors and by number of taxpayers”. In other words, the Leprechaun Economics model is wrought with risks of a sudden stop in Exchequer revenues, should global flows of funds and assets into Ireland reverse (e.g. due to EU disruption, such as policy shift or Brexit/geopolitical triggers, or due to the U.S.-led shock, such as radical changes in the U.S. corporate tax regime).

The above is worrying. Leprechaun Economics model - or as I suggested years ago, the Curse of Tax Optimisation model - for economic development, chosen by Ireland is not sustainable and it is open to severe risks of exogenous shocks. Such shocks can be sudden and deep. And were risks to the MNCs domiciling into Ireland to materialise, the Exchequer can see double digit deficits virtually over night.

2) CA&G report also attempts to compute the net expected cost of the banking crisis to the country. Per report, the expected cost of rescuing the banks stands at around EUR 40 billion as of the end of 2016, while on the long run timing, the cost is expected to be EUR56.4 billion. However, accounting for State assets (banks’ shares), Nama ‘surpluses’ and other receipts, the long term net cost falls just below EUR40 billion. At the end of 2016, per CA&G, the value of the State's share in AIB was EUR11.6bn, which was prior to the 29% stake sale in an IPO of the bank. As history tells us, EUR66.8 billion was used to recapitalise the Irish banks with another EUR14.8 billion paid out in debt servicing costs. The debt servicing bill currently runs at around EUR1 billion on average, and that is likely to rise dramatically once the ECB starts unwinding its QE which effectively subsidises Irish Exchequer.

CA&G report accounted for debt servicing costs in its calculation of the total expected cost of banks bailouts, but it failed to account for the fact that these debt costs are perpetual. Ireland does not retire debt when it retires bonds, but predominantly uses new borrowings to roll over debt. hence, debts incurred from banks recapitalisations are perpetual. CA&G report also fails to a account for the opportunity cost of NPRF funds that were used to refinance Irish banks. NPRF funds generated tangible long term returns that were foregone in the bailout. Any economic - as opposed to accounting - analysis of the true costs of Irish banks bailouts must account for opportunity costs and for perpetual debt finance costs.

As a reminder, the State still owns remaining investments in AIB (71% shareholding), Bank of Ireland (14%) and Permanent TSB (75%) which CA&G estimated to be worth EUR13.6 billion. One way this might go is up: if recovery is sustained into the next 3-5 years, the state shares will see appreciation in value. The other way it might turn a decline: these are sizeable shareholdings and disposing off them in the markets will trigger hefty discounts on market share prices. CA&G expects Nama to generate a surplus of EUR3 billion. This is uncertain, to put it mildly, because Nama might not window any time soon, but morph instead into something else, e.g. ’social housing developer’ or into a general “development finance’ vehicle - watch their jostling for a role in ‘resolving’ the housing crisis. If it does, the surplus will be forced, most likely, into some sort of a development finance structure and, although recorded on paper, will be used to pay continued Nama wages and costs.

In simple terms, the CA&G figure is an accounting underestimate of the true net cost of the bailouts and it is also a gross economic underestimate of the same.

3) As noted above, the third aspect of the CA&G report worth mentioning is the rapid acceleration in Ireland’s overpayment to the EU on foot of the rapid superficial GDP expansion of 2015-2016 period. According to CA&G, Ireland’s contributions to the EU rose to EUR2 billion - up 20% y/y - in 2016. This increase was largely driven by the fake growth in GDP that arises from the multinational companies shifting assets into Ireland for tax purposes. CA&G expects this figure to rise to EUR2.4 billion in 2017.

In simple terms, Ireland is overpaying for the EU membership to the tune of EUR1 billion - an overpayment necessitated by the MNCs-induced superficial expansion of the national accounts. This activity has zero impact on the ground, but it induces a real cost on Irish society. Of course, one can as easily make an argument that our beggar-thy-neighbour tax policies are conditional on us being within the EU, so we are paying extra for the privilege of housing all corporate tax optimisers in Ireland.

All in, the CA&G report is a solid attempt at making sense of the Kafkaesque economics of the Irish State. That it deserves some critical comments should not subtract from its value and the quality of effort.

25/3/15: Irish Residential Property Prices Fell Marginally in February

The residential property price index from CSO covering Irish property markets has posted second monthly contraction in February, falling from 80.3 in January to 80.0 last month. With that, y/y on growth rate in Irish residential property prices has slowed from 15.54% in January to 14.94% in February, the first sub-15% reading since September 2014. In effect, property prices in Ireland have now fallen back to the levels between September and October 2014. Cumulated gains in property prices over the last 24 months are now totalling 24.22% or an annualised gain of 11.46%, outpacing growth in the economy by roughly 5-fold.

Based on Nama valuations formula, residential property prices are now somewhere 18.5% below Nama business model expectations.

Prices of all residential properties excluding Dublin  remained static in February at 74.8, same as in January and up 8.25% y/y, marking a slowdown in the y/y growth from 9.20% recorded in January.

The decline in national prices was driven by Dublin prices, which fell for the second month in a row from 82.2 in January to 81.6 in February. This is the lowest index reading since September 2014 and marks a slowdown in y/y growth rates to 21.43% - the slowest rate of growth since April 2014. Still, cumulated expansion in Dublin residential property prices over the last 24 months is blistering 37.6% (annualised rate of 17.3%).

Within Dublin segment:

  • Houses were the driver to the downside in overall property prices, with houses price index for Dublin standing at 86.0 in February 2015, down from 86.9 in January 2015 and back to the levels of September 2014. Y/y rate of growth in Dublin house prices fell from 21.7% in January to 21.1% in February, although over the last 24 months hose prices in Dublin are still up cumulatively 37.6% (+17.3% annualised). 
  • Apartments prices in Dublin rose in index terms to 72.2 in February from 70.8 in January, erasing the declines that took place during Q3-Q4 2014. Cumulated gains in Dublin apartments prices over the last 24 months stand at 37.5% (+17.3% annualised) and y/y prices are up 24.5% - the fastest growth rate in 3 months.
Few charts to illustrate the above trends:

 Lastly, summary of price changes on pre-crisis peak and y/y:

Despite all the talk about the new bubble in house prices in Ireland, three themes remain true:
  1. Property prices are still far below fundamentals-justified levels. In Dublin, undershooting of long-run (inflation-linked) prices is around 26-27%.
  2. Property price increases are worryingly high, especially in the Dublin segment, warranting some ongoing concern; and
  3. Moderation in property prices and downward correction over the last two months, driven by Dublin (but likely to translate into similar outside Dublin with a lag), predicted on this blog before, is a welcome change. However, I suspect we will see renewed increases in property prices later this year, albeit at rates more sustainable in the longer run.