Ireland's Tax Dilemma
The biggest news story in financial markets this week has been Ireland deciding that they will accept a bailout package from the European Union and other international organizations. Global markets have been affected by the debt problems in Ireland over the last couple of weeks, and news that they will accept a bailout has recently given stock markets, and the euro, a bit of a boost.
Ireland currently has a very low corporate tax rate (just 12.5%), and this is much lower than its European counterparts. Its low tax rate was implemented in order to encourage business to invest in Ireland, and for the most part it has contributed to Ireland's growth in the last decade. Its current crisis is largely due to problems in the property market and the banking sector.
As part of the negotiations for the bailout package, France and Germany are insisting that Ireland raise its corporate tax rate, more in line with levels seen across Europe. According to them, it is a necessary step to raise revenue and cut the deficit. After all, they want to be assured that Ireland will take steps to cut its deficit so that it can eventually repay any loans from the bailout package. Ireland on the other hand is confident it can cut its deficit through other measures.
But why are they insisting on this corporate tax rate? Surely Ireland should be allowed to cut the deficit as they wish to - as long as they can assure the Europeans that the deficit will be cut and the loans repaid. The answer to this goes back to why Ireland had a low corporate tax rate in the first place.
They lowered their corporate tax rate to attract business to setup their offices in Ireland. As you would expect, this was to the detriment of other European countries that lost businesses to them. By insisting that Ireland increase its corporate tax rate in exchange for a bailout, France and Germany are implicitly trying to improve their own economic competitiveness by reducing the competitiveness of Ireland.
As a result, a bailout with conditions like these is not in the best interest of Ireland. Of course, given that France and Germany are funding most of the bailout, it is entirely fair that they can request things like this.
It is difficult to predict which way this will play out. Ireland has repeatedly insisted that this is not something they are willing to budge on. But then again, only a couple of weeks ago they were insisting that no bailout was necessary and look where we are today. I do think that the bailout is still very likely to go ahead, whether or not this tax issue is solved.
One thing that certainly should be said about Ireland's situation is that the whole
debt problem has so far been much better handled than the situation with Greece a few months ago. The European authorities have recognized early on that this needs to be solved before financial markets end up in free-fall.
Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!
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