May 15, 2001

It’s Not the Luck of the Irish — It’s Their Low Corporate Taxes

Treasury Secretary Paul O’Neill raised quite a few eyebrows in a May 21 interview with the Financial Times, by suggesting that it is time to abolish the U.S. corporate income tax. At a minimum, he argued, simplifying the tax code would improve U.S. global competitiveness. “It would certainly make us more formidable if we had a simplification of this sort.”

O’Neill’s comments signaled that the administration was not waiting for the ink to dry on the recently passed $1.35 trillion tax bill before it began work on phase two of its long-term tax agenda. Speaking at a Cato Institute forum on June 26, Glen Hubbard, chairman of the president’s Council of Economic Advisors, told the audience that the “stars are in alignment in terms of the president’s commitment to tax reform. … It’s not just academic head-scratching.”

Hubbard said that administration officials were looking at a broad range of tax reform ideas, including lowering corporate and capital gains rates and repeal or reform of the Alternative Minimum Tax.

While the administration is casting about for ideas, they may want to look at the economic miracle taking place in Ireland. I’ve just returned from Ireland, a country some are now calling the Celtic Tiger. Dublin was the first stop in this year’s European Tax Conference, which then went on to Brussels and Rome.

This was the tenth year in which the Tax Foundation has hosted a delegation of senior congressional tax staff – including representatives from the Joint Tax, House Ways and Means, and Senate Finance Committees– to view first hand the tax challenges facing U.S. multinational corporations. Over the past decade, the Tax Foundation has given more than 100 congressional staff the opportunity to get an in-depth perspective on a broad array of international tax and trade policy issues.

In Dublin, we were treated to a tour of Intel’s chip manufacturing plant by Bob Perlman, the retiring Vice President for Tax, Licensing and Customs. Intel was among the first U.S. firms to see the advantage of investing in Ireland.

We were then given an impressive day-long presentation by officials from the Industrial Development Agency (IDA) on how the country’s low corporate tax structure has stimulated new foreign investment – especially in knowledge-intensive industries – and strong economic growth. According to IDA figures, Ireland’s GNP grew 62 percent in real terms between 1993 and 1999, while unemployment fell from more than 14 percent to just 5.5 percent during the same period.

Foreign investment and exports are the engines driving this strong performance. For example, since 1994, fixed investment has grown by an average of 14 percent per year. Indeed, while Ireland accounts for just 1 percent of the European Union’s total GDP, it accounts for 6 percent of the inward foreign direct investment flows. Even more impressive, exports have grown by an average of 16.4 percent per year since 1994, with U.S. firms accounting for 70 percent of Irish industrial exports.

According to IDA economists, U.S. firms are not wage shopping in Ireland. In fact, they are hiring high-skill, high-wage workers. What is drawing U.S. firms to Ireland is the country’s 10 percent tax rate for manufacturing.

This rate drew fire from the European Union which claimed that Ireland’s low tax rate “unfairly” competed with the higher tax rates in other EU nations. They also attacked the 10 percent rate as “ringfencing” – taxing foreign taxpayers at a lower rate than domestic taxpayers – a practice that the EU and OECD have tried to eliminate with their Harmful Tax Competition projects.

Ireland did respond to the criticism, but rather than “harmonize” its rates upward to match those high-tax countries, it decided to replace the multi-tiered tax system with a uniform 12.5 percent corporate tax rate for all sectors beginning in 2003. While many EU countries are, no doubt, unhappy with Ireland’s “race to the bottom,” others are already moving to lower their corporate rates to stay competitive.

For example, Great Britain (like Japan) has a top corporate rate of 30 percent. Meanwhile, Australia is lowering its rate from 34 percent to 30 percent, and Germany is lowering its split rate tax (30 percent on distributed profits and 40 percent on retained earnings) to a uniform rate of 25 percent.

To be sure, a country’s effective rate may differ markedly from its statutory rate. Still, a strong case could be made that with a top corporate rate of 35 percent, the U.S. is falling behind in the global tax competition race.

During the 1980s, the U.S. set an example by dramatically lowering individual tax rates and broadening the tax base. That became the international trend as nations all over the world followed suit. Since Ireland has already started the trend on the corporate side, the unanswered question is whether Secretary O’Neill can get the U.S. to follow.

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