Oireachtas Joint and Select Committees
Tuesday, 4 October 2016
Committee on Budgetary Oversight
Forecasts for Budget 2017: Department of Finance
Before we begin the meeting with officials from the Department of Finance, I remind members to turn off their mobile telephones as the interference caused by them affects the sound quality and transmission of proceedings. Apologies have been received from Deputy Pearse Doherty who is being substituted for by Deputy Peadar Tóibín. Apologies have been received also from Deputies Seán Barrett and Calleary.
I wish to inform members that a work programme will be circulated in the coming days and members are invited to make observations to the secretariat in advance of a draft work programme being produced. We have written to the Ceann Comhairle on foot of Deputy Donnelly's request last week. We have already indicated that the area of corporation tax is likely to be the first issue on our work programme, but members may have issues and other items for inclusion on it. Should Deputy Donnelly's letter of request to the Ceann Comhairle in respect of the finance Bill result in this committee receiving ownership of it, then the finance Bill will be the first big chunk of our work programme. It is imperative that a decision is made soon on that matter.
The committee report highlighted some areas that the committee will examine further, such as the CSO and the Central Bank consultative group. Deputy Eamon Ryan mentioned it at the time of the discussion on GDP and Brexit. We wrote to the Ceann Comhairle requesting that he consider the transfer of the finance Bill to the committee.
Do members wish to make observations before our meeting with the officials from the Department of Finance?
Does Deputy Burton wish to comment?
It is whether the finance committee or this committee will deal with Committee Stage of the finance Bill. That decision has not yet been made by the Business Committee but we need that decision to be made soon. Before they leave this week, I would encourage members to forward their observation on the work programme to the secretariat as soon as possible and we can then discuss them. As there are no other members offering, we will call the witnesses.
I welcome from the Department of Finance Mr. John McCarthy, who is accompanied by colleagues from the macroeconomic forecasting team, including Mr. Feargal Ó Brolcháin, Ms Laura Weymes, Dr. Javier Papa and Mr. Ian Power. They will be dealing with the short-term economic outlook in advance of the budget. Today's meeting will consist of an opening statement from Mr. McCarthy followed by a PowerPoint presentation. Members will then have an opportunity to engage in questioning the witnesses.
I draw witnesses' attention to the fact they are protected by absolute privilege in respect of their evidence to the committee. However, if they are directed to cease giving evidence on a particular matter and continue to so do, they are entitled thereafter only to qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person or an entity by name or in such a way as to make him or her or it identifiable. Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person either inside or outside the Houses or an official either by name or in such a way as to make him or her identifiable.
I invite Mr. McCarthy to make his opening statement.
Mr. John McCarthy:
I thank the Chairman for the opportunity to present the short-term economic outlook in advance of the 2017 Budget Statement. As the Chairman mentioned, I am accompanied by my colleagues, Mr. Feargal Ó Brolcháin, Ms Laura Weymes, Dr. Javier Papa and Mr. Ian Power from the macroeconomic forecasting team in the Department.
By way of background, since 2013, reforms to economic governance mean that budgetary policies for euro area member states must be based on macroeconomic forecasts that are either independently produced or are endorsed by an independent body. This is contained in the so-called two-pack. In Ireland, as in the majority of euro area member states, we have gone down the endorsement route with the endorsement function assigned to the Irish Fiscal Advisory Council. The endorsement process has been under way since mid-September. We have a memorandum of understanding between the Department and the council and on that basis, we will present our assessment of the short-term outlook to the council this afternoon.
For the budget, the council has a role in assessing the short-term projections, namely, those for this year and for next year.
We have provided for the committee the exact same presentation that will be provided for the council, although I do not propose to go through every slide, unless members are willing to do so. We will publish the information on the Department's website this evening. The economic projections we are presenting are based on the assumption that there will be a budgetary package amounting to €1 billion for 2017, to be split two to one between expenditure increases and taxation reductions, as set out in the Government's summer economic statement which was published in June.
This is our third or fourth time to appear in front of an Oireachtas committee. As is the norm, we will comment purely on the technical aspects of the forecasts. We will not discuss policy issues, or the fiscal situation. We will not discuss either of these issues with the council either.
In high-level terms we are projecting GDP growth of 4.2% this year and 3.5% next year. We have reduced the forecast for next year by around half a percentage point to take into account the uncertainty associated with Brexit. These are contingent forecasts. They are contingent on continued growth in external markets, particularly key external markets, namely, the United Kingdom, the United States and the euro area. In this context, it is fair to say the current outlook is characterised by considerable uncertainty, with the impact of Brexit still unfolding. However, there are other issues, including a prolongation of relatively subdued growth in many advanced economies. This has led some to question whether the world economy has entered a permanently lower growth phase, or so-called "secular stagnation".
In overall terms, it is our assessment that the balance of risk to our central scenario is tilted firmly towards the downside. An important issue I shall highlight is that there are, as members are aware, problems in setting trends in the economy at the current juncture, given that the information content in key aggregates such as GDP and GNP is much more limited than elsewhere. This is most evident in the exceptionally high growth figure published in July, 26%, with which members will be familiar. Clearly, this figure is misaligned with actual developments in terms of employment, per capitaincome developments and so forth.
More generally, the highly globalised nature of the economy and the concentration of economic activity mean that confidence bands around any short-term forecast will necessarily be wide. Therefore, it is fair to say in these circumstances that it is necessary to look beyond simple aggregates such as GDP and GNP in order to gauge properly what is happening in the economy. By this I mean the consideration of employment and consumption levels and so forth.
Turning to the actual presentation, Mr. Power will outline the latest domestic developments. Ms Weymes will discuss the labour market, while Dr. Javier Papa will discuss price dynamics. I will then summarise the key trends and what they mean for the short-term economic outlook.
On the external circumstances, the slide shows some of the key variables that have an input. Members will be familiar with the decline in inflation in recent times. This is partly attributable to the very sharp decline in oil prices. Two years ago the average price of oil was approximately $100 per barrel. This year it will be about $44 or $45 per barrel. This is having a big impact in supporting disposable income but in also reducing inflation.
A significant issue to which I wish to point for the committee is evident in the green bar which shows the year-on-year change in the euro–sterling exchange rate. One can see that there has been a very sharp appreciation of the euro against sterling over the course of the year. It is approximately 12% in year-on-year terms. This obviously negatively affects the exporting sectors of the economy, especially those involved in the indigenous sector which are more regionally based and labour intensive.
It is fair to say, as I have mentioned, that demand in key external markets is relatively subdued. What we show in the slide is the quarter-on-quarter growth rates in the United Kingdom, the United States and the euro area.
This shows the quarter-on-quarter growth rate in the UK, the US and the euro area. The US had fairly modest growth in the opening part of this year. In the UK things were not too bad in the lead-up to Brexit and certainly since Brexit some of the high-frequency data have held up. In the euro area the legacies of the crisis - high levels of public and private debt and so forth, and some problems in the banking sector - are restraining growth.
In terms of key external assumptions, we are projecting for next year growth of about 1% in the UK, about 1.5% in the euro area and about 2.25% in the United States. All member states fix their euro-dollar and euro-sterling exchange rates at levels at mid-September, implying that €1 would buy 85 pence sterling for next year. As I mentioned at the outset, a very modest increase in oil prices is assumed for next year.
I will ask Mr. Power to speak about domestic developments and I will summarise at the end.
Mr. Ian Power:
I will go through the components of GDP starting with consumption. Consumer spending has been quite strong in the first half of this year, up by 3.5%. This has been driven by the very strong performance in goods consumption in particular. As members will see from the graph on the left hand side the high-frequency indicators, such as retail sales and core retail sales which excludes car sales, all show robust growth. Consumer sentiment remains solid and well above its long-run average.
The sale of cars has been very strong in the opening months of this year, supported by a pick-up in medium-term consumer credit growth which can be seen in the panel on the right. This acceleration in credit growth is helping drive the very strong performance we have seen in consumer durables over the past year or so. Car sales are particularly strong in the first quarter, up 30% year-on-year. However, as members can see there has been a bit of a deceleration in the second and third quarters. Overall we expect consumption to remain solid in the latter half of this year and into next year, supported by favourable labour market dynamics and continued increases in personal disposable income.
On investment the most noteworthy development relates to intangibles, with investment in intellectual property assets increasing by almost 20% in the first half of this year. However, it is important to note that the bulk of investment in intangibles is actually imported so the direct impact on GDP is relatively limited.
Encouragingly, building and construction investment recorded double-digit growth in the first half of this year with strong contributions from both residential and commercial construction investment. Slide 14 shows that the commercial vacancy rate in Dublin is now at its lowest level on record. This should also help support commercial construction investment along with the pick-up in public capital expected from 2017 onwards.
On the external side, underlying exports, in other words exports produced in Ireland have remained very strong in the opening half of this year with positive contributions from both goods exports and service exports. However, on a headline basis, export growth has moderated sharply in the first half of this year. As members can see, this is due to contract manufacturing, represented by the green bar in the slide. Contract manufacturing is where a multinational operating in Ireland contracts the production of goods to a third-party firm abroad. If those goods are sold abroad, it is recorded as an Irish export even though the good may never have actually been physically located in Ireland. Last year contract manufacturing was one of the main factors behind the inflated GDP figures, whereas this year contract manufacturing is having a negative contribution on overall export growth and overall GDP growth. We-----
Mr. John McCarthy:
----- in GDP. In recent years we have seen a new form of outsourcing. The outsourcing is called contract manufacturing. An Irish-resident multinational contracts out, under licence, the production of goods and services - mainly goods - to a third party in Asia.
At all stages in the production process, the Irish entity owns all of the inputs into that production, including the very valuable intellectual property. The reason it may be doing this is that there might be doubts about property ownership, the business models in Asia and so forth, so it wants to retain the intellectual property in advanced economies. The crucial point is that it has ownership of all the inputs into production right up until the final widget is produced and sold from, say, China to Japan. At that stage, there is a change in economic ownership and it is classified as an Irish export.
This is not just a feature in Ireland as many companies throughout the world are engaging in contract manufacturing. It is just that, in an Irish case, the firms involved are very large and a large amount of the intellectual property is here, so it has much more of a distorting impact in an Irish context than elsewhere. It is very much in line with the new methodology for compiling national accounts. There is a problem in that Europe is one of the main jurisdictions that has moved to this way of dealing with it whereas not every jurisdiction has done this, so there could be problems of double counting. It leads to a situation in which there are goods and services - mainly goods, I would stress - produced in other jurisdictions that are now formally being recorded in the Irish accounts. This was one of the main features of the 26% figure last year.
Mr. John McCarthy:
The chart shows the position in euro millions and I believe we can see a massive increase in the level of contract manufacturing during 2015. This year we are seeing high levels of contract manufacturing in the first two quarters, just not as high as the level in previous years.
There is one point that relates to the questions from both Deputies. Until 2014 this was a phenomenon but it did not impact on GDP because, while the export and the production was classified as Irish production, the Irish entity had to import a royalty payment from the Caribbean, Bermuda or wherever to be allowed produce these under licence. What we saw in quarter 1 of 2015 was that this intellectual property was brought from wherever and onshored to Ireland. We were getting the actual exports but we no longer had to offset these with imports because the royalties and the intellectual property were based in Ireland.
To come back to Deputy Tóibín's question, the level is still very large in the first half of 2016, just not as large as it was in 2015.
Mr. Ian Power:
As Mr. McCarthy said, contract manufacturing exports were one of the main drivers of the inflated GDP figures but this year they are making a negative contribution to overall GDP growth. We expect this to continue in the latter half of this year.
On the imports side, goods imports have been quite weak in the first half of 2016. Once again, contract manufacturing is weighing on goods imports, although to less of an extent than on the goods exports side. As we can see from the slide on display, service imports accelerated in the first two quarters, mainly because of the substantial onshoring Mr. McCarthy alluded to earlier in that the investment in intellectual property assets is all being imported. Again, we are anticipating something broadly similar in the latter half of this year. In 2017 we are assuming that imports will move in line with final demand, that is, in line with developments in consumption, investment and exports.
The graph shows the current account in the balance of payments. We are anticipating the current account will fall in 2016 and 2017 as a share of GDP, reflecting a weaker contribution from net exports and also a negative terms of trade effect.
This means that import prices will move faster than export prices, weighing on the current account balance.
Mr. John McCarthy:
The current account balance in 2015 was over 10% of GDP, which was quite unprecedented in Irish historical experience and probably the largest current account surplus in Europe. However, it was due to trade exports and contract manufacturing and having no offset in imports.
Ms Weymes will talk about the labour market.
Ms Laura Weymes:
In 2016 to date relatively robust employment levels have been recorded, with the numbers at work having rebounded to levels last seen at the end of 2008. Some 180,000 jobs have been created since the low point of the crisis. Outturns in the second quarter of the year marked the 15th successive quarter in which there was employment growth. Importantly, it remains broad-based, with expansion across 12 of the 14 sectors of activity, for which figures are recorded by the CSO.
On the outlook for employment, data for economy-wide vacancy rates augur well for employment growth in the coming quarters of the year. With no further momentum beyond what we have seen in the year to date, this would imply annual growth of 2.3%. Our forecast of 2.6% factors in a slight softening in the second half of the year and is consistent with the creation of 52,000 jobs in annual terms. Employment growth of 2.1% is forecast in 2017, which is very much in line with the outlook for underlying domestic demand within the economy. Unemployment continues to decline, although the pace of reduction has been somewhat muted throughout 2016, reflecting a labour supply response which is beginning to gather pace in response to improved labour market conditions. The first half of the year saw labour force growth of 1.1% and our outlook for the year as a whole is for growth of 1.3%, unchanged from our last published forecast in April. Despite evidence for persistence in the rate of unemployment in the year to date, the number of persons unemployed continues to fall, with 23,000 fewer unemployed relative to this time last year. Overall, in 2016 we are projecting an unemployment rate which will decline to 8.3% and fall further to 7.8% in 2017.
Slide 24 shows that rising participation rates can be expected to drive expansion in the labour force this year, a phenomenon we are seeing for the first time since 2013. We are beginning to see evidence of a long-awaited pick-up in participation rates which rebounded in the second quarter largely on the back of females who had been within education during the crisis returning to the labour force. The cyclical pick-up in participation rates points to evidence of a strengthening labour supply response to improving overall labour market conditions. Demographics and inward migration are expected to contribute progressively to the expansion of the labour force in 2016 and 2017.
Slide 25 shows the outlook for wage dynamics. Our forecast is for a modest pick-up in wage growth, with wages projected to expand by just over 2.5% per year in the medium term. Hourly pay rates are forecast to evolve broadly in line with productivity trends over the period and the short-term outlook for the wage bill is for continued growth underpinned by broadly balanced contributions from wage rates and numbers at work.
Dr. Javier Papa:
Price inflation in Ireland continues to stay low, slightly below the euro area rate. The annual harmonised index of consumer prices, HICP, decreased by 0.7% in August, while it went up, only marginally, by 0.2% in the euro area. In the next slide we analyse the outturn in the HICP in detail.
We can see that in 2016, to date, headline inflation is averaging -0.2%, while core inflation which excludes volatile energy and unprocessed food prices is averaging 0.8%. Until August, non-energy industrial goods and energy prices made the largest negative contribution to headline inflation. However, the fall in the price of goods and energy continues to be partially offset by increases in service prices which, in turn, are boosted by rents and improving labour market conditions.
Looking ahead, in 2016 we forecast slightly negative HICP inflation of -0.1%, with, at 1.2%, modest acceleration into 2017. The drag from energy prices is expected to ease gradually from the fourth quarter of this year, with its contribution to turn positive in 2017. We also forecast a sustained positive contribution in service price inflation, again due to labour market conditions and rents. Overall, headline and core inflation are expected to converge in 2017.
Mr. John McCarthy:
I will wrap up with a couple of slides, if that is okay with the Chairman. This is essentially what we will present to the Irish Fiscal Advisory Council, IFAC, this afternoon. I will concentrate on the position in 2016 and 2017 because that is probably what the committee is most interested in. I will give it the headline picture.
Members can see that in 2016 we are projecting GDP growth of 4.2% - that is a real figure; in other words, it takes account of price developments - with a very modest deceleration to 3.5% next year. At the time of the stability programme and the SES, the figure was closer to 4%; therefore, as I mentioned at the start, we have taken off about half a percentage point, mainly because of lower investment, uncertainty and so forth associated with Brexit.
Consumption is an important indicator to consider, given the distortions in the GDP number. We are still looking at fairly robust consumer spending, an increase of about 3.2% for the year and 2.8% next year. As Mr. Papa mentioned, we are not really seeing any inflation in the system. It is essentially flat this year, but there will be a modest pick-up to about 1.25% next year.
We see employment growth of 2.6% this year and 2.1% next year. The unemployment rate, as all members will be aware, peaked at 15.1%, I think in 2012; it has, therefore, fallen fairly dramatically. What we have seen over the course of the year is that it has continued to fall but not at the same pace as before. The reason for this, as Ms Weymes mentioned, is there is a labour supply response. There is returning migration and participation rates are going up. We still expect unemployment to fall but perhaps not at the same pace as before. It will be about 8.3% on average this year and about 7.8% next year.
In the budget documentation and our discussions with the IFAC we typically highlight the risks. As I said earlier, these are contingent forecasts. They are contingent on continued growth in external markets and so forth. It is fair to say the risks are tilted towards the downside and mainly external in origin. Obviously, with Brexit, we have seen fairly substantial appreciation of the euro against sterling. This time last year €1 bought 73p sterling. I think yesterday it bought 87p; therefore, there has been substantial depreciation of sterling or appreciation of the euro.
There is also the possibility that if the UK economy goes into recession, it will have an impact in terms of lower trade levels and so forth. However, as I mentioned, it is not just about Brexit. There appears to be an underlying structural weakness in advanced economies. We have seen very weak productivity growth. We are all aware of the ageing of the population in the euro area and the United States. Then there is the possibility of sectoral stagnation, by which we have seen a number of years of disappointing growth figures which is affecting growth expectations globally. Of course, if one expects growth levels to be weaker, firms will invest less and so forth; therefore, it almost becomes, as some suggest, a negative feedback loop. There is also the perennial risk posed by geopolitical factors.
On the domestic front, there is always the possibility of further de-leveraging, that is, households, firms and so forth trying to repair their balance sheet at a more rapid pace than we have assumed. Then there is the possibility of a further loss in competitiveness, either via the exchange rate or because wages in Ireland move out of sync with productivity or inflation picks up much more rapidly than elsewhere. I will not go through this, but we have tried to construct a fan chart of our central scenario just to show how uncertain the situation is. We will publish this on budget day, but in an Irish context in which there are 189,000 enterprises, five of those account for one third of our exports, so we are very much into firm-specific developments. If firm-specific issues happen, that can throw a forecast off track.
We have a lot of material about the supply side. It is of a technical nature, and I do not think it is really relevant to the committee's work. It is something on which our colleagues in the Fiscal Advisory Council probe us quite deeply. We are happy to go through it here, but this gives you a flavour of how we see the short-term situation evolving.
I thank Mr. McCarthy and his team for their presentation. Regarding the fiscal space, are we still accepting that it is €1 billion, that there are no changes to it? The Summer Economic Statement was in June and the witnesses are basing their projections on that, but has anything happened since June that has led them to revise that figure?
Mr. John McCarthy:
To give ex anteclarity to policymakers, the European Commission, as part of the European semester, that is, in the spring every year, locks down what is required for the following year. This is to give greater clarity so policymakers know whether the figure is €1 billion, €2 billion or zero. It is based on a number of inputs that are available in the spring every year. Nine out of ten of them are locked down. There is one variable that can change but it does not really impact to that extent. The answer to the Deputy's question is that the €1 billion is pretty much locked at this stage. One issue I would flag is that there is a little more scope for spending this year because in the mid-year expenditure report, €200 million was identified for schools and flooding that was not provided for in the numbers. There is therefore a modest uptick this year, but for next year the fiscal space is pretty much locked down at €1 billion. By fiscal space I mean the maximum amount one can do to be compliant with the fiscal rules.
Mr. McCarthy mentioned secular stagnation and that there is a body of opinion that this will perhaps be a permanent feature. What is his own view on that? Are we looking at a permanently slower growth rate in this country?
Mr. John McCarthy:
It is not an issue just yet in Ireland. It is a phenomenon of advanced economies. The euro area and the US are good examples. We are seeing very weak productivity growth. In the past, productivity in advanced economies was 1.5% to 2%. Over the past couple of years it has been less than 1%. This is not cyclical. It has been there for a number of years. Then there is this slow-burning issue of ageing populations. We all know there was a baby boom in the US from the 1940s to the 1960s. They are now coming towards retirement age. The same is the case in many euro area countries. For instance, the German population, leaving aside migration, is declining and the working-age population is shrinking. All these factors impact on the capacity of the economy to grow. We are at a slightly different stage in the sense that we still have a relatively young population, we still have labour force growth and our productivity numbers are highly volatile on a year-to-year basis but are still, on an underlying basis, reasonably strong.
However, there is this problem of growth consistently underperforming expectations. That happens on a one-year or maybe two-year basis and is not something to worry about. Since we have seen growth disappointing pretty much every year since the financial crisis, economic agents are saying that perhaps the outlook is weaker than they had thought. They are reassessing their projections for where the world economy will be, and if demand is likely to be weaker, there will not be as much investment as they thought there would be.
Without investment, an economy cannot grow so it becomes self-fulfilling. This is an issue for some advanced economies and one about which Larry Summers, a well-known economist, has written. To answer the Deputy's question, while I do not believe it is an issue for Ireland just now, if our main trading partners suffer very weak growth and this becomes a permanent phenomenon, we will simply not be able to export as much. Therefore, It could have spill-over effects here.
Mr. Power indicated vacancy levels in commercial property were at a record low. According to the graph provided, they are lower than they were in 2003. The witnesses take the view that this should stimulate growth or greater investment in commercial property. The committee has discussed the issue of access to commercial property as it is hampering growth, particularly in the capital. Are there any indications that investment in this sector is beginning to take place?
The Deputy raises a good question. The ESRI did a report about two years ago in which it indicated that the reason for the high vacancy rate at that time was that the economy was only coming out of recession and there was no incentive to invest. It noted also that there had been no commercial investment for about five years. However, when things began to turn around, we saw the sector beginning to pick up. The problem with commercial investment, that is, offices and so forth, is that there is a long lead-in time and it is not something that can be turned around overnight. While there is activity in the sector, it will be some time before everything begins to come on stream. I accept the Deputy's point in the sense that there is probably a bottleneck now, especially in the capital, but the position should be alleviated, probably in the short term as there has been activity in the sector for two or two and a half years.
Ms Weymes presented some figures on the labour market. The figures on projected increases in employment rates were national figures. Are figures available for employment growth in the regions? One of the concerns expressed by members is the regional disparity in employment growth, particularly in the west, which is not experiencing the required level of employment growth. Does the Department have figures for projected reductions in unemployment or increases in employment in the west next year?
Mr. John McCarthy:
While it measures, it does not project. While employment is growing in every region, some regions are growing much more rapidly than others. With the Department forecasting 2.6% growth for this year, it is not a huge leap forward to assume that a large part of that will be in urban areas. There will also be growth in other regions, albeit not to the same extent as in urban areas, which I understand is point the Deputy is making.
Does the Department have figures on the number of net new jobs that will be created next year and the number of vacancies that will be filled by people returning to Ireland, graduates and school leavers and people on the live register? Does it have figures on projected average wage growth in 2017? What will be the difference in wage growth rates in the public and private sectors? Which sector will grow faster?
Ms Laura Weymes:
On the Deputy's question on net jobs growth in 2017, the implied figure on the back of the 2.1% growth rate we are projecting is for an increase in employment of 42,000.
With regard to the Deputy's first query on regional breakdown, although the CSO records, it is always at pains to point out that the regional distribution can be prone to estimation revision and so on that basis, we tend to look forward in aggregate terms. The Deputy had a question on wage growth figure. Was that for next year?
Mr. John McCarthy:
I will give the committee a figure on where we are for this year in public versus private sector. The members may then be able to infer for next year. In the second quarter of this year, hourly earnings rose by 0.2%. The increase in the private sector was 0.8% whereas there was a fall in the public sector of 0.4%. Some of that, of course, is going to reflect compositional effects such as people retiring who might be at the principal officer level and people then coming in at the entry grades.
My last question relates to job vacancies. Do the witnesses have any figures on where they expect those vacancies to be filled from? Would it be graduates, people returning to Ireland or from the live register?
I thank all the witnesses. That was very useful. I want to ask a question about the presentation but I would like to make a related point on the convergence margin and the fiscal space. We have heard a lot of evidence as to why it is 1%. I presume Mr. McCarthy's team was in-----
Apologies, it is €1 billion. I presume Mr. McCarthy's team is involved in the work that gets them in. The convergence margin shrinks it by €1.4 billion, that is, from a potential €2.4 billion down to €1 billion, and it is because we miss our medium-term budgetary objective, MTO. Our MTO is .5% structural deficit while our forecast is 1% structural deficit. That calculation was done before our odd GDP figure. It is my understanding that it was done before the unexpected additional 26%. Presumably the 1%, if one used the revised GDP figure, the €1 billion structural deficit would shrink to maybe .7% or .8%. It is the structural deficit. The denominator is GDP, so if the GDP goes up, the ratio will fall. Does Mr. McCarthy have a sense of how much of the structural deficit is accounted for by overheating? I know the Commission uses a bunch of different metrics. It goes back ten years on employment, it has stated that 8%, 9% or 10% unemployment is about a steady state in Ireland. Many people in Ireland would say that it is not and it should be lower than that and so forth. Does Mr. McCarthy know how much the structural deficit was increased on the basis, or on the assumption from the Commission, that Ireland's economy was overheating, as opposed to if we were just at about capacity? I apologise because I know it is slightly off topic but it is in the same realm.
Mr. John McCarthy:
If one goes back to taking into account the 26% growth, and with everything else being equal, that would actually increase the size of the structural deficit because one has an economy where we estimated a small positive output gap for 2016 at the time of the stability programme.
In 2015, we had 26% instead of 7.8% so there is an even larger positive output gap which means more of the deficit is structural. There are offsetting impacts in the sense that one of the reasons for the 26% figure was the massive influx of intellectual property, which is included in our capital stock and so is also on the supply side. It also means the estimate of the output gap goes up ever so slightly so that we are further away from the MTO. The reference rate is based on a ten-year average which is fixed in the spring so the figure does not take into account the 26% actual GDP growth.
The Deputy asked how much the economy was overheating and what it means for where we are in terms of the business cycle and the structural balance.
Yes, but I specifically referred to the fact that the Commission said we were overheating while a lot of domestic experts are saying we are not and are approximately at potential. Does Mr. McCarthy know how much the structural deficit has grown? The Commission says we are overheating and that the structural deficit is bigger but were it to say that was not the case, and that we were at approximately output potential, by how much would it shrink?
Mr. John McCarthy:
I can give the Deputy my general views but I do not have the figures to hand. It comes down to the Commission's methodology, which is agreed by member states and which finds that the labour market clears at about 8% or 9%. My own view is that the labour market in Ireland probably clears at about 5% or 6%. In other words, full employment is in that region. I believe that harmonised methodology understates the true potential of the Irish economy and the gap between the two figures might be two or three percentage points. At the moment we are probably at or very close to full potential. In other words, there would be no output and on that basis the headline balance would be very close to the actual balance. In 2016 we are looking at a deficit of 0.9% of GDP, as is shown in the SES, and for next year we are looking at a headline deficit of 0.4%. If one takes the view that we are close to potential the structural deficit would go from 0.9% to 0.4% and we would be very close to our MTO next year.
That is useful and I thank Mr. McCarthy. Is it, therefore, the case that a technical assumption is being made? The Commission is saying we are at full employment at 9% but we are saying we are at full employment at 5%. Were the Commission to accept Mr. McCarthy's view that the adjusted structural deficit would go down from -0.1%, which is what is in the SES, to approximately 0.4%-----
Mr. John McCarthy:
It would be significantly larger, yes. However, there are legal issues here in that all Ministers, back in 2002, signed up to the harmonised framework for producing potential output. I accept the Deputy's point in principle but legally we are bound in to this harmonised approach. What the Deputy says, however, makes sense.
Yes. It goes from a negative figure of approximately -0.16% in Q1 2013 to a very significant positive figure. Is that a proxy for personal borrowings? Is it the country spending money it has? Is it households beginning to borrow with unsecured debts such as car loans, credit loans, etc.? What is going on here?
Are we beginning to see a new debt risk for households?
Mr. Ian Power:
First, it is only within the one-to-five-year credit category. The Deputy is correct that it applies to phenomena such as car loans and consumer durables, but not mortgages. However, the reason we have been seeing quite a large increase over the past year or so is because the base was so low. There is expansion at a high rate, but from a very low base. We see that household de-leveraging continues to increase. There was a household savings rate last year of approximately 10%. Therefore, I do not believe any issues arise over increasing debt. The rate of debt to disposable income continues to fall.
Let me refer again to the labour market. With regard to the statistics, which obviously represent significant improvements on the earlier years, does the Department have sub-data or sub-analysis that would indicate the proportion of jobless households? In this regard, Ireland is quite an outlier by comparison with the rest of Europe. Has the underlying figure begun to improve? Could the delegation give us the figure or send it to us in a note?
My second point is on the composition of inward migration flows. I assume an element comprises returning emigrants. What are the countries from which there is a significant migrant flow? From my constituency, I know there seems to be a very significant flow of Romanians at present. They are all becoming employed and doing very well. I do not know whether the flow of eastern Europeans has resumed. I refer to Poles and people from the Baltic states. Has Mr. McCarthy underlying figures on this?
There are two problem areas in the Irish labour market, the first of which concerns people under 26. What is the pick-up in this regard? The delegation partly addressed that in response to the question by Deputy Lisa Chambers. Is it that people with qualifications, such as degrees, are doing better, or is the pick-up also extending to people regarded as unskilled?
There is a very significant problem growing in the Irish labour market concerning people over 50. Mr. McCarthy was talking about the five big companies being so responsible. I challenge people to find anybody other than the staff at senior management level in any of those companies who is much over 30. Does the delegation have statistics on people over 50 and 55? Is their unemployment situation more difficult because of unspoken bias by employers against middle-aged workers or, as with many of the companies the delegation referred to, those who are classified as older? Could Mr. McCarthy explain chart 32, which shows the changes in real disposable income? I could not quite catch what was said.
Mr. John McCarthy:
I will respond to the Deputy's last question first and then Ms Weymes might handle some of the questions on the labour market.
With regard to chart 32, in producing the national accounts we show the expenditure side, which entails consumption, investment, exports and so forth, and also the matching on the income side. Being in employment generates income for people. It generates employment for the self-employed and so forth. There are various transfers and so forth. These figures are published in the detailed national accounts every year. The chart contains our forecasts. The beige or brown bar shows a 5% increase in labour income in 2016. It shows what the Deputy and I, for example, earn from being employed. It is a composition of increases in employment, increases in the number of hours worked and increases in hourly pay. I refer to labour income, which makes up the bulk of household disposable income. Capital income is essentially the income of the self-employed in addition to some dividends from company owners and so forth.
Mr. John McCarthy:
The horizon for other household income in 2016 is fairly small.
Net cash transfers refer to the interaction between the household and the general Government sector. So I make transfers to the general Government sector by paying taxes on income and wealth - in my case just income; I do not have any wealth. In addition the Government makes transfers to me via child benefit and to the unemployed via social welfare and so forth. Therefore, it is a net position. That would be the dark green bar. PCD, which is the light green bar, takes into account the inflation rate because we are trying to look at this in real terms.
Mr. John McCarthy:
Personal consumption deflator. Let us call it the CPI. It is slightly different, but it is the inflation rate. We are trying to look at it in real terms.
All these components added together give the light blue line. We can see that in 2016, households on average throughout the economy will see real income gains of between 4% and 5%; I cannot read it exactly off the chart there. That is the explanation for that chart. It is all available from the national accounts.
The Deputy mentioned a couple of issues and Ms Weymes can help me out here. I do not have figures to hand on jobless households. We can certainly get them and forward them to the secretariat or to the Chair.
The figures for the composition of unemployment by age cohort are available, but that is detailed information that I do not have with me. We do participation rate at an aggregate level. I do not have the figures here, but they are available. Does Ms Weymes wish to say something?
Ms Laura Weymes:
I just wanted to come in on the participation trends by age cohort. The Deputy asked about the return of the under 26 bracket in particular. During the crisis we saw a very significant tail-off in participation in the two younger brackets. A lot of the uptake in participation we are seeing now is being driven by those returns.
Ms Laura Weymes:
In those younger cohorts. Certainly their outflow from the labour force would have been behaviour driven by cyclical conditions. There is not really evidence that uptake of educational participation among that younger cohort is dropping off. That perhaps would seem to be a more structural phenomenon - remaining in education.
Ms Laura Weymes:
The CSO produces very detailed participation rate data, broken down by disaggregated age group. There has been some rise in the 50 and over component in terms of its future capacity to keep driving overall upward participation trends, but perhaps somewhat more limited.
The Deputy also asked about the proportion of overall migration accounted for by returning Irish. The census data, produced by the CSO on a usual-residency basis have shown stronger net inward migration than the annual population and migration estimates. That would point to an uptake in returning Irish. The reason for that is that the annual estimates are produced using PPS issuance.
I think it will be some time before those annual April figures produced by the CSO are aligned with what we are seeing in the more comprehensive census data.
I have a nagging feeling about this whole session. I am wondering exactly what we are doing here. I know that all this technical work has to be done. When the witnesses say that the risks are all tilted on the downside, it is at that point that I begin to wonder the extent to which all of this goes out the window if certain of those risks materialise. What precisely are we supposed to do about the risks? I understand that the witnesses cannot veer into policy but maybe they can talk to me a little bit about precisely what their role is in setting out risks and how far they go in suggesting that we have to respond to certain risks. Perhaps the witnesses could talk a little bit about that.
I agree with the witnesses. I believe the external risks and I would say the internal risks are very significant. They could throw all these projections out the window. The witnesses might correct me if I am wrong but would it be fair to say that when the crash came in 2007, all of the projections prior to that happening did not in any sense predict what then actually happened? When we talk about the downside risks, I wonder about all of this. I am reading that Citibank has put a percentage - I do not know how it is worked out - of 65% on the likelihood of a recession in the US this year. In the next year, it is saying that there is a 100% chance of a recession in Latin America. The Bank for International Settlements is saying that we are perilously close to another major slowdown. The IMF has made five different revisions, I think, to its growth forecasts and all are downwards. What are we doing about these risks and how do we protect ourselves? It is a kind of ideological point of "told you so" but I am going to say it anyway. Secular stagnation, in my opinion, is what Marx called the long-term tendency of the rate of profit to fall and it is materialising. It is about the ratio of capital to labour essentially appreciating. For that reason, I think that stagnation is going to continue and we are going to move into it.
Will the witnesses talk a little bit about what exactly their role is in guarding against the risk? Also, one of the most shocking things the witnesses said was that five firms account for one third of all exports. That is just shocking. The jump in the GDP figures of 26% which has spawned the term "leprechaun economics" is further confirmation of just how vulnerable we are. Five firms account for one third of exports. There are gross distortions in the growth figures. Is this a risk? It strikes me as a risk. When we are talking about downside risks, that seems to me a very extreme risk.
If I understand Mr. McCarthy correctly, he is saying that, overall, there will be a slight increase in wage income.
Can he tell us anything about the distribution of that income? Average income can mean very little when we are talking about people at the top doing very well but people at the bottom not doing so well. What does it really tell us and can Mr. McCarthy tell us any more? My reading of the economic growth, and I suspect the feeling of many people, is that the benefit of economic growth is going largely to the better paid and better off. Indeed, according to a paper I am reading, the share of gross income of the top 10% of earners increased from 34% to 39% over the last five years and, over the same period, roughly half the increase in total income, which was €21 billion, also went to that cohort. Other figures suggest the bottom 50% received a tiny proportion of the growth in GDP. Has Mr. McCarthy anything to say on this? Are there tables, figures and statistics on the distribution of wage growth, income growth and GDP growth?
Mr. John McCarthy:
I thank the Deputy. I think I picked up from the start of the Deputy's intervention that he agrees with me that risks are tilted to the downside - he looked at the Bank for International Settlements, Citibank and a few others. I certainly stressed in my opening statement and in the presentation here that I think that is the case. I believe the source of those risks are, as the Deputy correctly said, mainly on the external side, given the highly uncertain environment.
The Deputy mentioned projections at the time of the crash. I can say, hand on heart, that they were subsequently out of date within months in 2009, given what happened. However, what happened both in Ireland and in the vast majority of the global economy was a once in a lifetime situation. This had not happened since the Great Depression. I remember that, when we trying to compile the budget for 2009, which was brought forward to October 2008, we were basing our projections on IMF projections which were published a few days earlier. Within two weeks, the IMF, which is the global leader in terms of economic analysis and economic projections, had to revise down its forecast substantially. For such an institution to reduce its forecast within two weeks was simply unheard of. I have spoken to those who do my job in the Treasury and practically every finance Ministry throughout Europe so I know everybody was in the same boat and everybody was behind the curve. It was obviously a very difficult time for people on the ground but for those trying to understand what was going on, it was also difficult. Projections were out of date within a couple of weeks, given the scale of what happened at the time.
I will now turn to the question of what we can do. I have a copy of the stability programme and I would urge the Deputy to have a look at it, in particular pages 26 and 27. In order to try to quantify the impact of some of these scenarios, we undertake a sensitivity analysis based on models we have access to, some of which are developed by the ESRI and colleagues on my econometrics team. We are all talking about the world economy and, for example, if world growth is 1% lower than we thought, what is the impact on the Irish economy, what is the impact on the labour market and, from a Department of Finance perspective, what is the impact on the deficit? We look at a number of scenarios, for example, more de-leveraging within Ireland, a change in world demand, a rise in interest rates or a percentage point sterling depreciation, although we have, of course, seen even more than that.
We outline what the impact would be and then we provide advice to our Minister and to the political system on the appropriate policy response. Needless to say, part of the advice we would give is that there must be sustainable public finances in order to be able to accommodate the shock.
The Deputy mentioned the five firms accounting for one third of our exports. That figure is publicly available and is in various presentations. We did a risk matrix, which is set out in the stability programme, where we talk about our concentrated industrial base and the impact and main transmission channel. It states that Ireland's industrial base is highly concentrated in a small number of high tech sectors with the result that output and employment are exposed to firm- and sector-specific shocks. We saw that, for example, in 2012 with the patent cliff in the pharmaceutical sector. A number of drugs were coming off patent and it had a massive impact in terms of value added. This is very difficult to control for because there is a small number of very large firms in Ireland and they pay a disproportionate amount of our corporation tax. One cannot tell them to go away. They are significant employers in their own right. They contribute to the Irish economy and they are very valuable. However, there is no doubt that it raises concentration risks.
It is difficult as well, without going into economic theory, for a small economy to have comparative advantage in a large number of sectors. It is difficult to diversify. It is not like Germany or the US where it is easy to develop comparative advantage in many sectors. In our case, we must be quite specific. What we can do to mitigate this concentration risk is remain competitive and ensure that workers have the appropriate skills, because these firms are in the high technology sectors. They are not locating here just for the corporation tax but for the quality of our labour, the work-life balance and so forth. Ireland is generally deemed to be a good place in which to live. By addressing some of these concerns we can further embed these multinationals and that can mitigate the risk. However, it can never fully eliminate it, as the Deputy will appreciate.
Regarding the distribution of wages, on budget day or shortly thereafter we will publish an analysis of what the budget measures mean for each decile of income earners. We split the total population from the first decile to the tenth and we will be able to say who gains most from the budget measures. If one looks at the past five or six years, and obviously it differs on a year to year basis, in general the budgetary measures have neither been progressive nor regressive. It remains to be seen what the impact of budget 2015 will be. We conduct that analysis - we are conscious of the social impact as well - and we publish it.
With regard to the share and distribution of income, wealth and growth over time, there has been much debate about whether it is regressive. It depends on one's definition of "regressive". That is one debate. However, one way to examine these matters is to chart things over time, examine what proportion of income is going to capital and labour and whether that changes over time and look at the distribution of income and wealth and see whether there are shifts and changes in it. Does the Department keep such tables and does it monitor that?
Mr. John McCarthy:
The answer to the first part of the Deputy's question is "Yes". One can see the evolution of the profit share and the wage share over time from the national accounts. There is a rise in the profit share from the 1970s. One of the reasons for that is the multinational sector, which is profitable. However, the profits do not accrue to Irish residents.
They feed out from GDP and are subtracted to form gross national product, GNP. The figures must, therefore, be distorted or adjusted accordingly. A priori, however-----
Mr. John McCarthy:
It depends on the timeframe used. Let me put it this way. While I cannot provide exact figures, a figure of 20% in the period since the 1970s would not be out of the ballpark. However, one needs to take into account the growth in the multinational sector in this period, especially during the 1990s and 2000s.
The headlines emerging from the presentation are volatility in growth and taxation, uncertainty and exposure. Mr. McCarthy highlighted this exposure when he noted that five companies were responsible for one third of exports. Obviously, we should not say "Good luck" to these companies. However, in comparable economies such as Austria and Denmark much greater efforts have been made to expand the indigenous sector so as to insulate the economy from the types of risk to which the Irish economy is exposed. The GDP figure continues to be at variance with the real experience of the economy and this has a distorting effect on many economic indicators, including investment. We measure everything as a percentage of GDP, including investment in education, debt-to-GDP ratios and so forth. These indicators are becoming more corrupted over time. What would happen if the figure for last year when GDP increased by 26% were flipped? How would the fiscal rules be affected if the 26% increase were reversed for a particular reason?
Mr. John McCarthy:
It comes back to the point that the fiscal space is set each year in spring. It is pretty much locked down at that time as nine of the ten variables are fixed. If there was to be a major surprise subsequently, it would not really impact because the rule on which we focus most, the expenditure benchmark, is based on the potential rather than actual growth rate of the economy. The rationale for this is that expenditure should grow in line with the trend in the economy, rather than actual developments. It is, if one likes, about avoiding the mistakes we made in the noughties when we allowed expenditure to increase on the basis of temporary growth, in other words, growth in the construction sector and so forth. This benchmark strips out actual growth and does not feed into it because it is calculated on the basis of the trend or the potential growth rate of the economy. It is also smoothed over ten years to remove volatility on a year to year basis. It is these variables, rather than an actual 26% growth rate, that would feed into the relatively complicated formula used to calculate the fiscal space. If one were to have a negative surprise, it would not impact on the fiscal space. I think where the Deputy is coming from - I have some sympathy with his view - is that if GDP were to fall by 26%, everything else being equal, the debt ratio would jump up. This would create a communications challenge and so forth which we would have to try to overcome.
To express a personal view, my concern, at least in the short term, is not that we will see some intellectual property being relocated out of Ireland but that more of this investment may be located in Ireland and we could have another growth shock on the other side. Another 26% increase in GDP would probably be too extreme.
Yes. When Mr. McCarthy and I last spoke, we discussed the fact that corporation tax receipts were so far ahead of profile and that people were trying to get their heads around it. On changes in corporation tax rates, is the reason for the investment in intellectual property to regularise the new corporation tax regime that will come into place?
Mr. John McCarthy:
Deputy Tóibín raises two highly relevant issues. First, we had a discussion on the over-performance of corporation tax last year and I believe the figure was 49% or 50% higher than we anticipated in the budget. It is important to point out that we now have the national accounts showing the full 26% growth in GDP. If one examines the detail of the accounts, one sees that corporate profitability rose by 44% or 45%. The figures are, therefore, very much aligned. In one sense, we can explain what occurred last year, whereas we could not explain the growth rate of 7.8% when it was initially estimated by the Central Statistics Office. That is an important issue.
The second issue is the overall BEPS process. The mood music is changing on the international corporate taxation front, with some multinational companies becoming less aggressive in their tax planning. Instead of holding their intellectual property offshore, they are bringing it onshore. What does this mean for Ireland? We probably have first mover advantage in the sense that we have substantive multinational actual activities here, as everybody knows, and in the sense that multinationals which own IP are now taking a decision to co-locate their IP in countries where they have substantive economic activities. That is the reason for the substantial increase in IP in Ireland. It is coming through two channels, as discussed by Mr. Power earlier. First, the subsidiary here will purchase the IP from abroad. This is included in investment but it is also included in imports, which means it does not affect aggregate demand in the short term. What we saw in 2015 was IP being brought onshore through a different channel when companies rehoused a subsidiary's entire balance sheet - its assets and liabilities, with the assets being the IP - in Ireland. This process involves setting up a company in the Companies Registration Office and closing down a company in the Caribbean. Suddenly, the assets - the intellectual property - are in Ireland.
Mr. McCarthy noted that the GDP figures are somewhat distorted. This has a brass tacks effect in terms of what we pay into the European Union. Growth in GDP results in an overpayment. Has the overpayment been calculated?
Mr. John McCarthy:
I would add a slight nuance to the Deputy's question. When intellectual property is moved onshore, the company is then profitable and pays a significant increase in corporation tax. Last year, the increase in corporation tax was of the order of €2.3 billion, which gives rise to a contribution to the EU budget. There is, therefore, a substantial net gain, if one likes. The bigger problem relates to the so-called issue of inversions, where one has a relatively small firm taken over by a larger firm simply to shift its head office to Ireland. Once its head office is in Ireland, all the subsidiaries, from a national accounting perspective, locate their profits in Ireland. We do not get any of the money because we have double taxation agreements with a large number of countries. This results in an increase in our gross national product as opposed to gross domestic product and, as a result, gross national income or GNI, which is essentially the same thing as GNP. Our contribution to the European Union budget increases because of these corporate taxation issues.
On foot of the revised national accounts, the quantum is about €280 million, additional to the EU budget. As I stressed, it must be seen in the context of a substantial increase in corporation tax receipts.
On the other side of the equation, with Brexit and Britain's contribution to come out of the EU budget, has there been any assessment of the readjustment required for remaining countries, both to inputs and drawdowns?
Mr. John McCarthy:
Not that I am aware of thus far. It needs to kick off, given that we have a timeline and know that the United Kingdom will have exited by the first quarter of 2019. All of that work will begin on how it is to be redistributed and whether everybody else will pay a little more or whether expenditure will be reduced. These are decisions that will need to be made in the next couple of years.
On bottlenecks in the economy, housing provision is a major bottleneck. It affects so many sections of society directly in people being made homeless, in terms of the physical and mental health of individuals but also in terms of foreign direct investment. The less housing capacity there is, the more difficult it will be to attract foreign direct investment and achieve internal growth. There is also the potential for housing issues to have a destabilising effect on the banking system. Has there been any assessment of the effect of such bottlenecks on growth and development?
Mr. John McCarthy:
We have been conscious of this issue for a few years. There were a number of years in which supply essentially was at minimal levels. We then saw a much more rapid pick-up in the economy than would have been anticipated, with the demand for housing rising rapidly. Of course, the price elasticity of supply is very low, given that so many developers have gone out of business and access to capital is a problem. With the new finding model, a person cannot walk in and get a 955 loan from a bank, which is good from a financial stability perspective. There is certainly a mismatch or an imbalance between demand and supply in the economy. We are very conscious of the impact from a social as well as a competitiveness perspective. As the Deputy rightly said, workers need to be housed to make Ireland attractive for foreign direct investment. We need to be able to provide affordable accommodation. That is why the Government has come out with the rebuilding Ireland programme, with 80 or 90 sub-actions. It might take some time for all of them to come on stream, but it will ultimately lead to an increase in supply. Everybody is of the same opinion: this is a supply rather than a demand side problem.
We mentioned the output gap. Obviously, it will have an effect on the investment a state can make in the future without it becoming inflationary. There are major capacity gaps within our infrastructure. What level of investment can the State continue to make in its infrastructure before it becomes inflationary or leads to overheating?
Mr. John McCarthy:
The fiscal rules state nothing about what a country can do in terms of current or capital spending. They merely stipulate that whatever is spent needs to be financed. A country can choose a UK-type model, a relatively low size of government, or a Swedish-type model. The country just needs to finance the expenditure. In principle everybody agrees with this.
Some flexibility is included in the Stability and Growth Pact in that investment is smoothed over a four-year period. Therefore, spending can be ramped up in a particular year. In the summer economic statement we set out that by increasing the level of investment by €60 million, it could be leveraged upwards to something like €240 million or €250 million in 2017. This is certainly in the Government's plans and there is scope to do it. I stress it is above and beyond what is already identified in the public capital programme. As I mentioned, an additional €200 million was announced at mid-year that had not been provided for to be used, I believe, for school projects and flood relief measures.
There will be a fairly significant increase in investment over the medium term.
Mr. John McCarthy:
It depends on the scale. My own view is we probably have sufficient capacity in the short term to be able to absorb that investment. I stress that it is the scale. If went from €5 billion to €10 billion, there would be huge inflationary pressures and we would get less bang for our buck because it would all be in terms of inflation. Taking a more graduated approach probably leads to a better bang for our buck.
Ms Weymes referred to labour force growth. I may have misinterpreted it but did she say it is attributed to female returns because women were in education during the crisis? If I did not misinterpret it, can she drill down into that for me? Did women disproportionately return to education during the crisis? Why was that the case? Does Ms Weymes have any data on that?
Mr. McCarthy outlined the gain for each decile after the budget. Will that be proportionate to their income? We always hear that a reduction in USC will give a person on low income €10 but what about the person on a far greater income? People may deliberately leave out the proportionality of that. Is that taken into consideration with the figures Mr. McCarthy gave? Does it also take into account child benefit and other payments people get? If there were to be increases in that, would it be reflected in that?
Mr. McCarthy spoke about the co-location of intellectual property by companies that have economic activities here. Is there any reason for that trend not to continue? Are companies likely to continue to co-locate their intellectual property here? Is there any reason that we might negatively impact on that practice?
Mr. John McCarthy:
Let me answer the last question first and then hand over to Ms Weymes. I ask the Deputy to give me time to think about the switch model.
There are obviously a lot of moving variables in this. It is important to stress that with the globalisation we have seen in recent years, some of these things can change at the stroke of a pen. Everything else being equal, we have this bringing onshore of the IP and co-locating it where there are substantive activities. The Minister took an important policy initiative in either the budget for 2013 or the budget for 2014 with the introduction of a knowledge development box with essentially half the corporation tax rate for knowledge created in Ireland. It is part of a trend that is going on elsewhere; I believe the UK, the Netherlands and perhaps some other countries are moving down this road.
Another attractive feature of our corporation tax regime is the research and development tax credit. I am not supposed to talk about policy but I think I can say something briefly on policies that have been implemented. Those two policies will help to further embed the IP in Ireland and help Ireland move up the so-called value-added chain. We have a strong comparative advantage given our investment in third level education, etc., and the high skills attainment of the labour force.
I ask Ms Weymes to respond to the other issue.
Ms Laura Weymes:
The Deputy asked about the pick-up in participation being predominantly driven by female returns. The Deputy is right that I mentioned it. It was not so much in terms of outlook but it was the position reported at the end of the second quarter that the 0.4% increase in the participation rate was predominantly driven by the younger cohort and, within that cohort, by females.
The CSO has collected data that look at the potential additional labour force where people declare that they have remained outside the labour market for reasons of education or otherwise. The data are broken down by gender and they substantiate the claim that there were strong cohort effects of the younger group remaining in education. It is their return into the labour force that is driving the current pick-up.
Mr. John McCarthy:
On the question of distribution effect, the budget book publishes average income tax rate tables right across the spectrum, and this is worth looking at. We have what is deemed to be the second most progressive income tax system in the OECD but it is difficult when we make concessions which most benefit those in the higher decile. That is a function of the progressivity of our income tax system.
As far as I know, child benefit is not included in the switch model. I am 90% sure of that but the Deputy should not hold me to it.
In respect of corporation tax, one of the arguments about Apple at the moment is that if we were allocating profits fairly they would not be allocated here but to where the intellectual property was developed. On the other hand, Mr. McCarthy says we are going up the value chain because representatives of some of these companies walk into the companies registration box and, with the stroke of a pen, relocate intellectual property assets. They are not actually relocating real economic activity - they are just doing an accountancy trick. This may benefit us but is not about the movement of real economic activity. One cannot have it both ways. Either we are entitled to the tax from the €13 billion because the profits were booked here or we are not entitled to the stuff the company is relocating here. There is a bit of a dichotomy in this respect.
The company may now feel under pressure as the mood music changes and it is no longer sustainable to avoid tax in the aggressive way they have been doing. It may now have decided that the Irish tax jurisdiction is better from its point of view than the US, where it would be paying 37%. However, it raises the question of how a company books intellectual property profits. How does it cite them? It strikes me that we are talking about accountancy here, not real economic activity.
Mr. John McCarthy:
I will not comment on individual companies. The Deputy's question concerns my point about moving up the value chain, which I mentioned in the context of the knowledge development box and the research and development tax credit. The preferential treatment in this case cannot be availed of by moving IP to Ireland but only by developing the knowledge in Ireland. A company cannot simply develop it elsewhere, move it into Ireland and avail of our research and development tax credit.
Mr. John McCarthy:
The question was whether intellectual property that is here could move out somewhere else. These policy initiatives will help further embed the development of intellectual property in Ireland.
A company can develop synergies with companies that already have, or are bringing in, IP but a company cannot avail of it by just bringing the IP here.
Mr. John McCarthy:
It could be there or it could be stateless. In an Irish context, the scenario is that a company has set up a subsidiary through the Companies Registration Office and has brought an IP, its assets and all its liabilities to Ireland. If every other country did the same thing the assets and liabilities in some other country would go to zero. We know now, however, that these are now housed in Ireland.