Be yon d t h e ba ilou t

ebuilding confidence confidence, , driving growth

IBEC Budget 2014 Submission ubmission

Beyond the bailout

Rebuilding ebuilding confidence confidence, , driving growth
IBEC's Budget 2014 submission sets out in detail how we can use the upcoming budget to support economic growth and job creation, as the country prepares prepares to exit the EU-IMF EU IMF programme. Ireland has been through a series of tough budgets, and while the path ahead is not easy easy, , we are now moving to a new phase of the recovery. Budget 2014 must clearly signal that the end of austerity is in in sight, so business businesses and consumers alike can plan ahead with certainty. Proposed tax rises should be abandoned, employment costs frozen and investment and activity in the domestic economy incentivised. Despite economic headwinds, t the he business community remains ambitious for the future. But ut we need to make the right choices. Last year IBEC set out an economic road road-map map for the country in our Driving Ireland s Recovery campaign. In it we outlined how, together, together we can: Restore domestic domestic demand Support job creation Keep Ireland strong in Europe Deliver world-class world class public services During the past 12 months, the campaign has informed all of IBEC's key activity: whether it was setting out a range of proposals to boost spending in the domestic domestic economy; opposing ill-conceived ill conceived plans that would add to business costs; making the case for meaningful reform of our training and education system; advancing a new EU EUUS trade deal; or leading the call for radical reform of the public sector. While there has been significant progress to date, many challenges remain. High unemployment, a weak domestic economy and ongoing uncertainty in Europe continue to hold us back. Budget 2014 is an important opportunity to move the economy into a new phase of sustainable stainable growth and recovery. It is vital that this opportunity is not missed.

Danny McCoy Chief Executive Officer

Contents
1. 2. Five key messages for Budget 2014 .............................................................................. 1 Fiscal policy priorities................................................................................................... 2 2.1 Introduction ................................................................................................................ 2 2.2 Scale of adjustment for 2014 ..................................................................................... 2 2.3 The tax burden on the economy ................................................................................ 3 2.3.1 International context .............................................................................................. 3 2.3.2 Historical context .................................................................................................... 4 3. A tax framework for economic growth ........................................................................ 6 3.1 Taxation of work ......................................................................................................... 6 3.1.1 Taxation of employees ............................................................................................ 6 3.1.2 Employer labour costs ............................................................................................ 7 3.2 Indirect taxes .............................................................................................................. 7 3.3 Taxation of pensions................................................................................................... 8 3.3.1 Proposed changes to the Standard Fund Threshold .............................................. 8 3.3.2 PRSAs..................................................................................................................... 10 4. Supporting the recovery ............................................................................................ 11 4.1 Introduction .............................................................................................................. 11 4.2 Jobs Initiative Measures ........................................................................................... 11 4.3 Tax support for home improvements ...................................................................... 12 5. Incentivising Investment ............................................................................................ 13 5.1 Review of the R&D tax credit scheme ...................................................................... 13 5.2 Access to funding ...................................................................................................... 14 5.2.1 SME access to credit ............................................................................................. 14 5.2.2 State-backed enterprise/investment bank ........................................................... 15 5.3 Supporting entrepreneurial investment .................................................................. 15 5.3.1 Entrepreneurs reinvestment relief ...................................................................... 16 5.3.2 Employment and Investment Incentive Scheme .................................................. 16 5.3.3 Entrepreneurs and insolvency .............................................................................. 17 5.4 Investment in education ........................................................................................... 17 5.5 Tackling high electricity costs ................................................................................... 18 Annex 1 Analysis of Jobs Initiative measures .................................................................... 19 Annex 2 International review of home improvement tax incentives ................................. 24

1. Five key messages for Budget 2014

Our five key messages for Budget 2014 are: 1. There should be no further additional tax increases and the scale of planned fiscal adjustment should be reduced from 3.1 billion to 2.6 billion in 2014: a fiscal adjustment of 2.6 billion in 2014 would enable Government to comfortably meet its budget deficit target. A lessening of the scale of adjustment and the abandonment of new tax increases would provide a significant fillip to the domestic economy, deliver greater certainty to households and would unlock consumer spending. Government also delivered more than planned tax increases in Budget 2013 and it should redress this in 2014. 2. Existing supports for the hospitality and related sectors introduced in the Jobs Initiative should be retained post 2013: the reduction in the VAT rate from 13.5% to 9% for hospitality and related items and the introduction of a lower employer PRSI rate for low wage workers have been very successful measures. Our analysis demonstrates significant gains in employment, activity and Exchequer benefit from these measures and they should be retained. Budget 2014 should also support the domestic economy through the introduction of a home improvement tax credit or grant incentive scheme. 3. No increases in employment costs: although Ireland has regained much labour cost competitiveness in recent years, average wages here remain higher than in many of our competitor locations. It is essential that Government does not introduce any further measures to increase labour costs. In particular, it should not introduce statutory sick pay proposals or make further adjustments to the pricing of private beds in public hospitals as this measure has already resulted in sharp increases in health insurance costs paid by employers. 4. The R&D tax credit scheme should be improved in order to underpin Ireland s attractiveness for mobile investment: IBECs submission earlier this year to the Department of Finance review of the scheme has shown strong economic rationale for its continuation. The scheme should be enhanced by reducing the current uncertainty regarding the existing claim process and also by allowing a greater use of outsourcing and contract specialist staff. The need to enhance this scheme is increasingly relevant in light of the improvement in the business tax offering in the UK in particular, through a reduction in its corporation tax rate and enhancements to its intellectual property regime. 5. Enhance the investment environment: changes to the capital gains tax regime are needed in order to support entrepreneurship in the employment generating enterprise sector of the economy. Measures are also needed to support business financing through increased statebacked investment funds and a revamped Employment and Investment Incentive Scheme (EIIS).

2. Fiscal policy priorities

2.1 Introduction

IBEC to date has been supportive of the front-loaded fiscal consolidation Ireland has undertaken, believing it to be necessary for returning public finances onto a sustainable footing and re-entering the bond markets. Ireland has successfully met all the fiscal targets under the EU-IMF loan programme and in 2012 delivered a deficit of 7.6% of GDP, a full percentage point below the target of 8.6%. For 2013, the April 2013 S tability Programme Update (S PU) projects a deficit of 7.4%, marginally below the target of 7.5%. Looking out to the next two years, the deficit limits set by the European Commission are 5.1% in 2014 and less than 3% in 2015. The planned budgetary adjustment for 2014 is 3.1 billion and 2 billion in 2015. As a result of the wind-up of the Irish Bank Resolution Corporation (IBRC) and restructuring of the promissory notes in February 2013, the general government balance will improve by about 1 billion annually during the years 2014-2016. As a technical assumption, the SPU allocates the saving towards debt repayment, keeping the pace of consolidation unchanged. The SPU therefore projects that these adjustments would deliver a deficit of 4.3% in 2014 and 2.2% in 2015, substantially below the official targets. In fact, Ireland is forecast to be running a primary surplus (the budget balance excluding interest payments) from 2014 onwards.

2.2

Scale of adjustment for 2014

As Table 2.1 shows, the 3.1 billion planned adjustment for 2014 consists of 2.0 billion in expenditure reductions and 1.1 billion in revenue increases. Of these, some 600 million arise from carry-forward measures announced in Budget 2013 but not taking effect until 2014, and some 500 million are new or higher taxes to be introduced in 2014. Table 2.1: Planned consolidation for 2014 and IBEC recommendation
billion Expenditure Current Capital Revenue New measures Carry forward from Budget 2013 Total consolidation Planned 2.0 1.9 0.1 1.1 0.5 0.6 3.1 IBEC recommendation 2.0 1.9 0.1 0.6 0.6 2.6

Source: Ireland Stability Programme Update, April 2013 and IBEC Given the assumptions outlined above, Ireland is now on target to achieve a budget deficit substantially below the official target in 2014. We see merit in delivering a deficit somewhat below target; this would reassure markets of Ireland s commitment to debt sustainability and give some room to manoeuvre in case of adverse shocks such as lower-than-expected global growth. However, at this point we believe some easing of the pace of adjustment is warranted. Fiscal consolidation has inevitably a contractionary impact and Ireland s economy has been able to return to growth over the last years mainly thanks to a strong exporting sector. While the domestic economy showed signs of improvement during the latter half of 2012, the disappointing start to

2013 highlights the fragile nature of the recovery. Government now has the opportunity to ease off the pace of adjustment, while still delivering a deficit below target. At this juncture, Government should abandon the 500 million additional tax measures planned for 2014, reducing the adjustment to 2.6 billion; this would result in a deficit of close to 4.5% of GDP, still substantially below target. The next section outlines the tax burden on the economy in an international and historical context. In summary, the tax take as a share of the economy has returned to pre-recession levels and adding further to the tax burden would damage the fledging economic recovery. The expenditure reductions should progress as planned, given that these are necessary to ensure that the cost-base remains sustainable. It should be noted that Government delivered 300 million greater tax increases than planned in Budget 2013 and this excessive reliance on tax hikes to close the deficit should be redressed in Budget 2014.

2.3

The tax burden on the economy

2.3.1 International context A popular narrative argues that Ireland is a low-tax economy relative to its European peers. The figure usually cited considers the total tax burden1 as a percentage of GDP. Latest comparable data by Eurostat are for 2011, when Ireland s tax burden at 30.4% was lower than the EU-27 average of 40.1%. However, this measure is incomplete in a number of ways. Firstly, it is well established that, owing to the large profit flows of multinational companies located in Ireland, there is a wide gap between GDP and GNP in the Irish case, which is usually not present in other EU countries. Consequently, GNP is often seen as a more appropriate measure of the Irish economy; however, this excludes the ability to tax multinational profits, so when looking at government finances, a best measure likely lies somewhere in-between GDP and GNP. S econdly, total government revenue as measured in official statistics includes social security payments. In most countries benefits received (such as pensions and health care) are paid out of social security payments2. However, Ireland has opted for a largely privatised method of providing many of the benefits covered under social charges in other countries, leading to lower-than-average social contributions recorded in government financial accounts. As a result, total government revenues understate the significant contributions Irish companies make towards social benefits such as pensions and health care. Pension provision and health insurance are two key examples. Many countries operate compulsory occupational pension schemes, where a portion of social security contributions is linked to pensions provision. Ireland, in contrast, has a largely privatised model of occupational pensions, which is not reflected in the official statistics on social security contributions. Nonetheless, this is a significant cost item for many firms; the IBEC 2011 Pensions Report found that 80% of firms that had responded to the questions on pension provision operated a pension scheme, and the average employer contribution was about 15% of salary. Meanwhile, the IBEC 2011 Medical Health Report found that 68% of firms operated a medical health care scheme, with the vast majority of these providing full coverage of insurance premiums (79%) and cover for some combination of dependents/ spouse/ civil partner/co-habiting partner (69%).

The tax burden is defined by the European Commission as taxes on production and imports, taxes on income and wealth, capital taxes and actual and imputed social contributions. 2 Differences among countries exist of course; for instance in Denmark social benefits are almost entirely paid from general taxation and social charges are almost nil.

Given that total government revenue understates the level of social protection provision in Ireland, tax receipts excluding social contributions is a better international measure of the tax burden on the economy. Figure 2.1 shows Ireland s tax burden (as percentage of GDP and GNP) relative to selected EU economies. When measured on GDP, Ireland s tax burden is slightly below the euro area average, but above Germany and the Netherlands. Relative to GNP, Ireland is above the EU-27 average, roughly between the UK and France, but below Finland and Sweden. Figure 2.1: Tax receipts as percentage of GDP - selected EU economies
40.0

35.0 % og GDP

30.0

25.0

20.0 SWE FIN UK IRE (GNP) FRA EU-27 Euro area IRE (GDP) NL GER

Source: Eurostat, IBEC calculations 2.3.2 Historical context International comparisons do not show that Ireland is a low-tax economy, given the economic model it has chosen. A historical comparison can also be useful in assessing where the tax burden in Ireland lies. For this we return to the European Commission s definition, which includes social contributions. While this understates the extent of private sector contributions, it is nonetheless the complete measure of the amount of revenue the government takes from the economy. Figure 2.2: Tax burden as percentage of GDP and GNP Ireland
41.0 39.0 37.0 35.0 33.0 31.0 29.0 27.0 25.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 % of GDP % of GNP

Source: Eurostat, SPU 2013 and IBEC calculations 4

Figure 2.2 shows Ireland s tax burden as percentage of GDP and GNP from 2000 to date; the black dotted lines mark the averages for the period. During the recession the tax burden on the economy fell somewhat, but has increased again from 2011 onwards. As percentage of GDP, the tax burden in 2013 will be marginally below the medium-term average, while measured relative to GNP the tax burden is already higher than the trend line. Given that some 600 million in new and higher taxes have already been pre-announced for 2014, the tax burden will in any case increase further next year.

3. A t a x fr a m e w or k for e con om ic gr ow t h
3.1 Taxation of work
3.1.1 Taxation of employees Ireland s marginal tax rate is currently one of the highest in the EU and at average earnings it is currently the highest of all OECD countries. This is providing a range of challenges for high valueadded businesses in their efforts to attract and retain specialist staff. The problem is particularly acute, but not exclusive, to the mobile multinational sector. When compared internationally the Irish income tax system remains relatively attractive at the lower earnings level but it has become particularly uncompetitive at the higher income level. The high rate of marginal income tax is now an obstacle to business start-up and development in a number of sectors and threatens to undermine Ireland s long established success in attracting FDI. It is therefore essential that no further income tax increases of any type are introduced in Budget 2014. The impact of the higher marginal income tax rates has been most evident in the multinational sector and in those companies which employ foreign domiciled workers. The removal of the remittance basis of taxation in 2006 has made Ireland a particularly unattractive location for such high skilled mobile employees and this situation has been exacerbated by the recent hikes in the marginal income tax burden. The changes made to the S pecial Assignee Relief Programme (S ARP) in Finance Act (2012) were welcome but unfortunately they have not been effective. The difficulty in attracting foreign domiciled mobile employees remains extensive and in particularly mobile sectors such as financial services and technology, the retention of employment and activity in Ireland for Irish and foreign domiciled employees is becoming increasingly challenging. The business community recognises the social, political and equity issues surrounding the preferential income tax treatment for high skilled workers but IBEC believes that the economic and employment rationale for an enhanced S ARP cannot be ignored. In summary3 we recommend that a reformed SARP should involve: Allowing new hires to avail of the relief eligibility to existing employees only is excessively restrictive and doesn t enable employers to address their skills gaps Removing the five year restriction this is unnecessary and has the effect of reducing the scheme s attractiveness and ultimately forcing senior executives to relocate out of Ireland after the five year period Increasing the attractiveness of the scheme in line with such schemes in competitor jurisdictions the current S ARP is simply not competitive in an international context and it must be amended in order to be effective. This should be done by providing an exemption from US C and PRS I for amounts over 100,000 and by reducing further effective income tax rates on relevant earnings in excess of 100,000. In this way the S ARP can be closely targeted at the skills gap challenge and will deliver a higher return on investment. S eparately, the abolishment of the PRS I allowance of 127 per week has amplified an existing kink in the tax system, where an increase in gross pay at certain levels actually results in lower net or takehome income. Previously, someone on 18,400 per annum received 399 less in take-home pay than someone on 18,300 per annum, and had to earn 19,100 before experiencing an improvement in
3

The nature of this submission does not allow a full analysis of the issues but IBEC is happy to engage further on these if required.

net income. Now, the loss is 663 per annum and requires an income of 19,400 to achieve a net increase. This anomaly has a disproportionate impact on people at these income levels and has also had an impact on employers by effectively entirely disincentivising the take-up of overtime work at these income levels. Budget 2014 should correct this anomaly by adjusting the tax system appropriately, while not adding to the administrative complexity for payroll processes. 3.1.2 Employer labour costs The substantial increase in medical insurance premia in recent years has led to sharp increases in labour costs for many Irish employers. Health insurance costs have more than doubled in the space of just five years and increased by 13% in the past year alone. As noted in S ection 2 some 70% of employers operate a health plan for their staff and the vast majority of these carry the full cost. As a result of the recent price increases, many employers are now reviewing this cost item. The sharp increases have also registered very unfavourably from a labour cost perspective in multinational businesses. Public policy changes have contributed significantly to the increase in premia and Government plan to make further changes to the pricing of private beds in public hospitals with further implications for health insurance costs. IBEC believes that this decision should be suspended pending a detailed analysis of the health insurance pricing implications and the resultant impact of the sustainability of schemes for householders and employers.

3.2 Indirect taxes

S ignificant increases in indirect taxes in recent years have undermined the overall price competitiveness gains which Ireland has achieved. VAT rates in Ireland are now amongst the very highest in the EU while excise on alcohol and tobacco is also in the very top rankings. The latest Eurostat figures show that alcohol and tobacco prices are 63% higher than the EU average, predominantly due to higher excise rates. The most recent increase in alcohol excise has also failed to deliver the expected revenue increase and risks contributing to a return to cross border shopping trips motivated by lower alcohol prices in Northern Ireland. Although Ireland has closed the price differential with other EU countries in recent years, the higher cost of doing business and Government taxes mean that average consumer prices remain circa 15% above the EU average. From an overall competiveness and cost of living perspective it is therefore essential that consumer prices do not increase further as a result of excessive indirect tax increases. Specifically IBEC is opposed to: Any increase in VAT rates, which are already exceptionally high, or any broadening of the VAT base Any further increases in excise which would be counterproductive from an Exchequer perspective due to resultant rises in illicit trade or various forms of cross border shopping Discriminatory taxes on certain food and drinks products on a sugar or fat basis Further increases in carbon taxes, which have already exacerbated growing problems in relation to Ireland s relative energy cost competitiveness Discriminatory taxes on food and beverages The Irish food and drink industry is fully committed to playing its role in tackling obesity and has demonstrated it through measures such as product reformulation and enhanced consumer 7

information. Discriminatory taxation of food categories will not resolve the obesity issue and would cost jobs. Academic research into food taxation is inconclusive. However, the experience of countries with discriminatory food taxation, such as Denmark, provides real-world evidence that such taxes are regressive and ineffective in changing diet and lifestyle-related issues. Countries that adopt such taxes, unfortunately, are still experiencing increasing rates of obesity. Denmark has had discriminatory taxes on certain products since the 1930s and still has seen increasing obesity rates. In October 2011, Denmark introduced a further tax on saturated fat levels within products. This tax was shown to damage competitiveness, cost jobs and drive cross-border trading leading to the announcement of its repeal in November 2012. Proposed sugar tax plans were also scrapped. Fiscal measures specifically aimed at altering behaviour are complex to design and can be highly unpredictable. In comparison with our European neighbours, Ireland already has a high tax regime on certain foods including beverages and confectionaries. While the vast majority of foods in this country are zero rated, the standard rate of 23% VAT applies to confectionary items like sweets, chocolate, crisps, ice-cream and soft drinks. For instance, given the proximity to Northern Ireland, consumers would be encouraged to avoid the tax by doing their weekly grocery shopping across the border. Furthermore, the impact would also be highly regressive, with a disproportionate impact on low-income families that spend a higher proportion of income on food. The proposed measure is at odds with the current drive for economic recovery and the growth targets set by Government in Food Harvest 2020. A tax of this nature would give a negative signal internationally, where Ireland s reputation as the food island would be diminished. Mineral oil excise collection The oil excise duty regime in Ireland is outdated and out of line with practice internationally. The industry is significantly disadvantaged by the requirement to pay excise duty before fuel leaves bonded warehouses and prior to the sale or collection of excise from customers. This anomaly has proved increasingly difficult for the largely Irish owned fuel importers and distributors since the onset of the credit crisis. The present system imposes an intolerable strain on the working capital of the oil industry and discourages it from holding stocks a matter counter to Government energy policy. Excise on oil should be collected on a duty deferment basis in line with the collection of carbon tax. This would improve security of supply, reduce the administrative burden on the state, and would mitigate the unsustainable burden on the oil industry and hence on the wider economy.

3.3 Taxation of pensions

3.3.1 Proposed changes to the Standard Fund Threshold The previous reductions in the standard fund threshold (SFT) impacted on a relatively small number of individuals but these were key employees at a senior level. In some cases, Irish operations of multinational groups reported that many of these key employees cited the S FT change as a factor in their decision to relocate out of Ireland. This has led to a strategic and competency loss for these operations and may impact on their future ability to win new investment projects. A further reduction in the S FT would result in an escalation of these difficulties by a substantial factor. Employers which have acknowledged that the previous changes to the S FT impacted on a relatively small number of their employees estimate that the proposed changes would impact on a much larger cohort. The percentage would obviously vary significantly across employers and 8

different sectors, but in some cases it would impact on 10% or more of total employees. S pecialist and senior staff retention problems, which have already become more acute due to the increase in the marginal tax rate, would increase significantly. Increasing numbers of senior staff, particularly, but not exclusively, those with mobility options in multinational organisations, will chose to relocate outside of Ireland. For many employers, a further reduction in the S FT would result in an increase in the administrative complexity of their DB schemes and would significantly increase the negative pressure under which such schemes operate. Given the funding pressure that the majority of schemes are already under, a further S FT reduction could be an additional factor among those already existing factors which are leading to an accelerated closure of schemes. The administrative complexity of bringing a larger number of employees within the S FT net will be a significant cost for business. Employees subject to the S FT will require independent financial and actuary advice and this in most cases will be provided by employers at considerable cost. Likely impact of changes on the Exchequer It is very difficult to accurately estimate how much revenue any change in the S FT threshold will raise for the Exchequer. The Exchequer savings will depend on the behavioural response of employers and employees to the change and this is almost impossible to measure ex-ante. Feedback which IBEC has received from its members suggests that many more companies will close their DB schemes and move to DC schemes in which the aggregate employer and employee contributions are lower. This will ultimately result in lower pension provision and may significantly diminish the additional tax revenue for the Exchequer that this policy initiative anticipates raising, due to lower taxable pension incomes on retirement. In cases where employers and employees cease making contributions to a fund which has reached the SFT, employees will not be fully compensated through other methods of remuneration, thereby lessening any potential additional revenue for the Exchequer. A significant factor in the final cost-benefit assessment for the Exchequer will be the impact on the location decisions of senior employees. A change in the S FT which results in a larger number of senior executives relocating from Ireland will not only result in lower income tax revenues for the Exchequer but will also undermine efforts to attract new investment projects and further job creation. Alternative options IBEC believes that a further reduction in the S FT will not be a costless change and will ultimately result in the loss of some revenue streams for the Exchequer. If Government opts to proceed with a reduction, the following would limit the damage to the overall business environment: In order to ensure equity between all types of pension schemes, the S FT should be reduced to no lower than 1.8 million, exclusive of a tax free lump sum, and this will necessitate the use of an appropriate conversion factor The tax free lump sum of up to 200,000 should be retained with the next 250,000 taxable at the standard rate of tax The SFT should be indexed annually in line with increases in the consumer price index (CPI) Benefits accrued in funds should be grandfathered Early drawdown should be allowed for funds which exceed the S FT at the marginal rate of tax. We believe that this would deliver immediate revenue for the Exchequer and would also provide a stimulus for the domestic economy Under no circumstances should the existing pensions levy be extended beyond 2014, nor should any new levies be introduced in the context of pension scheme insolvency 9

3.3.2 PRSAs Personal Retirement S avings Accounts (PRS As) are a form of pension provision which is of growing importance in Ireland. More than 200,000 people now have PRSAs. IBEC believes that inequitable tax treatment of PRS As when compared to other forms of pension saving operates as a disincentive to PRS A coverage and adequacy. Employees and employers who might otherwise contribute to employees PRS As are dis-incentivised in a number of respects: Age-related contribution limits apply to both employer and employee contributions to PRSAs. Other types of pension provision do not have such limits on employer contributions Employer contributions to PRS As are treated as benefits-in-kind to the employee, albeit that certain tax reliefs apply. This means that employer contributions may result in income tax and Universal S ocial Charge being paid by the employee on contributions made by the employer if the total contributions exceed certain thresholds The tax treatment of lump sums which may be drawn down by PRS A-holders on retirement is significantly worse than the treatment of lump sums drawn by other pension savers IBEC recommends that these anomalies should be addressed in Budget 2014 and contributions to PRSAs should be provided the same tax relief as other forms of pension savings.

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4. Supporting the recovery

4.1 Introduction
Recent international reviews of global macroeconomic policy since the start of the Great Recession acknowledge that many Governments have delivered excessive austerity in recent years and have failed to sufficiently support growth and employment. In Ireland s case, Government simply did not have any choice but in the post-bailout period it will indeed have greater flexibility. It is essential therefore that Budget 2014 delivers appropriate stimulus measures for the economy. In the first case, IBEC believes that it should retain those measures which have been proven to work effectively such as the Jobs Initiative package. It should also target the construction sector which is labour intensive and is likely to produce a positive return on any Exchequer investment.

4.2 Jobs Initiative Measures

As part of the Jobs Initiative announced in May 2011, a new 9% rate of VAT on selected categories of largely hospitality goods and services was introduced for a temporary period running from July 2011 to December 2013. The measure was originally estimated to cost 350 million in a full year. As part of the same package the government halved the lower rate of PRS I until end-2013 on jobs that pay up to 356 per week. The gross cost of this to the Exchequer was estimated to be in the region of 190 million for a full year. These two schemes were funded from a levy on private pension funds which is due to expire in 2014. In Annex 1 we present a detailed analysis of the employment and Exchequer impact of these measures. The analysis shows that: The measures have been very successful and have delivered strong employment gains and retention and a substantial direct and indirect buoyancy for the Exchequer The total number of jobs created or retained directly by the measures, over the 18 months since they have been enacted, is 25,000. These jobs have supported a total of 35,000 jobs directly and indirectly in the Irish economy. The direct annual Exchequer gain from the employment benefit alone is circa 380 million In addition to the employment benefits, there has been significant revenue buoyancy arising from higher Irish consumer and visitor spending in both the sectors directly affected by the VAT reduction and in other retail sectors Vulnerable employment in non-hospitality related sectors such as manufacturing also benefited significantly from the lower employer PRS I rate. Many employers engaged in very cost competitive export businesses continue to struggle due to energy, labour and exchange rate competitiveness factors. The reduced employer PRS I charge has allowed these businesses to regain some competiveness and to retain vulnerable employment We estimate the total net gain to the Exchequer from the measures at between 40 and 140 million annually It is clear that the Jobs Initiative measures have been effective and have resulted in strong employment and Exchequer gains and supported tourism, the wider hospitality sector and important market sectors such as international conferences. The economy remains far too fragile for these measures to be removed and we recommend that they are retained in their current form. Failure to retain the measures would result in employment and Exchequer losses and would also undermine Government s budget deficit target. 11

4.3 Tax support for home improvements

The informal economy, estimated at some 21 billion, represents a drag on the economy in terms of lost tax revenues to government and unfair competition against legal operators. Given that construction employment has fallen by over 60% from peak, it is likely that a significant proportion of informal activity is related to this sector. International experience has shown that fiscal incentives for home improvement works would bring existing activity into the formal economy by making it tax compliant. This type of policy also acts as an effective domestic stimulus by increasing spending and employment. The cost will be offset by increased tax buoyancy from the additional spending and by bringing more activity into the tax system. In this way the incentive would be revenue positive for the Exchequer. Our analysis of a proposed scheme indicates a net Exchequer benefit of between 40 and 80 million annually4. Home renovation schemes were introduced in many countries in recent years with evidence showing the schemes succeeding in boosting expenditure and formalising parts of the black economy. Annex 2 presents an overview of schemes operated in Canada, Italy, Finland, Denmark, France and the UK. IBEC believes that there is now extensive international evidence that schemes of this nature are effective. Given the high level of unemployment amongst construction workers and the elevated rate of household savings, such a scheme would be particularly impactful in the current Irish context. Government should introduce a home improvement tax credit or grant for a period of three years. This should involve a refundable tax credit or grant of 20% of approved home improvement between the value of 2,000 and 20,000, carried out by tax-compliant contractors.

Introduction of a home renovation tax credit. IBEC Policy Brief 1/2013 (see www.ibec.ie/economics)

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5. Incentivising Investment
5.1 Review of the R&D tax credit scheme

IBEC undertook extensive research on the R&D tax credit scheme in spring 2013 in response to the Department of Finance review of the scheme5. Our research demonstrated substantial economic benefit from the scheme and identified the following changes which would enhance the overall effectiveness of the scheme: 1. Introduce measures to remove uncertainty: the current uncertainty surrounding the retention of the credit benefit under audit is damaging the reputation of the scheme. The issue can be addressed by: a. Establishing a structured process (similar to the clearing house model used in other policy areas) whereby Revenue, policy, industry and advisor professionals can address difficulties with the scheme and establish clarity on areas of uncertainty b. Set up a streamlined technical appeals process c. Ensure greater consistency on R&D definitional issues between grants and other S FI policy and the eligibility criteria used in technical assessments of R&D claims by Revenue appointed external experts. Improved guidance is needed for technical experts and S FI should have a role in ensuring that this guidance is consistent with wider innovation policy d. Reduce the current audit period of four years 25% of companies surveyed identified this as their most important priority for change e. In order to ensure that there is greater clarity and consistency in communication from Revenue officials to industry it should establish a central specialist unit of scheme experts. The current model of non-specialist advice at a district level results in a lack of consistency in rulings and guidance to industry 2. Facilitate greater use of agency/ contract staff: the use of on-site agency / contract staff should not be subject to the current outsourcing cap and all such expenditure should be eligible for the credit 3. Introduce an innovative solution for the base year problem: the retention of the arbitrary base year remains a barrier to R&D activity and disadvantages some companies competing internationally for mobile projects. Our research has demonstrated the net economic benefits of the credit and addressing the base year issue will increase these net benefits. We recommend that some flexibility is required in the base year application through either: a. allowing companies the flexibility to choose their base period from a number of years i.e. 2003 to 2005 or to use their average annual R&D spend over the 2003 to 2005 period b. allowing companies to reduce their eligible base year spend by a certain percentage and offsetting the cost to the Exchequer by reducing the value of credit by a corresponding percentage i.e. a firm with a high base year spend might opt to reduce it by 50% and accept a credit value of 12.5% rather 25%. In this way additionality is encouraged and R&D activity would be more likely to increase at a very modest cost to the Exchequer 4. Launch a credit lite model for SMEs: despite good progress in recent years, many S MEs are not engaging with the credit due to its complexity and administrative requirements. We recommend that a streamlined or credit lite model should be developed for S MEs which would include the use of pro-forma templates for R&D project management, recording R&D activity and calculation of eligible costs and revenue benefit associated with the credit.
5

IBEC submission to the Department of Finance review of the R&D tax credit scheme (see www.ibec.ie/economics)

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S imple on-line calculators demonstrating the benefit and eligibility rules of the credit would be a useful resource for S MEs and would also greatly improve awareness and promotion of the scheme. Our survey identified that about 30% of companies would like to see a simplification of the calculation of the credit 5. Improve the key employee element: this aspect of the scheme is currently not fit for purpose and could be enhanced by: a. Reducing the audit period for the scheme so that remuneration awarded to staff would not be subject to an audit claw-back for a four year period b. Allowing firms to allocate the credit in a tax efficient manner on a team based approach rather than just to key employees c. Introduce a lower R&D time activity threshold for S MEs the current 50% requirement remains too high for smaller firms.

5.2

Access to funding

5.2.1 SME access to credit In a recent IMF working paper Abiad et al (2011) note that so-called creditless recoveries, characterised by continuing declines or stagnation in lending, are more common after banking crises and credit booms these are exactly the conditions from which Ireland is emerging. Lack of credit has important consequences for economic performance and average growth in a creditless recovery is typically a third lower than under normal credit conditions. Access to credit is therefore one of the fundamental conditions that must be in place if Ireland is to realise its growth potential. Restricted access to credit is likely to be faced by S MEs and start-up companies in particular; larger corporations, both indigenous and foreign-owned, are not as reliant on domestic Irish financial markets for investment credit. Policy makers in Ireland are well aware of the risks that the prospect of a creditless recovery poses and a number of measures have been put in place over the recent years to ease SME and start-up access to credit. The most substantial of these are: Pillar bank SME new lending targets 4 billion in 2013 S ME credit guarantee scheme operational from October 2012 targeting an additional 150 million in lending per year SME funds by the NRPF - 850 million together with private investment finance. Despite these measures, credit constraints remain a real and tangible problem for Irish firms. Analysing ECB data, O Toole et al (2013) find that one in nine Irish firms are credit constrained and that the percentage of firms reporting access to finance as being a problem rose from 15% in 20092011 to 24% in the period October 2012-March 2013. Two aspects stand out. Firstly, as the recovery in the economy is taking hold, access to credit is becoming more problematic. To date, demand for credit has been relatively weak, owing to deleveraging, perceived lack of investment opportunities and risk aversion, and this, alongside credit rationing, has contributed to declining lending. However, in a recovery phase, access to financing is likely to become a constraining factor unless the supply of credit expands in tandem with increasing demand. S econdly, the paper explicitly does not take account of cost of credit and therefore the findings may understate the extent to which access to credit remains problematic. The cost of credit in Ireland remains above what might be considered normal and is certainly higher than in other euro area countries; table 5.1 below shows the differential between the cost of credit for new business and 14

consumer loans in Ireland and in the euro area. A high cost of capital will lead to underinvestment and abandonment of productive ventures as rates of return would need to be exceptionally high in order to make projects viable. Table 5.1: Cost of credit in Ireland and the euro area New loans March 2013 (annualised agreed rate) Households Lending for house purchase Consumer credit, maturity > 1 year Non-financial corporations Source: ECB 5.2.2 State- backed enterprise/investment bank IBEC has previously identified that a state-backed enterprise or investment bank could usefully fill the gap in the market that exists in financing growth-oriented smaller enterprises and start-up companies. The model of a state-backed enterprise/ investment bank is an established one, used in Canada, the US and Germany to mention a few examples, has been recently launched in France and is under development in the UK. An enterprise/ investment bank would provide the certainty of source needed to fund growing and high potential businesses and would act as a catalyst to leverage funding from other equity and debt sources. Investments should be made efficiently without huge friction cost by using information already available from existing state agencies and the banking network. Maturity > 1 year

Germany Ireland 2.81 6.32 2.89 3.36 10.14 5.47

Euro area 3.14 6.74 3.44

5.3

Supporting entrepreneurial investment

Table 5.2 shows the sharp increase in the capital gains tax (CGT) and capital acquisitions tax (CAT) rates over the last few years. The rate has increased from 20% in 2008 to the current 33%, effective from December 2012 this represents a 65% increase in the tax rate over a mere four-year period. This headline rate is now amongst the highest in developed economies. Germany charges a GCT rate of 25% on individuals; the UK 28%; S weden 30%; and France 34.5%6. However, those countries with the highest rates typically also have incentive schemes with lower rates and/ or certain exemptions in place in order to support entrepreneurial investment. These types of reliefs are currently absent in Ireland and it is clear that the rapid increase of the headline rate has not been coupled with any structural reform of the taxation regime. As a consequence capital gains taxation in Ireland is no longer supportive of productive investments by domestic, indigenous entrepreneurs and should be reformed. This would be in line with practice in other jurisdictions with similarly high capital gains tax rates, including the UK and most recently France, where President Hollande has introduced an ambitious reform package. Table 5.2: Capital gains tax rates in Ireland
Applied until Tax rate Oct 2008 20% April 2009 22% Dec 2011 25% Dec 2012 30% Current 33%

Source: Revenue
6

KPMG Individual Income Tax and Social Security Charge Survey 2012

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5.3.1 Ent r e pr e ne ur s reinvestment relief The UK capital gains taxation regime contains two mains schemes which aim to support entrepreneurship and productive investments. The first of these is entrepreneurs relief, introduced in 2008, which reduces the CGT charge on qualifying business asset disposals, including business premises and goodwill. The relief is available for individuals and is subject to a one-year qualifying period with associated conditions depending on precisely the type of asset disposal in question. Upon introduction, the reduced CGT rate was 18%, but this was reduced to 10% in June 2010. The initial lifetime cap was 1 million, but this has been gradually increased to the current limit of 10 million, effective of April 2011. A second type of relief in the UK is business asset rollover relief, a deferral of CGT on the sale of old assets in conjunction with a re-investment in certain types of new assets. Rollover relief was abolished in Ireland in 2002; while a full reintroduction may not be possible in the current climate, the principle of providing relief for reinvestment of asset disposal proceeds could nonetheless inform a reform of the Irish capital gains tax regime. Recommendations for Ireland: As a first step, the Government should commit to not increasing the CGT and CAT tax rates further, or reducing the CAT threshold. The UK experience in providing targeted CGT relief for trading enterprises should guide more fundamental reform. Taking account of the constraints on the Exchequer, Government should introduce an entrepreneurs reinvestment relief. The relief should target trading enterprises where the proceeds of an asset disposal are reinvested in another (new) trading business. 5.3.2 Employment and Investment Incentive Scheme Uptake of the Employment and Investment Incentive S cheme (EIIS ), which replaced the Business Expansion S cheme (BES ) in 2011, has to date disappointed. This is due to three main reasons: poor awareness and lack of promotion; an overly restrictive nature; and a challenging investment climate. Finance Bill 2013 committed that the scheme would be extended to 2020, which is welcome; however, the scheme should be enhanced to improve its effectiveness. This is particularly urgent as the economy is beginning to recover but S ME access to credit remains constrained, a situation which may lead to subpar growth in the medium term. IBEC therefore recommends that the following steps should be taken to improve the EIIS to ensure it works effectively in channelling capital to indigenous SMEs with bright growth prospects. Rebranding and communications: Traditional investors in BES / EIIS have been affected strongly by the downturn and the scheme would benefit if the target group was broadened to include non-traditional and household investors, which to date have tended to overinvest in the housing sector. However, these investors are likely to have difficulties in finding suitable information and advice on investing in SMEs. In the first instance the scheme should be rebranded to make its purpose clear investing in Irish S MEs. S econdly, the rebranded scheme would benefit from greater marketing and promotion to help smaller investors become aware of the opportunity. Risk mitigations: Non-traditional investors have a different risk profile to the typical cohort of seasoned BES / IEES investors and are currently not sufficiently encouraged to make investments in SMEs due to relatively low value returns and relatively high investment risk. A number of methods, including guarantees against a proportion of losses have been successfully used to promote investment schemes similar to the EIIS in other countries. The Netherlands and Austria have introduced such guarantees aimed at mitigating risk and attracting capital. Relax the restrictive nature: Relief for individual investors should not be treated as a specified relief under the high earners restriction and the EIIS should be removed from the 16

list of specified reliefs for high earners. Investors should also receive the full value of the tax relief upfront. This type of tax relief is available under similar UK schemes and is perceived as more valuable and is likely to encourage further investment. 5.3.3 Entrepreneurs and insolvency The Personal Insolvency Act 2012 represents a significant improvement in Ireland s regime for dealing with over-indebtedness. Nonetheless, a few areas of concern remain; these should be addressed in order to ensure that the aims of the act are fully realised. Under the current provisions, tax and commercial rates debts are excludable, meaning that they may remain outside of any debt arrangements, but may also be written down with the consent of the Revenue or the local authority. To ensure that debtors do not remain constrained by legacy debts owing to the S tate, the Government at all levels should play its fair and proportionate part in any debt arrangements where it is a creditor. While pension funds are by and large excluded under the act, the same provision does not extend to approved retirement funds (ARFs), which, owing to their flexibility, have been particularly popular with self-employed people. To ensure equitable treatment under the insolvency arrangements, ARFs should be afforded the same level of protection as other pension schemes.

5.4 Investment in education

A sustainable economic recovery will depend on a world class education and training system. This does not suggest that education and training can be exempted from the consequences of the need for on-going fiscal adjustment. It does mean, however, that we should avoid damaging cuts to budgets, and regard education as the most important investment block for our future growth. A number of key reforms such as the literacy and numeracy strategy, junior cycle reform and the rollout of project maths are under way in the school system. It is critical that they receive adequate resources to ensure effective implementation. While welcome, the recently announced plan to reorganise the country s higher education sector will flounder in the face of ongoing funding cuts. We have reached a tipping point in terms of the impact of these cuts on quality. Government should put in place an effective student fees and loan system to underpin the sustainability of a high-quality higher education system. The introduction of competitive-tender based funding programmes to support upskilling, such as Momentum and S pringboard, have been a successful innovation over the last three years. Preliminary evaluations indicate that the courses made available through these mechanisms are close to labour market requirements and should result in positive employment outcomes. This model should be retained and, if possible, expanded. S imilarly, there has been a high level of interest among both interns and host organisations in the JobBridge internship scheme. Evidence suggests that the scheme has delivered positive outcomes in terms of employment progression. Given that some labour market programmes in the past resulted in insignificant or even negative impacts on employment probabilities, the Government should continue to promote the scheme and match the number of places available to demand.

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5.5 Tackling high electricity costs

Exchequer support to mitigate the competitiveness impact of high industrial electricity prices Recently published Eurostat data for the second half of 2012 illustrate the sharp increase in electricity costs since 2010. Ireland is amongst one of the highest cost countries in the EU and prices (and the annual rate of price increases) are well above the EU average. With the prospect of further increases on the horizon, the competitiveness of energy-intensive manufacturing firms is increasingly under threat. This serves as a significant challenge not only to the ability to create highquality jobs but also to retain current employment levels in sectors subject to international cost competition. The all-island wholesale electricity market is designed to be transparent and cost-reflective; however some of the final costs incurred by households and businesses are directly attributable to Ireland s obligation to comply with EU-mandated national targets on energy and greenhouse gas emissions. Figure 5.1: EU electricity prices for industrial users, July-December 2012
0.25 0.20 0.15 0.10 0.05 0.00
BA FI BG SE FR EE RO NO HR SI TR PL NL DK LU CZ HU BE AT LV LT PT EU- ES UK EL EA SK DE IE MT IT CY 27

HT

Other non recoverable taxes

Source: Eurostat Proposal for consideration IBEC recommends the development of a financial instrument, to be administered by EirGrid or the CER, to mitigate the impact of high electricity costs on firms facing international competitiveness pressures at times when Irish electricity costs are higher than the EU average. A portion of Ireland s carbon tax revenue could be set aside each year, to be dispersed amongst energy-intensive manufacturing firms. The Revenue Commissioners reported the collection of 298 million in carbon tax in 2011. We envisage that up to one-quarter of this would need to be ring-fenced going forward. The proportion of this money disbursed in each year could be varied at the discretion of the CER, depending on the amount (in cents per kWh) by which Irish industrial electricity prices exceed the published EU average. Proposal for qualification criteria The default criteria for firm eligibility should be the same as that previously applied by EirGrid to the Large Energy User Rebate in 2011. However, Government could also explore possible alternative criteria, provided that this did not delay implementation.

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An n e x 1 measures

An a lysis

of

Jobs

I nit ia t ive

The impact of changes in the VAT and PRSI regimes on employment As part of the Jobs Initiative announced in May 2011, a new 9% rate of VAT on selected categories of consumer goods and services was introduced for a temporary period running from July 2011 to December 2013. The measure was originally estimated to cost 350 million in a full year. As part of the same package the government halved the lower rate of PRS I until end-2013 on jobs that pay up to 356 per week. The gross cost of this to the Exchequer was estimated to be in the region of 190 million for a full year. These two schemes were funded from a levy on private pension funds. In November 2012 the Department of Finance produced a report on the effects of the lower rate of VAT on the economy, during its first six months. The findings of this report state that the lower rate of VAT had provided an employment stimulus in the targeted sectors, resulting in both the retention and creation of jobs. The original report by the Department of Finance used employment data from the accommodation and food services sector in the Quarterly National Household S urvey (QNHS) as a proxy for the effect of the change in VAT on employment. The reason for this is that the accommodation and food sector is the only sector in which a majority of firms would be affected by the VAT cut. Goods and services from this sector account for more than 70% of the value of the total VAT cut. Thus the accommodation and food sector is the most reasonable proxy for the impact of the VAT cut on employment. In addition, the report found significant evidence of price pass through to customers across the products involved using data from the CS O s consumer price index. We extended this analysis to cover the impact of the PRS I cut, and take account of the first 18 months of the Jobs Initiative package. From this we argue for the retention of the lower rate of VAT at 9% and the lower rate of employer PRSI at 4.25%. Effect on employment of Jobs Initiative measures When comparing employment in the accommodation and food services sector with general labour market trends since the introduction of the Jobs Initiative package the comparison is favourable. Figure A1.1 shows that the steep incline in employment in the accommodation and food sector coincides with the introduction of the Jobs Initiative. Figure A1.1: Private sector employment Q4 2009 Q4 2012
135 130 125 120 115 110 105 100 Q4 09 Q2 10 Q4 10 Q2 11 Q4 11 Q2 12 Q4 12 975 950 Accommodation and food Other private sector 1,025 1,000 1,075 1,050

Source: Central Statistics Office 19

In the period since the change in VAT and PRS I regimes the accommodation and food sector has added 4,700 jobs while other private sector industries employed 3,600 less. This of course does not take into account the number of jobs which have been retained due to the scheme. To do this we calculate an implied employment number for the sector in the absence of the Jobs Initiative. This is done by adjusting employment in the industry from Q3 2011 onward using the average quarterly trend over the six quarters before Q3 2011. We also control for the underlying quarterly trend in general private sector employment. This is done by multiplying the employment numbers at Q3 2011 by the previous trend plus or minus the actual underlying private sector trend. Under this counterfactual scenario, where we assume the accommodation and food sector would continue on as it was while adjusting for overall changes in private sector labour market trends, employment in the sector would now be 102,800, a full 17,000 fewer than actual employment. In the alternative counterfactual scenario where employment in the sector bucked its trend and followed the overall private sector trend, employment would now be 114,000, or around 5,000 below the actual level. This is the less likely of the two counterfactual scenarios given that over the previous 18 months the sector was losing jobs nearly three times faster than the overall private sector. Figure A1.2: Actual and counterfactual employment

125 120 115 110 105 100 2011Q2 Actual 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 Adjusted sectoral trend Overall private sector trend

Source: Central Statistics Office and IBEC calculations It is clear the jobs initiative has had a strong effect and has led to accommodation and food services employment gaining from a large turnaround at a time when consumer spending remains weak. By advancing a reasonable counterfactual scenario where we control for the underlying economic trends we find that the Jobs Initiative has led to the employment or retention of about 17,000 more people than would have been employed without it. These figures represent the effect for the accommodation and food services sector alone. Lack of data at the level of detail required means we cannot give a full total estimate across all sectors, although given that this sector accounts for 70% of the value of the VAT cut it is likely the number of jobs supported by the VAT cut is in the region of 25,000. Moreover, firms in sectors such as manufacturing and non-tourism related household services (such as domestic cleaning) have been able to maintain and add jobs as a result of the 20

reduced lower rate of PRS I, so the economy-wide number of jobs created and sustained may be higher than our estimate of 25,000. The creation and retention of 25,000 jobs within the economy affects employment figures not only directly but also indirectly. Every job retained or created within the sector supports other jobs in suppliers and other domestic firms. Employment multipliers show the ratio of direct plus indirect employment changes to the direct employment change. Given the lack of recent employment multipliers for the Irish accommodation and food sector we use 2009 employment multipliers for the comparable S cottish sector which indicate that for every 100 jobs created or retained directly in the accommodation and food services sector, another 40 are supported indirectly. This means the 25,000 jobs created or retained in the sector by Jobs initiative are supporting approximately 10,000 in the domestic economy. This means a total of 35,000 jobs have been directly or indirectly supported by the jobs initiative over an 18-month period. Impact on the Exchequer The Department of Finance initially estimated that the VAT and employer PRSI reductions would cost the Exchequer in the region of 540 million per annum. Given that we estimate that 35,000 jobs have been supported and created directly or indirectly because of the VAT and PRS I changes over an 18-month period, this translates to an annual equivalent of 23,000 jobs. The CS O s earnings database EHECS shows weighted average weekly earnings, in the sectors affected by the changes, between Q3 2011 and Q1 2013 was 3757. Taking an average single person this would equate to tax payable of 2,064 during a year (including PRS I, income tax and the US C). Data from the CS Os Household Budget S urvey shows that the average household with the head of that household unemployed receives 12,853 per annum more in social transfers than those not in employment. S umming these two figures we estimate the net benefit to the state of employing one person in the accommodation and food services sector is roughly 14,917 per annum. This would mean the VAT and PRS I changes save the state 343 million per annum in welfare transfers and taxes alone. Employer PRS I contribution per employee add another 38 million to this, giving a direct positive Exchequer flow of over 380 million annually. In addition to the employment-related benefits of the measures, the Exchequer has also benefited from increased VAT receipts arising from higher spending and activity in the hospitality-related sectors. Tourists also contribute to spending to other sectors of the economy during the trip to Ireland, hence supporting further employment in industries such as retail and also boosting the Exchequer VAT receipts in that sector. The VAT reduction also resulted in Irish consumers spending more in the hospitality and related sectors than would otherwise have been the case, thus creating an overall buoyancy factor to offset the initial cost of the VAT and PRS I reductions. We estimate this buoyancy factor from visitors and Irish consumers to be in the region of 200 to 300 million annually, thus yielding an overall net gain to the Exchequer from the measures of at least 40 to 140 million. Pass-through of VAT change Figure A1.3 shows the VAT pass-through to customers in the 12 months after the introduction of the lower rate of VAT8. From figure A1.4 we can see that as the general level of prices was rising, prices in the 9% VAT sectors were on a downward trend signifying the VAT pass-through to customers in the form of lower prices.

Sectors were weighted as accommodation and food services (70) and wholesale and retail (30) as a proxy for the non-hospitality sectors. 8 Index for the 9% VAT categories was kindly provided by the CSO by special request.

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Figure A1.3: CPI of 9% VAT rate items and overall trend

103 102 101 100 99 98 97 96 95 94 93 2011M06 2011M09 2011M12 2012M03 2012M06 2012M09 All items 2012M12 2013M03

9% VAT Total items

As some of these sectors are heavily seasonal figure A1.4 shows some pass through to the consumer as prices fall on a year-on-year basis. Figure A1.4: VAT pass-through (y-on-y % change)
4 3 2 1 0 -1 -2 -3 2011M05

2011M09

2012M01

2012M05

2012M09 All items

2013M01

9% VAT Total items

While the overall level of prices in the economy increased in the 12 months subsequent to the introduction of the lower rate of VAT, prices in the hospitality sector fell significantly on a year-onyear basis. This was particularly true in the accommodation sector and was also in other sectors such as sports activities, cinema and hairdressing. 22

Conclusion From this analysis we can see that the changes to the VAT and PRS I regimes complemented each other in having a substantial impact on both employment and consumer prices. The sectors in which the regime has had the greatest impact are at the same time dynamic industries in terms of job creation and fragile due to exposure to external competitiveness and domestic disposable incomes. The original Department of Finance analysis of the 9% VAT rate explains the reasoning behind the original initiative: The reduction is consistent with the economic literature which suggests that the price elasticity of demand for tourism related goods is relatively elastic. This means that consumer demand increases by proportionately more than the percentage reduction in prices in the tourism sector. It was hoped that this demand side stimulus would increase the demand for jobs in the sector through consumer responses to lower prices and by sustaining employer margins. We have provided evidence here that the Initiative achieved its aim in providing a demand side stimulus while also providing an employment incentive in the form of lower employer PRSI. Together these measures are supporting a large number of jobs and creating affordable consumer goods in a sector which is important both domestically and in attracting tourism to the state. It must be noted, however, that the excerpt from the Department s report also comes with an implicit downside risk. The target goods and sectors were affected so positively by the VAT cut because they have relatively elastic price elasticity of demand (PED). Therefore it can be expected that a return to the higher rate of VAT for these industries will have the opposite and negative effect, damaging tourism, consumer prices and employment. In the same way, a return to the higher rate of PRS I may see employers who operate in a fragile domestic economy unable to afford current or additional employees. Firms, particularly in the industries targeted by this package, are operating with very tight margins in an economy which has suffered a large contraction in domestic demand. Placing additional employment related tax burdens on these employers at this stage of the recovery would result in detrimental effects for employment. For these reasons it is imperative that the VAT and PRS I sections of the jobs initiative be retained even in the absence of the pension levy which funded them. This is something which current fiscal space may allow and which would support sectors which are creating thousands of jobs.

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An n e x 2 I n t e r n a t ion a l r e vie w improvement tax incentives

of

h om e

Canada Type: Tax credit (refund), ran originally for a 12 months period and has since been extended. Benefits: 15% tax credit for expenses greater than $1,000. Spend up to $10,000 covered so max is $1,350 Eligibility: Personal use property, family based (one per family). Enduring nature and integral to the dwelling. Expenditures include building materials, labour, equipment rentals, and the cost of permits Examples included are - A kitchen or bathroom, new flooring, decks, retaining walls, a new furnace, water heater, or painting the exterior or interior of the house. Expenditures that cannot be claimed include normal repairs, carpet cleaning, furniture or appliances, financing costs, or tools that retain a value after the renovation. Cost: $3 billion in tax relief to an estimated 4.6 million households. In the Canadian governments sixth report on Canada s economics action plan It was estimated that renovation activity was boosted by $4.3 billion over January 2009 to January 2010 due to the presence of the tax credit, which represents a 0.3% boost to real GDP (Government of Canada, 2011).

Italy Type: Tax deduction of costs Benefits: 36% tax deduction of the costs incurred for maintenance, refurbishment and renovations on houses or other common parts of residential buildings. It is a tax deduction and not a reimbursement, each taxpayer is entitled to deduct from taxes this percentage in a certain number of annual payments. 10 years if the age of the taxpayer is less than 75 years 5 years if the age of the taxpayer is between 75 and 80 years 3 years if the age of taxpayer is more than 80 years This has been extended to 50% for one year from June 2012. Eligibility: Owner or tenant, borrower, family member of the owner The maximum amount of expenditure on which you apply the tax deduction is 48,000 per housing unit coming off your income tax bill. Extended to 96,000 for the costs incurred from June 2012 to June 2013 Cost: The number of taxpayers who have renovated a building using the tax relief has been steadily increasing, from 240,413 of the first year (1998) to 402,811 in 2009.

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Finland Type: Tax refund Benefits: 60% of the money paid out, including value-added tax (VAT), is refundable if the party performing the work is a company or small entrepreneur registered for the prepayment of income tax. Overall, 30% of the total costs incurred for hiring an employee are eligible for a tax refund, including the employee s wages and social security costs. Eligibility: The maximum tax refund that each person can receive is 3,000 a year. Impact: Finnish government evaluations in 2003 and 2004 suggested very positive results. In 2003, about 8,000 jobs were covered by the tax deduction - about half of these were estimated to have been additional. An evaluation for 2004 estimates that the employment impact was about 12,000 jobs, some 40% of which were net new jobs. The tax credit helped create a market for home cleaning services and 40% of cleaning jobs created were filled by unemployed people. The jobs created were market-based, durable and did not displace other work. It is estimated that the share of informal economy activity in home services fell from 60% to 25%. The scheme has been continued in successive budgets.

Denmark Type: Subsidy Benefits: Ran from 1991 1995. The subsidy covered 40% of wage costs and profits. However, materials to carry out repair work in the home were not subsidised. The maximum subsidy was set at 939 per household; this subsequently increased to a maximum threshold of 1,342. Total expenditure as a result of this subsidy amounted to 711 million. Eligibility: This scheme is a wage and profits cost subsidy. All residents in Denmark could use the scheme in order to lower the costs of wages in connection with energy-saving improvements to homes such as fitting new windows or solar energy systems water-saving improvements, as well as improvements to roofs, walls, windows, bathrooms, toilets, kitchens and electric installations. The subsidy was only paid with respect to wage costs and profits; materials to complete these works were not subsidised. The subsidy was paid directly to the household.

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France Type: Reduced VAT Benefits: The rate is 7%, as opposed to the normal rate of 19.60%. This rate applies from 1st January 2012, having been increased from the previously reduced rate of 5.5%. Eligibility: applies for works concerned with the improvement, conversion, and repair of a residential property. All routine repair and maintenance work to the property is eligible for the reduced rate as are works of renovation or improvement. The reduced rate is also available for an increase in the size of existing property, provided it does not increase the net surface area by more than 10%. However, an increase in the height of an existing property is not eligible. Neither are balconies, loggias, a veranda, open parking area or a terrace. Must be done by a registered building professional. UK Green Deal Type: Grants Benefits: 3,500 ( 3,900) per household for home efficiency measures Eligibility: Enabled private firms to offer consumers energy efficiency improvements to their homes and businesses at no upfront cost, and recoup payments through a charge in instalments on their energy bills.

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