Government should put some of the corporate tax windfall into a rainy day fund – The Irish Times

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When large reserves of natural gas were discovered in the Netherlands in the 1970s, it boosted government revenue, funding the “good times” without the pain of taxation. However, it brought its own economic, social and environmental problems. These gave rise to the term “Dutch disease” to describe the economic challenges of a boom based on the exploitation of natural resources – as these resources are usually limited, these booms are essentially temporary.

Natural resources such as oil or gas eventually run out. In the meantime, as the flow of money from gas or oil accumulates, it adds to the demand in an economy. If there is an independent exchange rate, there is appreciation of the currency. Once this economy reaches full employment, the increase in demand leads to higher inflation.

The combination of inflation and a stronger currency is in turn causing the closure of many traditional businesses that cannot bear the loss of competitiveness. It is not a major problem if the personnel concerned are already leaving for higher paying jobs in the natural resource-based economy. However, the end result is an economy clinging to natural resource revenues.

It does not matter as long as the flow of income from the exploitation of gas or oil continues. However, once it starts to falter, the problems set in. Traditional businesses, which traded successfully before the boom, are no longer there to pick up the growing slack. It is easy to close a business but much more difficult to revive it.

The field of economics that studies how to manage these temporary booms was led from the 1980s by the late Professor Peter Neary of UCD. This work shows the economic recipe for avoiding this cycle of boom and bust. Instead of immediately spending the proceeds of a resource boom, it is wiser to invest the income offshore, which eases demand pressures and exchange rate pressures. When boom revenues begin to dry up, a country can then live on the income from its foreign investments.

Norway is a very good example of how to deal with success issues. While he has used some of the oil revenue to improve the already high standard of living, his sovereign wealth fund has accumulated huge investments abroad. By reducing upward pressure on the exchange rate, it has allowed traditional businesses to continue to succeed in export markets. All of this will ensure a soft landing as oil revenues decline over the next few decades.

However, many other resource-rich economies have not shown the same wisdom. Russia is an example where oil and gas wealth has had a serious negative impact on normal domestic affairs. If Europe manages to shut off much of Russia’s fossil fuel revenue stream in the coming months, the Russian economy will have little to fall back on. Its oil boom prevented the development of normal export businesses. Having become dependent on oil revenues, it is very difficult to return to a more normal economy.

American multinationals

Ireland is also currently benefiting from temporary windfall revenues, not from natural resources, but from possibly time-limited tax revenues from US multinationals that have located intellectual property here. The recent report by the Irish Fiscal Advisory Council (IFAC) highlighted the danger that the Republic could suffer from early-stage ‘Dutch Disease’ due to booming corporate tax revenues. The council pointed out that, like the depletion of oil and gas revenues, between 6 and 9 billion euros in tax revenues could disappear quite quickly if US tax policy changes. If the government continues to spend these revenues, it will maintain the good times as long as the revenues last, but a consequence would be that some traditional exporting companies would lose their competitiveness and close their doors. If tax revenues then disappeared, we would have a major problem, both for employment and for the sustainability of public services.

It looks like the government could run a surplus this year and Ministry of Finance projections suggest a growing surplus through 2025. As IFAC suggests, the obvious solution is for the government to invest windfall revenues in a fund. If the revenue continues, the government could safely spend the revenue from this investment fund as it is built. However, if income suddenly stopped, the fund would help ensure a smooth transition to a more normal world.

This is the right strategy to adopt. However, the temptation to buy popularity by spending revenues will increase as the next general election approaches.

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