John FitzGerald: Tech downturn could pose a serious threat to the exchequer

One of the key factors in the relative resilience of the Irish economy during the financial crisis was the presence of a substantial high-tech sector, principally information technology and pharmaceuticals. Demand for these goods and services continued to grow during the serious recession between 2008 and 2012, and again throughout the pandemic.

These are areas where demand is not particularly price sensitive. As the world switched towards working from home, demand for IT services grew, as did global spending on pharmaceuticals.

California’s economy is rather similar to Ireland’s in its dependence on taxes paid by the large multinational enterprises, and the bursting of the dotcom bubble in 2002 had a serious impact on California’s state revenues

But the IT services sector is not immune to the economic cycle. California’s economy is rather similar to Ireland’s in its dependence on taxes paid by the large multinational enterprises, and the bursting of the dotcom bubble in 2002 had a serious impact on California’s state revenues. That suggests Ireland’s public finances could face more difficult times ahead.

In recent years, the high-profile IT firms have seen remarkable growth in their output and employment, and in the valuation of their shares. Quite a number of firms experienced a large rise in their valuations, despite the fact that they were not actually making profits. Instead investors ploughed in, expecting very big future profits as the firms grew.

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For some firms these expectations have been realised, but in others the businesses are proving vulnerable to the current slowdown in demand.

Advertising, rather than user fees, is the main source of revenue for companies such as Meta (formerly Facebook) and Twitter. With the current slowdown in developed economies, spending on advertising has fallen, so companies like these are feeling the consequences.

On the other hand, for IT firms such as Microsoft, which earn most of their revenue from sale or licensing of their software, revenue is less volatile. In addition, those with a more diversified shareholder base, such as Microsoft or Apple, tend to have stronger boards and better governance, also helping them to weather a storm better.

Ireland is fortunate in that many of the largest IT companies, across a range of revenue models, have substantial operations here, so that we are less vulnerable to bad results for one or two firms. Nonetheless, the effects of a recession in the major world economies will have an impact across the sector.

Irish-owned operations

While the big multinationals tend to dominate the perception of Ireland’s IT sector, a substantial range of smaller, Irish-owned operations contribute about a third of the sector’s total value to Ireland. Some of these Irish firms are subcontractors to the big names, and are vulnerable to how the big companies are faring.

Our tech sector is a major contributor to national income. First, there are the huge sums in corporation tax that these firms pay. In 2021, they accounted for over 20 per cent of all corporation tax received by the Government. In addition, because of the high average pay in the sector, tax paid by employees accounted for almost an eighth of all income tax revenue in 2021. Thus, any job losses will have a negative impact on income tax receipts in 2023.

An even bigger hit can be expected from a fall in profitability among some of the largest multinationals. Because of the lag in corporation tax payments, most of this effect would be felt in 2024, not 2023.

Apple is one of the biggest firms in the sector in Ireland, booking a significant share of its worldwide profits here. Apple’s profits depend significantly on phone sales, rather than advertising revenue. Because of the disruption to the Chinese economy from China’s zero-Covid policy, output of the latest Apple phones is badly affected. That means that the supply of phones this winter will be substantially less than planned.

Samsung, which is Apple’s major competitor in the smartphone market, is well poised to take some of its worldwide market share. If that happens, it would affect Apple’s profitability

Samsung, because of problems in the labour market in China, had already moved much of its phone production to Vietnam, where it currently employs hundreds of thousands of workers. If Apple can’t maintain a sufficient supply of new phones, Samsung, which is Apple’s major competitor in the smartphone market, is well poised to take some of its worldwide market share. If that happens, it would affect Apple’s profitability, not only on smartphone sales but also on sales via its app store.

There’s been a lot of focus on how potential changes in international taxation pose a long-term risk to our corporation tax take. Even without such disruptive changes, a downturn in IT sector profitability may have a significant negative impact on tax revenue in Ireland in 2023 and 2024. For an economy as dependent as Ireland on corporation tax receipts, this is worrying, even if that proves to be a temporary dip.