Bleed the rich? Ireland’s tax ratio of 33.9 per cent is five per cent below the EU average, leading to low-to-average public spending – Tom McDonnell
Budget season is here again and the Government is faced with a €13 billion hole in the public finances. As a result, we are facing a minimum of three more austerity budgets – that is increases in taxes and reductions in public spending. The IMF’s chief economist, Olivier Blanchard, recently admitted that the IMF had been systematically underestimating the damage austerity was doing to domestic demand, economic growth and employment in the European periphery. Unfortunately, the Troika’s prescription for Ireland remains unchanged. As it stands, Michael Noonan and Brendan Howlin will announce a combined €3.5 billion of tax increases and spending cuts in early December and there will be a minimum of €5.1 billion of similar measures in future budgets.
But we do have choices. The Troika does not micromanage budgetary decisions and we can choose any combination of tax increases and spending cuts we like so long as the numbers add up. Despite their protestations to the contrary, responsibility for these choices rests with our Government alone. The Government can choose to place the burden of the adjustment on the most vulnerable in society – or it can place the burden on those best able to pay.
Spending choices should reflect five considerations of long-term development, short-term demand, social justice, efficiency and sustainability. We already know that higher levels of public spending are consistent with greater equality. The same five considerations apply to tax policy. There is little empirical relationship between higher taxes and economic growth. The three most competitive countries in the EU according to the World Economic Forum are Finland, Sweden and the Netherlands and all three have higher tax-to-GDP ratios than the EU average. The higher tax countries in Europe have weathered the crisis far better than the low-tax countries.
According to Eurostat public spending in EU countries varies between 30 per cent and 60 per cent of GDP. Ireland had relatively low levels of public spending prior to the crash. Spending averaged 34 per cent of GDP from 2002 to 2007 while the EU average was 46.5 per cent. The spending ratio exploded in 2008-2009 as the unemployment rate trebled and economic output collapsed. Nevertheless, if we strip out the bank costs, the public spending ratio is still only middle of the pack by EU standards. Reductions in public spending are inconsistent with Western European quality public services. We cannot have Western European standard public services unless we are willing to pay for them, and, in the long run, spending levels are constrained by the amount of revenue the state can raise.
Eurostat describes Ireland as a low-tax country. The vast bulk of Government revenue is generated from taxes and the European Commission annually undertakes a comprehensive review of EU tax structures. According to the latest review, conducted for 2010, Ireland’s overall tax-to-GDP ratio was 28.2 per cent. This was the second lowest in the Eurozone after Slovakia. The weighted EU average in the same year was over ten percentage points higher at 38.4 per cent.
This massive difference is largely the result of low social-security contributions and low levels of local-Government taxation. Social-security contributions were dramatically lower than elsewhere in the EU at a paltry 5.8 per cent of GDP. At 12.8 per cent the weighted EU average was more than double this amount. A closer look at the composition of tax revenue can be informative. The tax rate on consumer goods is high in Ireland. Consumption taxes are by and large the most regressive taxes. On the other hand the implicit tax rates on labour and capital are substantially lower than the EU average.
One school of thought contends that Ireland’s tax ratio should be measured as a proportion of GNP rather than GDP, at least when international comparisons are being made. This is because a significant portion of Ireland’s GDP is repatriated out of the country by multinationals in the form of profits. Even so, Ireland’s tax ratio as a proportion of GNP was 33.9 per cent in 2010 – still five percentage points below the weighted EU average. Using GNP instead of GDP brings its own problems. GDP measures all income generated in Ireland, and all of this income is theoretically available to be taxed by the Irish Government. Profits intended for repatriation are not immune to taxation.
The impact on employment and growth varies considerably between taxes. Ireland is unusual in not having an annual property tax based on either market value or site value. The wide body of available evidence suggests annual taxes on immovable property are the least damaging to growth, are stable over the economic cycle, and are redistributive if properly designed. Property taxes are wealth taxes and if constructed fairly should be embraced by all those genuinely interested in considerations of equality. TASC’s budgetary submissions have proposed a property tax incorporating a system of income-related deferrals to protect those on low incomes. A minimum of €600 million could be raised in December’s budget from a property tax while at least €100 million can be obtained from inter-generational wealth transfers by reducing the reliefs and thresholds on CAT (inheritance and gift tax).
At the same time the ESRI estimates 80 per cent of pension-tax reliefs go to the richest 20 per cent. Standard rating pension tax reliefs would raise €500 million. Abolishing tax exemptions for lump-sum pension payments would raise a minimum of €200 million. Passive income should also be targeted, for example, by reducing the ability to claim interest repayments against tax for residential rental properties. This could yield over €200 million. Increasing excise taxes on betting shop profits would yield over €100 million. This is just a small sample of the viable measures available to Government.
Unfortunately there is still no commitment from Government to equality-proof budgets. The ESRI found last year’s budget was the single most regressive since the economic crisis began. That was a choice made by Government Ministers and they cannot blame the Troika. Deeds matter and not words. An overall strategy focussed on raising taxes to EU norms and protecting EU levels of public spending would help ensure that those who can best afford to pay for this crisis actually do so.
Tom McDonnell is a Policy Analyst with TASC