Why is Ireland’s tax collapse so severe?

Publication of the Exchequer Returns today provides more hard evidence on an aspect (previously mentioned by myself and others) which helps unravel this mystery.

Much of the answer lies in the systematic shift towards cyclically sensitive taxes over the past two decades.  There has been more and more dependence on corporation tax, stamp duties and capital gains tax (in that order).  These three saw their share in total tax revenues rise steadily from about 8 per cent in 1987 to 30 per cent in 2006 before falling to 27 per cent in 2007 and just 20 per cent as soon as the economy turned down in 2008.

This has been an almost automatic albeit unintended consequence of the combination of Partnership with an almost unbroken period of rapid growth.  At each pay round, Government negotiators offered concessions in those taxes that are felt by the working person — Income tax and expenditure taxes.  These concessions could be afforded because of the steadily soaring revenues in the cyclically sensitive taxes.  But each notch in this ratchet made the tax system more vulnerable to an economic downturn.

In 2008, tax revenue fell by almost 14 per cent — but the percentage fall in the cyclically sensitive taxes was much larger, at 36 per cent.

Had Ireland’s tax structure been less cyclically sensitive, the fall in revenue would have been much lower.  Indeed, if cyclically sensitive taxes had been back at their 1987 share of total revenue, the fall in revenue last year would have been much lower: 8 per cent instead of 14 per cent.

The medium-term policy implications are clear. The tax structure must be rebalanced in favour of non-cyclical taxes such as income tax, VAT and excises.  Politically painfully of course but ultimately inevitable, I would say.

12 replies on “Why is Ireland’s tax collapse so severe?”

I would not describe the asset-related taxes as cyclical in that these tax revenues are not driven by the level of GDP. Rather, these tax revenues are driven by high asset values and high levels of asset transactions. While the recent boom was ”asset-rich”, the next economic recovery may not be. This reinforces the importance of traditional sources of tax revenue, which may be cyclical but are less volatile than asset-based taxes.

I’m open to different terminology, but not sure that “asset-related” hacks it as a one-word description in this context any better than “cyclical”.

For one thing, I do want to include Corporation Tax in there.

But more important, it is precisely the cyclical sensitivity of these taxes that caused the problem. In the context of pay negotiations, their lured us into an unbalanced tax structure on the upswing, and are giving us a whuplash on the downswing.

“Asset-related” doesn’t convey that dynamic.

By Post Author

I would like to see property taxes added to Patrick’s list of less-cyclical taxes, or whatever we want to call them. Taxing transactions in property rather than the ownership of property always seemed silly for a number of reasons, and we can see its effects on government receipts now. To make those property taxes less volatile, one might want to think about ways to stop them from going up too much in bubbles.

The key feature of CGT and Stamp Duty (but not Corporation Tax) is that they are taxes on transactions. So is the VAT on new house sales. CGT is a misnomer – it is a tax on the realisation, not the occurence, of capital gains. All three have a PQ tax base, and both P and Q have collapsed, sending revenue south from (according to Rossa White) about €8bn to €2bn in two years. The short-term fiscal ‘cost’ of scrapping Stamp Duty, in favour of a residential property tax, is now very low. Both CGT and Corporation Tax allow the taxpayer to roll forward losses. These taxes may not recover for many years given the scale of losses now available. In the IFSC sector, some international banks have lost so much money that they may not have any incentive to minimise Corporation Tax liabilities for a decade or more – why locate in a high-cost (if low-tax) jurisdiction? Ireland’s key incentive (or compensation for high costs if you prefer) has lost potency in a world of large carry-forward losses.

Thanks Colm, that is very interesting. So the good news is that we have an opportunity to move to a more rational tax system. The bad news is that the country’s basic business model is under threat for the reason you give and that I haven’t seen mentioned yet — and this is even absent the political forces worldwide that will be operating against jurisdictions like Ireland in the years ahead.

The reliance on transactional tax in their forecasting is why the government were taken by surprise – the speed of the property slowdown wasn’t expected. The real issue is why they spent all of the money rather than putting some aside?

Even squirrels have figured this out, they put nuts aside for winter, we seem to put our nuts in the dail and give them a cheque book.

It is the speculation for capital gains that drove the property market but once people are vested there is no way to force ongoing tax out of them until any gain is realised (as per Colm’s post).

The answer – and most unpopular concept to all- is annual property tax, it would prevent speculation and give a reliable and planned income stream. It would make land banking difficult and ensure that properties do not lie dormant, we need to find a way to move away from a culture of rent taking & Capital Gains into one where we offer a highly educated and competitive workforce.

I don’t see how any sales (i.e. vat/excise) or income tax are non-cyclical. You were right the first time when you referred to them as “less cyclical”. I’d be interested to know what the proportions referred to in para.1 would have been in the late 70s.

Now rates – there’s a non-cyclical tax for you. Determine an amount to be levied, a basis for assessment and a mill rate. If assessment by value is used, an increase in the value of your home doesn’t mean an automatic increase in rates unless you exceed the average increase adjusted for increases (or decreases) in the number of properties assessed.

Personally I find property assessment by value to be overly coarse and counter to good policy but based on lot and home square footage is worth looking at. Additionally, property owners in many jurisdictions are currently receiving bills based on boom assessments and figure they are now being hosed (even though the same principle applies as above – if everybody’s value is inflated, nobody’s overpaying).

The other problem with property tax is that sometimes you do need help from cyclical taxes in order to keep pace with an upcycle. Here in Toronto, the City government has been struggling with the political imperative to keep the levy amount at CPI while construction and public sector wage inflation are multiples of that number. Older homeowners (who vote disproportionately as a cohort) won’t like being charged the same on their fixed income as the DINKIES next door, which means a whole raft of bureaucratic rebate structures (including one which essentially liens tax increases against your estate).

There’s a reason FF’s abolition of rates was extremely popular albeit fiscally unsound in its execution.

@Colm McCarthy – linking the scrapping of Stamp Duty to imposition of Property Taxation should include a fairness element, where partial rebates are available to new purchasers of a house lest they be hit with a double whammy.

@Karl Deeter – “It would make land banking difficult and ensure that properties do not lie dormant” – only if you don’t let the bureaucrats write exemptions to protect landlords/owners from weakness in the property market. Then you get property which lies dormant because it would be more expensive to get the going letting rate and have to start paying PTax again.

I think it will take alot to convince the gov to change current stamp duty laws even though they are as you say cyclical (although i would see them more detached from the business cycle as the term [to me] suggests. They are more in common with secular bear market).

Anyone who has even taken a glimpse of the ESRI house price index could see that the 9percent was increasingly becoming a big part of tax collection to the gov. It would be somewhat like walking into a party after midnight and trying to tell them that they all have to go home, there is not going to be anymore good times here. It will fall on deaf ears. I think the panic will be to increase tax rather than try to reform make better. That must follow.

Taxes are too low here anyway, nearly 30percent GDP in 07, now this decline. We will be lower than Mexican levels at this rate by summer.

The tax base today looks very different than it did two years ago. Those taxes, which were very dependent on the property market, now constitute a very small part of that base. It seems likely, therefore, that we will see a more “normal” relationship between tax revenue and economic activity over the coming two years than in the last two. Paul Van den Noord and colleagues in the OECD estimated a relationship between budget deficits and GDP for ,many OECD countries. The elasticity was generally close to 0.5. (It was much higher for Sweden.)

I believe the country will enter a period of prolonged recession. the property bubble has finally bursted and at long last peoples aspirations will be adjusted. it was crazy. plumbers and factory workers were not feeling successful unless they had a bmw and a villa in spain!!!!!! get real folks!!!

Comments are closed.