No Room for Tax Increases?

During last night’s Prime Time, former Department of Finance official Cathal O’Loghlin made the following comments:

There’s a €16.5 billion gap to be filled by 2013 … If we go down the tax route to fill the whole of that, we’d be talking about a tax burden which is way above European levels … solving one-third of that problem by raising taxes would push our tax burden to the same levels as the Euro area average.

If true, these figures suggest that the room to use taxation to close our deficit is very limited and this should be a central issue in public debates about the fiscal crisis. However, I would not have characterised the tax burden in this way and thought I’d explain why. 

Let’s go back to the where the €16.5 billion comes from. It comes from the Stability Program Update document released in January. An adjustment of €2 billion was proposed for this year. Subsequent adjustments of €4 billion in 2010 and 2011, €3.5 billion in 2012 and €3 billion in 2013 were projected to gradually reduce the deficit over time to 2.5% in 2013. As percentages of GDP, these adjustments were 1% this year, 2.25% next year, 2% in 2011, 1.75% in 2012 and 1.5% in 2013. Adding these adjustments together, the 16.5 billion translates into a cumulative adjustment of 8.5 percentage points.

Table 6 of this document then set out an illustrative plan in which all of the adjustment occurred through expenditure cuts. The revenue share of GDP stayed stable at about 34% while the expenditure share declined from 43.3% this year to 37% in 2013. Suppose, however, that the government’s plan had instead reported a scenario in which the 8.5 percentage points of adjustment had all occurred on the revenue side. Then instead of the 34.4% projected in the document, the projected tax share for 2013 would have been 42.9% (i.e. 34.4% + 8.5%). Taking O’Loghlin’s other scenario in which only one-third of the adjustment occurs through taxes, the projected tax share would have been 37.2% (i.e. 34.4% + 2.8%).

Where would these hypothetical tax burdens place us relative to European levels? Consider this chart from my presentation at the DEW conference in January. Based on data from Eurostat, it shows that, as of 2007, the average government revenue share of GDP in the EU-15 was 45.3%. So, a full tax-based adjustment would still leave us below the EU-15 level and the one-third tax-based adjustment wouldn’t even put us close.

I guess one can raise these tax share figures by using GNP instead of GDP (and perhaps this is what Cathal had in mind).  I don’t particularly agree with that argument but, in any case, as I pointed out the last time I had the temerity to raise the issue of tax shares, you can’t then include all the corporation tax revenue we get from the income included in GDP but not in GNP, so this adjustment isn’t as big as some think.

In any case, I was a bit puzzled by Cathal’s comments and thought I’d try to clarify what I think the right figures are.

10 thoughts on “No Room for Tax Increases?”

  1. I saw the programme and found the comments depressing. This is really not a time for ideology. People on the left need to accept that we need expenditure cuts. People on the right need to accept tax increases.

    If the economy had been managed better over the past decade then taxes would not have to rise so much, but that is at this stage a purely academic point.

  2. One, of the big problems, is that people are so fed up with the mismanagement of the economy, that they are resisting every effort to take more tax from them. They are deliberately, myself included, not spending money because we do not like what we see. Unions playing games, opposition playing games and government just being its usual incompetent self. All this is happening as the country’s finances spiral out of control.

    Psychology, is playing, and will play, a major role in what is happening. Banking is about confidence. So too, is every single decision to purchase goods and services. Every single purchase decision postponed is a tax revenue postponed or foregone altogether!

    How will the government buy back confidence or the legitimacy to govern?
    Unless the quango’s are torched, the junior ministries abolished and salaries across the board given the capacity to fall just as dramatically as they rose, there will be no confidence! Take one example, the National Consumer Agency. Do we really need 20 employees, 13 board members who include Mr. Eddie Hobbs and Ms. Celia Larkin to tell consumers that a basket of goods is cheaper in the North and that things are expensive here. The answer is no we don’t! That is just one Quango, there are 799 more with over 5000 political appointees. Get rid of the lot and their PR buddies too this is how Mr. Cowen needs to operate and he does not need to postpone all decisions until the april budget.

    The scope for tax will be determined by the government leading. That is, if they want to lead? If they do, they must take the pain themselves. If they don’t take this pain, in full view of the public, they have two chances of getting in more tax revenue slim and none and it will be the end game.

    On the capital expenditure side we don’t need any more infrastructure for an economy that is shrinking by the day! If projects create significant jobs, at economic costs, fair enough, but we certainly cannot afford to build for the future when our very survival in the present is what is at stake!

    Finally, if they want revenue, they must bring EVERYONE in to the tax net. Farmers who seem to have seriously gone to ground, welfare recipients, tax exiles, every single person in the state except old age pensioners and the infirm will have to contribute. We cannot afford to have 750,000 people on low incomes paying no income tax. These low income earners need to protect their own jobs. They can do that by paying some taxes which might allow the state to avoid bankruptcy.

  3. Ireland does not need the same tax/GDP ratio as other countries to deliver the same standard of public services.

    This is for a number of reasons. First, the costs of public services are more related to GNP per head rather than GDP.

    Most countries finance pensions directly from taxation to a much greater extent than we do in Ireland. Public sector pensions are unfunded here and private pensions are supported by tax relief. In Ireland most of the cost of pensions does not hit the tax line.

    In addition our demographic structure is favourable so we have to spend much less on the health service and our spending on defence is low.

    On the other side we are investing more as a share of GNP than other countries and we were until recently making contributions to the Pensions Reserve Fund.

    I tried to quantify the effects of all this in my Kenmare paper (with Don Thornhill) last October using 2006 data. The adjusted tax ratio for Ireland came out at 42.5 % of GNP compared with an EU average of 39.8 %. If (and it is an if ) Ireland’s public services in 2006 were not up to EU standards it was not due to a lack of funding.

  4. Donal, Can you provide a link to your paper with Don? I think that the point Karl makes is valid, namely that one can’t insist on simply using GNP as a measure of “ability to pay” when so much tax revenue was generated from the profits of foreign MNCs not included in GNP.

  5. Karl,

    Considering that your blog would likely be used to contradict my Prime Time points – as in today’s Sunday Independent – its a pity you opened by suggesting my figures were plain (and significantly) wrong.

    And considering that the core of our disagreement on the figures relates to the issue of whether GNP is “as taxable” as GDP, it is even more a pity that your blog did not highlight this. As demonstrated below, a GNP-based assessment absolutely supports my Prime Time comments.

    You were correct in your (closing) guess that I worked with tax/GNP for Ireland. I continue to believe, as e.g. Colm McCarthy in his Jan 18th response to your use of tax/GDP comparative ratios, that “It is fatuous to believe that Karl’s E28bn factor flow gap between GDP and GNP gap is somehow available to us to tax on the same basis as personal income or consumer spending. … The E28bn belongs to foreigners and is not ours to tax”. You are, of course, entitled to hold a different view: but your justification for that view – at least as expressed in January – is less than convincing.

    I do agree, however, with your January point that a simple tax/GNP ratio is NOT an appropriate basis for measuring the comparative Irish tax burden. The appropriate base for Profits Tax is GDP, rather than GNP, and this must be allowed for. Here are my figures, on this basis.

    The projected (unchanged tax regime) 2013 Irish revenue/GDP share in the January SPU is 34.3%. The Euro/EU average runs around 45% of GDP (more or less ditto, of GNP, for them). We must assume a 2013 Euro/ EU “take” from profits taxation – I used 3% of GDP. What would that mean for our tax burden by 2013 if we were we to resolve the E16.5bn budgetary gap via taxation only?

    My calculus was as follows. Given a 2013 GDP of E209bn, and E16.5bn higher revenue than in the SPU, our 2013 tax/GDP ratio would work out at 42.3%. Assuming we took 3% of GDP in profits taxation, that would leave need to raise 39.3% of GDP from our remaining taxes/charges. The base for the latter, with a net 18% of GDP flowing abroad and 3% already “lost” to government in profits tax, would amount to 79.3% of Ireland’s 2013 GDP. Accordingly, we would need a regime of taxation yielding 39.3/79.3 = 49.8% of our remaining, domestically taxable, national income.

    That’s considerably “north” of the Euro-area/EU average of recent times of 45% – and would leave us, as I said, with a tax burden way above European levels.

    So long as taxation, globally, is based on “residence” (and the “KWhelan method” of taxing the income of, or spending by, other countrys’ citizens” is unrevealed!!!) we will remain unable (CT apart) to tax that slice of Irish GDP which is attributable abroad.

    In the interests of assuring WELL-FOUNDED debate, you might wish to clarify to this blog that our difference is NOT one of stupid error on my part, but an economy/taxonomy difference of view where I a NOT an isolated voice and you are NOT “the infallible guru” – the impression some (Gene Kerrigan?) appear to have taken from what you wrote.

    Sincerely,

    Charles (Cathal) O’Loghlin

  6. Kevin,

    Can you clarify a conundrum for me, please?

    On Prime Time, I advocated achieving not more than 1/3rd of the (SPU-planned) E16.5bn budget consolidation via revenue increases, and the balance from spending cuts (a la my characterisation of Ireland as “certainly not a low-spending country”).

    Your second paragraph above implies a similar (both tracks) view on your part. Yet, you make clear that you found SOME comments on the Prime Time show “depressing”.

    Can you clarify whether you were depressed by the above comments of MINE? If so, would you please advise us whether second paragraph above reflects your own conclusions about the desirable nature of overall adjustment? And if the thoughts in your second paragraph do reflect your views on this, perhaps you will let us know whether your own analysis/conclusions also “depress” you?

    Yours sincerely,

    Charles (Cathal) O’Loghlin

  7. Kevin,

    My references to “your second paragraph” should each have been to “the second part of your first paragraph” – in effect, to where you noted that “left” and “right” would respectively have to accept expenditure cuts and tax increases. Apologies for any confusion caused.

    My conundrum remains…

    Yours sincerely,

    Charles (Cathal) O’Loghlin

  8. Just to clarify a couple of points in relation to Cathal’s comment. At no point did I say that he made a “stupid error” nor are any phrases of that type to be found in the post. I merely stated that I would not have characterised the issue as Cathal had. Moreover, the post clearly pointed to the GDP\GNP issue as a likely source of the difference in calculations. At no point in this post, or the one linked to, do I suggest a new “KWhelan method” for taxing corporate income.

    Returning to substance, I would note that Cathal’s claim on Prime Time that raising taxes by one-third of the €16.5 billion would push our tax burden to average European levels does not seem to me to be accurate even by his own preferred GNP-based methodology.

    Cathal’s calculation of a tax rate of 39.3/79.3 (which amounts to 49.55% not 49.8%) can be thought as coming from 4 figures: Tax revenues of €88.4 bn, tax receipts of €6.3bn on repatriated profits, GDP of €209 bn, with an adjustment of 0.793 applied to give a GNP-based tax base. In other words, one gets this figure as (88.4 – 6.3) / (0.793*209). If the Irish government raised additional tax revenue of only €5.5 billion rather than €16.5 billion, then the tax revenue figure would be €77.4 billion rather than €88.4 billion. Using Cathal’s procedure, this would then imply a tax burden figure of (77.4 – 6.3) / (0.793*209)=0.429. To my mind, 42.9% is a good bit lower than the 45.3% European average.

    Finally, I’m happy to issue the requested clarification to our readers that I am not indeed an “infallible guru”!

  9. Cathal,

    It is good that we agree that both expenditure cuts and tax increases are required, and I accept that we do agree on that.

    On the other hand, I don’t think there should be ex ante constraints placed on the allocation of the adjustment between taxes, on the one hand, and expenditure on the other. I particularly don’t think that the constraint should come from arbitrarily deciding that the upper bound to taxation should be determined with reference to the European average, whether calculated on the basis of GNP or GDP. When successive Ministers for Finance have pursued the pro-cyclical policies we have seen, and then guaranteed a bunch of bank liabilities which they had no business guaranteeing, that has fiscal implications. If Karl is right, the good news is that we may not end up a high tax economy. If you are right, then I suppose that we will.

    We are going through an unprecedented crisis without the escape valve of emigration. We want to maintain our fiscal independence, if that is possible. We also want to avoid social chaos. If the rich dislike tax hikes, and the poor dislike expenditure cuts, then that has implications for the sorts of policy packages that will be politically sustainable, in my view.

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