Taxes and the Price Level
This post was written by Philip Lane
It looks like the CPI will fall by a substantial amount during 2009 due to the economic slowdown, the weakness of Sterling and the cut in mortgage interest rates, amongst other factors.
This provides an opportunity to raise VAT and excise taxes, in view of the fiscal situation (less painful to raise indirect taxes when the CPI is in decline than when the CPI is increasing). The is the mirror image of the situation several years ago, when Ireland’s relatively high inflation rate led to widespread calls for cuts in indirect taxation in order to combat inflation. While there would be undoubtedly some leakage across the border, an increase in indirect taxes should be a significant source of revenue.
In a way, an increase in indirect taxes can be interpreted as a mechanism by which the government can reap some of the gains from the terms of trade improvement that is embedded in the appreciation of the euro against Sterling: this provides a real income gain for Ireland vis-a-vis other euro area countries, since Ireland imports much more from the UK than is the case for other euro area countries.
The regressive nature of indirect taxes can be taken into account in terms of the overall package of tax and welfare policies.