Category: Fiscal Policy

Tax Treatment of Debt

Various commentators and parties have recommended that landlords should not be able to deduct interest payments on debt in calculating taxable income.  More generally, ending the favourable tax treatment of debt is one of the central recommendations from the IMF, in its recent analysis of how macroeconomic policies should change in the wake of the global financial crisis (paper is here).  By favouring debt over other funding options, the tax deductability of interest charges encouraged excessive leverage and thereby contributed to risk in the financial system.

Accordingly, tax reform in this area has the potential to improve allocative efficiency while also raising revenue.  No doubt the shift to a new system must involve a transition phase, such that the initial improvement in revenue may be limited.

Bad news from Brussels

Eurointelligence kicks off today with an FT story which makes depressing reading: European finance ministers appear to have turned down Larry Summers’ eminently sensible call for a coordinated global macroeconomic stimulus package. The eurozone is not the gold bloc, to be fair, but one wonders whether a political generation that has invested so much political capital in the SGP will be capable of averting the disaster that faces Europe. (And even if individual policy makers do understand what is needed, European fiscal fragmentation appears an almost insuperable obstacle to the Europe-wide Keynesian policies that are needed now, as events in our own little country dramatically illustrate.)

Europe may be a second class political power on the world stage, but it is a first class economic power, and so all of this is very bad news indeed. Has the April conference failed before it even opens?

Colm McCarthy on the Fiscal Position

Colm McCarthy’s presentation to the Green Party conference this weekend is available here.
McCarthy Green Conference March 7th 2009

Publish at Scribd or explore others: Academic Work irish economy fiscal policy

Tax breaks for pensions

The Sunday Independent reports that an important debate is taking place within the Commission on Taxation:

“But its report may also call for a reduction in tax relief for ordinary private sector pension-holders and a “fierce argument” is raging within the commission over the €2.9bn cost of this relief versus the incentives that it gives to provide for the future.”

The idea of limiting tax breaks on pension contributions has received a good deal of attention, with Fintan O’Toole a notably vocal advocate (see here).  This focus is understandable given that the better off are the primary beneficiaries of the tax breaks.  

The fact remains that many households – even better off ones – are not saving enough to sustain their living standards in retirement.  This is compounded by staggering losses in both defined contribution and defined benefit pension plans.  (See Brendan Walsh’s post from December on the crisis in occupational pension plans.) 

The tax incentive can be viewed as a device to overcome the inertia that keeps people from making adequate pension provision.  As such, I would agree that it is not particularly efficient.  But it is encouraging to see that at least some on the Commission believe it is important to approach pension reform in a comprehensive manner rather than simply eliminating the existing incentive.

The Green Paper on Pensions looked at the possibility of moving to some sort of mandatory or “soft mandatory” (with default) contributions to retirement savings accounts.   Unfortunately, with households being squeezed from so many different directions, it is hard to see from where they would find the money.  In a post a few weeks back, I proposed the idea of a Swedish-style system of unfunded – or “notional” – defined contribution accounts that could at least reduce the pressure for other tax increases.

What is most important is that reforms take place in the context of an overall plan for the retirement income system.   The complexities and importance of pension reform are such that it should not be driven solely by short-term fiscal considerations. 

Income tax exemption limit

In my post on income tax of a few days ago, the sample structure that I presented went part of the way back to the rates and bands in effect in 1996, a good year.

One feature of the mid-1990s income tax structure was the much lower exemption levels effectively achieved nowadays through tax credits. Should this trend be reversed?

Two comments on my earlier post point to problems in lowering the effective threshold. Colm McCarthy worries about incentive effects given the interaction with social welfare. Aedin Doris finds it difficult to justify taxing a low income single mother with two kids.

I have sympathy with both views, and this is not a make or break issue for revenue (though there is some revenue potential even at the low end).

I also note counterpoints. The more revenue we seek from the system as a whole, the more a high exemption threshold/general tax credit pushes other workers into higher marginal tax rates; bad for incentives. And, depending on their family/household circumstances, not all low income part-timers have low consumption.

Then there is the political/ideological view that as wide a range of citizens should feel involved in the national housekeeping by paying some income tax (though all pay expenditure taxes anyway).

The impact of a lower exemption threshold on low income tax payers could be considerably eased, as has been suggested, by re-introduction of a third low income tax rate.

My guess is that, for a Minister of Finance, lowering the effective threshold (by lowering personal tax credits) offers too big a hostage to fortune to be worth the revenue it would raise.

What do others think?

(Update: the first version of this posting used misleading language about thresholds, I have modified it without changing the intended sense).