The Irish Economy

On Tuesday night near the end of his TV3 show, Vincent Browne returned to one his favourite themes, the taxation of those on higher incomes. He put the following statement to Fianna Fail TD, Timmy Dooley

In June of last year, the Department of Finance showed that in spite of efforts to close off tax loopholes in the 2007 and 2008 budgets, people earning over a half a million still pay only 20 percent of their income in tax. Now why weren’t they targeted rather than people on social welfare?

Dooley told Browne that the budget had seen an increase in the effective tax rate for these individuals to 30 percent, to which Mister Browne responded, “Not true, It’s just not true.” Later, after Mister Dooley discussed other steps taken to stabilise the public finances, Browne asserted that “You could have achieved the same thing by targeting people earning half a million and you didn’t bother.”

On the same theme, in his column in Wednesday’s Irish Times, Browne stated

How come there was no crisis when a report by the Department of Finance last June disclosed that, in spite of the alleged attempt to close tax loopholes, the average effective tax rate for people earning over €500,000 was just 20 per cent?

I’d like to address three aspects of the TV exchange and this column.

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One of the major issues that I think needs to be addressed this year is the role played by tax expenditures in our budgetary system. Reports such as this one by TASC have pointed to closing off tax expenditures as having an important role to play in closing the budget deficit. Chapter 8 of the Commission on Taxation report does a pretty good job of listing many of these tax reliefs and recommends shutting many of them off. There are serious discussions worth having in relation to many of these reliefs, such as those for pensions, but I don’t have the time to get into these issues now.

Interestingly, one particularly controversial type of relief that the Commission report does not examine is property incentive schemes; the report argued that since the decision had been taken to close off these schemes on their completion, they should not be examined. Information on the cost of these schemes was, however, reported to the Dail by Minister Lenihan last November in response to a parliamentary question from Joan Burton. The link to this answer is here but I know not to trust links to the Oireachtas website so I’ve also put up the answer as a Word document here.

The total amount of tax revenue lost from these schemes in 2007 was €435 million. I suspect this is smaller than some people might have expected, given the widespread nature of claims that the very richest in society are managing to pay almost no tax through their extensive use of these schemes.

Still, it is a decent amount of money. It would be interesting to know what these schemes are expected to cost this year and next and whether they can legally be closed. I suspect they can. Another interesting question is whether many of the individuals that availed of these schemes are now bankrupt and wouldn’t be able to pay any tax.

There has been a lot of discussion in recent months about the scale of tax reliefs in Ireland and I’ve been planning to write a couple of posts on this topic. In relation to this issue, an opinion that is commonly expressed by leading figures in the Irish media is that the very richest in Ireland pay very little in tax because of these reliefs.

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I’ve criticised Pat McArdle on a couple of occasions recently so I’m happy to say that this article on tax makes some useful points. In particular, the following points are correct and are simply not being said enough by our economic and political commentators:

Income taxes are both too high and too low. Too high because marginal rates have gone above 50 per cent – Irish people seem to be averse to parting with more than half of their extra euro. Too low because half the population does not pay any tax.

The problem is not just high rates but, critically, the low levels at which they kick in. It is astonishing that a PAYE earner on a lowly €40,000 has a marginal rate of 51 per cent.

And

From now on, the challenge is to broaden the income tax base not increase the rates.

Perhaps unsurprisingly, there some points of emphasis in the article I’d disagree with. That the 2009 tax yield has fallen below its 2008 level despite tax rate increases is not proof that “we’re into negative Laffer curve territory”. It’s proof we’re in a very severe recession. But yes, the top marginal income tax rates are too high and they could be pushed into Laffer curve territory if we’re not careful.

Moreover, whatever about the upcoming budget, it will be essentially impossible for the government to stabilize the public finances over the next few years without finding extra tax revenue. Hopefully, this can be done, as McArdle recommends, by broadening the income tax base and by implementing some of the revenue-raising recommendations of the Commission on Taxation, such as a property tax. But getting these measures through won’t be made easier by comments such as McArdle’s jibe here that “tax increases are the last resort of a weak Government.”

When addressing the issue of raising income taxes, two objections tend to come up. The first is that the combined marginal tax rate (including PRSI and levies) is already up to 54%  (see page 161 of the Commission on Taxation Report) and this marginal tax rate kicks in at fairly low incomes. Further increases in this marginal tax rate are likely to trigger increased tax avoidance and can also have negative side effects in terms of work incentives.

The second objection is that we don’t want to raise taxes on low earners because they already don’t make much money and we have to be careful about not creating poverty traps in which people are better off earning unemployment benefit than working (Suzanne Kelly’s Irish Times article on this presented some interesting calculations.)

One way to address these objections is to introduce a flax tax with a large exemption limit. This would keep the lower paid out of the tax net and keep marginal tax rates from reaching dangerously high levels. But this approach could raise additional revenue, essentially because it would abolish the 20% tax band.

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A prominent part of ICTU’s ten-point plan campaign has been the proposal to introduce a new third rate of tax on rich people. As far as I know, the proposals have not precisely defined who qualifies as rich. However, it is certainly understandable that the average person may find some appeal in this proposal, particularly as most people don’t consider themselves to be rich.

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