Coleman on Taxes and the Evils of PhD Economists

Even by his own standards, Marc Coleman outdid himself in his latest column in the Sunday Independent. In addition to standard Colemanisms such as the invocation of the Laffer curve as an established fact (tax rate increases “emaciate tax revenues”) he delivered the following assessment of PhD economists:

With their theoretical backgrounds and lack of real world forecasting experience, many PhD economists sadly don’t grasp these realities.

Worse still, they have tremendous influence. Last January a bevy of them tried to prove that our tax burden was too low. By measuring our tax revenues as a share of GDP — which is about one fifth higher than GNP — they made the tax share of the economy look one fifth smaller than it actually is. This is because the bit of GDP that isn’t included in GNP — multinational activity — generates relatively little taxes and shouldn’t be included. Their point wasn’t just illiterate. They have been a major contributor to the disastrous mistake the Government has made, a mistake that will create tens of thousands of job losses. It is a good reason why the suggestion of recruiting PhD economists to the Department of Finance — made unsurprisingly by PhD economists — is at best wrong-headed (in John McGuinness‘s case) and at worst self-serving (in the case of PhD economists who want taxpayers to feather their nests).

I’ll leave it to our commenters to discuss the issue of whether a ban on PhD economists is the best way to improve the quality of economic analysis in the Irish public sector. However, as one of the apparently illiterate economists referred to (the chief dunce, I reckon — damning evidence here and here — and this despite years of “real world forecasting experience” at the Fed) I will note that I don’t agree with Marc’s argument that our tax base is best measured by excluding sectors “that generate relatively little tax”. This is for two reasons.

First, multinationals do pay taxes on their repatriated profits and it is incoherent (illiterate?) to include those taxes in a measure of the tax burden but not include these profits in the measure of the tax base.

Second, it is a deliberate policy choice to set a low corporation tax rate. One can debate this choice on substantive grounds (and we have had some discussion about the importance of corporation tax to the Irish economy on this site) but it is simply not correct to argue that multinational profits are not part of the tax base.

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. 

Where is Ireland’s Tax Burden Heading?

In my discussion at Monday’s conference (slides here), I raised the question of where Ireland’s tax burden was going to settle down once the public finances have been stabilized. The Addendum to the Stability Report published last week by the Department of Finance shows how the Gross Budget Balance can be brought back to a deficit of 2.5% by 2013 through an adjustment process in which the revenue share of GDP stays roughly stable so that almost all of the adjustment occurs on the Revenue side. The document itself does not comment on the composition of the adjustment described in this table, so perhaps this isn’t an actual plan but instead an illustrative example. Still, it’s worth starting with as a baseline for discussing where we are heading.

I noted on Monday that the plan projects a government revenue share of GDP of 34% in 2013 and that this is well below the equivalent share for EU15 countries, which has been stable at about 45% for a number of years. A number of observers at the conference questioned this calculation on the grounds that the calculation should be done relative to GNP. In particular, since GDP has been about 17% higher than GNP in recent years, one might want to adjust the tax share upwards by this amount. Doing so would give a figure for 2013 of about 41.5%. This is still a reasonable amount lower than the EU15 average but not nearly as much as the figures I quoted

However, I do not view this higher GNP-based figure as a useful one, for two reasons.

First, I believe that GDP rather than GNP should be viewed as the correct tax base when making calculations of this sort. GDP represents all the income generated in this country and, technically, all of it is available to be taxed by the Irish government at whatever rate it chooses. Of course, profit income generated by multinational corporations is likely to move elsewhere if we tax it at a sufficiently high rate but this is an issue faced by all governments, not just our own.

Second, if one is going to exclude the substantial factor income repatriated abroad (€28 billion in 2007) from the tax base it is not consistent to then include the taxes earned on this income in the measure of the tax burden. Assuming that the €28 billion figure represents corporate profits repatriated after paying the 12.5% corporate tax rate, one comes up with a figure of €4.1 billion in taxes paid by multinationals on repatriated profits. Excluding tax payments of this magnitude would give a 2013 (adjusted) tax share of GNP of 39%. So, even if one agreed with the idea of GNP as the tax base, an internally-consistent calculation of the Irish tax burden would still leave it well below the European average.

The broader and more important point here is that we need a wider debate about the shape of future fiscal adjustment than the one currently taking place, which focuses almost without exception on the need to reduce public sector pay.