Reform must be driven by a sensible long-term economic strategy rather than by short-term necessity or political expediency
THE CURRENT PERIOD of economic adjustment and reform is a massive ongoing challenge for Irish society. However, the decisions we take now are also likely to shape our country for a generation. We need to make sure we get it right.
Changes in our tax system are needed to close the budget deficit, but reform must be driven by a sensible long-term economic strategy rather than by short-term necessity or political expediency.
Over the past four difficult budgets, the Government has focused its deficit reduction measures excessively on the taxation side and has failed to deliver meaningful efficiency gains in public expenditure. While it has achieved spending reductions, these have largely come from cutting services rather than finding savings through efficiencies.
The balance of adjustment over the coming years moves to the expenditure side, which is sensible from a growth perspective, but there are still some key decisions to be made on the taxation side. As tax rises are much more damaging to growth and employment than expenditure cuts, bad decisions will stifle our economic recovery.
Despite the extensive post-mortem on the policy mistakes which led to the economic crisis, there has been limited debate on the nature of public services Irish people want their government to provide and how much they are willing to pay for them.
A more Nordic type model of public service delivery, with higher taxes to fund public services and welfare payments, has its attractions, but to be effective requires us to develop a stronger sense of civic responsibility and very efficient government. This won’t be achieved overnight. Pre-crisis experience in Ireland demonstrates that higher expenditure does not always lead to proportionate improvements in service quality.
Proponents of the “higher tax, higher spending” model argue that Ireland’s taxation burden is low by international standards. However, this claim does not stack up to scrutiny. In the five years prior to the crisis, tax revenue in Ireland averaged 30 per cent of GDP or 35 per cent of GNP – a more appropriate measure for international comparison purposes. In the Nordics, the tax share averages more than 45 per cent of economic output. In the US it is 27 per cent, while Canada delivers excellent public services with a tax share of 33 per cent and Australia with 29 per cent.
When you factor in issues such as Ireland’s much more favourable demographics – which should mean a relatively lower health spend – and the size of the military, Ireland’s tax burden is relatively high by international standards and is above the OECD average.
If the pre-crisis level of taxation was about right, the tax structure and mix definitely were not. The folly of the over-reliance on asset transaction taxes, particularly stamp duty, has been well debated. An equally important issue which has received much less attention was Government’s policy to remove one in two workers from the income tax system by increasing tax credits. This resulted in Ireland having the lowest effective income tax rate in the OECD and an unsustainability hollow income tax model.
Ireland still had a relatively high marginal tax rate but there simply weren’t enough people paying tax. This left Ireland particularly vulnerable when the crisis occurred.
The austerity budgets have seen the income tax system broadened somewhat through the reductions in credits and bands, but the bulk of the adjustment has been taken by middle and higher income earners. Since 2008, budget measures such as the introduction of the universal social charge have sharply increased the marginal rate from 46 per cent to 52 per cent, which is very high by international standards.
The higher tax bracket also kicks in at a much lower earnings level than in other countries. In France, for example, a worker on average earnings faces a marginal tax rate of 30 per cent. In Ireland the equivalent rate is 52 per cent. If this moves any higher, we will have trouble attracting and retaining top talent in Ireland.
Property tax is less damaging to growth than increasing taxes on work. Ireland was out of line internationally by not having a residential property tax. In an ideal world, a site valuation tax would be the best model to adopt as it helps maximise economic efficiency. It would be more difficult to administer, however, and for the moment the sensible approach is to proceed with a property valuation model.
However, the Government’s proposal to collect the tax through the income tax credit model would turn a residential property tax into a de facto tax on work. The clamour for exemptions will be deafening and those left footing the bill will be the already hard-pressed middle income earners. A residential property tax makes sense only if it is genuinely a tax on property ownership and not one on PAYE workers who own their homes.
While we are two-thirds of the way through a difficult journey to correct our public finances, many tough choices remain. The Government must balance the need for equity and fairness with the necessity for economic growth. The decisions on taxes and spending will have a significant impact on economic recovery. More taxes on work will cost jobs and stifle growth. The Government’s proposal for a statutory sick pay scheme is simply a further levy on employment.
We live in a time of dramatic and difficult change. If done properly it can help shape a more sustainable economic model and a fairer society. However, the consequences of poor tax policy decisions could haunt us for many years to come.
Danny McCoy is director general of Ibec
