ANALYSIS: Property tax is the "hot potato" of taxation policy and the proposal is likely to attract a great deal of attention
INVITED TO identify the most important element of the Commission on Taxation’s report in an RTÉ interview yesterday, Frank Daly, the commission chairman, zeroed in on the principle of revenue neutrality.
What he meant by this was that commission was not recommending that overall tax revenue be increased, rather that the revenues raised on foot of the new measures it was proposing be used to reduce the tax burden in other areas.
This take on the report draws attention to a difficulty for the commission caused by the tumultuous events of the last two years. When the commission was set up in early 2008, it was against the background of a growing economy and apparently healthy public finances – GDP had grown by 6 per cent in 2007 and the general Government balance registered a small surplus that year. It was reasonable to suppose that the tax burden at the time – the ratio of taxes, inclusive of PRSI contributions and the Health Levy, amounted to the equivalent of 30 per cent of GDP – would be sufficient to finance public expenditure into the future. Hence, one of the commission’s terms of reference instructed it to have regard to the programme for government commitment to “keep the overall tax burden low”, a commitment widely interpreted to signify no increase from the current level.
What’s happened since, of course, is that tax revenue has collapsed. So great has that collapse been that despite the significant tax-raising measures of the past 12 months, the tax burden this year will be lower than in 2007, perhaps by as much as four percentage points (the equivalent of about €6.5 billion).
Notwithstanding this, should this year’s tax burden be set as an upper limit? Given the enormous fiscal adjustment that has yet to be carried out to restore sustainability to the public finances, such a limit would appear to impose an unreasonably, if not indeed an unrealistically, tight restriction on policymakers.
A far more robust approach, in current circumstances, would be to represent the commission’s report as providing a hierarchy for raising revenue. Here, the commission is on strong ground.
It argues compellingly that, in the interests of maximising economic performance and minimising distortions, Government should look to property taxes, spending taxes (including environmental taxes) and income taxes, in that order. It also argues that in each of these categories, policy should seek to broaden the base and reduce rates.
The generality of economists would concur. Theory and evidence suggest that broadly-based taxes levied at relatively low rates are preferable to narrowly-based taxes levied at high rates. Likewise, the empirical evidence, both Irish and international, indicates that taxes on immovable assets do the least economic damage, while taxes on mobile factors of production inflict the most harm, particularly in very open economies.
In this respect, the most salient aspect of the evolution of Irish tax revenues over the last two years is that there has been a major shift away from property-related taxes towards taxes on income. There is an obvious need to do something to reverse this shift. Hence the commissions proposal for an annual property tax (APT).
Property tax is the proverbial “hot potato” of Irish taxation policy and the commission’s proposal, though unsurprising, is likely to attract a great deal of attention. Having pointed out that setting the rate of tax is a matter for Government, the commission takes the trouble to examine the impact of a narrow range of rates (0.25 per cent and 0.3 per cent) for illustrative purposes.
These “illustrative rates” will probably take on a life of their own. They suggest that the APT proposal is a rather modest one, with an annual yield of about €1 billion and an average bill of about €500 per household.
The shift in the composition of the overall tax burden brought about by the introduction of a measure along these lines would be correspondingly small: the revenue raised would be the equivalent of not much more than 2 per cent of this year’s projected total.
A similar point applies to the proposed carbon tax which might raise something in the region of €500 million per annum. So, even if the Minister were minded to introduce both of these new taxes as straightforward revenue generators rather than elements in a revenue-neutral package of reforms, he would achieve only a small fraction of the overall fiscal adjustment of €16.5 billion planned for the 2010-2013 period.
There is no big bonanza for the exchequer here.
jim.oleary@nuim.ie