Today, S&P announced that Ireland’s sovereign debt rating has been cut again, down to AA. Given this, which comes as no surprise, and given the latest Exchequer figures to come out last week, I thought it might be no harm to recap the bigger picture on the government’s revenue side (the expenditure side is a thesis in itself).
A quick look back shows that tax revenue peaked in 2007, at €47.25bn, up from €45.5bn a year earlier. Income tax and VAT comprised about 30% each, while almost another 30% came from corporation tax and from customs & excise. The remainder was made up of 7% each from capital taxes (gains and acquisitions) and from stamp duties.
Fast forward to mid-2009 and tax revenues are scheduled to come in this year about €35bn (Ulster Bank suggest €34.4bn as a more exact figure). So far this year, VAT has stumped up almost 40% of revenues, while income tax has given us another 34%. That’s almost three quarters of our tax revenues coming from sources that used to produce just 60%. Meanwhile, capital taxes and stamps – which had given the government about 15% of its revenues in 2006/2007 – have given it just 4.4% so far this year. Customs and excise has been largely static, in relative terms, while corporation tax is also likely to come in at about 14%.
Where are the holes, then, and how should they be plugged? The Irish government had targeted what now looks like an astonishing €57bn in tax revenues in 2009, as recently as 2007. I think if one were to suggest to them today a way of getting our tax revenues back up to where they were in 2007 – €47bn – they’d bite your hand off. (For sustainable public finances, incidentally, that would mean cutting back total government expenditure from the €56bn+ of 2008/2009 back at least to 2007 levels, €51bn, and ideally to €47bn.)
The government has a choice. It can choose to keep the broad structure of the Irish taxation system the same and work on getting each source of revenue back up to where it was. Or it can try to fundamentally revise the taxation system. Suppose they want to do the former, given that Irish taxation policy has, at least on the face of it, been very successful in attracting capital and labour here. In that case, the graph below is important, as it shows how the €12bn in lost tax revenues, comparing an annualized 2009 with 2007, breaks down by taxation type.
Interestingly, the smallest gap is in income tax, less than a billion euro. If the government wants to keep the overall structure of the taxation system the same, the level of the measures taken so far is sufficient. Presumably the nature will change, though, and by fixing the bands, the lower ones in particular, and adjusting the official rates (and abolishing the income levy), income taxes should revert to their 2007 levels.
That, unfortunately, is the easiest of the lot. The next two smallest gaps concern predominantly business and international trade. Corporation tax looks like coming in €1.5bn below 2007 levels, while the customs and exise gap may be closer to €1.7bn. The latter in particular is probably out of government hands – if trade falls, trade falls, all it can do is promote exports to get this back up. (The only thing to do would be to hit domestic excise duties, e.g. on cigarettes and alcohol, yet again.) The former – increasing corporation tax – is more controversial. Low corporation tax rates have been a staple of Ireland’s enterprise policy for at least a generation and the argument against increasing our 12.5% tax rate at all is that business could see this is as the thin end of the wedge of drifting back up towards the EU average (which is getting a lot closer to our own rate anyway).
Here’s a thought, though. We’ve increased our rate before, when we increased it from 10% to 12.5%. The argument then was that this was due to exceptional circumstances, the EU having essentially put a gun to our heads. The outside option was working with the 40% rate, so international business appreciated the necessity of the increase. Given the current state of the Irish economy and the Irish fiscal situation, increasing corporate tax to 15% is a step worth considering – particularly if discussions with businesses currently based here are thorough. Ireland is unique, being an English-speaking EMU member, with GMT and an open labour market and well qualified young people. To sustain that, a one-off change needs to be made, just as it did a decade ago. Perhaps, this could be done in tandem with other strategic objectives of Irish enterprise policy, e.g. innovation or R&D tax credits, which may offset the total impact, while still achieving social outcomes. (These are the broad arguments for and against fiscal support for innovation.) Taxes that meet other objectives society has set itself – such as a carbon tax on sectors outside the EU Emissions Trading Scheme – could also be considered to ensure that business contributions increase in the order of €3bn back up to their 2007 levels.
In total, “fixing” income, corporate and trade taxes would boost Government revenues by about €4bn. This still leaves €8bn to sort out, though. Unfortunately, the bulk of this seems property-related, and therefore most unlikely to pick up any time soon. Perhaps the guts of €10bn of 2007 tax revenues, spread across capital gains, stamp duties and VAT, came directly from Ireland’s booming property market, which would also have boosted the rest of the VAT take as well as income tax. Whatever about VAT – whose gap this year compared to 2007 looks likely to be over €3bn – the €5bn gap across capital taxes and stamp duties cannot highlight more clearly the need for a sustainable source of government revenue from Ireland’s property, which after all represents the bulk of Irish wealth holdings.
I’ve argued before that a tax levied on residential property that averaged 1% could raise in the order of €4bn. Again, this could be combined with other government objectives, such as energy-efficient buildings, so that taxes do more than just fill government coffers. There is a lot of resistance to the idea of a property tax – much of it, such as this piece in the Irish Independent, couched in logistical difficulties. Next Monday, I’ll tackle these issues and show how a tax on residential property is very feasible, particularly if Ireland put its mind to it.
Given the state of the public finances and the fact that, even if we do generate €10bn in public expenditure cuts, we need to raise raxes by about €12bn, there can be no more compelling case for putting our minds to it than that.