Almost a year ago, the Minister for Finance stated that the Budget he was introducing before Dail Eireann, with its €4bn in savings, was going to be the toughest on the road to Ireland’s recovery. It was, even then, a bold statement and one I doubted at the time.
In recent weeks, interest – at home and on the international bond markets – in Budget 2011 has increased. (For example, on this site, four phrases to do with Ireland’s upcoming Budget have driven 20% of all traffic in the last month.) And it is clear that if last year’s Budget does prove to be the toughest, it will be by a hair’s breadth, as savings of a further €4bn or more are sought in December.
How will this €4bn in savings be achieved? Should the balance be in tax increases or in spending cuts? The TASC proposals, for example, suggest that Ireland can – without deflationary impact, to the scepticism of some commenters on irisheconomy.ie – raise an extra €2.7bn in taxes next year, while only cutting spending by €300m.
In my next post, I’ll be focusing on expenditure. But that is only one half of the equation and today the focus is on taxation and the government’s receipts. I’ll look at measures that can be implemented for the coming year but also with an eye on the Government’s commitment to reduce the deficit to 3% of GDP by 2014 (I actually work off 2015, as I just don’t think 2014 is feasible).
This year, Ireland’s government will take in about €50bn in receipts. The bulk of this, about €44bn, will be in the form of direct or indirect taxes, or “social solidarity” such as health levies or PRSI. By 2015, if the deficit really is to be reduced, revenues will have to rise to between €55bn and €57bn, depending on how growth and spending evolve. This means that we need to increase our total tax take by about 10%-15% in five years. Do-able? I think so, if done right. Here are two ideas that should drive the government’s taxation strategy.
1. Make income tax simple and normal
I have made this point on numerous occasions: Ireland’s income tax system is abnormal. It has evolved over the 2000s to a system based on the wealthy paying a disproportionate share. (Try selling that idea down the pub!) In the last year for which public information is available, 2006, Ireland’s top 0.5% of earners, the 11,714 people who earned more than €275,000 in a year, paid almost 18% of all income tax, over €2bn in total.
As their average tax rate was 27%, it is perhaps less their paying “above their fair share”, and more the average earner getting away practically scot free. A family with one earner on the average industrial wage was actually subsidised by the state, that’s right, negative income tax all-in, in 2007. Ireland’s income tax system is not normal.
Not only that, Ireland’s income tax system – for years so simple – has become complicated by income levies and a raft of different thresholds. It is no longer a straightforward job trying to explain to someone from outside the country what people pay income tax. Ireland’s income tax system is not simple.
Ireland should go back to having a normal and simple income tax system. Firstly, a complicated system of health and income levies serves no purpose. Secondly, it is frankly not sustainable that one can earn €18,300 a year without making any contribution to the society you live in. And lastly, it is certainly not good for Ireland’s competitiveness that as soon as you go over €34,000 a year, you are faced with one of the highest marginal tax rates in the developed world.
The graph below shows the highest “all-in” marginal tax rate in a range of countries (“all-in” includes social insurance/PRSI and any local government taxes). As you can see, Ireland is by no means undertaxing its highest earners. Its top marginal rate is the fifth highest in the eurozone. So it is not the tax rates that are the issue – it is the number of tax credits. In France and Germany, for example, people pay tax after their first €6,000 and €8,000 in income.
Simplicity could be regained by replacing the current mix of rates and levies with two rates, probably 22% up to €34,000 and 45% above €34,000. Normality could be brought about by two simple moves that would raise up to €2bn next year and somewhere in the region of €4bn by 2015. The first is a reduction in tax credits. Cutting tax credits from €18,300 to €14,000 next year and to €10,000 by 2015 would bring Ireland back in line with our peers. The bad news is that this would cost everyone who earns over €18,000 an extra €860 in 2011, a figure that would increase to €1,660 by 2015. The good news is that this would make a dent of about €1.6bn in the deficit next year and of €3.3bn in the 2015 deficit.
To compensate – everything has to be politically acceptable, after all – a flat-rate income tax of 35% could be levied on those earning more than €275,000. This might sound generous but is well above their last known effective rate of 28% and could of course be a minimum. This is similar to the Swiss flat tax of (wait for it) 11.5% on anyone who earns more than (wait for it) €530,000 a year. This latter move wouldn’t be a silver bullet – after all only about 12,000 people earned more than €275,000 a year even at the height of the boom – but it could still raise €300m next year and perhaps €500m by 2015.
2. Introduce a property tax
I’ve talked about property taxes before. The current property tax “system” is a huge part of the problem. Tax receipts from property sources – including stamp duty, VAT on new homes and capital gains taxes – ballooned during the property bubble to over €9bn a year. They have since fallen by about 90% and will probably contribute less than €1bn this year. Put simply, if you want to know where the hole in Ireland’s government finances came from, it came from unsustainable spending increases on the back of temporary property-based revenues.
This sort of volatility speaks for itself, when considering what property tax we want to have in the future. What we replace it with, though, must have a number of desirable properties. Three are central:
- It must be relatively stable, falling only slightly as an automatic stabiliser for consumer spending during times of recession. This means it must be wealth-based, rather than transaction-based. That means getting a property bill every year, unfortunately.
- It must be relatively significant: the typical developed country gets just short of 10% of its tax revenues from property, so we are looking at about €3bn a year.
- It must preserve incentives to improve your property. The last thing we need is a property tax that somehow convinces people to live in, say, one-off and energy-inefficient homes. This means a tax based on the value of the land, rather than on the value of the building.
With 1.6 million occupied homes in the State, the average property tax bill per year would need to be in the region of €2,000, to raise the €3bn or so needed. This would be significantly reduced if other land was included, for example farms, although this would be anathema to one of Ireland’s most entrenched vested interests. (Incidentally, talk – usually from TDs – about how hard it is to compile databases of properties and value them is complete rubbish.)
There is the option of bringing in an initial flat €500 property tax on all residential properties next year. However, combined with the tax credit adjustment above, that would represent an overnight fall in average monthly take-home pay of over €100 a month, which I think is too sudden and too large. Instead, the government should take the opportunity to make a firm announcement in December that an annual land value tax will be introduced on 1 January 2012, with a 50% exemption for the first two years, as people get used to the regime change. For full fairness, the full tax could be “grandfathered in”, meaning that those who have paid stamp duty since 1 January 2004 would be entitled a sliding scale of tax credits based off the amount of stampy duty paid. For ease of payment, PAYE workers could opt to have the amount deducted at source. The total tax take from the land value tax by 2015 would be in the region of €3bn, some of which would be offset by the virtual disappearance of €1bn currently taken in via stamp duty.
There are, of course, other options, ranging from the economically illiterate, such as flat water charges, to the idealistic, such as a voluntary 2.5% “Economic Solidarity” corporate tax surcharge. Standardising tax reliefs for pensions and abolishing various tax reliefs could, according to Department of Finance and TASC figures, raise €1bn. But we shouldn’t forget that a small number of taxes make up the bulk of government income, so the focus must be on those. Implementing the two measures above should increase the tax-take in 2011 by €1.9bn and in 2015 by about €6bn. This would represent half the battle in terms of savings required for 2011 and would go a huge way to delivering targets for 2014 and 2015.