'These truths we hold to be self-evident...'
Posted on April 25, 2015 by Tom Healy
‘These things we hold to be self-evident …. ‘ is a line taken from the 1776 USA Declaration of Independence. Given the emerging debate - such as it is – in the Republic of Ireland on matters to do with taxation, social spending and related areas it would seem that the following ten canonical statements are universally believed in, rarely contested and frequently asserted:
- ‘Ireland has the most progressive tax system in the (OECD) world’
- ‘The vast bulk of tax is paid by relatively few people with high income’
- ‘The squeezed middle are the hardest squeezed of all’
- ‘Income taxes along with taxes in general are higher in Ireland than elsewhere’
- ‘The 2008-2013 fiscal correction placed enormous tax burdens on people; it is time for some pay-back’
- ‘Tax cuts are good for economic activity’
- ‘Public spending in Ireland is high’
- ‘Ireland should follow the example of the US and the UK in implementing flexible labour markets and light-touch regulation; this can teach lessons to other European member states’.
- ‘The reasons for our recent economic calamities included out-of-control public spending; tight fiscal rules will avoid another calamity; we just need to stick to fiscal rules and undertake structural reform’
- ‘The key to competitiveness is (i) low wage costs and (ii) keeping corporate taxes low’
Let’s consider the first statement or assertion, above.
‘Ireland has the most progressive tax system in the (OECD) world’
This statement is based on a very partial and selective interpretation of just one item of statistical information; namely the estimated amount of income tax paid by individuals or households just above the average (167% of the average) compared to that paid by those just below the average (67%). Indeed, there is a steep income tax curve by income. The problem is that this statement neglects two important things:
- It measures tax that would be paid without a range of tax reliefs which tend to be availed off by higher-income households
- It neglects the actual tax paid by low-income households in VAT, excise duty and other taxes on consumption.
The estimated actual total tax paid (income tax plus VAT and excise duty) in a recent year by different households sorted by income is shown in Chart 1 below and is drawn from work by my colleague Micheál Collins:
Chart 1 Percentage of household gross income paid in taxes (direct and indirect) in 2009/2010 by income decile
Source: "The Total Direct and Indirect Tax Contributions of Households in Ireland: Estimates and Policy Simulations,"(Dublin: NERI Working Paper Series, 2014), 19, table 8
While there are problems and limitations in any exercise based on estimations of household spending and income the Chart, above, provides the best available estimates based on official CSO statistics. It shows that higher income households pay higher tax as a % of their income but the difference between the highest and the middle (say the 5th decile) is not that huge. A perverse finding is that the bottom or poorest group of households pay the most tax. True, the better off pay proportionately more income tax (reflected in direct tax in the chart) but this is counter-balanced by ‘flat’ consumption taxes which take up a larger proportion of poorer households spending and income as a general rule. Unfortunately, there are no comparable international data to contrast Ireland with other countries on the above metric. However, the evidence that Ireland has a sharply progressive overall tax system – one of the most progressive in the OECD – is simply not there.
‘The vast bulk of tax is paid by relatively few people with high income’
This is true if we were talking about income tax. It is also true that relatively few people earn most of total income! This is why, in part, we have taxation on income – to redistribute some of total income. What matters is not the % of total tax paid by this group or that group but, rather, the average effective tax rate paid by different income groups.
Chart 2 Average effective tax (including income levies, USC, PRSI and ‘income tax’) payable on different levels of gross income (single persons only)
Source: page 98 in "Taxation" by Micheál Collins in “The Economy of Ireland: National and Sectoral Policy Issues”, ed. John O'Hagan and Carol Newman (Dublin: Gill and MacMillan, 2014).
Chart 2 tells a number of interesting stories:
- Average tax payable (based on Department of Finance reported rates in 1997 and in 2014) rises with income - income taxes are indeed very progressive
- Average tax payable by low income households is low both in 1997 and in 2014 (reflecting an Irish faustian pact involving a low social wage, considerable wage and income inequality balanced off by a skewed income tax distribution to produce a less sharply inegalitarian distribution of disposable income)
- Taxes were much higher for any given income level in 1997 than in 2014
Even allowing for growth in incomes between 1997 and 2014 the estimated overall income tax rates for each income level in 2014 are significantly lower than is the case for the majority of tax payers in 1997. For example, a single person earner on €15,000 (or pounds equivalent) in 1997 paid around 22% of gross income on income tax while a single person on €40,000 in 2014 paid about the same (the contrast is even starker still for jointly assessed couples). For further detail see the NERI Working Paper ‘Taxes and income related taxes since 2007’ by Micheál Collins
‘The squeezed middle are the hardest squeezed of all’
One of the difficulties in assessing this claim is that few commentators define what the middle is. Dividing households into ten ‘deciles’ is useful way of comparing different households by gross income. The non-surprising result, perhaps, is that most people who comment on economic matters are above to well-above the median income. In other words, people’s notions of middle is shaped by the world in which they work, socialise and exchange information. There are a lot of households and individuals on annual incomes well below the vaguely claimed ‘middle’ ground of €30,000 to €70,000. Indeed, as measured by household gross income the ‘middle’ was approximately in the range of €30,000 to €48,000 in 2011. 40% of all households had a combined gross income of below €30,000 per annum. While estimates vary, there is no evidence based on analysis by the Economic and Social Research Institute that households in the middle took the biggest hit in terms of income cuts, job losses or the impact of withdrawal of social payments or services. Limited as it is the evidence points towards a slightly higher proportionate impact on the very wealthiest and the very poorest of households (thus putting into question the ‘squeezed middle’ hypothesis).
‘Income taxes along with taxes in general are higher in Ireland than elsewhere’
This is an old chestnut. Whatever way we measure it – by total government revenue as % of GDP (or GNI or some contrived hybrid of GDP and GNI) Ireland is certainly not above average compared to most European Union member states. The evidence points to a lower overall tax take – driven to a large extent by two factors – lower income taxes on the very low paid (a type of employer subsidy in exchange for greater wage inequality) and lower contributions by employers especially in the form of social insurance. To illustrate the point in relation to income taxes the reader is referred to chart 4 below. The example is for a single person on the average wage.
Chart 4 Percentage of Gross Income paid by a single person in income taxes (average wage in 2012)
Source: Source: OECD Tax Benefit Modeller
‘The 2008-2013 fiscal correction placed enormous tax burdens on people; it is time for some pay-back’
The recent crisis saw sizeable increases in the amount of taxes paid by all households (or nearly all) via changes in tax credits, PRSI rates and bands, USC, removal of reliefs etc. However, the overall adjustment was more severe on public services including the ‘social wage’ (more anon in a future blog). Also, the tax bill facing households in 2014 is nowhere as much as it was in 1997 (admittedly another era but not that long ago). Furthermore, Ireland’s overall tax take is lower than in other countries (as already pointed out). We get what we pay for in terms of social services. And what we get is a two-tier health service (with a new added dimension for those over and under 34 years of age), a multi-tiered education system, a public transport system that could be a lot better in terms of investment, a water infrastructure that is largely Victorian and an early childhood education and care provision that is closer to Boston than to Berlin.
‘Tax cuts are good for economic activity’
This is one of those statements that are made with much confidence as if the literature on the impact of tax cuts is clear cut and overwhelming. Far from it. The evidence is under-whelming. Moreover, the evidence points, historically to countries with high levels of taxation and high levels of productivity as well as public services and industrial innovation.
‘Public spending in Ireland is high’
We can look at indicators 6.1 and 6.2 in the NERI Quarterly Economic Facts (most recent Spring 2015 edition) to see that this assertion does not hold up.
‘Ireland should follow the example of the US and the UK in implementing flexible labour markets and light-touch regulation; this can teach lessons to other European member states’.
This is a significant belief underlying many claims including slightly euro-sceptic leaning commentators in Ireland. Paradoxically, the notion of ‘structural reform’ (code word usually for making it easier to hire and fire workers and to keep wages down) appears often in the lexicon of the European Commission (e.g. Country Specific Recommendations as well as various communications about fiscal rectitude and growth-friendly fiscal consolidation). The peculiarity of the US and UK experience since 2008 is explained, in part, by their less doctrinaire approach to austerity compared to what occured in Europe since around 2010. It should be pointed out, however, that the price of anglo-american labour market flexibility is higher incidences of poverty wages and social inequality more generally. In the UK, there is the added problem of low productivity as a result of under-investment in skills as well as a shift in the composition of the workforce (it is even more complex than this of course).
‘The reasons for our recent economic calamities included out-of-control public spending; tight fiscal rules will avoid another calamity; we just need to stick to fiscal rules and undertake structural reform’
If only people followed the rules to the letter we would not have bust and boom and secular stagnation! The problem in Europe was not run-away public spending. The biggest casualties (Greece apart) in 2009-2010 included Spain and Ireland which were well within EU fiscal rules prior to 2008. Macro-economic imbalances, a property boom, lax regulation, capital flows to the periphery of the EU from the core all helped to magnify the post-Lehman crash in 2008.
‘The key to competitiveness is (i) low wage costs and (ii) keeping corporate taxes low’
The evidence does not stack up that keeping wage low is a success factor nowadays in most European countries. Ireland’s recovery in 2012-2014 had more to do with what was happening in pharma, IT and other areas of the multinational sector than what was happening to wages in these sectors. True, a policy of keeping corporate taxes low (some would say too low) has helped to encourage foreign direct investment (FDI). Two observations arise:
- Many, many other factors also matter including skills, infrastructure, political stability etc.
- A long-term strategy to develop the Irish economy cannot rest mainly on FDI implying a gradual reorientation in industrial, training and national innovation strategy.