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Exploring the outer regions of hidden fiscal space

Posted on July 14, 2017 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

The 2017 Summer Economic Statement appeared last week.  The Statement follows a seasonal pattern along with the Spring Economic Statement and, ultimately, Budget 2018 due to be presented to the Dáil in October and approved by the European Commission on behalf of the EU28. The debate, such as it is, in the run up to Budget 2018 in Ireland follows familiar patterns each year:

  • Some commentators call for increased investment
  • The same or other commentators call for cuts in income tax for ‘middle Ireland’ (of which a definition varies).
  • While still other commentators call for additional funding for education or health or social protection or transport or business support or regional investment (depending on who you are).

It is less common for commentators to call for:

  • More public investment
  • More current spending
  • More taxes

Yet, the logic of what most people say they stand for is shaped by:

  • The need for more and better impact spending given demographics and other pressures
  • The need for fiscal sustainability (living within our means as well as keeping our EU partners happy)
  • The need to be re-elected in the case of political parties.

A major help to the debate would be a fair, balanced and informative consideration of the facts as well as the policy implications of a growing and ageing population. In relation to the European Union, as a whole, its main concern is that monetary and political cooperation is protected and no Member State drags down the rest whether by way of a full-blown crisis in sovereign debt confidence, such as happened in Ireland or Greece, by way of political instability and/or collapse in market confidence. There is a merit, so it is thought, in squeezing recalcitrant countries as hard as possible just short of causing a political breakdown in those countries. By the same token, it is deemed to be important that any responsibility for the mess on the part of the large creditor member states is denied or avoided (usually both).  While the EU fiscal rules are stacked against spending more rather than taxing less (the language used is ‘expenditure ceilings’), it is also the case that Member States are free to choose the level and composition of spending and taxation. What matters is net fiscal measures after potential tax increases are deducted from additional spending.  Sweden and Denmark as not compelled to reduce their spending and taxation to Irish levels (these being the lowest when it comes to spending and taxes as a percentage of GDP).

The rise of what some call ‘leipreachán’ economics in the case of Ireland in 2016 has been a godsend to the fiscal hawks as well as those addicted to an ever smaller state for many for at least three reasons:

  • It generates a lot of additional corporate tax flows (though the companies most implicated in leipreachán activities probably pay a relative pittance in corporate tax))
  • It makes the official public debt to GDP figures look good
  • It muddies the waters when it comes to any international comparison of public spending and taxation because we do not know what benchmark of total domestic or national economic activity to compare levels of spending and tax to (the awkwardly labelled GNI* is probably about to replace the crudest of labels known as ‘hybrid’ GNI-GDP).

GNI* (or what CSO call modified GNI) estimates were released last Friday by the Central Statistics Office [National Income and Expenditure Annual Results]. GNI* estimates have the merit of removing questionable economic activities that are not to be considered as core, sustainable and reliable economic activity of genuinely Irish based corporations abroad and/or enterprises in Ireland who might be using Ireland as a flag of convenience rather than contributing much by way of taxes, wages and materials purchases. However, it must be acknowledged that all income, output and expenditure captured under GNI* is actually or potentially taxable by Irish law. Moreover, the application of EU fiscal rules is premised on GDP and not GNI*. 

When reality hits we have tough choices to make:

A  Do we aim to surpass other EU member states as well as the UK (inside or outside the UK) in reducing rates of personal direct tax (on income or capital)?
B  Do we continue – as a matter of national policy priority – to maintain a relative light reliance on corporation tax at the expense of households?
C  Is there the will and the mandate to simplify and streamline indirect taxes such as VAT and excise duty?

Are we serious about ‘carbon taxes’?

As readers of this blog will realise, I am no fan of tax cuts. Rather, along with other colleagues at the NERI we have consistently, since 2012, made the case for Ireland to transition gradually to European norms of public spending and taxation. That said, to make a case for higher taxes over time will take courage, evidence and resolve. It would greatly help the cause if:

  • Areas of spending economies and diversion of resources are critically examined so that people feel that they get ‘value for their taxes’.
  • The implications of future likely patterns of demand for public services and income support are researched in greater detail with due allowance for uncertainties in any future forecast scenario.
  • Existing levels of tax and welfare were assessed against ‘good practice’ in other jurisdictions.

On A, above, there is an urgent need to assess how resources in the health sector, for example, could be freed up to enable healthcare to be delivered as much as possible outside expensive hospital settings.

Also, on A, above, Government should list and quantify in greater detail the extent of ‘Tax Expenditures’. Progress was made during the years of fiscal austerity in closing off some of the more egregious and anti-equality tax breaks on super pensions, property and other areas. More needs to be done. Tax expenditures, as the name suggests, should be viewed as a type of spending which goes to particular groups or individuals (and not uncommonly to those in the higher income brackets availing of tax relief on the higher income tax rate of 40%). Moving beyond the question of tax expenditures, we need to consider the exceptionally generous tax reliefs given to particular groups and individuals. Is there a continuing rationale for a sharp divergence in tax treatment of single persons and married persons (regardless of whether either have children under 18 years of age or not)?  Is there a case to streamline the entire income tax system and create a two-tier system based on the USC absorbing the current income tax system and a separate system based on a meaningful social insurance model paid for by employees and employers?

On B, above, we need to have an honest conversation about taxation. Ireland has taken something of a battering in relation to image and reputation on the global corporate tax avoidance industry.  We cannot continue to play this card indefinitely and it is, in any case, not very ‘European’ to be seen as the odd person out. After all, the departure of the UK from the EU club means that the remaining EU26 may trade concessions to Ireland to soften Brexit in exchange for progress on taxation matters.

Three cheers for the EU on this matter!

On C, above, the complexity of VAT charging and administration makes little economic or social sense.  By its nature, VAT and excise tend to be regressive taxes in so far as they hit households on low incomes. Might there be a case for streamlining the entire system to create three rates of VAT: zero on a small number of products and services, a middle rate (say 13%) on most other goods and services and a much higher rate on ‘bads’ plus ‘luxuries’?

Rather than treat each year’s Budget as a debate about relatively little changes at the margin we ought to have a mature, evidence-based debate about reshaping Ireland’s taxation and public services over a 10 year period in which Total Fiscal Space is considered – the most of one trillion Euro if you add up total annual revenue over a 10 year period and allow for some growth in GDP.

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