Brendan Keenan

Saturday 2 August 2014

Brendan Keenan: Tax system needs overhaul but leaders lack the nerve

Published 16/01/2014|02:30

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Stephen Byrne's cartoon

OCCASIONALLY -- just occasionally, politicians get the chance to do the right thing when it is also the popular thing. That chance may present itself to this Government, with the prospect of some adjustment (we'll come to "cuts" later) to income taxes. There is already a remarkable amount of talk about this, given that nothing will happen until October's Budget -- if then.

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The Taoiseach has spoken. Priority will be given, he says, to the "very high tax rates" faced by middle-income families. Enterprise Minister Richard Bruton has spoken. His concern is for the high-income, high-skilled people that he says we must attract and retain to fuel growth.

Transport Minister Leo Varadkar and junior minister Brian Hayes zeroed in the on the universal social charge (USC). Mr Hayes described the USC as a "recession tax." That seems fair enough. It is crude, simple and raises lots of revenue.

Mr Varadkar mused about cutting income tax itself, and creating a "proper" social insurance fund, where money from PRSI and the USC would be allocated specifically to the payment of benefits.

That would be a major reform. PRSI receipts, but not the USC, are already earmarked for the social insurance fund. However, they are enough to pay for unemployment and sickness benefits only in boom times.

A fund big enough to cover claims in a recession would bring tears of joy to the Department of Social Protection. It would also be a very useful counter-cyclical device to dampen booms and ease busts. But it would induce tears of frustration in the Department of Finance at having so much money outside its control, and tears of rage from the other spending departments.

Something needs to be done. To do any good, it would have to be something big -- overhauling the PRSI/USC system, changing the income tax structure, raising more revenue from consumption and property and re-jigging the welfare system in the light of these changes.

The report by Mr Bruton's taskforce of entrepreneurs, revealed this week, is full of radical proposals; most notably a flat rate of income tax. First political reaction was that this deserves long-term study - in other words, it is much too alarming.

One certainly sees why politicians would be frightened of change on this scale.

They need what is nowadays called a roadmap -- something, perhaps, along the lines of the paper written by Brendan O'Connor, a senior economist in the Department of Finance, first presented to last June's Finance conference, "Enabling a Growth Friendly Tax System".

The title says it all, holding out the beguiling vision of increasing the economy's potential by changing the tax system -- and making it look like tax cuts. Irish circumstances are a lot more complicated than just high tax rates, whatever Mr Kenny may think.

The evisceration of the income tax system down the years has produced a strange skeleton of a structure. The entry point for income tax -- €10,000 a year, or one-third the average wage -- is one of the highest in the OECD. The entry for the top rate, at just about the average wage, is the lowest.

This combination -- taxes of less than 20pc below average earnings, and more than 40pc above it -- makes Ireland's system the second most "progressive," after Israel's.

In plain language, that means the Taoiseach's middle-income folk must pay for the particularly light taxation of those on less than average wages.

At the same time, Mr Bruton's high earners, paying over 50pc on most of their earnings, think that is just a bit too progressive. They may vote with their feet, either by leaving or not coming here in the first place.

Standard tax theory, based on what is claimed to be hard evidence, says systems like this, with high marginal rates and narrow bases, are bad for growth and employment. Mr O'Connor's paper suggests that a major shift from income taxes to those on consumption and property could add up to 0.4pc to growth and employment after five years.

That may seem a small number, but it is around 8,000 jobs. It still might not be enough to get the politicians going, but they will be lured by the thought that this would involve cutting income tax rates and increasing the top rate entry point. There are complications, however.

Lost revenue would have to be restored through higher consumption and property taxes. Weekend reports that ministers fear over-runs in the health service will end their tax-cutting dream suggest that they have not bought into the idea of a major shift within the tax system, but are merely fantasising about old-style cuts.

A revenue shift would involve much more than that. Mr O'Connor's analysis (not a policy recommendation) studies the impact of a €1bn increase in revenues from VAT or property taxes.

The model says it would be beneficial to the economy, but the model doesn't do politics.

ANALYSTS

Department analysts are not the only ones looking into the tax system. The trade union sponsored Nevin Economic Research Institute has also been challenging the notion that we are heavily taxed. On this, the experts are as one -- we are not -- but everyone else is on the other side.

The NERI researchers, Micheál Collins and Dara Turnbull, very usefully combined direct and indirect taxes. They found the customary Irish pattern, where the bottom 20pc of earners pay more, at 28pc of income, than the middle 60pc; and just a bit less than the top 20pc.

The supposedly squeezed middle might better be called the complaining middle. Property tax may make this U-curve more of the straight line it is supposed to be but straightening it properly will require changes to income tax, indirect tax, PRSI, USC and probably, property tax.

The boom left Ireland with an income tax take well below the EU average, and well below what is needed. The USC has brought the total up to the average, but it ought to become either part of the tax system or a social security fund.

Negligible inflation rates mean this is an ideal time to increase consumption taxes. Those do hit lower income groups hardest and there would have to be compensating reductions in direct tax and increases in welfare benefits.

Analysis in the UK suggests this can be done and that it would be popular. So, too, would be the removal of a lot of people from the top rate of income tax; ideally to a new, middle rate. It would be a mighty piece of policy-making, with the advantage that the details would bamboozle almost everyone and therefore be great for an election manifesto.

I am not sure that our current crop of politicians has the ambition or nerve for such a grand scheme but they are deluding themselves if they think they can get much mileage from the existing shambolic system.

Irish Independent

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