Thursday 27 November 2014

Brendan Keenan: We are hamstrung by idiotic election pledge on tax rates

Published 08/11/2012 | 05:00

COULD next year be the one that makes or breaks the Coalition -- and with it, perhaps, the country?

You may say, with some justification, that the country is broke already, but there are still two paths that events may take.

One is further adjustment to the core public finances, to the point where stronger economic growth and an agreed re-structuring of government debt do the bulk of the work in restoring stability to the general public finances.

The other possibility is inability to complete the essential basic adjustments; a political crisis; a threat to withhold further payment from the troika, and a set of consequences which no one can predict.

I do not expect the Coalition to fall in 2013. But by this time next year we may well be able to say which of the two paths is the more likely over the following several months.

The official view everywhere, of course, is that the former, more optimistic scenario is the more probable. The official view may be correct.

But the alarm with which the troika reacts to political difficulties such as the resignation of Roisin Shortall, suggest official worries lurk not far below the surface.

Part of the difficulty is that the unofficial view -- ie the one held by almost everyone else -- is that the official scenario is optimistic to the point of impossibility. The numbers who believe it can be done are dwindling even, it sometimes seems, within government.

That is why next year is important. It looks like being the first year since the crisis began that things will depart markedly from the plan.

In particular, economic growth will not be what it should have been.

The latest projections in the Department of Finance put real growth next year at 1.5pc instead of the previous 2.2pc.

Unlike most other things, what matters for the public finances is not "real" growth in output but the "nominal" money increase when inflation is added.

Inflation is not much help at the moment, but it may provide some. The plan envisaged nominal growth of 3pc next year and the outcome may not be far short of that. Even so, the target of an extra €1.8bn in tax revenues next year may come up short.

Big deal

One might suppose that, in a €3,500m Budget, another €200m would be no big deal but, of course, it does not work like that.

Already, at this stage of the process, everything is a big deal and even a modest shortfall in tax revenues could represent major political slippage.

This is assuming that the troika does not insist on bigger corrections to make up for any shortfall, but this now seems a reasonable assumption.

There is a new consensus that it is a mistake to chase a fixed deficit target, such as the EU's 3pc of GDP, if the economy is even weaker than the austerity plan assumed.

But the existing programme would continue. It is just that the finishing date would be postponed. That is where the political danger lies.

The idiotic election pledge not to change tax rates or bands (and the more idiotic decision to keep the pledge) does not help; but the tax system itself is a large part of the problem.

And, despite all the bleatings to the contrary, the problem is that the system is highly progressive, where taxes rise rapidly with income.

"Progressive" is a loaded word. It is hardly progressive in the normal sense of the word that the top rate of tax kicks in at earnings of €35,000 a year. Even in Sweden, the top band begins at €65,000.

Two-rate system

They do not have our attenuated two-rate system, so they can be more flexible with bands. Two recent reports show the result: Ireland has some of the biggest tax burdens for higher earners, along with one of the lowest burdens overall.

A report from accountants Ernst & Young showed a tax take of 36pc from someone earning €75,000 a year. That is roughly the same as Sweden or Norway, and 16pc more than the UK.

But the latest annual report from the OECD found that Ireland had one of the lowest tax takes from all its population, at 28pc of GDP -- less than the UK and a third less than Sweden and Norway.

One must be careful here. In line with research from the Fiscal Advisory Council, we will add 10pc to get a percentage of national income (GNP), which brings the tax take to 31pc.

One might even add a bit to that for when things return to normal, allowing for the particularly heavy revenue losses from the Irish crash. But it is still a low tax burden by OECD standards.

OECD levels

Getting it up to typical OECD levels of, say, 35pc of GNP would always be a major political challenge, but the squeezed tax system makes it a night- mare.

The low entry level for the top rate means one in three workers face "marginal" deductions of over 50pc on any extra earnings, when the USC and PRSI are included.

These are imposts normally reserved for the very rich in other countries -- if at all.

The adjustment programme calls for an extra €4bn from income tax and social security by 2016.

Projected nominal growth of 1.6pc over the same period would have delivered most of that but, if it does not, new tax measures will have to be taken.

You may be under the impression that spending is supposed to bear the brunt of the adjustment: in which case you have not read the small print.

Government spending before debt costs or investment will remain constant while tax revenues rise by more than €7bn.

In the strange world of government accounting, that represents spending cuts providing most of the correction, but not in anyone else's world.

Saner tax system

The great question is, what happens if the growth does not arrive? There is only one way to create a saner tax system, and that is to increase the 20pc rate significantly -- say to 25pc -- for incomes above €25,000 or so, and begin a process of bringing the top rate threshold closer to €50,000.

Political suicide -- but what a way to go! One could sweeten the pill by applying a 60pc marginal rate to incomes over €100,000, as Labour has suggested in the context of the existing tax system -- although experience in the past suggests tax rates of this size have all kinds of unintended consequences.

But even modest increases in tax bands or rates could prove terminal with less than two years to an election and in the turbulent wake of property tax and water charges. They had just better hope that, despite the forecasts, something turns up next year .

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