Taoiseach's tax comments are set to frame general election debate
Bringing personal taxes into line with Britain makes a lot of sense, but honesty is needed about the implications for public spending, writes Dan O'Brien
Published 27/12/2015 | 02:30
Taxing and spending are the meat and potatoes of politics in mature, stable democracies. How much is taken from whom and how the money is spent are the matters which tend to dominate political discourse over all other issues. With an election campaign about to kick off, the future of tax and spending will be front and centre among the issues that are discussed and debated in the run-up to polling day.
In a pre-Christmas briefing of political correspondents, Taoiseach Enda Kenny made one of the most potentially significant statements on tax, and by implication on Government spending, in recent times. He said his party would seek to bring the personal tax burden closer to levels that obtain in other English-speaking countries.
The reason the statement is so significant is because taxes on personal incomes, which includes PRSI and USC, raised €26bn last year, or almost half of all tax revenue. As this source is far larger than any other, making changes to it will have very big implications for the amount of money any government has to spend.
Ireland's personal income tax system is different from other English-speaking countries in two respects. First, those on low incomes pay less tax than their counterparts in the UK and US, and many are not in the tax net at all. It can be taken as a given that Mr Kenny is not going into the election promising to raise taxes on the lower paid.
It was, presumably, the second unusual feature of Ireland's personal tax system that the Taoiseach was referring to when he made his pre-Christmas comment. This feature is that as your income rises above the national average, your tax bill starts rising rapidly. On €70,000 - an unremarkable salary in a multinational - you start paying a lot more tax than your counterparts in the UK and US. When Mr Kenny spoke about bringing the Irish tax system more into line with the rest of the English-speaking world, he was talking about lowering personal taxes for this group.
If Fine Gael returns to government and brings taxes on people earning €60,000-€200,000 down to levels paid on the same incomes north of the border, then there will be implications for the amounts of revenue collected. That, all other things being equal, means spending cuts. If we are moving into an era of greater fiscal responsibility, then the party needs to discuss in a lot more detail where it will cut spending to allow for lower taxes (I understand that the Taoiseach did not go into that side of the fiscal arithmetic during the briefing).
Before looking at the spending implications, it is worth examining the case for bringing personal taxes into line with our nearest neighbour and north America.
One reason is the effect on jobs. It has long been agreed among economists that the Irish jobs market is more like a region of the UK than that of most independent countries. The ease with which people migrate from west to east and vice versa has meant that if take-home pay for a given job in Ireland moves much out of line with the same job in Britain, workers take heed and consider moving to the place where they can earn most.
Although wage growth in Britain has been surprisingly low in recent years, that is likely to change as the unemployment rate is now close to 5pc and still falling. If wage growth in the UK outstrips that of Ireland over the next couple of years, as is likely, working in the UK will become relatively more attractive. Given considerably lower taxes on better paid jobs in Britain, that will reduce the numbers moving here from there and incentivise higher earners here to move there.
A second reason the Taoiseach cited for bringing the personal tax regime into line with competitor countries is the effect high taxes have on foreign companies operating in Ireland and those considering locating operations here.
This is an even more important consideration than the first one as capital is more mobile than labour. It is particularly important because of the unique role foreign capital plays in the Irish economy - no other OECD country has as large a share of its workers employed in non-national companies and no country in the world has 90pc of its exports accounted for by foreign multinationals, as is the case in Ireland.
Put simply, that Ireland over the past two decades has enjoyed prosperity levels similar to our peers in north west Europe, after so many decades of being the poor man of the region, is down to the influx of foreign multinationals in the 1990s. As such, it is imperative for all governments to do everything possible to keep them here and lure additional ones.
If labour costs rise and multinational managers feel their personal financial situation is considerably worse than it would be elsewhere, then Ireland as an investment location will be less attractive.
If there is a very strong economic argument for bringing personal taxes down towards levels in competitor countries, the broader fiscal implications need to be considered.
It goes without saying that the Irish Government has historically high levels of debt. It needs to be said more often that the gap between what is spent and what comes in remains in the multi-billions. As such, there is little scope for radical tax cuts unless they are matched with radical spending cuts. If Fine Gael is advocating the former, it cannot plausibly do so without discussing where the savings would come from.
Given that public spending per person fell by one-tenth between 2008's peak and last year, causing considerable resistance from those who lost out, finding more cuts will be hard, particularly in the context of a population that is growing at one of the fastest rates in Europe.
Health and public sector pay account for more than one quarter of total public spending. For political reasons it is all but impossible to envisage any government cutting either. For demographic reasons it is almost impossible to see education and infrastructure spending being cut. Debt servicing costs, accounting for one-tenth of total spending, are largely out of any government's hands but must be met in full to avoid a sovereign default. That leaves the largest single item of public spending - welfare.
When all kinds of social transfers are included, the welfare bill stands at €30bn - more than 40pc of total government spending. Fine Gael could, in line with its make-work-pay stance, look to emulate the kind of radical welfare reform that has been implemented in the neighbouring jurisdiction. But, as was the case in Britain, big reforms generate big opposition. For a catch-all party of Fine Gael's ilk to propose changes as radical as that going into an election would be unusual, to say the least.
If any party does promise big tax cuts, something to watch for in the general election campaign will be whether they try to claim that a growing economy will of itself reduce the welfare budget and free up resources for tax cuts and/or additional spending. That won't happen to any great extent because dole payments - contrary to what most people think - actually account for only a small share of total welfare spending. Pensions, a myriad of working-age benefits, housing benefits, illness and disability payments and other benefits account for the lion's share.
As with all elections in every democracy, parties will try to offer gain without pain. If our political discourse is to become more honest, there needs to be plain speaking about how tax measures fit with spending plans.
By all means be radical, but radical change will impact some people radically in negative as well as positive ways. There are no free lunches.