News Stephen Kinsella

Tuesday 23 September 2014

Income tax change may win elections but it just doesn't make any sense

Published 04/03/2014 | 02:30

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Finance Minister Michael Noonan
Finance Minister Michael Noonan

There is now incontrovertible evidence the domestic Irish economy is recovering.

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Employment growth has exceeded expectations for two quarters now, with unemployment decreasing to 12.1pc, domestic demand for goods and services increasing by almost 3pc when you adjust for seasonal effects and price changes, and retail sales going up by almost 2pc.

These might sound like small changes, and they are, but taken together they are signs of a febrile recovery taking place within the domestic market where it matters.

I have argued many times in this column that external measures of success, like bond yields, should not be taken seriously until the domestic economy starts to recover.

We should all welcome these positive changes. They have been a long time coming, but we need to put them in perspective. Our leaders are not putting these changes in their proper context, presumably for electoral reasons, as well as a need to provide some type of forward guidance on policy.

The Taoiseach was guilty of this in his leader's speech at the Fine Gael Ard Fheis last weekend. Mr Kenny said: ". . . when the public finances allow, our priority will be to reduce the tax burden on families with average incomes, too many of whom are paying the high rate of tax."

Michael Noonan echoed the Taoiseach on Sunday in a radio interview. Income taxes will fall, subject to resources being available.

The strategy seems to be to increase the threshold at which a taxpayer hits the higher rate of tax.

Right now this threshold is very low by international standards at just over €32,000. Ireland's top rate of tax actually starts at around the average wage. Mr Kenny thinks too many families with average incomes pay the higher rate of tax. "Too many" in this context, is practically everybody. The Irish taxation system is also highly skewed by the Universal Social Charge, Social Security Contributions, and the income threshold at which the top rate kicks in.

An excellent paper by Brendan O'Connor in the latest issue of the 'Economic and Social Review' shows that labour taxes, income taxes basically, were the fifth lowest in the European Union in 2011, while the 'core' burden of income on taxation, when you include social security contributions, jumps to 42pc, some of the highest in the EU-28.

The top 5pc of all income earners in 2011 paid 40pc of the tax. Those earning more than €50,000 paid 77pc of all tax. The Irish taxation system has the odd feature of being both highly progressive and therefore distributive, but also hitting lower earners earlier.

The Taoiseach's speech echoes the Finance Minister during last October's Budget, and a host of other senior ministers since then.

The Government is effectively taking out an option on income tax changes even as the gap between government expenditure and receipts stands at more than 7pc of economic output. In round, real numbers, the Department of Finance's fiscal forecast for 2013 to 2015 puts the gap between government spending and income €11.3bn in 2013, €9.6bn in 2014, and €6bn in 2015. Why?

It makes no sense for the leader of the country to talk about income tax changes, except in electoral terms.

In a previous column, I talked about the risks policymakers take in setting expectations early on in the fiscal year to get consumption to increase, in the hopes that increased growth in demand, and increased income taxes generate the windfall necessary to allow the tax cut at the end of the fiscal year.

The Government has decided to take that risk.

This version of 'forward guidance', where the policymaker says 'if I see situation X happening, I'll do Y', is risky at the best of times. The Government just doesn't have that level of control over the economy. But now? With the economy barely breathing on its own again? The Government is making the kind of predictions it will need to fulfil now, electorally, and that may be very bad for an economy on an adjustment path away from national insolvency.

Unless the Government's plan is actually to cut income taxes, but increase property-type taxes to compensate for the shortfall. The Government's medium-term economic strategy, page 65, discusses exactly this scenario. In this situation, the Government gets a win on both sides of the fence. Property-type taxes don't really have an impact on the labour market, but income taxes do.

Higher income taxes hurt productivity and employment growth. Property taxes don't. Think about it – you're less likely to take a job or work harder when you'll lose more than 50pc of your last hour's income. If the Government changed that threshold to (say) 45pc, then you might work the extra hour. Both you, and the economy, benefit.

Property, carbon and water taxes, on the other hand, have to be paid regardless of any extra effort. So the Government could push income tax thresholds significantly lower and ramp up property taxes, and still try to increase the tax-take required to balance the economy's finances.

Regardless of which policy path the Government takes, talking about income tax changes at this stage just doesn't make sense.

STEPHEN KINSELLA, SENIOR LECTURER IN ECONOMICS, UNIVERSITY OF LIMERICK

Irish Independent

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