Putting squeeze on high earners a risky strategy
Wealth tax proposal could backfire as revenue evaporates from distorted regime
The 2015 Budget is due in mid-October. Since government debt is uncomfortably high relative to national income, and still rising, further Budget deficits are imprudent, and must be reduced in line with commitments to official lenders. The European Commission repeated during the week its view that a further €2bn in Budget adjustments – which means expenditure cuts and tax increases – will be needed in order to stay on the agreed path of deficit reduction.
Should the monthly budget figures improve over the next few months, the Government might take a chance with a lower adjustment target, but there is likely to be limited joy on that front. Even if the Government hits the target for next year, the deficit will still be around €5bn and the debt burden will still be rising through 2015.
An unjustified public expectation has been created that the economy is recovering to the point where actual tax reductions can be afforded in the Budget. This could turn out to be premature.
Even if the Budget deficit had already been reduced to zero, there would be very little room for manoeuvre, since the outstanding debt is already so high that access to the credit markets for the longer run is not assured. In the current year, the debt will rise by about €8bn as a result of new borrowing, with that further €5bn to be added next year. At some stage the borrowing has to end.
The opposition parties in the Dail, for all the objections to cuts and austerity, accept that the borrowing cannot go on indefinitely. Sinn Fein has offered specific alternatives to the Government's proposals, including an increase in the top rate of income tax, a new wealth tax, increased Dirt (Deposit Interest Retention Tax) and reductions in tax relief for pension contributions. It also wants to cut the pay of ministers and TDs.
Most people pay tax on their income under three headings. When PRSI and the Universal Social Charge are taken into account, the top rate of tax is not the higher 41pc income tax rate, but 52pc for higher-paid employees and 55pc for the self-employed.
Sinn Fein proposes a new income tax rate at 48pc, which would translate into a total top rate of 62pc for the high-earning self-employed and 59pc for high-earning employees.
Soaking the rich is entirely acceptable to most people, provided the definition of 'rich' is sufficiently removed from their own circumstances. The Sinn Fein definition would be €100,000 in taxable income. The problem with higher cut-off points is that revenue declines sharply: there would be no objections to a punitive rate for incomes over, say, €1m, but there would also be no taxpayers, or very few. A €100,000 cut-off for a new higher rate would raise a worthwhile €365m in revenue on Sinn Fein's figures and would re-create a three-rate income tax system, which we used to have. The cut-off point is critical though.
In order to raise meaningful amounts, it cannot be pitched at a level much higher than the €100,000 indicated, but that pulls into the high-tax bracket many people who do not consider themselves exceptionally well-off. If the cut-off were to be €200,000 or higher, there would be far fewer people affected, the yield would be lower and the measure more symbolic than a revenue-raiser.
A more radical step would be to have one income tax instead of three. The drawback for politicians here is that the public would then have a clearer idea of what is going on and would come to realise that the Irish system of direct taxes on income is already pretty onerous. This is particularly the case at moderate incomes, where liability at high marginal rates arises quickly. In most European countries, you need to be very well-paid before you get to pay at the highest rate.
Dirt tax has been increased sharply in recent years and Sinn Fein would like to see a further increase. But deposit interest rates are so low that retired people with cash deposits are already grumbling that they have very little income from savings. A further increase in Dirt would also reduce the incentive for savers in younger age groups.
The taxation of funded pension schemes is complex. The basic idea behind the Irish system is that retirement saving should be taxed once, either on the way into pension funds or on the way out, but not twice. Pensions-in-payment are taxed in Ireland, so pension contributions are tax deductible. There have been several dilutions of this principle in recent years and there is a cap on the deductible amount, which Sinn Fein wishes to reduce further. Ireland now has a two-tier pension system, to go with the two-tier health service. Unfunded pension schemes apply throughout most of the public sector (the exception is the semi-state companies).
Government tax rules cannot siphon money out of the unfunded public service schemes, since there are no funds. Contributions are notional and no limits apply to these notional contributions. There is an annual levy on the amounts accumulated in funded schemes but no levy on unfunded schemes. Most of the funded schemes are already in deficit, and many private sector workers may not receive the pensions they expected. There needs to be a comprehensive re-think on pensions policy, in place of the smash-and-grab raids on the underfunded private sector schemes.
The most radical proposal from Sinn Fein is for the introduction of a wealth tax – something which was attempted in Ireland back in the Seventies, with disappointing results in revenue terms. Several countries, notably France, operate a wealth tax and it is certainly a feasible option. The proposal is that net wealth above €1m would be taxed, with exclusions for farms, business assets and pension funds, and a partial exemption for residential property.
These happen to be the principal forms in which wealth is held. The more exemptions are offered, the more modest the yield. Of course Ireland is about to have a tax on the largest component of wealth for most people, namely residential property. Since the poorest people in society do not, in the main, own residential property, the tax proposed by the government will be progressive in its incidence. It is a surprise that so many Irish socialists object to this particular form of property tax and some have even asserted, without evidence, that it would be regressive.
One of the priorities in policy over the next few years, given the huge external debts of both the public and private sectors, must be the encouragement of a recovery that includes restraint in domestic demand, the better to ensure a surplus in the balance of payments. This in turn reduces the external debt overhang. Measures which diminish the incentive to save through bank deposits, or for retirement saving through pension funds, both on Sinn Fein's agenda, need to be considered carefully from this angle. The household sector, after the extraordinary borrowing binge of the bubble years, has been repaying debt and this should be encouraged through a supportive taxation regime for saving.
The alternative to tax increases is reductions in public spending. Despite the extensive measures already taken, public spending in Ireland under all headings reached almost half of GNP last year.
Balancing the books solely through tax increases has attractions for those on the political left who are unconcerned about a rising State share, but there are practical constraints. Ideology aside, the rates of tax charged in neighbouring jurisdictions, particularly the United Kingdom, is a concern.
Rates of tax in Ireland cannot drift too far ahead of comparable UK rates without risking a haemorrhage of the tax base. A further practical concern, which applies to the wealth tax proposal, is the inevitable administrative workload which arises when a completely new tax is introduced. Our old friend the Law of Unintended Consequences tends to put in an appearance too.
Sinn Fein is proposing to further squeeze top pay rates in the public sector, including the pay of senior civil servants, executives in State companies and politicians.
There should be reservations about this: the pension arrangements in the public service are generous but pay rates are no longer out of line with private sector norms. The risk is that you get what you pay for.