Tom Maguire: Donohoe must heed expert advice on our tax strategy
We should take suggestions to improve competitiveness, including USC cut, on board
Not too long now until Paschal Donohoe's next Budget or, as I call it, 'Oscar Night' for accountants.
The Tax Strategy Group (TSG) is a government think tank chaired by Donohoe's Department of Finance, with its membership comprising senior people from a number of civil service offices. Their Budget 2019 papers were published recently in line with the Government's commitment to facilitate informed discussion.
The TSG is not a decision-making body and the papers contain a list of options and issues to be considered in the Budgetary process. As I've always said, consultation with us decreases consternation among us, and we'll see more of this as the year progresses.
These papers cover all tax heads and some other policy issues, but some points stand out including one I discussed in this column recently: the rate of Capital Gains Tax (CGT). The TSG estimates that "in the absence of behavioural change", each 1pc reduction in the CGT rate would reduce yield by about €34m annually.
Here's the thing, behaviours do change. Remember the economist John Maynard Keynes's dictum: "When the facts change, I change my mind. What do you do, sir?"
This is something that is recognised by TSG. It explains that CGT can result in delays in selling investments that have large unrealised gains. Therefore, people can hold assets too long which can reduce economic growth because it blocks the beneficial shifting of resources from lower- to high-value uses. This can be problematic for small startup companies, because investors may have a reduced incentive to sell investments in favour of newer companies' offerings.
It continues that reduced CGT can encourage entrepreneurship. Low taxes also boost outside investment from those not directly involved in the management of companies because their reward for taking risks on unproven young companies is a possible gain years from now.
On the flip side, the TSG notes that arguments against reducing the rate are "also compelling". It recognises the possibility of an initial rise in tax revenue from a CGT rate reduction, but argues that it might be transitory based only on the increased sell-offs immediately after the change.
A reduced rate may also bring forward asset sales that would have happened anyway. It continues that a reduction in the tax rate would further undermine the progressivity of the tax system "because relatively wealthy individuals tend to receive capital income".
The TSG argues that quantifying the above is difficult since investors' behaviour would inevitably change. It argues that a rate reduction would incentivise investors to take returns of capital gains rather than income and "may spawn" economically inefficient schemes to disguise income as capital gains for tax purposes.
Okay, I get that, but there are significant anti-avoidance provisions to counter such activity. And, if all else fails, then a tax advantage can be removed by the General Anti-Avoidance Rule (GAAR) where it was "reasonable to consider" that something was done primarily to achieve a tax advantage. There's a whole book on the GAAR but modesty prevents mentioning its author.
So let's play devil's advocate here: a rate reduction could bring cash into the Exchequer today rather than tomorrow. Bringing sales forward which would have happened anyway means that there is a de facto Exchequer reduction given the lower rate - but how far into the future would we wait for that cash because the time value of money matters?
The TSG notes the wealthy may benefit but regular readers of this column will know Nobel prize-winning economist Myron Scholes's maxim: "Success is achieved when the tax rules subsidise activities that benefit society as a whole more than they benefit the individuals engaging in the activities."
There are so many causes that need cash now rather than cash tomorrow and I don't have to list them here. Cash eats good intentions for breakfast.
So the TSG outlines a number of options: (1) introduce a 30pc rate over one or two budgets, ie a 3pc rate reduction (estimated cost: €102m, which ignores a behavioural change ie the €34m explained earlier x 3); and (2) move to a 25pc rate over a two- or four-year period (estimated cost: €272m, ie €34m x 8).
A two-tier rate isn't considered because it would add complexity and could encourage holding assets of preferred types etc.
The TSG's "alternative" to changing rates involves a more targeted approach. They say that if the specific policy option aim is to improve the environment for the formation or maintenance of business activity, then changes at a sectoral level may be more appropriate. At that level it's considered that a reduced rate of CGT can reward entrepreneurship and innovation and TSG suggests a change to Entrepreneur Relief.
Right now that relief allows a 10pc CGT rate on chargeable gains arising on a disposal of qualifying business assets up to a lifetime limit is €1m. Suggested options include increasing the lifetime limit to €5m, €10m, or €15m or indeed a level somewhere between these amounts.
The respective cost of increasing the limits is €49m, €54m and €56m respectively in a full year. The paper notes that the cost to the Exchequer of introducing a €15m lifetime limit is lower than the cost of a 3pc reduction in the overall rate. The UK's current limit is way beyond our current one and you have to remember the basic UK CGT rate is currently 20pc with 28pc applying in certain instances.
So why not combine the TSG suggestions - ie reduce the rate and improve the regime?
On income tax, the TSG explains the Universal Social Charge (USC) is a component factor in our top marginal tax rates of 52pc for all income over €70,000 and 55pc for non-PAYE income over €100,000. High marginal tax rates are a virus which can infect international competitiveness. The TSG suggests reducing the USC's highest rate (8pc on income of €70,000 plus) and increasing lower rate thresholds could improve Ireland's comparative competitive advantage. It also suggests increasing the standard income tax rate band thereby raising the entry point to the higher income tax rates. So let's do that.
You know the line from the movie Jaws: "We're gonna need a bigger boat." In the meantime, let's rock the one we have.
Tom Maguire is a tax partner in Deloitte
Sunday Indo Business