Ireland’s problem isn’t high taxes, it’s high dependency

With the October budget approaching, the clamour for tax cuts and spending increases has begun and, reminiscent of the Celtic Tiger era, competing “special interests” are limbering up to claim the fruits of the recovery.

Ironically, this is precisely the type of “boom-bust” cycle targeted by the Fiscal Compact treaty, ratified by a 60 per cent majority in a referendum, in 2012. Sadly such policies, embraced during recessionary times, prove less politically palatable in the recovery, especially preceding a general election.

That said, the planned €1.2 billion-€1.5 billion giveaway, worth less than 1 per cent of GDP, is relatively sober compared to past election budgets. Some reduction is likely in high, 50 per cent-plus marginal tax rates on income. A cut of 1 percentage point in the 7 per cent Universal Social Charge rate would cost €370 million. A cut of 1 percentage point in the higher 40 per cent income tax rate would cost €230 million. But room for tax cuts will be limited by spending pressures.

The Minister for Health has indicated a €1 billion increase in health spending is required. A €5 increase in child benefit could cost €70 million. No doubt other Government departments will bargain hard for higher expenditure allocations.

Little mature discussion takes place on how our tax-benefit system compares with other countries, and what direction policy should take. Far from arguing for taxes to fund Government services and investment, left-leaning voices advocate eliminating property taxes, water charges and the USC – seemingly closer to Boston than Berlin. The message that we are entitled to world-class public services without paying for them is clearly appealing. However, those who advocate a Nordic model of public-service provision will have to convince those on low incomes to pay higher taxes, not less.

The confusion reflects the false perception Ireland is a high-tax economy. Ireland’s aggregate tax take from household or corporate incomes has not stood out as particularly high by European standards. However, the system is highly redistributive. In 2014, the top 10 per cent of income earners contributed 58 per cent of revenues from incomes taxes, reflecting high 50 per cent-plus marginal tax rates. In contrast, 881,000 low-income earners were exempt from paying income taxes (38 per cent of the total), a legacy of Celtic Tiger era policies that dangerously narrowed the tax base.

OECD data show Ireland’s tax rate for low earnings is the lowest in the EU. Overall, the OECD’s standard measure ranks Ireland’s tax system as the second most redistributive across 34 developed countries.

That Ireland’s tax-benefit system is highly redistributive should be plainly obvious. More surprising is the outcome. The OECD’s measure of income inequality, the Gini coefficient, places Ireland only 17th, midtable across 31 countries surveyed, with Denmark at the top and the United States near the bottom. Although Ireland’s tax-benefit system works hard to redistribute income, the starting point is a high level of inequality before the system kicks in.

The underlying inequality reflects demographic factors. Economists define the dependency ratio as the number of people that are not available for work relative to those in the labour force. In 2014, Ireland’s dependency ratio was 114 per cent so the numbers not available for work at 2.5 million exceeded the labour force itself at 2.2 million.

Ireland’s dependency ratio was the sixth highest among the 19 euro area countries, inevitably straining the social-welfare system.

The high dependency ratio may seem surprising. Ireland’s young population is often cited as protection against the costs of longer life expectancy and ageing. However, the 22 per cent of the population under 15 years old provide their own strains on the public finances through education costs and social payments such as child benefit and one-parent family allowance.

Furthermore, their parents are less likely to work. Ireland’s labour-force participation rate for females aged 15-64 years was the fourth lowest in the euro area in 2014, with only Greece, Italy and Malta below. Here, the lack of affordable childcare is just one potential constraint on participation.

Ireland’s high-dependency ratio explains strong demand for public services and social benefits. In the UK, chancellor George Osborne’s July budget recently implemented sharp welfare cuts, following analysis from the Office for Budgetary Responsibility (OBR) showing the UK spent 5 per cent of GDP on working-age benefits (ie excluding pensions), above the OECD average of 4.4 per cent. The OBR’s study shows Ireland spent 8.3 per cent of GDP on working-age benefits, more than any other OECD country.

Looking forward, employment growth and the broader recovery should help reduce the dependency ratio, freeing up resources for tax cuts and public services. If not, it will raise the uncomfortable question: can Ireland’s disproportionately high working-age benefit payments be sustained and do they foster a dependency culture that perpetuates inequality?

Conall MacCoille is chief economist at Davy