Economics: Tuesday's Exchequer statement indicated that Government tax receipts were running almost €1 billion ahead of the budget target at the mid-year point, suggesting that a tax revenue overshoot of about €2 billion is in prospect for the year as a whole.
Compared to an expected overall tax take of some €42 billion for 2006, the likely overshoot doesn't amount to a hill of beans. Still, it is the equivalent of about €1,500 for every household in the State, and it raises some interesting issues.
First of all, it is worth pointing out that revenue overshoots of this magnitude are nothing new. In each of the years 2003 through 2005, total tax receipts exceeded budget forecasts by amounts ranging from €1.5 billion to €2.3 billion. Likewise, in the years 1997 through 2000, tax receipts typically overshot by well in excess of €1 billion. The 2001-2002 period, which saw the pace of economic activity decelerate sharply, saw taxes generate substantially less revenue than projected at budget time, by margins of €2.5 billion in 2001 and €1 billion in 2002.
What is of at least equal significance to the overall overshoot recently registered is the distribution of that overshoot across the principal tax categories. Although the Department of Finance does not furnish all the details at mid-year, it seems from the figures published that, in the first six months of this year, the greater part (perhaps €800 million) of the €1 billion margin by which total receipts exceeded target was accounted for by capital taxes and stamp duties. By contrast, receipts under other important categories such as income tax, corporation tax and excise duties appear to have been behaving pretty well as expected.
This is very much in line with the experience of the past three years. In 2003, capital taxes and stamp duties accounted for virtually all the €1.6 billion overshoot in total tax receipts; in 2004, these two categories accounted for €1.2 billion of the overall overshoot of €2.3 billion, and in 2005 they accounted for €1.1 billion out of €1.5 billion. What's been happening here is that each year the Department of Finance has forecast a decline in receipts from these tax categories on the assumption that the surprisingly high level of receipts delivered the previous year was due to once-off factors.
In the event, there have been sustained and spectacular increases in revenues from capital taxes and stamp duties. It now seems likely that these two tax heads together will deliver receipts of over €7 billion to the Exchequer in 2006, compared with less than €2 billion as recently as 2002. Much of that exceptional buoyancy is due to the extraordinary levels to which prices and activity have been driven in the property market. To that extent, as has been pointed out by several other commentators, it indicates a significant vulnerability in the state of the public finances, a vulnerability that needs to be acknowledged in the shaping of next year's budget.
The Irish taxation system has changed greatly over the past 10-15 years. Perhaps the single most important change has been the enormous reduction in the burden of income tax for the vast bulk of individual earners. The average tax rate (inclusive of PRSI and all levies) faced by a single person on average industrial earnings, for example, has fallen from 33 per cent to 15 per cent since 1993; the equivalently defined average tax rate for a married person in a one-earner household has come down from 25 per cent to less than 7 per cent over the same period. Broadly comparable reductions have been enjoyed by earners across the full income spectrum.
Reductions in income tax rates have been associated with a big fall in the share of total tax revenue accounted for by income tax. In the early 1990s that share was close to 40 per cent; this year it is likely to be no more than 28 per cent. Of course, as the share of income tax in the total tax revenue has been falling, so the share of other taxes has risen. But, it has not been the mainstream expenditure taxes - VAT and excise duties - that have taken the strain, as is commonly supposed. Yes, the share of VAT has risen by about six percentage points since the early 1990s, but the share of excise duties has fallen by a roughly offsetting amount, so that the share of these two sources of revenue taken together has remained broadly unchanged.
Instead, the categories of tax revenue that have seen their shares of the total tax take rise most significantly over the past 10-15 years are corporation tax (up from about 10 per cent to perhaps 14 per cent in 2006), and the two categories that have already drawn our attention: stamp duties (up from 3 per cent to a prospective 8 per cent this year) and capital taxes (up from 1 per cent to a prospective 6 per cent in 2006). Most of the increase in the share of stamp duties and capital taxes in the total will have been due to the especially rapid increase in revenue from these sources since 2002.
It is sometimes claimed that the shift away from income tax as a source of government revenue is the result of deliberate policy choice, and to a considerable extent it has been. But it needs to be recognised that this shift is in significant part due to the unexpectedly persistent strength of other revenue sources and, to that extent, has happened by accident rather than design. It also needs to be recognised that one of the main underpinnings for this unexpected revenue buoyancy - the extraordinary condition of the property market and the construction industry - is something that cannot be sustained indefinitely.
A straightforward inference can be drawn from all of this. When the property/construction sector cools, as assuredly it must, the buoyancy of tax revenues will subside with it. In these circumstances, given levels of public spending and borrowing, and without the will to introduce new taxes, the downward trend in income tax rates of the past 15 years will come to an end and will give way to upward pressure.
Jim O'Leary currently lectures in Economics at NUI-Maynooth. He can be contacted at jim.oleary@nuim.ie
