Market View

Too much tax on property kills revenue - that's what history teaches, says Marc Coleman

Push anything, or anyone, too far and they will snap. It's as true of taxes as anything else. Inspired by John Maynard Keynes, US economist Arthur Laffer revolutionised our understanding of taxation. Sitting beside Ronald Reagan at a function one day, Laffer pulled out a napkin and drew what looked for all the world like a semi-circular hump nestling on the base of a large L figure. Beside the horizontal bit of the L he drew the words "tax rates" and above the vertical part the words "tax revenue". The Laffer curve - a very simple idea - was born.

The idea, which Keynes articulated several generations before, is that increasing tax rates does not guarantee you more tax revenues. According to Laffer, you get no tax revenues on anything for tax rates of 0 per cent or 100 per cent - the points where the hump intersects the base of the L. Somewhere in between - the high point of the hump - you get an "optimal" tax rate that maximises your tax take. The trick is to find that optimal rate and stay there, ie to avoid going over the hump.

In the mid-1980s and without the benefit of Prof Laffer, Ireland was learning this lesson the hard way. Instead of seriously curbing public spending, successive governments spent most of that decade increasing income tax rates until marginal rates of taxation were above 60 per cent. By 1986 it was evident that, far from growing, income tax revenues were seriously contracting: aside from the disincentive for those in work to work more, the tax rates pushed up the cost of hiring workers for firms and reduced consumer purchasing power. The result was a domestically induced recession and falling revenues, the reverse of what was hoped for by the minister of finance of the day.

In relation to income taxes, our present minister for finance has grasped this lesson fully. But 20 years after its core principles were demonstrated here, he is about to learn that it also applies to the property market. On Tuesday his own department published the latest monthly exchequer returns, the results of which make grim reading. Yes, total tax revenues are still higher than a year before, both for the month of May and the first months of 2007 up to and including May. For the period as a whole, the rate of annual growth - about 9.6 per cent - is a shade lower than the department's own, usually prudent, forecast of 10 per cent.

But for the month of May, annual growth is 5.9 per cent, significantly lower than the 9.4 per cent forecast. For some categories of taxation, receipts that month are down on May 2006. Stamp duty receipts suffered a 9.6 per cent drop, the biggest annual fall since August 2002. Even when added to receipts for the preceding four months of the year, receipts are still down by €107 million on expectations. And although the cumulative growth in this take remains higher than a year before - some 11.2 per cent higher - this is much lower than the 19 per cent growth forecast. Moreover, that cumulative growth is reliant on strong growth in January and February.

Other taxes sensitive to the property market also performed poorly last month. Vat receipts were €28 million below target while capital gains tax receipts were €78 million below target. Although less directly exposed to the property market, the weakness of income tax receipts, some €56 million below target, is not unrelated to it.

Together with higher interest rates, the Government's excessive reliance on capital taxes is finally coming home to roost: too much taxation is killing activity with exactly the opposite of the intended effect on tax revenues. As it ponders yesterday's quarter point rise in interest rates, the Government might ponder the consequences of doing nothing. Although only marginally below target in the year to May, tax receipts in the final month of this period - together with growing evidence from the property market - suggest a deteriorating revenue position as we head towards the next budget.

If it cannot abolish stamp duty, then at least take Laffer's advice and recalibrate thresholds and rates to those that maximise its revenue. It'll be no laffing matter if it doesn't.

Marc Coleman is Economics Editor of The Irish Times - mcoleman@irish-times.ie