Tax increases are the last resort of weak government

 

ANALYSIS:Union claims about a pot of untaxed money just don’t wash . . . that said, tax hikes cannot be ruled out next week, writes PAT McARDLE

BRIAN LENIHAN has ruled out new taxes in the budget, apart from a carbon tax, which is in the Renewed Programme for Government. At the same time, the Greens, whose idea this is, have suggested higher carbon taxes be offset by reductions elsewhere. On the face of it, therefore, there should be little enough on the tax front on Wednesday.

However, people are sceptical because tax increases are the last resort of a weak Government. It is easier to tax than to face down unions or social welfare recipients. But the damage to the economy is greater.

We have had a taste of this already. The income tax increases in the October and April budgets were designed to boost 2009 receipts by €2.3 billion (much more in a full year).

Despite this, the 2009 yield will be only €11.8 billion, €700 million below the April target and compares with €13.2 billion in 2008.

In economist speak, we are into negative Laffer curve territory. The Laffer curve shows the amount of tax raised at different rates of tax. The two extremes are zero and 100 per cent – no tax is raised at either rate. The optimum is somewhere in between; the trick is not to exceed it.

Anyone who remembers the 1980s will know what I am talking about. It was a time when the Labour tail wagged the Fine Gael dog, spending grew inexorably and taxes were steadily increased in a forlorn attempt to curb deficits.

Income taxes are both too high and too low. Too high because marginal rates have gone above 50 per cent – Irish people seem to be averse to parting with more than half of their extra euro. Too low because half the population does not pay any tax.

The problem is not just high rates but, critically, the low levels at which they kick in. It is astonishing that a PAYE earner on a lowly €40,000 has a marginal rate of 51 per cent. Stranger still, the top 4 per cent pays half of all taxes. Claims by the Irish Congress of Trade Unions that there is a pot of money out there waiting to be taxed don’t wash.

Will anything be done about this in the budget? Unlikely, but there is a strong case for reducing tax credits at least in line with negative inflation of 5 per cent to bring some more people into the net. If this is done, the top end should also be looked at.

While higher earners were encouraged to avail of tax breaks, these were curtailed a few years ago so that the minimum average rate of income tax paid is 20 per cent. There is now a case to increase this to 25 or even 30 per cent. This would yield no more than a paltry €25 to €50 million but, as with politicians’ pay, appearances are important.

From now on, the challenge is to broaden the income tax base not increase the rates.

The Commission on Taxation has produced a long list of tax expenditures it believes could be terminated or amended. The most controversial one has to do with pensions – it seems the commission did not properly evaluate the principle of relief on the way in, taxation on drawdown of pension. In any event, Minister for Social Affairs Mary Hanafin has indicated it will be several years before this nettle is grasped.

Property tax is an even bigger issue but Taoiseach Brian Cowen and the Minister for Finance rushed to rule it out even before the tax commission’s report was published.

It is unlikely that we will see any serious widening of the tax base next week; indirect taxes we can pretty much forget about too. We are already at the top of the international league when it comes to alcohol and tobacco and have cross-Border issues to boot. VAT rates are also very high and, as the Minister probably found out in the last budget, tinkering with them is a waste of time.

This brings us to capital taxes. The capital gains tax rate has been raised from 20 to 25 per cent. Since this was never going to bring in any money, it must have been done by someone with a grudge against Charlie McCreevy. There is no case for further hikes; indeed, my preference would be for a return to 20 per cent.

However, many of us now have so many capital losses that we are unlikely to pay capital gains tax for a long time.

The principle of carrying forward losses should be retained but there is a case for restricting them and extending them over time. For example, past losses could be offset against future gains at a 50 per cent rate. This would ensure the exchequer gets an earlier benefit from a recovery in stock markets.

A similar case can be made for corporate tax losses but there are international ramifications and corporation tax is unlikely to be touched. The recent experience of the UK in this regard is salutary.

Will there be any good news at all in the budget? Probably – just as Charlie Haughey needed the idea of the IFSC for his 1987 manifesto, Lenihan could do with a small bit of cheer.

There are a number of candidates. The car scrappage scheme is an obvious one, given its success abroad and the decimation of that industry. However, the problem is that it would boost activity in Germany or Japan. Moreover, such schemes frequently merely accelerate purchases that might occur anyway.

The other one is a housing initiative. However, this sends all the wrong signals. The OECD has slated us for having the most tax-friendly housing regime in Europe and tax incentives were a significant factor in the housing boom.

It’s a toss-up whether either of them will make it but we can expect some positive announcements on Wednesday.

Overall, the net amount raised from taxation is unlikely to be more than a few hundred million. The major effort will be on the spending side and the Government cannot afford to undershoot the €4 billion target.


Pat McArdle is economic commentator with The Irish Times