Cliff Taylor: With big budget surpluses, why are we being warned that we will have to pay more tax?

We are still coming to terms with the Department of Finance forecasts of strong and rising budget surpluses in the years up to 2026.

But despite the prospect of Government revenue being well ahead of spending, there have been a string of warnings in recent days – from the department, the Commission on Tax and Welfare and the Fiscal Advisory Council (IFAC) – that the tax and social insurance take will need to rise over the coming years. How can this be the case, with annual surpluses in the €10 billion to €20 billion range forecast?

1. Higher bills ahead

The first key thing to understand is that the State is going to have to spend a lot more in the coming years just to maintain existing service levels.

This is mainly due to the ageing population, which requires extra spending in a range of areas, notably pensions and healthcare. And the proportion of the population at work will fall, meaning there are fewer people to pay the bills.

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There are currently about four people of working age for each person of retirement age; by 2060 this ratio is projected to fall to just two, and the numbers will start going against us, in public finance terms, from towards the end of this decade.

The department estimates that these ageing costs will add €7 billion to €8 billion to annual spending by 2030, just to keep services and pensions at current levels. There are also big costs coming down the line, it warns, from the climate and digital transitions, the latter referring to automation, AI, digitalisation and so on, where there are pluses and minuses for the exchequer.

IFAC, which has done a lot of work in this area, calculated Government spending on pensions would rise from 7.7 per cent of national output (GNI*) to 11.9 per cent in 2050. Health spending would rise from 8.3 per cent to 13 per cent.

So a central point of the argument that we will all need to pay more tax in the years ahead is that State spending is going to rise strongly and overtake revenues in the years ahead.

2. Rising tax revenue

The take-off in the size of the budget surplus of revenue over spending has been driven in large part by corporation tax.

It has increased by an extraordinary €20 billion over the past decade to €24 billion this year and has doubled since before the pandemic. Other taxes, notably income tax, have also risen strongly, but it is the corporate tax rise that has been the big swing factor.

And it is this that makes it so hard to calculate what happens next. The department calculates that a large part of the corporate tax – about half of the €24 billion forecast for this year – is “windfall” revenue.

The department has again this week underlined the need for higher social insurance contributions to underpin future pensions and welfare

This means, roughly, that it is not based on what we know about the real economic activity of the companies here, but rather on the fact that a lot of profits earned around the world are declared in Ireland for tax purposes. This, the department argues, means this cash cannot be relied on to all recur. But the truth is we just don’t know. Estimate of windfall taxes are very rough guesstimates, at best.

The key exposure is probably that we rely on a small number of really big companies – 10 companies pay nearly six euro in every 10 of corporation tax. And one euro in every seven of all taxes.

And in reality four or five companies are responsible for the vast bulk of this. That is the argument for not relying on this revenue and planning to increase taxes to help pay the bills in future years. Potentially once-off revenues should not be relied on to pay ongoing spending commitments.

Also, taxes will disappear or fall in some other areas. The Commission on Tax and Welfare has warned that the exchequer will lose €5 billion annually from tax on driving and fuels as the fleet goes electric.

3. The key question

What exchequer forecasts being redrawn time and again due to surging corporate tax revenues, the big question is when spending might be expected to overtake revenues, necessitating higher taxes.

This is where it gets difficult. The Commission on Tax and Welfare warned this week that this could happen over the next five to 15 years, a wide window. IFAC had warned on pressure starting to emerge on the State finances after 2025, but its long-term forecasts were drawn up in 2020. However, the scale of the costs it calculates shows that, at some stage, spending will outpace revenues and the gap will then start to grow.

Now, the Department of Finance is forecasting strong surpluses out to 2026. Crucially, it is predicting that even if we set aside the windfall element from corporate tax receipts, a surplus of €4 billion will be recorded in 2024, rising to €8.4 billion in 2026. Adding the windfall taxes back in, the surplus by 2026 would, on its forecasts, exceed €20 billion. That is a big buffer.

So, the surge in State revenues of recent years may delay this evil day when spending starts to exceed revenue, even if it does not put it off indefinitely. Judging when the two lines might meet require a judgment on how quickly spending will rise and how long the corporate tax windfall will last.

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4. How to plan

Just about everyone agrees that it is clever, given the unpredictability of corporate tax, to set up an investment fund into which part of the windfall element would be paid.

The idea is that this money would be invested and that the return on it would help pay the bills in the years to come. How the sums would work out would depend on how much money is put in, what the return is and what rules would be set for withdrawing cash.

Back-of-the-envelope calculations by the Department of Finance estimate that it might be possible to fund 30-40 per cent of the costs of an ageing population from 2030 on via return from such a fund – though as we don’t have a political decision on how much would go in the number could be significantly lower (it could also be higher if a decision was taken to salt away all the revenue estimated to be windfall in nature, but this looks unlikely).

A fund could help pay the bills in the years ahead and safeguard the public finances if corporate taxes did fall off sharply. If the windfalls continue, it could grow into something more significant.

5. Where to raise the tax?

So will we still end up paying more tax? These are essentially political decisions, but the huge upward pressure likely on spending means the answer is probably yes, though the huge surpluses may have pushed this out a few years.

The department has again this week underlined the need for higher social insurance contributions to underpin future pensions and welfare – the Government decision to freeze the State pension age at 66 increases future costs here considerably.

Ireland needs to plan for significant increases in taxes to help pay future bills

Employers’ PRSI, low by international standards, looks likely to rise and IFAC and the tax commission have both argued that employee PRSI needs to rise too.

Beyond that, the commission has said that Ireland needs to plan for significant increases in taxes to help pay future bills – it argues that these should be focused on property and other wealth, and on environmental taxes, rather than on higher income taxes.

Economically, taxes on immobile assets like property are seen to be more efficient than income taxes. It calls for higher local property tax, rises in capital gains tax which it says should apply to the sale of people’s homes and a rise in inheritance tax. However, making the political case for these at a time when surpluses are so high looks very difficult.