We’ve all been here before. The government has more cash coming in than it had expected. There is an election on the way, so promises have to be ramped up massively to secure another five years of influence. The public has a set of expectations around tax decreases and spending increases. Yes, folks, it’s 1968, 1976, 2006 – and 2015.
Buoyant tax revenues are not a problem. They never are. It’s what you do with those revenues that matters. Ireland typically doesn’t spend a lot of its tax revenues on infrastructural investment. Take a look at the chart which shows the ratio of investment to gross domestic product since 1970, taking in the forecasts from the Department of Finance from 2016 to 2021, and comparing it to its long-run average, but excluding the crisis, which for obvious reasons meant capital expenditure had to drop massively.
We can see that between 1970 and 2008, a 38-year period, Ireland spent an average of slightly over 3.6 per cent of GDP on investment in hospitals, schools, roads, broadband, power generation, and more. (The really long-run average, including the crisis years and the forecasts, is 3.2 per cent.)
This is why we still get treated in Victorian hospitals and drink our water from Edwardian water pipes.
This tells you a story. In Ireland, fiscal policy works like this: typically, extra revenues go towards increasing current spending such as child benefit or social protection, or to tax cuts, or to increases in public sector pay.
Capital investment almost never gets a look in. This is a large problem, because counting on growth to replace taxes you give away is a sure-fire way to destabilise the economy once growth peters out.
Witness the behaviour of the economy’s main sources of revenue over the past ten years.
The second chart shows, in percentage terms, where the funds to run the state have come from. In 2002, income taxes made up 31 per cent of revenue from that year. In 2006, this dropped to 27 per cent, rising to 42 per cent by 2014 as the holes in the public finances created by the crash got plugged with income taxes.
When all the little economists are in short pants, we learn the principles of public finance. Governments have to tax households and firms in order to provide services the market won’t, such as libraries, street lighting, and national defence, as well as redistributing income from the rich to the poor as an aid to social solidarity. Taxes are a necessary evil. All taxes induce distortions to people’s behaviour. Some distortions, like the plastic bag tax, are clearly good. They make almost no one worse off, and lots of people better off.
Recurrent taxes on property are, in fact, the least distortive to long-run GDP per capita we have. While a site value tax would have been perfect, our property tax does a similar if suboptimal job.
Some taxes are highly distortionary, such as a very low corporation tax rate, or a very high income tax rate. These make lots of people better (and worse) off, and damage important incentives.
An efficient tax structure would deliver the funds to power public services with the minimum of distortions to individual and collective incentives. The theory of public finance has come around to the view that marginal taxes are not the most important thing to worry about, in information-opaque systems, the average tax rate should be relied on most heavily. The all-in tax rate for personal income tax and employee social security contributions is 52 per cent here, relative to 46 per cent on average across the OECD.
Perhaps more importantly, the ability to balance the average tax rate with a corruption-resistant tax structure through which taxes are collected and disbursed is a major asset of any public finance structure. Important results have now been established showing that the spread of corruption is quite badly affected by the ease with which the variables which determine the tax base can be manipulated by those in power.
If we worry about the Noonan-end of the tax-gathering element first, then two principles which therefore make sense are simplicity and certainty with respect to the tax system.
Our tax system is not simple, and there is little certainty about it. There are progressive and regressive elements within our taxation structure, with the poorest 10 per cent of households paying 17 per cent of their income in value added taxes, and the richest 30 per cent of households accounting for the vast bulk of the taxes we need to run the system.
Only 18 per cent of all taxpayers pay the higher rate of tax, while 45 per cent pay the standard rate, and 37 per cent are exempt entirely. It’s a messy system. Beginning from scratch, you would not start here. But how Irish is that?
This is where unrealistic expectations come in. Promises to phase out the universal social charge (USC) by 2021 as well as increasing spending on everything need to be tempered with a realistic assessment of the infrastructural deficit we have, as well as the destabilising effects tax changes have on the system.
Here’s an idea: lock spending changes to a fixed multiple of the increase in gross domestic product for everything except two or three very large capital projects over a five-year horizon. The National Risk Assessment exercise identified these for us: the lack of interconnectors for energy, the need to transition our power grid to renewables (yes, MoneyPoint, I’m looking at you), and next generation broadband connectivity. Large-scale water investment is now taking place via Irish Water, and our roads, for the most part, are fine.
A final point about tax-and-spend promises. Let’s get them costed by an independent agency, one tasked by the Oireachtas to actually figure out whether wealth taxes or USC abolition or taxing children’s shoes or whatever makes fiscal sense. A new report from the OECD, written by Ronnie Downes, makes this case strongly. Budget transparency is not our strong point. We are making strides in the right direct with the National Economic Dialogue and the Spring Statement, but we could do more.
A lot done, more to do. Now, where have we heard that before?