It's that time to take a break. Wishing all readers the best of the season. And look forward to coming back in the new year with a good debate and exchange. And, yes, there will be much to discuss.
We know what one of the big battles will be in 2014. Ministers are making declarations. Demands are being made. Analysis (after a fashion) is being put forward. Its tax cuts. Daily we are being fattened up for tax cuts.
Let’s cut to the chase. Wages will be depressed as part of the ‘wage-competitiveness’ strategy. To compensate for this, taxes will be cut to give some increase in disposable income (take-home pay). And with tax cuts, public spending will also be cut – public services, social protection, investment. If this sounds familiar – tax cuts in compensation for low wage rises - that’s because it is; back to the future with a low-tax, low-spend, low-resourced economy. If nothing is learned, nothing changes.
To clear the ground for this it has to be shown that Irish public spending his high. We had this last week with a highly misleading analysis. Now we have, courtesy of Chris Johns in the Irish Times, an article with the sub-heading: ‘Evidence does not support view Ireland is low tax economy’, Johns makes some incredible statements:
‘The data on international income tax comparisons do paint a very clear picture: we are at, or very close to, the top of the league tables in terms of effective tax rates . . . those who do pay tax and social insurance in Ireland shoulder a disproportionate burden, at least compared with other countries . . . if you are paying income taxes as well as PRSI and USC, you are amongst the hardest hit in terms of EU and OECD tax league tables.’
It would be nice if Johns put forward some evidence for this but, alas, that is missing. He only refers to the fact that there are a lot of people who don’t pay income tax. Therefore, he assumes that those who do are high-taxed. This is pretty thin (and that’s putting it mildly).
Fortunately, we have some evidence – and, surprise, it doesn’t support the ‘low-tax’ argument.
First, let’s look at the overall ‘effective’ tax rate. This measures how much tax (income tax and social insurance; in Ireland this would include USC) is actually paid out of wages. Therefore, this excludes the self-employed. What does it tell us?
Ireland is right down there at the bottom end – even below Greece which is supposed to be incapable of collecting taxes (but higher than France? See below). We would have to increase the total tax/social insurance take by over 30 percent, or €4.1 billion. That looks pretty low-tax to me.
When we look at total taxation on labour we really fall well behind other European countries. The following includes not only taxes and social insurance paid by employees, but social insurance paid by employers as well.
When we factor in employers’ PRSI Ireland falls to rock bottom. We’d have to increase total tax and employees’/employers’ PRSI by over 50 percent just to reach the average of other EU-15 countries – a massive €9.7 billion. That looks really low-tax to me (and in France, employers pay 29 percent PRSI - most of the taxes on labour; that’s why the employees’ tax rate is so low).
A counter-argument that some might use is ‘yes, the overall is low, but because so many are exempt from tax, this means the tax take is particularly onerous on those who do pay tax.’ That’s where Johns' argument comes in – that if you pay tax, it’s particularly high. The implication is that if more people were brought into the tax net, then we could reduce the level of taxation for all the others.
Well, let’s play this game, courtesy of the Revenue Commissioners estimated 2013 tax distribution table supplied in a Parliamentary Question. Income earners between €10,000 and €20,000 (and this includes couples counted as one tax unit) had an average income of €15,200 and an average tax bill of €120, or 0.7 percent of income (I’m going to assume that Johns is not arguing to tax those below €10,000).
It’s not much of a gain. If the entire proceeds went into reducing the standard rate tax band, it would only fund a half a percent reduction in the standard tax rate.
So there’s not much in the argument that ‘those who pay tax are overly-burdened because there’s a lot of people who don’t pay tax’. But what about the international comparisons? After all, Johns says Irish tax/social insurance levels are one of the highest in the EU-15.
We can turn to the OECD Benefit and Wages database and compare tax levels by various income levels. Let’s take the average Irish wage for a single person - €36,000. This is a particularly useful comparison because this earner would be hit by the top rate of tax – and it appears that the Government is preparing to increase the standard rate threshold. The reason offered is that we have one of the lowest high-tax rate thresholds – meaning that workers enter the top rate at a lower income level than almost anywhere else. So how does this comparison stand?
First, let’s point out one major caveat. The above table, taken from the OECD, refers to headline rates. It doesn’t factor in tax reliefs which can reduce the actual tax rate. For instance, it doesn’t factor in relief for mortgages, pensions, insurance, children, etc. So we don’t know what the effective tax rate is for other countries.
But the headline rates above are strongly indicative. And Ireland is once again at the bottom of the table (Portugal and Greece are excluded because €36,000 would be considered a very high income). At a headline level – just factoring in tax credits, tax rates and tax bands – the average income earner in Ireland would see their tax rate rise by 44 percent to reach the average of the other EU countries.
So while some commentators focus on the entry rate into the higher rate of tax – which is low – they ignore the fact that the overall tax rate itself is very low. And yet they demand more tax cuts.
This is going to be a terrible debate. All sorts of numbers and misdirection will be thrown about. What do people need? They need a pay rise, they need affordable childcare and truly free education (in other countries schoolbooks and transport are free), they need free GP care and heavily subsidised medicine, they need proper pensions with guaranteed incomes in retirement, they need higher social protection payments if they become temporarily unemployed, sick or pregnant (and partners of pregnant women need paid paternity care), they need cheaper public transport and low-cost, high quality rental accommodation.
There are so many things that people need to improve their living standards, their life-chances, and social security.
But the only thing on offer will be tax cuts.
Like I said, a terrible debate.
The bailout for Ireland has been a resounding success. The austerity programme that has been in place since 2008 has brought us back from the brink and piloted the economy back into recovery and economic sovereignty. Let us rejoice. Let us spread the word among the nations. We have succeeded. We are the solution to everyone's problems everywhere.
And we have so much to celebrate.
Nearly 300,000 jobs have been destroyed, - more than one in every twelve jobs. Our job destruction rate is five times the rate in the Eurozone. We lead the EU in precarious work. We have one of the highest level of low-pay.
One-in-seven of our young people have fled the island due to the recession.
25 percent of the population suffer multiple deprivation experiences – over one million people. Over 30 percent of our children live in deprived conditions, while one-in-five people at work suffer deprivation at home.
One-in-ten people suffer from food poverty – it’s called hunger.
Ireland has absorbed over 40 percent of all bank debt imposed on European governments. Every man, woman and child owes €9,000 in private bank debt (throughout Europe its only €200). We are paying off the debts of banks that don’t even exist anymore. But, as Ollie Rehn said, that’s water under the bridge
State debt has increased by nearly five-fold in only six years. Households have debts nearly twice their income while half of SME debts are underwater. Nearly 25 percent of all mortgages are in arrears or have been restructured. Welcome to Debtor Island.
Hospital waiting lists are on the rise.
Domestic demand has fallen by 20 percent – the biggest fall suffered by any economy since the war except for Greece, another Troika project. In fact, we’re still in a domestic demand recession (but shhh, don’t tell anyone, we’re trying to celebrate).
The Government sends young people job offers in foreign countries.
The minimum wage hasn’t been increased over its 2007 level. Statutory protection for the low-paid has been cut. Real wages are still falling.
Our tax haven tax efficient policies allow multi-nationals to get away with a 2 percent tax rate. No wonder profits are rising faster in Ireland than anywhere else in the EU.
Investment in Ireland is half the level in the Eurozone. Corporate investment is on floor. But investors are getting real bargains, buying up distressed assets at knock-down prices. Now that’s confidence.
Despair is up, car sales are down, manufacturing output is stagnating, homelessness is on the rise, most pension funds are insolvent and we have some of the highest paid bankers in Europe.
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So come to Ireland and help us celebrate. The experts were right. Our Government Ministers are wise. We were right not to listen to the doomsayers and naysayers. We are one people going forward together into a brave new future.
And don’t worry about our democracy – it won’t disturb the revelries. We hold elections, we change governments but nothing ever changes.
For we live in a one-policy state. We have so much to celebrate.
Now that the Troika is leaving town it is a good time to take stock. We don’t do that very well. We don’t evaluate, we don’t compare inputs with outputs. We have policy by feeling, intuition, inertia.
Take public spending; since the beginning of the crisis we have been lectured daily about bringing the deficit under control. To do that it was asserted that we had to cut public spending. There was rarely any evidence put forward as to whether public spending cuts would actually result in deficit reduction, or by how much – it was just assumed. As I said: feeling, intuition, inertia.
Dr. Rory O’Farrell from the Nevin Economic Research Institute has produced a working paper to help us assess the efficiency of spending cuts - The Effects of Various Fiscal Measures. And there is no doubt about it: we have been taken for a ride. Cutting public spending is one of the most inefficient and wasteful means to reduce the deficit.
Rory produces a number of budgetary examples: a €1 billion cut in social transfers, investment, public sector wages, public sector employment and non-wage public consumption (purchases of goods/services from the private sector). Using the HERMIN model which was created to examine the effects of EU cohesion and structural funds throughout Europe, Rory assesses the impact of these measures on a number of indicators: GDP, consumer spending, employment, balance of payments, the deficit, etc.
It should be noted that this is a model. It is not an empirical investigation and, just as with the ESRI’s HERMES model, it has limitations and caveats. So the following should be treated as indicative.
The following compares a cut of €1 billion with the reduction in borrowing, or the deficit, under the various budgetary measures. I have averaged the impact over the eight years that Rory measures the cut.
As seen, most of the austerity measures produce a deficit reduction of less than 50 percent of the headline cut. The highest deficit reduction rate comes from non-wage public consumption but the level of cuts in this area has been relatively small.
One particular finding is that cutting public sector employment actually increases the deficit. How’s that for perverse and irrational budgeting (this mirrors the ESRI’s finding that cutting public sector employment increases the overall debt).
But it gets worse. For spending cuts result in a lower GDP. So when you factor in the reduced GDP, the deficit falls even less. The following is a stylised attempt to assess the deficit-reduction efficiency of austerity measures between 2009 and 2013 under the three broad public spending categories. I use 2009 as the base-line and assume that all measures were introduced in one year, using the average impact over seven years. This is not completely satisfactory (to get a truer picture we’d have to assess the impact in each year the cut was introduced) but it is strongly indicative.
What do we find?
Let’s go through this table. Regarding public services, austerity measures (cuts in public sector employment and wage, in addition to cuts in contracts to the private sector) amounted to €6 billion, or 3.7 percent of GDP. The deflationary impact on the GDP was even greater – loss of employment, consumer spending, reduced wages, etc. This amounted to 4.1 percent of GDP. In other words, for each €1 in spending cut, the economy declined by €1.11. But when it comes to deficit reduction, the measures were largely irrelevant. The deficit fell by 0.6 percent, or 16 percent of the headline cut.
In other words, to reduce the deficit by an effective €1 (equivalent to a percentage of GDP), the Government had to cut public spending by over €6. That is not very efficient.
Cutting social transfers didn’t achieve a whole lot more. The deflationary impact on the economy was nearly one-for-one (a €1 cut depressed economic activity by 95 cents) while the deficit has fallen by less than 1 percent of GDP. Not much joy there.
However, when it comes to investment – this is where the irrationality of austerity comes home. A €1 cut in investment depresses economic activity by €1.71 (which is particularly deflationary). Because of this impact the deficit didn’t fall at all – it actually increased marginally in terms of percentage of GDP.
This all comes with caveats – and not only to the ones I referred to above. For example, public investment should be adjusted for the fall in the Tender Price Index. If we assume a fall of 25 percent over the period, the deflationary impact lessens but the impact on the deficit is still nil – there is still no effective gain in deficit reduction.
No doubt Rory’s findings (and my own extrapolations) will be challenged. Good. Can we please have a debate over the efficiency of public spending cuts and their impact on society. To date, we have been walking zombie-like down the austerity road under the misguided notion that not only is this the best road, but that is also the only road.
But to my mind, the benefit of Rory’s work is not only to shed light on past policy, but to help guide us in the future. It should become a platform for an alternative expansionary programme. The Government will be unveiling its medium-term plan next week. In all likelihood, it will reflect scenarios that the Department of Finance has already published; namely, that public spending will be depressed below the rate of inflation and GDP growth up to 2020. This will effectively maintain the austerity regime until the end of the decade.
With this analysis we can start to build alternative budgetary and economic policies. We can walk down another road. We can return to the land of the living.
This is a theme I will return to in the new year.
'Now it isn't easy to stand up for truth and for justice. Sometimes it means being frustrated. When you tell the truth and take a stand, sometimes it means that you will walk the streets with a burdened heart. Sometimes it means losing a job...means being abused and scorned. It may mean having a seven, eight year old child asking a daddy, "Why do you have to go to jail so much?" . . . Before the crown we wear, there is the cross that we must bear. Let us bear it--bear it for truth, bear it for justice, and bear it for peace. Let us go out this morning with that determination. And I have not lost faith. I'm not in despair, because I know that there is a moral order. I haven't lost faith, because the arc of the moral universe is long, but it bends toward justice.'
Dr. Martin Luther King
The drums are beating. Throughout the nation we hear a growing chorus demanding tax cuts (including the leader of the Labour Party) to relieve ‘hard-pressed’ families. And this demand is being buttressed by some highly misleading claims that Ireland is a high public spending country.
According to Brendan Keenan, using recent OECD data, we are a high-spender. There’s even a cartoon in the article showing Ireland ‘fat’ with too much public spending, compared to ‘lean’ European countries. Is Ireland a high spender compared to European countries? Of course not. One has to know how to read these figures.
For instance, the OECD data for 2011 includes special bank payments arising out of the financial crisis. When this is removed (and it represents some 5 percent of GDP), Irish spending falls well down the table. It is highly misleading to claim that Ireland is a high-spending country while including payments to banks; unless one wants to make the argument that Ireland is a ‘high bank-subsidising’ country which is certainly true.
So, can we assess Ireland’s ranking in the EU-15 spending table? Yes, with the help of the EU’s AMECO database. We’ll look at 2014. Even though this money hasn’t been spent yet, AMECO is working off of country’s estimated expenditure under their individual Stability Programme updates. Any change would be marginal. We’ll also exclude interest payments since we want to focus on spending on public services, social protection, subsidies and investment. Further, we’ll exclude defence spending.
So what do we find when we examine government spending per capita (after all, Keenan says ‘spending per person tells its own tale’)?
Well, this does tell a tale. Clearly, Ireland is not an ‘over-spender’. It is well below most other European countries and well below the average. Ireland would have to spend substantial amounts just to reach EU averages:
We will burrow further into these numbers over time; for instance, to assess the impact of expenditure on the elderly (other EU countries have a much larger elderly population which necessitates higher spending on pensions), factoring in purchasing power parities and to breakdown expenditure under different categories. We will also take into account economic capacity (the higher you're GDP, the more you can spend sustainably). So the above table should be treated as a base-line, the beginning of a more in-depth analysis. But here’s a teaser.
The AMECO database also estimates government spending out to 2015. This is a bit more tenuous (who knows where we will be early next year, never mind in 2015). However, it shows that EU-15 countries not in bail-out will increase primary government spending (excluding interest payments) by 2.5 percent on average. Ireland will cut its spending by 4.1 percent. We will slide even further down the table.
Social protection payments have been cut in real (i.e. after inflation) terms over the last three years; 24 percent of the population suffer multiple deprivation experiences; we badly need investment in pre-primary education, childcare and eldercare; we are in an economic and business investment crisis – there are a number of areas crying out for more resources.
Yet, all we get is the drumbeat of tax cuts. And to clear the way for this race-to-the-bottom agenda we get highly misleading commentary about the levels of public spending.
2014 looks set to be an ‘interesting’ year in the public debate.
Remember all those observations? About how the highest income groups pay almost all the tax and how terrible it is that begrudging lefties want to tax them more? About how Ireland has the most progressive tax system in this quadrant of the Milky Way? The Government has lead the chorus making this claim but in truth it is not based on comparative measurement of tax progressivity (see Note at the end of this post for a discussion of the Government’s claim).
So along comes a study that blows those arguments away. Dr. Micheal Collins and Dara Turnbull investigated the issue in a working paper published by the Nevin Economic Research Institute, based on the CSO’s Household Budget Survey 2009/10. They found that, contrary to the received wisdom, the poorest 10 percent income group pays as much tax as the top 10 percent tax and that our tax system is far less progressive than some have claimed.
Here’s the bottom line chart.
Oh, my. The poorest 10 percent income group pays a tax rate of 28 percent – that is, their tax payments make up 28 percent of total income (which includes income from work and social transfers). The top 10 percent pays a tax rate of 29 percent. Doesn’t look that progressive to me.
How could this be? Micheal and Dara estimated the impact of all taxation – income tax, USC, PRSI, and (and this is the key innovation of this study) indirect tax such as VAT and Excise, and levies such as TV licenses and vehicle taxes. Previously, claims about the tax contribution of high income groups narrowly focused on income tax and, sometimes, PRSI. But these make up only part of the tax system. Over 40 percent of tax revenue comes from indirect taxation. The following shows the extent to which indirect taxation undermines the progressivity of the tax system.
Unsurprisingly, the lowest income groups pay substantially more of their income on VAT, excise and levies than higher income groups. So when this is combined with direct taxation – income tax, USC and PRSI – we get only an overall marginally progressive effect.
Another perspective is to assess how much tax each decile pays in relation to the proportion of total income received.
We find that the top 10 percent income group receives 29 percent of all income in the state and pays 35 percent of all tax. The lowest income group receives only 1.8 percent of all income but pays 2.1 percent of all tax. In all other deciles, the amount of total income received and total tax paid are close together. That certainly isn’t very progressive.
Nationally, the average tax rate is 24 percent. For the top 10 percent it is 29 percent even though the top income group receives three times the income as the national average. And that, too, doesn’t sound very progressive.
This is a significant study and is worth reading in full. The authors state that this is only the first step in deconstructing the progressivity or otherwise of the Irish tax system. Further studies will analyse data based household size, composition (number of children, etc.) and direct / indirect tax per adult rather than household. They also intend to incorporate adjustments in subsequent budgets. When this project is finished it will be a considerable addition to our understanding of the distributional impact of our tax system.
However, I would urge one note of caution. Taxation is only one side of the redistributive coin. The other side is the range of benefits and public services that taxation finances. The gross income in this study does include social transfers (Child Benefit, pensions, unemployment payments and other payments) as per the CSO survey.
However, it doesn’t include the income benefit of public services. Free GP care and heavily subsidised prescription medicine would have a more progressive impact on average income groups than high income earners. Ditto for subsidised childcare and truly free education (without the charges for school transports, schoolbooks, uniforms, and ‘voluntary fees’).
For instance – what would you think of a tax system that has the following:
This doesn’t sound very progressive at all. High VAT on food, a two-tier tax rate of 20 and 25 percent, and a flat-rate tax which never progressive. Indeed, this tax system looks to be extremely regressive.
Who applies this tax system? Sweden. And Sweden has one of the lowest levels poverty and deprivation and one of the more egalitarian income structures, supported with strong public services (Ireland would have to spend €13 billion more on public services to match Swedish levels).
It is difficult and somewhat of an abstraction to put a monetary value on indirect benefits such as public services in order to assess the redistribution of tax revenue. This means that much redistributive analysis, based on income deciles, necessarily focuses on cash payments whether tax or social transfers. This doesn’t tell the full story, though.
This is not a criticism of Micheal’s and Dara’s study which is just intended to analysis the distributional impact of taxation – and which blows away some myths in the process. We must work step-by-step to get a firm grasp on aspects of these questions and the two authors have made an invaluable contribution to that end.
Is Ireland’s tax system progressive? Not very. Now let the debate start – this time from actual evidence.
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NOTE: The government’s claim that we have one of the most progressive tax systems in the industrialised world is based on OECD data from Taxing Wages. It’s not that this data is flawed, it’s just that, in the first instance, the data doesn’t attempt to measure overall tax progressivity.
1. The data measures the ‘tax wedge’. This measures difference between labour costs to the employer (wages, PRSI) and the corresponding net take-home pay of the employee including some child income cash benefit (Child Benefit). The average tax wedge measures identify that part of total labour costs which is taken in tax and social security contributions net of cash benefits.
2. This data focuses on statutory tax rates and basic allowances. It does not include tax reliefs, allowances and exemptions which would be difficult to do across all OECD countries. Nor does it include other cash income that households may receive (social transfers, capital income), nor does it include self-employment income.
3. It includes employers’ PRSI which, in the first instance, is not a tax paid by workers.
4. It only assesses three income levels. In Ireland’s case, it assess the tax wedge for incomes of €21,894 €32,841 and €54,736. This is can hardly be comprehensive.
5. It doesn’t include the monetary benefit that workers receive for, in particular, social insurance payments. For instance, a worker in country A may pay a higher level of social insurance (PRSI) than a worker in country B. Therefore, country A, according to the OECD table, is deemed more ‘regressive’. However, the worker in country A receives free GP care, subsidised prescription medicine, high maternity/paternity payments, pay-related social insurance pensions, pay-related sick pay, etc. Worker in country B doesn’t – s/he has to pay for these in the private market or out of personal savings; and these payments are higher. Who is better off? The OECD data doesn’t and can’t tell us.
6. The OECD data can produce perverse results. For instance, let’s say the Government decides to double employers PRSI to pay for those increased benefits mentioned above – free GP care, prescription medicine, pay-related pensions, maternity/paternity benefit, etc. This would be a major boost to the living standards of low/average income earners and would not entail one extra cent in tax. However, under the OECD measurement, the ‘tax wedge’ would become more ‘regressive’. This is perverse.
It’s not that there is anything wrong in the OECD’s methodology. The ‘tax wedge’ is a useful measurement but like all such measurements, it tells us what it tells us. The key is to understand that message in the context of other measurements. The problems begins when someone claims that it represents more than what it is intended to tell us. That’s the problem with the Government’s claim that Ireland has one of the most progressive tax systems in the OECD.