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May 08, 2009


James Conran

I accept your argument as to the political attractions of a social insurance based tax system, especially if benefits are more closely linked to contributions. But from an efficiency/incentives point of view I would pose a couple of questions.

Firstly, on the employer side, why tax employment/wages rather than profits? Firm A employs very few people and pays them next to nothing, making mega profits. Firm B employs lots of people, pays them well, makes small profit. If we use corporation tax to raise revenue from business, Firm A pays more, Firm B less. If we use employers' PRSI contributions, it's the opposite.

Secondly, on the employee's side. PRSI and income tax increase the tax wedge (gap between what an employer pays and what the employee receives). I hate to be neo-classical here (not my style) but whatever you make of the idea that the tax wedge (or the cost of labour) is a crucial variable in determining unemployment, indirect (and more regressive) taxes such as VAT do not pose this problem.

With regard to the broader question of redesigning the tax system in in a progressive direction (in the post-crisis medium term), I would above all stress that the number one priority in this regard is to increase the amount of revenue raised, wherever it comes from. The international evidence is that this is the key determinant of greater income equality, rather than the progressivity of the tax system (or indeed of the spending system). The point is if we want more egalitarian outcomes we need a higher share of GDP in revenues/expenditures.

I highly recommend Lane Kenworthy's work on this, for exampple:

Michael Taft

James, first thanks very much for turning me on to Lane Kenworthy's excellent blog. I intend to put him on my regular read list.

There is nothing in principle preventing a combination of profit/payroll tax as a basis for employers' social insurance contribution. The main roadblock currently is the rut we have found ourselves in regarding our low corporation tax. If we increases it - even as part of the insurance system rather than general taxation - do we not risk driving away FDI and brass plate operations which contribute to our tax base? I know this sounds odd coming from an ol' leftie but it is a consideration we should not treat lightly. For instance, both the Revenue Commissioners and the IDA have had some success with companies transfering their head offices from former tax shelters to here (many US companies are abandoning the Caymens in anticipation of US tax changes). But they have to compete with other low tax jurisdictions. The problem with corporation tax is that it cannot be resolved separately from our ability to create and expand indigenous enterprises. All that being said, I'd agree with your general proposition - it is fairer and distributes the burden more equally between labour and capital intenstive firms.

Regarding the tax wedge, again, I'd agree we must move cautiously. However, I note that all other EU countries - including highly successful ones - all have wider tax wedges than we do. It doesn't pose so much of a problem (though countries like France have severe youth unemployment problems - which has more to do with ease of firing than the actual wedge). One aspect of this wedge is - from the employees' point of view - is not merely about the gap in net take-home pay, but in Ireland's case, the withdrawal of benefits and supports when one moves from unemployment to a job. One thinks of medical cards, rent supplements, child dependency allowances, etc. A stronger programme of social protection could help us overcome these tax wedge problems.

And while I wouldn't fully agree with you regarding VAT and it's impact (or lack of) on the cost of labour - since I'm dubious about regressive taxes in Ireland - we should take note of Sweden which has the highest level of VAT (they have a standard rate of 25%). But they also have one of the most egalitarian economies in the world. So it really is a matter of 'the mix'.

That's why I fully agree with your last point - high taxation and expenditure can be a positive social and economic impact. Were we able to achieve this, we could work our way through these very real problems of tax wedges and labour taxes.

Proposition Joe

"Further, if PRSI was increased to include a specific ‘Earnings-related Pension Levy’, again, this might be more acceptable if people know, as part that contract, they would receive 50% of their pre-retirement income in a pension."

Do you have any idea how much PRSI would have to be increased by in order for the state to guarantee a 50% of final earnings pension for all?

According to a couple of researchers in the UCD Maths dept, the true actuarial cost of a public service pension is in the region of 30% of salary. You're talking about extending similar 50% of final earnings pension to the entire population. To fund this properly, PSRI rates would have to creep up close to PAYE rates. Which of course would be impossible. You've gotta leave workers with some money in their pockets to actually live on.

Now, the outstanding public service pension liabilities make a 100 billion euro hole in the state's balance sheet.

Extending this gold-plated pension provision to 6 times as many workers would cause that liability to explode up close to the ballpark of a trillion euros.

National bankruptcy here we come!

Michael Taft

Proposition Joe, I would strongly recommend TASC's pension proposal where they show that a mandatory two-tier earnings-related pension wouldn't cost much more (if at all) than the current system. This is due to the fact that we currely spend billions subsidising private pensions which disproportionately benefit the highest income groups.

In any event, the current system is going belly-up. Not only are we subsidising private pensions, now those same funds are pleading for more subsidies given that their funds have taken a bath on the equities market. This is neither rational nor sustainable.

A hybrid funded/Pay-as-you-go system is the way forward.

TASC Report:


Michael -

On Social Insurance I think your Health Insurance Levy proposal is a good one.

I have an issue with the earnings related pension levy however. Can you explain how this would remain affordable over time? If we have a particular dependency ratio today and this ratio worsens over time as the population ages, wouldn't the burden of providing such a generous pension increase over time? In other words I might be able to afford to pay towards an excellent pension for my father, but will my daughter be crippled when she is paying towards mine?

Or worse, under such circumstances would there be political pressure to adjust retirement ages ever upwards?


Michael -

I took a quick look at that Tasc report, their solution to the declining dependency ratio is the mantra 'economies grow'. Which is possibly true, but based largely on inductive reasoning, extrapolating into the future from medium term experience. If it does turn out to be accurate - won't wages , and thus the cost of the scheme grow with the economy? (Particularly as this is a final wage scheme, normally the highest real wage a worker achieves in their lifetime.)

If it doesn't turn out be accurate, for example if we enter into a prolonged period depression, war, or suffer from the rise of powerful economies elsewhere the consequences would be even more disastrous for our children.

Michael Taft

Mack, you have identified a weakness in that a long-term budgetary framework for a PRSI earnings-related pension has not been developed. This is not easy work as it relies on variables that can change rapidly (for instance, did anyone forsee in 1995 the explosion in inward migration? Can anyone predict with certainty patterns of migration over the next 5-10 years?). However, there are some points worth noting:

Our dependency ratio is estimated to be in 2056 what it is in some EU countries now. They are able to fund earnings-related pensions through state and social insurance companies. There's no reason why we can't perform that feat in three decades.

Second, much of the funding for the new scheme would come via redirecting the huge cash subsidies in pension tax relief - this is over €2 billion per year and was growing until now.

Third, the State, in addition to providing expensive tax relief, will also be called upon to bail out occupational funds.

Fourth, were the situation to continue - with so many uninsured and reliant upon the poverty-line state pension, the state will incur extra costs - especially as health and life-quality costs are related to income levels.

In addition we will eventually have to revisit the retirement age - not in a way to penalise people, but to, in the first instance, to incentivise people to work longer.

And the backdrop is that Ireland can absorb a much larger population. A sensible immigration policy would help alleviate the dependency ratio - since that, and not necessarily the actual number of elderly - is the key stat.

In devising an alernative fiscal framework, these and other issues will have to be investigated. My own guess is that it will show an earnings-related pension is affordable. However, one thing is certain - we have to come up with some alternative for the current system is not sustainable.


Michael -

I think sustained immigration would be key to supporting such a policy financially. I presume the 2056 dependency ratio forecast did not factor in the net-emigration we may now be experiencing?

But at some point, isn't this going to become unaffordable? Maybe it will work well for you and me, perhaps even our children - but what of our grand-children? I don't think, that just because a scheme will work for us (even in the medium term) we should lumber future generations with something that isn't self-sustainable. And believe me, 50% final salary guaranteed sounds great given the decimation our families defined contribution pensions have experienced in the last year.

Revisiting the retirement age? :( Boo! Down with that sort of thing! I recommend a visit to a New Hampshire Micky D's, staffed, mostly likely, by old dears who should be enjoying their golden years - not serving burgers. This fate awaits the unlucky, caught without a seat when the music stops, if we implement a musical chair pyramid scheme as pension policy. (Not saying the TASC proposal is such, any proposal needs to be self-sustainable).

I really do worry about proposals that are dependent on the income of future workers, rather than current incomes. There's none of us can know the future (a rapid flight of multi-nationals would rapidly and massively contract the economy, for example and could occur as a result of circumstances completely outside our control). If workers forgo saving for their own future to pay for current retirees, what happens to them if future workers for whatever reason can't meet their pension requirements? They'll have nothing to fall back on, as pre-tax income that would today be saved / invested in defined contribution pensions (however poor) will instead have been paid in higher taxes as part of social contract that may turn out to be unenforceable.

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