The The Unbearable Lightness of Economic Ignorance. The Recession Diaries - July 6th

I have to admire those who claim we must bring the low-paid into the tax net. I admire their chutzpah, their audacious willingness to flaunt in public their remarkable ignorance of the tax system. For the low-paid are already in the tax net – big time. Let’s go through the arguments and see if those making these claims are agenda-driven or just badly misinformed.

First, nearly half of all tax revenue comes from indirect taxation – VAT, excise, etc. In 2010, 47 percent of all our tax revenue will come from these sources. Ireland is somewhat unique in the EU for its over-reliance on indirect taxation. In 2008, the latest data year, indirect taxes made up 34 percent of all taxation in other EU-15 countries; in Ireland it made up over 42 percent.

Second, indirect taxes are highly regressive. The ESRI-Combat Poverty Agency found that households on the lowest incomes – the poorest 10 percent – paid over 20 percent of their gross income (social welfare, work income, etc.) on indirect taxation. Households on the highest income – the top 10 percent – paid 9.6 percent. While this data is somewhat dated, the proportions are still relevant; after all, taxes on consumption are regressive throughout the EU and the US.

Let’s pause here for a moment. In our biggest tax revenue stream old age pensioners living alone, lone parents, the unemployed and disabled, casual workers, part-time minimum wage workers pay more than twice the tax ratio as those on the highest income. Hmmm. And yet, we have commentators urging the Government to take the ‘bold, courageous’ decision – and bring the low-paid into the tax net. Hmmm.

But it gets more weird and creepy. A Department of Finance survey found in 2007 that of high-income taxpayers earning up to €500,000:

• One-fifth paid less than 5 percent of their income in income tax
• Over a third paid less than 10 percent

This tax avoidance is due to the proliferation of tax breaks.  We have to be cautious about putting two different studies together (different methodologies, different source data, etc.). However, if only as an exercise, let's combine the ESRI-Combat Poverty Agency study with the Finance survey,  We still find that that the poorest in society pay a higher tax ratio than many making hundreds of thousands of Euros a year. The Government tightened up slightly the ability to avoid tax in the last budget but it will be interesting to see what numbers the next tax survey produces (even so, none of this includes income streams which are exempt such as income from woodlands profits, artists, etc.).

The issue therefore, would seem obvious: how can we bring the highest income earners into the tax net, how can we increase the tax ratios of high income groups above that of the unemployed and the low-paid.

Then there is the economic ignorance of arguing for hitting low income earners – whether that hit comes via increased taxation or reduction in income supports. What happens when you hit such groups? You reduce consumer spending which in turn reduces tax revenue, hits domestic business which in turn reduces payrolls (either laying off staff, cutting hours, cutting wages) which in turn cuts revenue even more while increasing unemployment costs.

Of course, our economic ignoarti don’t get this simple ‘1-1-1 = -1’ equation. They keep shouting for more courage, more boldness, more ‘tough-love’ policies - without the love, of course. And when consumer demand falls by more than 10 times the Eurozone rate, when tax revenue collapses, when employment keeps falling – what is their response? Hole-shovel-dig-more.

So are such policy demands based on misinformation, laziness (looking up facts to back-up one’s argument can be such a drag) or plain ideology? Is there a connection between the demands to ‘bring the low-paid into the tax net’ and the warning that ‘if we tax high-income groups too much they’ll (a) leave the country, (b) go on an investment strike, (c) have a hissy fit, etc.’?

I’ll leave that to you. Whatever the reasons, the demand to increase taxation on the low-paid is a recipe for further bleeding the economy of demand – a low-growth, high-debt future in which unemployment will remain high, poverty will grow and the proceeds of any minimal growth will be concentrated among high income earners.

It’s time we got a bit angry about all this.

Comments

[Mack]

Michael -

It seems to me that Irish people left and right are wedded to the low tax model. Sure they both don't mind higher tax rates, but only for other people, never their base.

There is apoplexy on the airwaves about a property tax, but young families stuck in shoe box apartments will have to pay a huge one-off transaction tax to move to a house. While a retired multi-millionaire with a mansion in Ballsbridge will pay feck all.

I've taking look at tax rates in other countries. VAT is 25% in Sweden, although there workers on slightly above average salaries are paying 50% effective income tax rates.

I take your point about the deflationary impact, but any action to fix the structural deficit will be deflationary (could be offset by some sort of stimulus though).

I think how we bridge that deficit will determine what kind of society we have in the future. I don't mind whether it's the low-tax, pay for services yourself model. Or something more scandinavian (higher taxes, excellent services). Very difficult to see us changing one way or the other. Even with very high marginal rates today..

[Michael Taft]

Mack - I absolutely take your point. The debate, so far, has been dancing around the elephant - the need to raise tax levels across the board. What we need is an open and honest debate on the issue; a strategy that moves with, and not against, the grain of economic growth; and a framework in which to test concrete measures. All of this is for the most part lacking.

Any tax-driven fiscal consolidation must take into account the deflationary impact. While you rightly refer to the structural deficit (though there is a fierce debate over how to measure this and how much it is, with many arguing there's no such thing), steps to address this that aggravates the overall deficit is hardly a step in the right direction. This is all the more the case when current pro-cyclical measures are merely dampening fuure growth and postponing the closing of the deficit (the E&Y/Oxford Economics report projects that on current strategy, the deficit won't fall to Maastrich compliance until 2018/2019; that's a lot of debt and interest payments piled up). Therefore, the first steps must be to hit the least deflationary source of tax revenue - the savers. Only when the economy is in sustainable growth mode should we start to raise general tax levels.

But what kind of general tax incrases, what kind of framework? I have argued, in line with European practice, that social insurance play a pivotal role. Social insurance, in exchange for universal access to public services (health, pensions, etc.) is not only likely to be more efficient - it is also likely to be more popularly palatable.

Unfortunately, we are not even at the stage of beginning this debate because as you rightly point out - we don't want to know. What political party is going to step forward with that one? Personally, I believe that people are ready for an open and honest debate on this subject. But I'm not seeking office.

And by all means - a property tax. A comprehensive tax on all property, real and personal. That's the ticket.

[Mack]

Hitting the savers mightn't be a bad idea, if alternatives are made available. A lot of people in their 20's, early 30's who are saving are probably saving for a house. And prices are coming down to meet them. For everyone else it might make sense to mitigate a high tax on saving with tax breaks on productive investments made in the Irish economy.

If there is going to be a debate (and there probably won't) it would be worth making sure that alternatives are

1. Low tax / low services
2. High tax / high services

Any other combos, are either unlikely (low tax / high services - although the Swiss manage it) or undesirable (high tax / low services - Ireland of the 80's).

[Michael Taft]

Mack - it's my fault for using the term 'savers'; I don't want to give the impression that I want to tax 'savings'. I was referring to those on high incomes who have a high propensity to save, rather than spend. During a recession we need to bolster demand and spending. Therefore, a redistributionist agenda would tax high incomes and redistribute to those on low and average incomes - those groups likely to spend more of the money. But on your alternatives, you are absolutely correct. We need taxation levels comminserate with a modern service economy. And we need new programmes to ensure expenditure on services is as efficient as possible.

[Mack]

Michael a pity. Because encouraging savers (i.e people with savings) to

1/ Spend (boost consumer demand)
2/ Invest in a liquidity trap when businesses won't or can't ( banks not extendeding credit)
3/ Expropriating a portion of the savings through tax and spending that

might be a way to get the economy going again.

[Mack]

Left-wing American economist Michael Hudson in the FT Wednesday, arguing for alternatives to austerity.

http://www.ft.com/cms/s/0/337fef82-89f7-11df-bd30-00144feab49a.html

Facing these two unpalatable options, some of eastern Europe’s leaders have begun to realise that there is, in fact, a third option: radical reform of the tax system. Taxes in most post-Soviet eastern European economies, along with countries such as Greece, are regressive. They add to the price of labour and industry while under-taxing property. Latvia is an extreme example: its flat taxes fall almost entirely on employment, meaning workers take home less than half of what employers pay.

The good news is that these high taxes on labour leave open the option of shifting taxes on to other areas, in particular land. Lowering taxes on wages would reduce the cost of employment without squeezing take-home pay and living standards. Raising taxes on property, meanwhile, would leave less value to be capitalised into bank loans, thus guarding against future indebtedness.

He cites Hong Kong as an example of how this has worked. It actually sounds similar to Constantin Gurdgiev's proposals about how to fund a low flat tax (shift the burden of taxation onto land).

Incidentally, he was at least partially credited for preventing the privatisation of social security in the US (see - http://harpers.org/archive/2005/04/0080499)

There is a longer version of the FT article on his website.

http://michael-hudson.com/2010/07/latvia%E2%80%99s-third-option/

[Mack]

Harpers link minus the extra ')' that breaks it

http://harpers.org/archive/2005/04/0080499

[Mack]

Martin Wolf in the FT on a similar theme, as FF drop their property tax

http://www.ft.com/cms/s/0/8f06df9e-8ac1-11df-8e17-00144feab49a.html

although I think Wolf might mean capital gains taxes on resources (land) rather than taxes on labour.

"First, it makes it necessary for the state to fund itself by taxing effort, ingenuity and foresight. Taxation of labour and capital must lower their supply. Taxation of resources will not have the same result, because supply is given. Such taxes reduce the unearned rewards to owners."

and

"If “a crisis is a terrible thing to waste”, here is an urgent case for action. Socialising the full rental value of land would destroy the financial system and the wealth of a large part of the public. That is obviously impossible. But socialising any gain from here on would be far less so. This would eliminate the fever of land speculation. It would also allow a shift in the burden of taxation. Perhaps as important, with the prospects of effortless increases in wealth removed, the UK might re-examine its planning laws."