The structure of Ireland’s tax system and options for growth
enhancing reform
Brendan O’Connor, 19 June 2013
Motivation
Economic strategy post Troika
Several straw-men arguments need to be analysed
Ireland’s tax burden is too low?
No further scope exists for adjustment on the revenue side?
Burden too low on high earner?
Tax burden on labour is too high?
Discussions and commentary around Budget time tend to focus on fairness, equity and progressivity concerns
Limited focus on the potential for growth orientated reforms
Revenue neutral tax shifts – potential output gains?
What does the burden of taxation look like in Ireland
Total Taxes as % of GDP
60
50
40
36
29
30
20
10
0
Using GDP as a measure of economic output it might appear that Ireland has the capacity for greater tax revenue by European comparisons.
But is GDP the appropriate measure of tax base?
GDP includes net factor flows out of Ireland (profits of MNCs) which are very large and negative
2011 GDP represented 124% of GNP – second largest gap in EU (Callan et al 2013)
IFAC hybrid measure of GNP + 40% of net factor flows
What does the burden of taxation look like in Ireland
Total Taxes as % of GDP
60
50
40
36
36
30
20
10
0
Using GNP, Ireland has a greater than average share
Using the IFAC Hybrid Measure Ireland approaching EU average
33
29
Other Issues – Social Insurance Contributions
In Ireland SSC accounted for 5% of GDP in 2011 (3.5% employer, 1.3% employee)
Against an EU average of 11% and an OECD average of 9% and an EU high of 17% (France)
Should they be included in a comparison?
SSC an insurance in some countries and more akin to a tax on labour in others
Total Taxes excl SSC as % of GDP
50
40
30
23.9
20
10
0
24.8
Labour taxation comparisons also distorted by SSC
30
25
20
Labour Taxes as % of GDP
17
12
15
10
5
0
Share of GDP
Ireland
Ireland Rank in EU-
EU Average
27
Labour including SSC
12%
23
17%
Labour excluding SSC
7%
8
6%
Distribution of tax burden
Income
Share of tax paid
Top 1% of earners
> €200,000
20%
Top 5% of earners
> €100,000
40%
Top 23%
> €50,000
77%
Bottom 77%
< €50,000
23%
Income Tax and USC, all Tax Units, Cumulative, 2012
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Share of Tax Units
Share of Tax Paid
99%
81%
77%
59%
23%
95%
Irish income tax system is one of most progressive in OECD
3
2.5
Progressivity Measure, Single Taxpayers
Ratio of Effective Tax Rates
2
1.5
1
0.5
0
Measurement of progressivity - ratio of effective tax rates or tax wedges of tax payers at different income levels (167% of AW and 67%
of AW) – see OECD Taxing Wages
Low effective rates
0.6
0.5
Average Tax Rate
Marginal Tax Rate
0.4
0.3
0.2
0.1
0
66% of AW
100% of AW
166% of AW
Ireland
11.5%
18.0%
31.5%
OECD average
21.1%
25.1%
30.5%
Income tax (incl USC) and SSC
Top MTR not the highest in OECD but entry point one of the lowest
0.7
60.0%
0.6
0.5
0.4
0.3
0.2
0.1
0
-0.1
16
14
12
10
8
6
4
2
0
Top Marginal Tax Rate
52.0%
Threshold for Top Marginal Tax Rate as multiple of AW
4.2
4.2
1.0
Consumption Taxation
16
14
12.0
12
10.1
10
8
6
4
2
0
8
Consumption Tax
VAT
Consumption taxes low relative to EU average – hybrid measure also below average
Share of taxation at 21% is within 1 percentage point of EU average
VAT at 6 % of GDP also second lowest in 2011 (same share in 2012)
Commission identified consumption as a tax in Ireland as having potential for a ‘tax shift’ due to its low share of GDP
6
Corporation Tax
In line with EU average as share of GDP
8
7
6
5
4
3
2
1
0
2.7
Above average as a share of taxation
25
20
15
10
5
0
8.3
7.5
2.4
Other
Environmental taxes
At 2.6% of GDP equal to EU average in 2011
At 9% of total taxation, in excess of EU average of 7%, and sixth highest overall share
Property taxation
1.3% of GDP - in line with the EU average
Above the EU average in terms of the share of total taxation (4% v 3.5%)
Recurring tax on immovable property in line with EU average (0.9% v 0.8%)
Below other English speaking OECD countries (3%)
Benefits of higher recurrent property taxation on immovable property include their relatively stable source of revenue, which is important in small
open economies with volatile tax bases such as Ireland (Norregard, 2013)
Summary on Structure
Capacity for additional taxation depends on ones view of appropriate measure of economic output for the purposes of taxation taking into account the
structure of the economy and the size of the foreign owned sector
Using IFAC hybrid measure, Ireland in line with EU-27 average
Low social security contributions explains the difference in GDP terms
Consumption low relative to EU average in GDP terms
Income taxation highly progressive
Effective tax rates low up to average wage but entry to top marginal tax rate happens very quickly
The Theory – Macroeconomic Principles
Distortions to decisions affects components of output and growth
Y = F(L, K, A)
Total Factor Productivity the key driver of long run growth in GDP per Capita
Endogenous Growth Models
Explicitly models the process through which growth is generated
Models are results of choices of economic agents – taxation can influence these choices
Human capital (Romer) – accumulation of human capital - taxation affects the decision to undertake investment in education
Innovation (Aghion and Howitt 1992, 1998) – Schumpterian idea of ‘creative destruction’, expenditure on R&D results in better quality inputs
which are more productive – effect of taxation on decision to innovate is key
Technology transfer – spillovers from human capital arising from FDI
How taxes affect the determinants of economic growth
Research by the OECD suggests a hierarchy of harmful taxation exists
Property
Do not affect decision of economic agents to supply
labour, invest in human capital, to produce, invest
and innovate
Consumption
Neutral to savings and investment
But not the view of behavioural economists (Blumkin et al. 2012, EER)
Same impact on after tax wages as labour taxes – public finance
economists view!
Differential rates can improve labour supply for goods
complementary to work
Personal Income Tax
Affect labour utilisation and productivity
Affects TFP by distorting factor prices
Typically progressive – more harmful than
consumption
Capital income taxation affect savings and investment
decisions
An inefficient form of redistribution
Corporate Income Tax
Affects FDI and technology spillovers
Affects productivity by distorting factor prices
Affects after tax return on investment and R&D
Growth orientated reforms
Empirical and theoretical evidence suggests that there could be gains in terms of long run GDP per capita from increasing the use of
consumption and property taxes relative to income tax without changing overall tax revenues (OECD, 2010)
Largest gains if reduction in MTR rather than increases in thresholds (though latter at expense of equality outcomes)
Options for Ireland
Scope for shift to consumption (EC, 2012)
Scope for further property (relative to English speaking OECD countries)
Very low entry point to top MTR, (and very low effective tax rates) – shift burden within labour
Shift within Labour
Reforms within labour taxation (Abbas 2012)
Phase out PAYE tax credit between minimum wage and average wage – positive income effects
Raise entry point to top MTR – positive substitution effects
Lower standard rate – positive substitution effects
Regressive in nature – but effective rates would still remain low vis OECD
But did not simulate the impact on GDP and employment
Simulation Results for Ireland
Labour to consumption
QUEST III – Commission’s DSGE macrosimulation model (Public Finance in EMU, 2008)
Revenue neutral shift of 1% of GDP
Years after reform
Year 1
Year 2
Year 3
Year 4
Year 5
GDP
0.12
0.17
0.19
0.2
0.2
Employment
0.14
0.22
0.24
0.25
0.25
HERMES – Structural model of supply side of Irish economy
Revenue neutral shift of €1bn
Years after reform
GDP (%)
Employment (%)
Unemployment rate
Year 1
Year 2
Year 3
Year 4
Year 5
0.00
0.16
0.26
0.32
0.32
0.00
0.11
0.26
0.41
0.43
0.00
-0.07
-0.08
-0.12
-0.14
Simulation Results for Ireland
Labour to Property
HERMES
Revenue neutral shift of €1 bn
Years after reform
Year 1
Year 2
Year 3
Year 4
Year 5
GDP
0.00
0.17
0.30
0.42
0.38
Employment
0.00
0.11
0.26
0.41
0.43
Unemployment rate
0.00
-0.09
-0.17
-0.24
-0.21
Concluding comments
Presentation only addresses growth impacts of taxation
Progressivity and redistribution also important
Income tax highly progressive
Tax and transfer system highly redistributive (pre and post tax/transfer gini coefficient)
Thank you!