Taxing times ahead for all

It may seem the opposite of what's needed, but the best way for the government to raise revenue is via income tax.

With the current economic meltdown leading to an avalanche of job losses, it may be hard to believe that the most solid source of tax revenue for the government is income tax, but this may well be the case.

The capital taxes capital gains tax (CGT), gift and inheritance tax, and stamp duties – are all dependent on land and share values. When asset values fall, so does the yield. The falling yields from CGT will be especially persistent, as any losses from sales of land and shares can be rolled up against future gains.

As well as being contingent on business profitability, the corporation tax yield is also sensitive to asset values, like CGT.

Customs, excise and vehicle registration tax (VRT) are dependent to a great extent on consumer activity, as is VAT. VAT is further affected by a drop in the sales of new homes – the 13.5 per cent paid on every new house sold is a major component of overall VAT collection. So if we are to contemplate ‘broadening’ the tax base, what can be done to make a difference?

Contrary to the often-expressed view, Ireland has very few tax breaks left. A legacy of the introduction of a 20 per cent rate of CGT was the elimination of all but the most basic reliefs. There's no relief for reinvestment, no recognition any longer of the effect of inflation. If finance minister Brian Lenihan wants to increase the CGT yield, he will have to increase the CGT rate, as he did in the last budget, by two percentage points. But 2 per cent – or even 20 per cent – of nothing is still nothing.

Similarly, the introduction of the 12.5 per cent rate of corporation tax led to the elimination of substantial reliefs for companies. For example, for every €1 a company spends on a computer, it gets a mere 1.5 cent reduction in its tax bill. Even the new and much-vaunted incentives for investing in energy-efficient equipment only provide a reduction of 12.5 cent in corporation tax for every euro spent.

Other countries have been quick to criticise Ireland as a tax haven for corporates because of our low headline rate, but every cent of profit gets taxed. Even though we have a nominal rate of 12.5 per cent, the effective rate of corporation tax in this country is closer to 16 per cent.

So, just as for CGT, if Lenihan wants more corporation tax, he would have to increase the rate. He has stated quite categorically that he will not do that. VAT is a consumer, rather than a business, tax. If the VAT rate goes up, goods and services become more expensive and consumers are more likely to stop spending. If consumers stop spending, the VAT take goes down. This vicious circle means that there is little or nothing to be gained in an economic downturn by increasing the VAT rate. The same thinking applies to customs, excise and VRT.

Property taxes can be effective, but only if they are of at least 100 years’ standing and already part of the national psyche. So they don't really offer us a quick fix either.

Remember residential property tax (RPT), or the farm tax? All these property tax experiments over the last 25 years were extinguished in a tsunami of unpopularity – in the case of anti-speculative property tax, before it was even enacted. These property taxes weren't just unpopular – they didn't yield very much either. In its heyday in the early 1990s, RPT took in around €14 million, or just over 1 per cent of all tax collected. Farm tax must surely deserve a special place in history as one of the few taxes ever, anywhere, to have cost more to administer before it was repealed than it actually raised.

That just leaves income tax. I've yet to meet people who feel they pay too little income tax but, as a nation, we don't actually pay that much. By any international comparison, the Irish income tax burden is low, and the income tax system very progressive. The more you earn, the more you pay as a proportion of your earnings.

According to the Revenue's income tax distribution statistics, the top 8 per cent of income earners pay more than half of all the income tax collected in this country. The balance comes from everybody else. When things started to go seriously askew in our economy towards the end of 2007, there was no knock-on effect on income tax take for practically a full year. We knew people were losing their jobs, but this didn't translate to the overall income tax figures. Why? Because those losing their jobs in the first phase of the recession were primarily those on lower incomes. Over one-third of all workers in the PAYE system in this country don't pay income tax at all. So the impact of job losses on the income tax take was negligible, until the more highly-skilled jobs began to be lost later.

This inevitably leads to some uncomfortable conclusions. First, there is no doubt that Ireland Inc now needs to raise more in taxes. This has to be done by raising income tax – because it is the only show in town. Raising the other taxes may be ideologically attractive, but if we want to raise money, we will have to concentrate on income tax.

Secondly, any increase in income tax will have to be spread right across the taxpaying population. Otherwise the income tax yield will be reliant on too small a number of people – at present, about 165,000 individuals pay more than half of all the income tax for our nation of four million people. This sector will shrink, as those incomes are decreasing faster than those of other sectors in the economy.

The maths is straight forward. Every percentage point increase to the 20 per cent rate will raise about €600 million.

Every percentage point increase to the 41 per cent rate will raise about €300 million. Raise either rate by much more, and the increase in yields will start to tail off.

More than €2 billion can be raised with a standard rate of 22percentandatoprate of 45 per cent, while retaining the progressive nature of our tax system, and in particular not affecting the lowest-paid employees who would remain outside the income tax net. This €2 billion may not be enough – and we must all steel ourselves for more, particularly those on higher incomes.

Finally, no matter what else happens, we cannot pursue any tax policies that don't make job retention – and job creation – paramount. Income tax is likely to become, and remain, the most important source of taxation over the next few difficult years.

Fewer workers: less income tax. Fewer high-skilled, well-paid jobs: much less income tax.

By Pat Costello, Chief Executive of the Institute of Chartered Accountants in Ireland