Who will pay the inevitable tax increases?

Nat O'Connor: As part of our analysis of the Finance Act 2010 we looked at the national finances. An Saoi has pointed out that tax revenue is more or less on target. But even if those targets are met, the size of the deficit makes tax reform essential.

The primary role of the Finance Act is to make sure that the State's tax revenue is stable, sustainable and sufficient to fulfil its functions. But our analysis shows serious deficiencies in this area.

The following two diagrams illustrate the Department of Finance's headline figures on revenue and expenditure. Source for 2001-2008 data: Department of Finance (2009) Budget and Economic Statistics 2009. Source for 2009-2010 data: Department of Finance (2009) Pre-Budget Outlook November 2009. Figures for 2009 are provisional and figures for 2010 are projections.

Figure 1: Central Government Revenue and Expenditure (2001-2010), in Millions of Euro, net figures

Figure 1 includes all revenue and expenditure (including sources of revenue in addition to tax, such as selling State assets, loans to the State, etc).

Figure 2: Tax Revenue and Current Expenditure (2001-2010), in Millions of Euro, net figures




Figure 2 limits the figures to tax revenue and year-on-year ('current') expenditure only. This is to remove 'one-off' effects, such as from capital spending.

Simply looking at the illustrations shows the extent of the fiscal crisis. Both figures show the sharp drop in tax revenue (by a third, €14.2 billion) between 2007 and 2009. Some of the tax decline is due to the overall global economic recession. Optimistically, maybe half. The rest of the decline is due to the collapse domestically, especially in the construction and housing sectors. This is tax revenue that is not likely to ever return to mid-2000s levels.

Figure 2 also shows that the Department of Finance's 2010 projection for tax revenue is for less than 2009, whereas expenditure is increasing. In other words, the current deficit is getting larger, not smaller.

Figure 1 shows the reverse only because of large one-off cuts in capital expenditure, plus the effect of non-tax sources of revenue. In the absence of additional capital spending items to cut, any serious attempt to close the current deficit at the next Budget must involve more deep cuts in current spending and/or significant increases in tax.

Tax revenue for 2010 is projected to be €30.8 billion, whereas current expenditure is projected to be €47.5 billion. That's a gap of €16.7 billion.

Let's assume that global economic recovery will close half the gap in tax revenue over time (which is a big assumption). On this basis, using the Department of Finance's projections for 2010, the gap that remains to be bridged by spending cuts and/or tax increases is at least €8.3 billion.

(Note) This is a simplification of the overall situation. I am assuming that it is necessary to balance tax revenue with current expenditure because the major cuts on capital spending between 2009 and 2010 cannot be repeated and are not a permanent way of bridging this gap. I am also assuming that non-tax sources of revenue (currently including the Pension Levy) are not a stable replacement for tax revenue, although they provided over €800 million in 2009 and are projected to provide €2.3 billion in 2010. There is always disagreement about measuring the deficit, and of course State-led economic stimulus could also help decrease the gap by boosting economic activity. Yet, I think it is worth focusing on the basic mismatch between tax revenue and current spending because the gap is so large. And it seems certain that the Government must deal with the €8.3 billion question soon.

Unlike the last budget, which involved cutting one-off capital spending and making a pre-payment to the National Pensions Reserve Fund (NPRF), a continuation of the cuts strategy will require much more to be taken from front-line services. If the Croke Park deal holds, with its commitment for no more pay cuts, it is hard to see where billions in cuts can happen. Hence, I come to the conclusion that some significant tax increases are inevitable to help bridge the gap.

Tax increases at this time may further depress the economy, especially if they are based on income tax or consumption taxes. So there is a need to look at broadening the tax base to include different forms of tax, including taxes on wealth, in order to minimise the dampening of consumer spending. For example, ex-Taoiseach Bertie Ahern's regret at abolishing property tax may just be one example of the discussion on new taxes yet to come.

From an equality perspective, there is a clear need to examine how much tax everyone currently pays, relative to their income and their needs, and to seek the establishment of a much more progressive tax system, where those who benefit more from the economy also pay proportionately more tax. At the same time, we need to establish a target, such as the 45 per cent of GDP suggested by John Fitz Gerald of the ESRI, because we are not talking about temporary tax increases to weather out the crisis, but a long-term restructuring of the tax system to make it more sustainable and sufficient for the level of public spending that we settle on.

There is a real risk that new taxes (and service charges) will fall disproportionately on low and middle income households, while those on high incomes continue to benefit disproportionately from tax expenditure. While any move to consolidate Western European levels of tax and spending will require virtually everyone to pay more tax, there is nevertheless a need for more public discussion now on the future shape of our tax system, including how much taxation should be paid by different groups in society.

Posted in: Fiscal policy • Economics • Taxation

Tagged with: revenue • taxation • expenditure