A Vision for Ireland: A Question Of Tax?
Eugene Quinn , an actuary working part-time with the CFJ, examines issues of fairness in taxation.
Taxation is always a vexing question and in the modern Ireland particularly so. The role of taxation policy in stimulating the Celtic Tiger is disputed. The neoliberal view is that the creation of a low tax environment was integral to our economic success and is an essential ingredient if that success is to continue. This premise has not gone unchallenged. The opposing view points to factors that were funded through tax revenues such as the supply of an educated labour force and the presence of an adequate infrastructure as major contributors to our economic growth in the period. These differing perspectives bring into focus tensions at the core of taxation policy.
Most people do not like paying taxes, however the majority of people recognise that taxation is necessary for a state to function. Willingness to pay tax though is premised on two criteria: that it is fair and that it is value for money. The purpose of this article is to examine the Irish tax system using these criteria and trying to gain an understanding of how attitudes to paying tax have been formed and what are the hopes for reform.
Ireland has arrived at a position of unprecedented economic success by any macroeconomic standards but is facing an uncertain economic future. The Celtic Tiger of the mid-to-late nineties resulted in record economic growth that has been the envy of the world. Unemployment is at a record low with an estimated 400,000 new jobs created over this period. The belief is that \'a rising tide lifts all boats\' and that there is a trickle down effect of wealth to all levels of Irish society. The Government points to a reduction in consistent poverty as evidence of this improvement. Some commentators and political parties (e.g. Progressive Democrats) argue that key to economic growth has been a series of tax cuts that have made Ireland, according to the OECD, the lowest tax environment in Europe.i Lowering Corporation and Capital Gains Taxes substantially has resulted in higher revenue receipts and lowering income tax has created a more attractive environment for enterprise and significant income gains for most categories of workers. Therefore, tax cuts have become sacrosanct and non-negotiable if the whole economic edifice is not to be unwound. As the employers\' body IBEC warns, "Higher taxes would very quickly erode the jobs friendly environment patiently built up" in response to suggestions by the ESRI that recommended higher taxes as part of the package to protect the countries finances.ii
Some economists have strongly contested the importance that has been attached to tax cuts in delivering economic growth. They argue that our economic growth has been caused by factors we can control such as lower corporation tax rates, the work of the IDA and maintenance of industrial peace. Key to industrial peace was the Partnership process. Wage agreements were facilitated by the use of lower personal taxes as part of the package. The growth was built also on the foundation of earlier public investment (of taxation revenues) in ensuring adequate infrastructure existed and the supply of an educated labour force. Of course there were factors that were beyond our control; advantageous exchange rates against the dollar and sterling that made Irish industry competitive, the sustained economic boom in the US, low energy prices, cheaper access to and from Ireland and significant EU transfers of money to build better infrastructure. For the Celtic Tiger then, it can be concluded that tax cuts were a component not a determinant of growth.iii
While it is true in absolute terms that people are better off, in relative terms the gap between those who have and those who have-not has widened. Combat Poverty in their review of the last five budgets concluded that they have largely benefited higher income groups in the population. The richest 10 percent of the population received 25 per cent of the Budget giveaways during the five years of the last Government while the poorest 20 per cent received 5 per cent.iv Behind the numbers there are concerns that Ireland is becoming increasingly a two-tier society. If you have resources you can afford private health, voluntary pensions and access to better education for your children. On the other hand those who cannot are condemned to poorer health service, a frugal retirement and a similarly bleak future for their children.
For others relative inequality does matter because their vision of society is broader than the operation of the market and the preoccupation with economic growth (irrespective of how it is distributed). Relative inequality matters because a widening gap between rich and poor means the poor cannot participate equally in society. This view is predicated on a belief that we are all born equal but we are not born with equal opportunities, and so society has a responsibility to try and correct its failures. The state has a role in rebalancing the equation. The extent of state intervention and the redistributive role of taxation in providing resources often prove contentious. The needs of the poor, the marginalized and the excluded are seen as a higher priority than the needs of the rich. If higher taxes are seen as necessary to achieve this goal then these two perspectives may come into conflict, particularly if growth is perceived to be a casualty of equality.
What we are faced with is contending visions for Ireland. On the one hand there is the primacy of economic growth and the centrality of low tax rates in achieving that goal. As market advocates put it there is no point in arguing about how to split the cake if there is no cake in the first place. The opposite perspective envisages a more just and equal society, where there can be growth with equity. The Scandinavian countries are examples of higher tax regimes that are compensated for by an enviable level of public services (transport, health and education).
Principles of a \'fair\' tax system
Adam Smith\'s canon of taxation of 1776 enumerates criteria by which a tax system can be assessed: equity, efficiency, and ease and cost of administration. Smith expands on the principle of equity subdividing it into horizontal equity, people earning the same amount should pay the same tax and vertical equity, those on higher incomes should pay more than those on lower incomes.
The concept of horizontal equity is subject to challenge. It is plausible to hold the view that equity is best served by "making tax payment proportional to the degree of benefit derived from government expenditure"v. Thus it is not income but benefit from public services that determines the level of tax. Such a system is simple but unworkable for a number of practical reasons, not least how to measure how much each person benefits from public services since they do not pay for them directly.
In general a key principle of fairness is that taxes ought to be based on ability to pay. This means that people with higher incomes should pay a higher percentage of their incomes in taxes than people with lower incomes. A tax system that embodies this key principle of fairness is said to be "progressive". A system that, on the other hand, requires people on lower incomes to pay a higher proportion of their income than those with higher incomes is said to be "regressive".
Much of the debate on the Irish tax system seems to begin and end with the actual tax rates and income thresholds. In Ireland we have a system that is nominally progressive. There are two tax rates that are applied to taxable income after a series of allowances, exemptions, reliefs and exclusions. The standard rate of tax is applied to all taxable income below a certain income threshold. Above that income threshold a higher marginal rate of tax is applied. The aggregate of taxable income is termed the tax base. The size of the tax base determines the level that tax rates must be applied to ensure that the Exchequer raises the revenue required by government. Consequently, if a government is unwilling or unable to reduce public spending any measure that narrows the tax base will require higher taxes or borrowing. On this basis any concession that applies only to some taxpayers must be subsidised by all other taxpayers. There is a need for such concessions to be justified; otherwise the perceived fairness of the system is undermined.
The main concessions could be grouped as:
(i) Social: Pension Contribution Relief, Mortgage Interest Relief and Health Insurance Relief.
(ii) Development: Investment in properties in designated areas or in the film industry.
The aim of these concessions is to promote socially desirable goals such as home ownership and pension coverage. From a justice perspective however, we can ask who benefits most. In last months issue vi we saw clearly how regressive the current pension regime is. Ireland shares with the UK the worlds most generous tax concessions on pensions. There is an ever-increasing amount of tax expenditure (in terms of revenue foregone and consequently narrowing the tax base) on voluntary pension schemes benefiting the most those who make the largest contributions i.e. those on higher income. Is it fair that government expenditure is directed towards securing the future of those on higher income via voluntary private schemes as opposed to higher direct expenditure on social welfare pensions that benefit all?
Mortgage Interest Relief has led a checkered existence over the past decade. It has been reduced from marginal to standard rate relief as a token to fairness. There is however, still a considerable group of lower income earners that will never have the possibility of getting a mortgage and therefore can never benefit from this concession. The position with regards to investors is particularly problematic. The removal of relief from investors was welcomed as their presence was inflating prices for first time buyers trying to enter the market. This element was quickly repealed due to a resultant chronic shortage of rental accommodation. The government has to balance a number of objectives and tax concessions may be one way of achieving those aims, even if the measure is not equitable to all taxpayers.
Health Insurance is already vastly subsidised through public investment in the services available under private health insurance policies. The availability of tax relief deepens the inequity. The health system is truly becoming a two-tier system with one level of service for those who have private health insurance and a much lower and poorer service for those who cannot afford it.
One way of encouraging investment and development of underdeveloped areas of the country was by allowing special tax breaks for designated areas. It is difficult to evaluate the success of these schemes. People point out that the renewal of Inner City Dublin and of the Dublin Docklands would not have occurred without them. On the other hand there has been criticism of the lack of integration between these developments and local communities. Communities remain polarized as the office workers and young, mobile residents of securitized apartments share neither time nor interests with existing residents.
The film industry due to its specific nature is accorded a special position with respect to investment. The cultural contribution of this industry is difficult to quantify. Also the positive knock-on effects for the tourist industry remain open to question.
However what remains unquestionable is that both these developmental concessions are excellent vehicles for the wealthy to shelter their income from tax.
Another area that has been historically a bone of contention is the inequity in the different methods of levying tax on different sectors of the working population. There is a large captive PAYE element of the tax base that has tax deducted at source. The self-employed sector on the other hand are self assessed thus allowing considerable scope to \'manage\' income in a tax efficient way via capital allowances (relief for capital expenditure e.g. purchase of machinery or computers), deductible expenses (expenses in the running of the business e.g. staff salaries, travel and \'entertainment\') and the timing of realised gains (this is the amount of gains that have been made between the date of purchase and the date of selling an investment). Historically there have been powerful political lobbies such as the farmers, which have enabled them to resist being drawn into the tax net.
Difficulties in Taxing the Rich
"According to the Revenue Commissioners\' estimation 17% of people with incomes over £250,000 pay tax at an effective rate of 20% or less" (in comparison to the then standard and marginal rates of 24% and 46% respectively)vii. High-income earners have a good degree of discretion as to when they earn income as well as access to financial advisers to minimise their tax liability. The system appears to be biased towards the wealthy. The issue from a fairness perspective is not that there are opportunities available to minimise one\'s tax liability but that those opportunities are not available to all.
In the Irish system income is defined solely in terms of money earned from work. Money earned from gambling or capital gains although it gives the benefactor the same spending power is taxed differently or not at all. For example the highest marginal rate of income from work is 42 % whereas capital gains are taxed at 20%. Less than 1% of daily transactions in the stockmarket are in newly issued stock, thus it can not be argued that capital gains should be treated differently for tax purposes on the grounds that it encourages productive investment. Thus in the absence of an economic justification for taxing capital gains (mainly enjoyed by the wealthy) at a lower rate than workers\' hard earned wages it points to further evidence of a bias towards the wealthy inherent in the tax regime.
The taxation of the super rich is something that most governments appear to have given up on. The existence of tax havens allows the wealthy to locate their mobile assets in jurisdictions with minimal taxes. In a recent article on Irish Euro billionaires and millionaires it was interesting to note how many were non-resident for tax purposes (among those mentioned were Dermot Desmond (est. 1,034m), Tony O\'Reilly (est. 1,984m) and Tony Ryan (est. 810m))viii . The result is that taxes as a percentage of income increase steadily from low to middle incomes and then falls away rapidly at the higher income levels.
Since the super rich pay little tax they often seek to assuage their conscience through philanthropy. In Ireland we see the Arts, Universities and Charities all benefiting from this benevolence of some of the nation\'s richest individuals. It serves as a rather crude proxy for redistribution of wealth. Of course the individuals determine the projects that they have most empathy with, which in no way constitutes coherent social development. The American example is more extreme as is the wealth inequality. The Bill Gates Foundation has billion dollar resources meanwhile there remains a growing underclass of American poor people that remain steadfastly neglected by the state. Is a billionaire financier or the democratically elected government of a state the more appropriate trustee of funds to benefit the poorer off sections of society? In the longer term it would be hoped that the state is the better mechanism (even if that is not always immediately obvious!).
According to the Organisation for Economic Cooperation and Development (OECD) globalisation has created an environment in which "tax havens" thrive and in which governments may be compelled to adopt "harmful preferential tax regimes" to attract highly mobile financial and other service activities.
"If unchecked, such tax practices can distort trade and investment patterns, erode national tax bases and shift part of the tax burden onto less mobile tax bases, such as labour and consumption, thereby adversely affecting employment and undermining the fairness of the tax structure".ix
In simpler terms the existence of tax havens may mean that there is a shortfall of tax revenue in domestic economies that might need to be made up by the other taxpayers. This effectively adds insult to injury, not only do the super rich earn multiples of an individual\'s income but by avoiding tax they are indirectly responsible for a further fall in an already meagre net pay.
Among OECD\'s list of potentially harmful tax regimes was our own International Financial Services Centre (IFSC). Originally it offered a preferential corporation tax rate of 10% compared with a domestic corporation tax rate of 40% at that time. The IFSC was considered so advantageous to Irish businesses that it was reckoned to be in the best interests of the Exchequer to reduce the domestic corporation tax rate when the grace period for the IFSC preferential tax arrangement expired.
Corporation tax receipts increased despite the fact that the corporation tax rate fell to almost a quarter of its previous value. How can we explain this phenomenon? Multinational corporations simply recognise their profits through their Irish branch. A result that is achieved through artificially inflating profits in a given location through a process of transfer pricing that enables profits from the worldwide operations be notionally assigned to the most tax advantageous location, in this case Ireland. Ireland is in some way the ill-gotten benefactor of gains earned elsewhere, by definition depriving other economies of their just tax revenue. Ireland would well be warned against banking on such windfall revenues in the long term as the mobility of industries that source them ensure that the profits can just as easily be located elsewhere. Furthermore, Ireland has been criticized for resisting tax harmonization in the EU.
Since 1988 there have been three significant tax \'amnesties\', whereby there was a once off opportunity to correct tax affairs without the risk of prosecution. There is a general concern around the use of amnesties that appear to send out the wrong signal to compliant taxpayers but this fear is overriden in the short-term best interests of the Exchequer.
The 1988 amnesty was simply an amnesty from prosecution and interest penalties. The 1993 amnesty, however, included not only an interest and penalty amnesty but also introduced a special 15% tax rate for individuals with income tax, capital gains and levies arrears. This rate was tantamount to a reward for not making tax returns. Not only did errant taxpayers not get penalised but they also had the use of unpaid taxes to invest in the interim period. Ultimately then they paid tax at a lower rate than they would have had to if they had made their returns on time.
I believe that amnesties constitute governmental abuse of the tax system in the short-term interests of the Exchequer. The sense of civic duty in payment of taxes is undermined. The long-term best interests of the Exchequer and the state are not served by a fundamental lack of belief in the fairness of the system.
Business has recognised successive governments \'soft\' approach on tax avoidance. AIB were found guilty of irregularities in their DIRT returns and had to pay arrears and penalties of around £100M. One economic commentator estimated that this amount would have been £400M if the same system of interest penalties had been applied to them as is applied to individuals. Allowing for the fact that the banks were making investment return on the amounts not returned, it is unlikely that there was a financial penalty at all for their misconduct. As there is a consistent message being sent out to the Irish taxpayer it is no wonder they are so cynical about the system.
If businesses and the wealthy do not pay their fair share of taxes, those who work in Ireland\'s factories, schools, offices and hospitals wind up paying more than they should. But the antipathy of the Irish taxpayer is not solely sourced from present day anger at the unfairness and inequities of the system. There are historical antecedents that have been highly influential in the determining the disposition of many taxpayers.
Prior to independence there was an ideological and righteous objection to paying taxes to Britain. This was exacerbated by the fact that they were being overcharged. "It has long been an article of faith that Ireland had been overtaxed under British rule and that the country could be administered more cheaply under native rule" .x In fact once demobilisation occurred at the end of the Irish Civil War the government slashed the standard rate of income tax from 25% to 15%.
The low rate of income tax that existed in the early generations of the state reflected the minimalist state intervention that prevailed. The role of the Church as provider of social services substituted for the State. In the post war years public expenditure soared with capital investment in infrastructural and social programmes. In the sixties with the take off of the welfare state, public expenditure continued to climb rapidly. Shortfall in tax revenue was made good by borrowing. The Oil Crisis in 1973 precipitated a sustained growth in public borrowing encouraged by low interest rates. The huge hikes in interest rates in the early eighties placed a huge strain on public finances to service the interest payments on the national debt. The answer to this fiscal crisis was to levy very high taxes on PAYE workers, later accompanied by a very sharp cutback in public spending.
The growth of government, with the emergence of the welfare state, resulted in what was sometimes perceived to be a bloated and inefficient public sector. The use of the public sector to provide employment during recession helped to engineer this position. Austerity measures of the eighties were a response to earlier prolifigacy. Corrective policies, such as the policy of replacing 1 in 3 of those who retired, meant increased inefficiency in the public sector. At that time cost not efficiency was of primary concern. Taxpayers at that time were faced with the twin evils of high taxation and severe cutbacks in public expenditure. A legacy of that period and the following years of fiscal austerity is a deficit of investment in the infrastructure of health and education.
Currently, even though Ireland has one of the lowest tax environments in Europe, it also has one of the most underdeveloped public sectors. Years of under-resourcing has come home to roost with infrastructure (gridlock on our roads and the country grinding to a standstill), poor planning (ensuring that a viable public transport proposal for Dublin is impossible, ribbon development in rural areas placing unbearable strain on public amenities such as water and sewage disposal) and a decaying health service. All of this is occurring despite massive increases in public spending, most of which has been consumed in bringing public servants pay up to date.
Paying tax: A question of morality?
In addition to a historical antipathy there appears to be a moral ambivalence to paying tax. In this country there is generally only a qualified disapproval of financial misconduct. Recent tribunals have \'done much to determine the nature of corruption\' in Ireland but \'changes to improve the political and administration system are minimal\' xi . Our attitudes to so-called \'white collar\' crime are disingenuous amounting to a slap on the wrist and don\'t do it again. This is in stark contrast to our inclinations to punish \'blue collar\' crime. For example, an insurance broker found guilty of fraudulently misselling products to obtain higher commission is as guilty of theft as a person who breaks into the same person\'s house and robs it. The difference is perception and punishment. Normally for one we will demand a custodial sentence but for the other disbarment or the censure of his peers is normally deemed sufficient. It is a curious double standard and thus no wonder that tax avoidance and tax evasion is so commonplace in our society.
The influence of the Church has contributed to this dubious \'moral\' climate. The Church has never attached the same moral opprobrium to financial misconduct as it has to say sexual misconduct. The Church\'s teaching which is so rigid and inflexible on other matters is surprisingly circumspect when it comes to payment of tax. The moral obligation is to pay a \'just\' tax. But how does one define a \'just\' tax? Well for once the discretion is left up to the individual and their conscience. The Church has usually taken the lead in informing people\'s conscience on moral issues but not so in this case. For instance, PAYE workers of the early eighties could plausibly argue that a top tax rate of 66% was not just. It is the ambivalence of this position that enables people to justify tax evasion.
Ireland has arrived at a difficult juncture. Many taxpayers perceive the tax regime to be neither fair nor \'value for money\' (in terms of delivery of public services e.g. health). Even among those who believe that tax is necessary, many are of the opinion that a \'fair\' ( or just) amount of tax is as little as possible, an understandable viewpoint given the crisis of legitimacy that the tax regime is facing. This conception of paying tax is one of a \'negative\' duty, by this I mean that the emphasis in terms of obligation is placed on the burden to the individual or the penalties for non-compliance.
The task of reinventing tax payment as a positive duty is immense. The emphasis is placed on what should be done rather than what should not be done. A positive duty is defined in terms of the \'positive\' outcome for society, namely, the use of tax revenues to establish a more just and equal society. It requires rolling back distrust that is historically embedded. Reform of the system is necessary to re-establish legitimacy. This is not easy against the ongoing demands of running a country. If we really want better roads, schools and hospitals we as a society must be prepared to pay. If we want a more equal society with equal opportunities for all then that also comes at a price, the price being tax. It is then that our principles and beliefs start to cost by hitting us in our pockets. As we see the mechanics of how tax is levied needs to be fair and the fruits of public investment needs to be seen if the system is to retain its legitimacy.
In conclusion, I believe we must conclude that the Irish tax system in its current incarnation is facing a crisis of legitimacy. The combination of reliefs, allowances, exemptions and deductibles ensure that the outcome is not equitable either at the same income levels or at different income levels. The taxation of businesses and the rich certainly is not representative of their ability to pay. The regime is perceived as neither fair nor value for money. Tax amnesties have ensured that the tax dodgers and not compliant taxpayers have been rewarded. The Government has pursued its economic best interest even at the cost of destroying the remaining vestiges of credibility surrounding the fairness of the tax regime. There is a historically embedded perception that public funds are being used neither efficiently nor effectively in the public interest. The actions of recent governments have not disabused taxpayers of this notion. This and other factors have contributed to a dubious national attitude to paying tax and enabled an environment of tax avoidance to flourish.
"If we choose to define a \'good tax system as meaning one that is absolutely fair then we must be guided by the equity principle at all times. If however we view a good system as one that is workable and provides governments with the resources it needs, then we can settle for one that is accepted by the majority of tax payers without unrest or widespread tax evasion." xii
Unfortunately, successive Irish Governments appear to have settled for the latter
There has been a reluctance to create a new paradigm for taxation: a paradigm that sees taxation as essential to the cohesion of our society, as a means to level the playing field and redistribute wealth, income and most critically opportunities in our country. We have looked in reality to Boston and not Berlin. The European tradition of strong public investment in key services financed by higher taxation was bypassed for the more robust, individualistic model of the market. The problem with the latter model is that it has resulted in a growing inequality that means that a substantial proportion of our population is denied opportunity to participate fully and equally in our society.
Indeed, this model we are embarking on does have a precedent. The US is the wealthiest and the most unequal country on the planet. Even more regressive tax cuts are before Congress to ensure the rich get richer. The consumer is king so long as you have means to consume. There is no adequate safety net for those that fall between the cracks. The US is also one of the most dangerous countries in the world to live in. It has the highest imprisoned population in the world. There is a two-tier system in most facets of public goods: education, health and even public security. The market rules and the only game in town is growth.
But this is a vision that the Irish public does not totally share. Witness the election pledges of the major parties "A lot done. More to do", "Quality of Life", "Ambitious for Ireland". The parties in their rhetoric aspire to a more equal and just country with better public services. The burning question is how we can afford them if not through higher taxation. In recent days there are pertinent questions about their affordability given the large hole in the public finances. But for higher taxes to be acceptable there requires fundamental reform of the tax system and a restoration of credibility and legitimacy in the minds of Irish taxpayers. In the most optimistic sense taxation can and should be a partnership and not a hostile engagement between a state and its citizens. As Benjamin Franklin said, "in this world nothing can be certain except death and taxes". This is true of Ireland also. But it is how taxes are levied and spent that will determine the vision and character of our society.
i) \'Ireland has Lowest Tax Take in EU\', says OECD Report. Downloaded from www.tax-news.com
ii) \'Irish Think Tank Urges Tax Increases\', Jason Gorringe, Tax=News.com, London 24th April 2002
iii) \'Clinch, P., Convery, F. and Walsh, B. (2002) \'After the Celtic Tiger: Challenges Ahead\', O\'Brien Press
iv) \'Rich gets the breaks, poor get little\', Maev-Ann Wren, Irish Times, 17th April 2002
v) Allen, C. (1971) \'The Theory of Taxation\', Penguin: Harmondsworth
vi) See the article "Falling between two pillars: The Prospect for Pensioners in Ireland" in the April 2002 Issue of Working Notes.
vii) \'Irish Income Tax - Is it a good system?\', Ronan Clarke
viii) \'Desmond joins Euro billionaire\', Colm McKenna, Irish Times, 4th April 2002
ix) OECD Report on Tax Havens and Harmful Tax Regimes. For further information look up www.oecd.org under taxation
x) Meenan, J.F. (1970) \'The Irish Economy since 1922\', Liverpool: Liverpool University Press
xi) Harvey, C. (2002) \'Rights and Justice in Ireland: A new base line report\' The Joseph Rowntree Charitable Trust
xii) \'Irish Income Tax - Is it a good system?\', Ronan Clarke