Do Irish residents pay more tax than those in other countries? Does our Government spend more on health or education than other countries? Obviously, to answer the first question, we need some measure of the amount available to be taxed and, for the second, some gauge of what we can afford to spend.
But the two questions are linked in that public expenditure is limited in the long term by tax revenue. So, all public expenditure is constrained by our State’s ability to generate tax revenue – what is sometimes called taxable capacity.
Before we proceed, some national accounting concepts and numbers. Gross domestic product (GDP) measures the total value of goods and services produced in a country in a given period. In 2022, in Ireland, this amounted to €506 billion.
But this does not measure the amount available for residents to spend or save since it may be augmented by factor incomes from abroad – wages paid to Irish residents by foreign-resident firms, interest received on foreign debt held by local firms or households, or dividends received locally from foreign-resident firms. Or it can be reduced if these flows are outflows.
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The result is gross national product (GNP which, when adjusted for net subsidies from the EU, becomes gross national income, GNI).
Ireland experiences a net outflow which, in 2022, amounted to €143 billion, primarily through the payment of dividends by Irish-resident multinationals to their foreign parents. Thus, in Ireland GNI is considerably less than GDP.
There is then a further technical but substantial reduction relating to other international issues and we end up with modified GNI (GNI*), which, in 2022, was €273 billion. We are almost certainly unique in the world in having GNI* as little as 54 per cent of GDP.
Tax revenue depends on the base and rate of tax. In the absence of meaningful wealth/property taxes or significant taxes on international trade, almost the entire base of the Irish tax system is represented by income (for income taxes, including corporation tax) and consumption (for VAT and excises).
Although we defined GDP as the total value of goods and services produced in the country, it is also equal to the sum of factor payments – that is, wages, interest, rent and profit, which are the components of the base of income taxes.
But business regard depreciation as a deductible cost, and so the total income forming the base of income taxes is GDP less depreciation – that is, net domestic product.
So, the potential base (that is the base if policy did not reduce it) of our tax system is, approximately, GDP minus depreciation plus consumption. In 2022, depreciation (the amount to be deducted from GDP) was €122 billion and consumption (the amount to be added to GDP) was €132 billion. These more or less balance each other and so GDP is a good approximate measure of our potential tax base.
Of course, this potential tax base far exceeds the effective base because government chooses to reduce it via policy measures. That can be by excluding certain income, say, income below a certain threshold, or certain consumption by zero-rating certain expenditures for VAT purposes.
Further policy moves then reduce the nominal rates applied to these reduced bases – the lower rates of income tax applied to certain levels or types of income or the lower rates of VAT applied to certain consumption.
The point here is not the desirability or otherwise of such policies, merely that our own choices reduce potential tax revenue by reducing the taxable base and nominal rates, thus generating less revenue than would be the case if we did not make these choices.
Let us now return to the two sample questions posed at the outset. Does Ireland raise more or less in tax than other comparable (that is, rich) countries? And is public expenditure on health more or less than that in countries with similar levels of fiscal resources?
The reason comparisons of this kind cause controversy can be shown by some simple statistics. In 2022, the average ratio of total tax revenue to GDP in the EU was 41 per cent, whereas in Ireland it was a mere 22 per cent. The highest ratios were in France (48 per cent) and Belgium (46 per cent) and the only countries other than Ireland below 30 per cent were Malta and Romania.
Ireland is a remarkable outlier in the extent to which it fails to exploit its taxable capacity. The reasons for this need not concern us here, but it is a fact.
By reference to other EU members, we have huge opportunities to garner more public revenue if we choose to take advantage of them. Again, the extent to which it would be wise for us to raise this ratio significantly is not pursued here. One obvious problem is that tax bases are internationally mobile and increases in effective rates could reduce bases.
Those who cannot accept this fact argue that the denominator in these ratios should be GNI* rather than GDP.
This adjustment would make little difference to other members since their GNI* is much closer to their GDP than ours and would put Ireland at almost exactly the EU average. But why should we make even this adjustment?
A big difference between GDP and GNI* is an item which we rightly, and happily, tax – the repatriated profits of multinationals. So, when asking how much of our national income we collect in tax, why exclude from the denominator a major item which we actually tax?
The answer lies in an oft-repeated point which is, in fact, irrelevant to the matter in hand. It is certainly true that, for a country like Ireland with so much activity in the hands of multinationals, GDP is a poor measure of the domestic economy. Even GNI is defective and GNI* is superior to any of these if we want to measure the performance of our domestic economy or, especially, our standard of living. If we want to track growth rates and measure living standards, GDP just will not do.
But here we are not trying to do these things. We are interested in taxable capacity, and for this purpose, GNI* and GNI are definitely inferior to GDP.
The same reasoning applies when we ask the second question – does our Government spend as much of our national resources on health, or housing or education as other countries?
In late 2021, the Irish Fiscal Advisory Council published a report on Ireland’s public expenditure on health in which it made the headline claim that “Ireland’s public health spending is high relative to its peers”.
This claim is based on a table in which, for 33 OECD members, public heath expenditure is taken as a ratio of GDP in 32 countries but GNI* in Ireland, the result being that we have the sixth highest ratio. If the denominator for Ireland had been, as for the other countries, GDP, we would have fallen to 31st place.
The council does not explain why it made Ireland the odd man out by using GNI*, which is a pity since, as already noted, public expenditure is constrained by taxable capacity which is more closely represented by GDP than (in Ireland’s case) the much smaller GNI*.
This all comes down to a basic principle: the metric you should use depends on what you are measuring and why you are measuring it.
If you want to measure our standard of living (what we have available to spend or save) then GNI* is the appropriate measure. But if you want to measure our taxable capacity – and therefore our Government’s ability to spend – then GDP is much the better yardstick.
John Bristow is fellow emeritus at Trinity College Dublin
