It is curious that few if any oppose the plan to reduce radically the tax rates payable on company profits, but talk of income-tax cuts brings a decidedly more mixed response, with some opposing any reduction in the top rate of tax. Leaving aside that the Government has an electoral mandate to reduce the 24 per cent and 46 per cent rates, there is a strong case, both in equity and economics, for large tax cuts in the next few years.
For a start, it is surely inequitable that by 2003 Irish trading profits will be taxed at only 12.5 per cent but that four in 10 of individual taxpayers will pay tax at 46 per cent. On grounds of fairness alone, therefore, a move to narrow that gap is certainly warranted. If it is sensible to reduce taxes on capital why is it not the same case for labour?
The economic case for lower taxes on personal income is also compelling. This year the Government will raise £19 billion (€24 billion) in current revenue (i.e. excluding items such as privatisation receipts) but spend only £5.5 billion, largely on debt service, public sector pay and on social welfare. Moreover, if the Minister for Finance, Mr McCreevy, sticks to his annual target rise in spending of 4 per cent, revenue could exceed spending by £7.5 billion by 2003, even on conservative assumptions about growth in tax receipts.
In other words, revenue will dwarf spending and if the prime reason for the existence of taxes in the first place is to raise enough funds to cover Government outlays, then clearly the existing tax rates are more than high enough to accomplish that task, and should therefore be cut.
Indeed, the recent Irish experience suggests that lower tax rates actually boost revenue anyway. Ten years ago, three tax rates were levied on workers - 35 per cent, 48 per cent and 56 per cent - and not surprisingly, people voted with their feet by leaving the Republic in droves: more than 70,000 emigrated in 1989 and the net outflow from 1985 to 1990 was a massive 180,000.
Such an exodus decimates the tax base and puts pressure on the authorities to raise tax rates on what remains, so leading to further contraction.
Falling tax rates, in contrast, encourage those in Ireland not already working to join the workforce and those abroad to return: more than 40,000 have entered the State in each of the last three years, with a net inflow of more than 60,000 since 1996 (20,000 leave annually). If the Republic is to continue to attract labour above that of the natural rise in the workforce (around 25,000 per annum) the tax system has a key role to play.
For example, half the returned migrants come from Britain, where one can earn up to £34,000 before reaching the top rate of tax, which is 40 per cent. Compare that to the Irish situation, where an individual earning more than £17,200 would hit the top tax rate of 46 per cent. Similarly, for married women the problem is that joining the labour force can often mean paying tax at the 46 per cent rate. One often gets the impression from some of the Social Partners that few pay the top rate, but data on taxable incomes show that the average tax-payer's income is £16,500 and that the largest group of taxpayers (20 per cent) are in the £20,000£30,000 income range.
What of overheating? The problem with this thesis is that it is difficult to generate domestic inflation in an economy as small and open as the Republic. If demand rises, supply can easily be augmented by imports, which are bought at world prices.
In recent years, the world price for many consumer items has fallen, and this disinflationary pressure is evident on the High Street, even with 10 per cent growth in retail sales; clothing and footwear prices, for instance, are currently 20 per cent below their level three years ago and durable household goods are unchanged in price over the same period.
Where supply is fixed or slow to respond to higher demand, inflation can occur, and this is currently the case in the service sector in the Republic. The solution to this is to take action to improve supply and to encouraging competition. The cost of child care is a case in point, where the price is rising at more than 10 per cent per year. Yet this will resolve itself in time as more creches are established, no doubt with some fiscal encouragement from the authorities and is certainly not a rationale for postponing tax rates until "the time is right".
In 1993, the economy was on its knees, and mortgage rates were at 14 per cent, so the time was certainly right yet the Government responded by raising a 1 per cent levy on all incomes above £9,000.
Finally, tax cuts should also be seen in the context of the successor to Partnership 2000. That agreement promised £1 billion direct tax cuts over three years and the authorities can now trade that amount each year for a new pay agreement. Tax rates of 20 per cent and 40 per cent are no longer an ambitious target and the resources are there to achieve much lower levels, even within the next two or three years.
Dr Dan McLaughlin is chief economist with the ABN-Amro Group
