Economics: With low corporate and income tax, the time has surely come to stop reaching for tax incentives as the first answer when the State wants to encourage development, writes Cliff Taylor.
There is a group of "super-rich" people in Ireland who, quietly, believe Leona Helmsley was correct. "Only the little people pay taxes," the New York hotelier once famously declared. Various allowances in the Irish tax system, mostly related to property, have allowed some of the wealthiest in our society to successfully live by this dictum.
In recent weeks the word went around - quite openly it must be said - that another nice "shelter" was on offer. Estate agents, tax accountants and private bankers were putting together consortiums to bid for the big AIB building for sale in the IFSC.
The attraction was €55 million in tax allowances attached to the building, which - provided the scheme was structured properly - the investors involved could use to reduce their taxable income over the next 12 years. For those with annual incomes of €300,000 plus and the prospect of this earnings level continuing for the next dozen years or so, it would offer considerable tax advantages.
Following publicity about the sale, the Minister for Finance moved to close off the incentive, saying that from now on the capital allowances transferred to the individual investor could only be used against the rental income from the property they were purchasing.
It is a classic example of how tax incentives can "mutate" and have consequences that were not originally intended.
The capital allowances attaching to IFSC office blocks were originally incentives to get big companies to set up in the centre. AIB took the plunge and led the way in 1987, taking a considerable risk, and was later followed by Bank of Ireland. The IFSC now employs some 7,000 people and generates hundreds of millions in tax revenue. Without the original tax incentives to companies investing in IFSC buildings, the centre might not have been such a success - or might never have taken off at all.
However, smart tax advisers spotted how these incentives could be used as tax shelters for the wealthy. (Technically this happens because the allowances are clawed back from the company selling the building - adding to its tax charge in the year of sale - and passed on to the purchasing investors). Last year, Bank of Ireland sold its IFSC building, La Touche house. The 62 investors involved can use the attached tax allowances to reduce the amount of their total taxable rental income.
In the case of the AIB building, the likelihood was that it would have been bought by a group of around a dozen investors. By structuring the scheme in a particular way, they would have been able to use the allowances to reduce their total taxable income, not only from rental properties, but also income from all other sources.
They would have been able to use the allowances more freely than the investors in the Bank of Ireland building provided the maximum number was 13. The reason for this is enshrined in tax legislation, believed to have been designed to close off another big scheme in the early 1990s. Now the Minister has changed the rules again - and so the game goes on.
The range of property tax allowances has a significant impact on the tax bill of the rich. A Revenue Commissioners study shows that in the 1999/2000 tax year, 18 per cent of the top 400 earners in the State had an effective tax rate (the total income tax take as a percentage of income) of less than 15 per cent - compared to roughly 20 per cent for a typical PAYE taxpayer. Almost 13 per cent - 51 individuals from the 400 - paid less than 5 per cent of their income in tax in that year, with 29 of these paying no tax at all.
The Revenue study said property-based tax incentives were the main reason for the low tax bills, including the multi-storey car park scheme, the hotel scheme and other property-related tax allowances. The impact of 1998 restrictions on these allowances is not yet clear, the study says.
The lessons from this seem clear enough. The property tax allowances on offer may have served some economic purpose, but the cost in terms of lost revenue - and tax equity - has been substantial. In an era of low corporate and income tax rates, the time has surely come to stop reaching for tax incentives as the first answer when the State wants to encourage development.
It was one thing providing special incentives to companies in the late 1980s, when the rate of corporation tax was above 40 per cent, but quite another now when the rate is just 12.5 per cent. Similarly, the burden of income tax has fallen substantially. Surely the time has come to restrict special tax exemptions and allowances to very limited and clearly defined areas of the system.
The Minister has already promised to close off most of the property schemes and the film investment scheme by the end of next year. He should say no to the proposals to designate the Four Courts area as a special tax allowance area for legal development. And then each and every special allowances and relief (yes, Minister, including the bloodstock relief) should be examined - measuring the cost in lost tax against economic benefit.
Low tax rates are a central part of encouraging economic growth and risk-taking. However, if tax rates are low, the base on which taxes are levied must be wide - and must be fair. A recent National Economic and Social Council report estimated the total cost of allowances and incentives in our tax system was €8.5 billion, compared with a total tax take of €30 billion. Many of these are normal business allowances - but there must be considerable scope for Mr McCreevy to get out his knife and abolish a lot more.
