ANALYSIS:Plans to raise revenue from taxation may founder as incentives to work are dampened
YESTERDAY MINISTER for Finance Brian Lenihan filled in many of the 2011 budgetary blanks. Following the setting out of multi-annual budgetary parameters in the National Recovery Plan two weeks ago, and the release of further detail under the terms of the EU-IMF bailout 10 days ago, yesterday’s Budget gave more detail on exactly how the Government believes it can reduce the gaping deficit between its revenue and its expenditure.
As expected, higher income taxes, lower welfare benefits and the axing of a large part of the infrastructure budget were the three most important components of the 2011 Budget package.
Of the touted €6 billion adjustment in 2011, the single largest change to any individual sub-component of the taxation-expenditure mix was in income tax.
The Government will reach further into people’s pockets next year to take an additional €945 million. Because these measures will not come into effect until after the Finance Bill becomes law in the early months of the 2011, the full-year amount raised by yesterday’s measures will be even larger, at €1,245 million, according to Department of Finance forecasters.
The placing of so much emphasis on raising income taxes is questionable on two separate levels. First, the risk is high that the measures will fail to achieve the budgeted increases in cash revenues.
The revenue impact of changes to any tax band, credit or rate is always hard to predict because it depends on wider economic conditions which are not controlled by government.
The revenue-raising effect is also further complicated by the partially self-defeating nature of tax increases. A doubling of a given tax rate, for instance, will not result in a doubling of the revenue generated. This is because an increase in the burden of tax has a deadening effect on the economic activity upon which it is imposed. Economists call this the “deadweight” effect.
The Department of Finance has factored this in, but the effect could well be larger than anticipated.
A second, non-budgetary, reason for concern about an increase in the income tax burden is its deadening impact on job creation.
Yesterday’s changes amount to a big tax increase on labour. This has all sorts of negative supply and demand effects on working. To do this at a time when there is chronic unemployment is unwise. At risk of repeating a view put in these pages previously, tax hikes on consumption, such as VAT, would be less damaging now than higher taxes on work, such as income tax.
While VAT increases are scheduled for 2013 and 2014, if budgetary targets are not kept in 2011, it is hard to avoid the conclusion that VAT hikes will be brought forward.
That is not to say that higher income taxes are avoidable. In yesterday’s speech, the Minister of Finance rightly described the income tax system as “not fit for purpose”.
He spoke sternly about the decline in the proportion of workers who pay income tax and the need for more people to pay a share. This tut-tutting was faintly absurd given that the person responsible as anyone for this state of affairs was sitting beside him as he spoke.
Taoiseach Brian Cowen, three years and two days ago in his final budget speech as minister for finance, spoke repeatedly about taking and keeping people out of the tax net. Now, the Government no longer boasts about its visionary strategy of taking people from the tax net, but has done a 180 degree turn and states that it must bring more people into the tax net (this is now called “widening the tax base”).
The second single biggest change in yesterday’s overall package was a cut in the social welfare budget. In the 2011 tax year, cuts are to yield €873 million (the full year effect from 2012 will be marginally more, at €920 million). Of this total, €397 million will be the result of the reductions in most benefits, of around €8 a week, for those under retirement age (old folk, other than retired civil servants, escaped cuts to their pensions).
One reason for work-age welfare cuts, apart from the budgetary impact, was to ensure that the differential between income for those on welfare and income for those at work was maintained.
Some of the other cuts outlined yesterday for the welfare budget appear either hard-to-achieve or undefined. The Government believes that €100 million can be saved with better “activation” measures to help the jobless find work, thereby reducing the dole bill. There is considerable potential here, but no detail was spelt out yesterday, and given that the Government’s record on activation measures has been abysmal, there is good cause to wonder if the target can be met.
A further saving of €49 million is to be garnered from reforms that “will be announced at a later date”. Why is this sort of vague waffle still padding out budgets?
The final large component of the €6 billion package is to come from infrastructure spending. This is to account for almost one third (€1.8 billion) of the total. In 2011 the capital budget has been allocated €4.7 billion, half its peak in 2008. This was unavoidable, all things considered, even if the words of Brian Cowen from the 2008 budget speech, delivered almost exactly three years ago, still echo.
“In the past governments have reacted to economic slowdown by stalling capital investment. I will not do so.” Thus spoke the Taoiseach on December 5th. 2007. The National Recovery Plan, aka the four-year plan, gave considerable detail on how the capital cut is to be achieved on a department-by-Department basis. Surely Budget 2011 is the place to drill deeper and give a project-by-project plan. But there was no further detail.
It will be left to a new government to kill off projects such as Metro North and, more generally, get up the dander of Tom Parlon and the builders whose bidding he does.