The Government is skewered on a stick entirely of its own making. By refusing to sneak gently away from its election promise to “abolish the USC”, it has stored up political trouble and risked pushing the tax system back to looking a bit like it did before the “bust”. And that worked out well, of course.
We tend to associate the economic collapse with the failures of our banking system. But we also had a fundamental problem in our public finances. We were spending too much, based on a tax system that drew revenue from a base that was way too narrow and was too reliant on property.
Now it will be a long time before we get a massive wedge of property tax revenue again. But we are at risk of narrowing the tax base again, of becoming too reliant on a small group of sources – a dozen big companies and a few hundred thousand middle- to higher-income taxpayers.
It may all work out fine. But if a few companies change their accounting policies, or there is a downturn that hits incomes, we will be in trouble again.
Something for nothing
The election promise – peddled in different ways by most, though not all, of the political players – was that there was something for nothing here. We could abolish the USC without raising new revenue elsewhere. We could do without water charges and still invest. We could put more cash in our public services and still cut tax.
Growth in the years ahead may give us a cash dividend to tax a bit less and spend a bit more. The economic signs this week were good – employment is up and so far the British economy has not taken too much of a hit after the Brexit vote. The omens for the October budget are okay, though you would reckon that sterling weakness and a slowdown in the UK could hit us a bit next year.
However, we need a reality check. The scope for reducing the overall level of taxation will be small. If it isn’t taken out of one of your pockets via the USC, it will be taken out of the other via income tax, or excise duty, or whatever. Even in the short term, you may gain a bit from the USC cut next year, but, as tax bands and credits will probably not be adjusted for inflation, more of any wage increase you get will go in income tax. There is also the possibility that PRSI may also be adjusted to claw back some of the cash.
Narrow base
The danger is that what tax reductions there are will actually narrow the tax base, rather than keeping it as wide as possible. Consider where we are going. What spare cash there is will go to reducing the USC. A
Department of Finance
analysis showed that to achieve a substantial cut in the charge by 2020 – roughly halving the amount of revenue it raises – would require all the budgetary cash set aside for tax reductions to be used for this purpose.
We will thus be using all our room for manoeuvre – and a bit more – to reduce a charge that has a very wide base. It levies a charge on parts of income exempt from income tax. The USC burden on lower earners has been cut sharply. But the charge still takes a small contribution from some lower earners exempt from income tax – 29 per cent of income earners pay no USC, while 36 per cent pay no income tax.
But the USC hits higher earners much harder, and limits their ability to shelter income from tax through pension payments and the like. The top 1.2 per cent of income earners, taking in €200,000 plus a year, earn around 11 per cent of total income and pay over 22 per cent of total USC.
Chipping away at the USC will thus narrow the tax base, making it more reliant on old-fashioned income tax. Extending PRSI a bit to compensate would limit the damage, a bit. But shouldn’t we start from the position of having the best possible tax system, rather than from the obsession of USC abolition?
Of course reducing taxes on income makes sense, if the cash is made up for by new revenues elsewhere. Here we run into the other problem. After the water charge fiasco, no Irish government is going to introduce a new charge, or hike an existing one, if it can possibly avoid it.
Local property tax
Take the local property tax. The headlines during the week were that if the abolition of the USC was to be paid for by higher capital taxes, then local property tax would have to increase sixfold. The reality is that the Minister for Finance,
Michael Noonan
, has frozen the tax until 2019, removing a potential source of extra revenue. Also, the levy will not apply – until then at least –to new homes. So you could be paying €1,000 a year on your €550,000 home bought in 2012, and down the road someone who bought a new home with the same value last year could be paying nothing.
Similar anomalies eventually killed off the old domestic rates system in the late 1970s. The local property tax could also be heading for a slow death.
And so two of the big expansions of the tax base after the economic collapse – the USC and the local property charge – are both in danger. One of the key lessons of the crash was that we need a wide and stable tax base. Party politics at the moment is leading us in precisely the opposite direction.