Should the Government raise taxes instead of cutting back on spending? Tom O'Connorargues 'Yes', the government needs the revenue, while Moore McDowellsays 'No', Tax rises would hurt competitiveness.
YES:The tax take has been kept artifically low by an unsustainable boom. The Government needs more revenue to keep the economy from recession, writes Tom O'Connor.
THERE IS now a strong case on all grounds to increase taxes, but excluding the low to average income earners in the population. Why is this the case? In July tax receipts were running at €2.2 billion less than what was promised in the last budget and the budget deficit was forecast at €3.5 billion. This prompted €500 million of cutbacks, and the Government is now forecasting a far larger raft of cutbacks in December, unless it can access a reserves kitty of €2 billion. That does not change the fundamental need to increase taxes and is only postponing the inevitable.
Most citizens would agree that the Government has an economic, social and moral obligation to prevent the economy sliding deeper into recession, involving large increases in unemployment and huge economic hardship for many. At the moment, unemployment is over 220,000, with the increase in the first six months of 2008 being the worst since 1975. Largely driven by construction layoffs, and zero growth, this is forecast to rise sharply by the end of the year.
However, some commentators are still suggesting that we might register 0.5 per cent growth this year.
So, with the slowdown/recession only six months old and with falling tax receipts, there is now an enormous deterioration in the Irish public finances of Armageddon proportions. This cannot be attributed solely to a short slowdown.
It is attributable, to a large extent, to an economy where the tax take has become so low that it depends on indefinite and robust growth to keep tax receipts buoyant enough to support the country. The evidence for this is given by OECD figures which show Ireland with the lowest tax take of all EU member states, at 29 per cent of GDP.
This is the case even though annual births and fertility rates are the highest in the EU. The population has increased by 750,000 since 1996, and is still increasing by about 50,000 per annum. The demands these demographics put on tax receipts become evident when the economy slows, as the overall tax take is too low in the first instance.
So, unless we are to suffer further deterioration in health, education and social services, taxes will have to rise on the grounds of the social responsibility of the Government to the population.
However, there are clear economic grounds also for tax increases. Traditionally there have been two ways available to stimulate the economy in times of recession: monetary and fiscal policy. Monetary policy is now the preserve of the ECB and there is also a huge credit squeeze. This leaves just one remedy open to us, which is an expansionary fiscal policy, through government investment in the economy. This needs to happen through current spending and capital spending. There are thousands of jobs in health, social care, education and other areas which badly need to be filled. They are not artificial.
The Government's debt/GDP ratio is very low at 29 per cent. There is scope here for the Government to invest in schools, social and affordable housing projects and various other infrastructural projects already earmarked.
Already, the OECD has made tentative suggestions in August that the Government should move in this direction. Brian Cowen has hinted at expanding social housing projects. This would make economic sense when there is value in the market, when there are construction layoffs and when there are 45,000 people on housing waiting lists.
However, increased taxes will have to be found. Where? Well, there is now a clear social responsibility for those who gained most over the Celtic tiger years to shoulder a slightly increased tax burden.
This includes thousands who have benefited handsomely from government tax giveaways of over €13 billion over the period.
The Government could consider a second marginal tax rate of 51 per cent for incomes in excess of €100,000. This would yield approximately €500 million.
In addition, those who have amassed massive wealth over the boom years, where the wealthiest 1 per cent own €86 billion in wealth, might be asked to pay a modest 2 per cent tax, yielding €1.7 billion.
Also, the Government now urgently needs to close off the tax avoidance measures still in existence. We see publications being advertised regularly in Sunday newspapers, showing how those with high incomes can avoid paying any or minimal taxes.
Shutting off these avenues of tax avoidance would yield significant tax savings.
The time to prevent a deeper recession, increased unemployment, deteriorating public services and increased poverty is now.
The failure to contemplate tax increases to facilitate this can only be understood as a neo-monetarist preoccupation with keeping taxes low, irrespective of the social and economic costs to society and those who can least afford it. This is clearly not credible.
• Tom O'Connor lectures in the Department of Social and General Studies at Cork Institute of Technology
NO:Not all State spending is useful. Tax rises would hurt competitiveness and employment, writes Moore McDowell
THERE IS a view that current circumstances warrant neither spending cuts nor tax hikes, because the economy needs demand to be boosted, not cut. You may subscribe to this view, but Ireland cannot afford to accept such advice right now. The reason is that we now have what is called a structural deficit. Government spending commitments - capital, current and social - cannot be met out of tax revenues looking forward. Hence, tax rates must rise, or spending commitments must be cut, or both.
We must choose between them. The siren song of borrowing to tide us over should be treated as just that: something that will lure us onto the rocks. Borrowing is simply deferred taxation.
I believe the emphasis should be on spending cuts, but before explaining why I want to point out that over the last seven years we have seen tax revenues rise as a proportion of national income by about 5 per cent. The Government has been helping itself to an increasing share of our real incomes without raising tax rates, simply because the economy was growing at an unsustainable rate. It has used the revenues to let public spending commitments expand at an equally unsustainable rate.
Why spending cuts as the preferred policy? Answer three questions: (1) does all government capital spending on every programme make sense, and are all programmes equally important? (2) should the public sector payroll (including nurses, teachers and university personnel) always be sheltered from an economic downturn? (3) should all social welfare spending and direct provision in every circumstance be immune from cuts? Should a CEO on €400,000 a year get the same (if any!) children's allowance as a single mother in Darndale? Should all those over 70 get free medical care regardless of ability to pay? Should university fees for everyone be paid by the taxpayer?
Answer "no" to any or all of these and you are saying that, in principle, some government spending should be cut because government revenues have an opportunity cost, meaning they could be put to better use.
Why not avoid this by raising taxes? Okay, but on whom or what? On the rich? The Combat Poverty Agency has suggested raising the higher rate of income tax to finance its preferred areas of Government spending. The trouble is that the higher rate of tax is paid by people with very moderate incomes.
On "bad" things? Petrol (to keep the Greens happy)? Tobacco (to make us healthier than we want to be)? Drink? So why don't people simply buy less petrol, give up the fags and cut down on the booze? Because they don't want to. These taxes cut people's real incomes, just as an income tax hike does.
Corporation tax, perhaps? But corporate profits and capital gains provide your pension unless you are lucky enough to have a public sector pension. Re-introduce a house property tax as suggested by the NESC (ie bring back a better form of rates) when property prices are already falling and likely to continue to fall? Turn a fall into a collapse? Nice idea if you are one of the 20 per cent of households that do not own houses or apartments. But political suicide.
Apart from these quibbles, the real reason for rejecting tax hikes is that they have an economic cost that exceeds the costs to those who pay them. A tax is a price paid for engaging in a taxable activity (working, employing, drinking a pint, etc). A higher tax rate means a lower incentive at the margin to engage in that activity. One reason that the Irish economy grew so well until recently was that low tax rates encouraged people to use capital in Ireland because the price they paid for doing so was low (12.5 per cent corporation tax, 20 per cent capital gains tax). Low income tax rates encouraged people to offer more labour to employers because the price to both worker and employer of using labour here was lower than elsewhere. Increase any of these and Ireland will be less attractive as a location for investment and employing Irish labour will make less sense. Hardly smart when we are already in a recession and facing a competitiveness problem.
Higher taxes on capital and labour tend to lower output and employment, while higher taxes on consumption lower real household incomes and do so more for lower income households (if your income is lower, you spend more of it).
Current spending cuts can be focused on equity (avoiding hurting the less well off) and efficiency (start with a bonfire of the quangos) without disincentive effects in terms of economic activity. Calls for ring-fencing the National Development Plan reflect economic illiteracy. Money is scarce; some proposals make more sense than others, and some make little sense at all. The notion that no cuts should be made simply because something is classified as a capital spending project is nonsensical.
• Moore McDowell is senior lecturer at the School of Economics in UCD