Transcript Dublin Economic Workshop, The structure of Ireland`s tax system

The structure of Ireland’s tax system and options for
growth enhancing reform
Brendan O’Connor, Dublin Economic Workshop
19 October 2013
Motivation
 Economic strategy post Troika

How does Ireland’s tax system compare internationally

What does the economic literature say about tax policy and economic
growth

Can Ireland benefit from growth orientated tax policy reforms

Revenue neutral tax shifts – potential output and employment gains?
What does the burden of taxation look like in Ireland
Total Taxes as % of GDP
60
36
50
29
40
30
20
10
0

Using GDP as a measure of economic output it might appear that Ireland has the
capacity for greater tax revenue by European comparisons.

But is GDP the appropriate measure of tax base?

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GDP includes net factor flows out of Ireland (profits of MNCs) which are very large and
negative
2011 GDP represented 124% of GNP – second largest gap in EU
Perhaps a true base for Ireland’s taxable capacity is somewhere between GNP and GDP
IFAC hybrid measure of fiscal capacity(*): GNP + 40% of net factor flows
* Fiscal Assessment Report, Irish Fiscal Advisory Council, September 2012
Using GDP or the IFAC Hybrid Measure
Total Taxes as % of GDP
60
50
40
36
33
36
29
30
20
10
0
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From a purely benchmarking perspective Ireland’s capacity for additional
taxation depends on one’s view as to the appropriate measure of the tax
base taking into account the structure of the Irish economy and the large
factor flows
Other Issues – Social Security Contributions
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In Ireland SSC accounted for 5% of GDP in 2011 (3.5% employer, 1.3% employee)
Against an EU average of 11% and an OECD average of 9% and an EU high of 17%
(France)
Should they be included in a comparison?

SSC an insurance in some countries and more akin to a tax on labour in others
Total Taxes excl SSC as % of GDP
50.0
24
40.0
30.0
20.0
10.0
0.0
25
Labour taxation comparisons also distorted by SSC
30.0
Labour Taxes as % of GDP
25.0
17
20.0
12
15.0
10.0
5.0
0.0
Share of GDP
Labour
SSC
Labour
SSC
including
excluding
Ireland
Ireland
Rank in EU27
12%
23
7%
8
EU Average
17%
6%
Distribution of tax burden
Top 1% of earners
Top 5% of earners
Top 23%
Bottom 77%
Income
Share of tax paid
> €200,000
> €100,000
> €50,000
< €50,000
20%
40%
77%
23%
Income Tax and USC, all Tax Units, Cumulative, 2012
Share of Tax Units
100%
80%
81%
77%
59%
40%
23%
0%
99%
95%
60%
20%
Share of Tax Paid
Irish income tax system is one of most progressive in OECD
300%
250%
Progressivity Measure, Single Taxpayers
Ratio of Effective Tax Rates
200%
150%
100%
50%
0%

Measurement of progressivity - ratio of effective tax rates or tax wedges of
tax payers at different income levels (167% of AW and 67% of AW) – see
OECD Taxing Wages
Progression relatively high at a range of income levels
Average personal income tax rate progression indicator (2011)
Change ATR/Change in multiple of AW
0.4
0.4
0.3
0.3
0.2
0.2
0.1
0.1
0.0
50%-67%
67%-100%
Ireland
100%-133%
UK
Sweden
133%-167%
167%-200%
OECD Average ex. Ireland
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Change in AETR per percentage point increase in income

Consistently high rate of progression across a range of income levels
(expressed as multiples of the average wage)
From Paturot, Melbye and Brys (2013), “Average Personal Income Tax Rate and Tax Wedge Progression in OECD Countries”, OECD Taxation Working Papers, No 15
Low effective rates
60.0%
Average Tax Rate
Marginal Tax Rate
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%

66% of AW
100% of AW
166% of AW
Income tax (incl USC) and
SSC
Ireland
11.5%
18.0%
31.5%
OECD average
21.1%
25.1%
30.5%
Ireland has the highest entry point to ‘core’ income tax as a share of the average wage
Top MTR not the highest in OECD but entry point one of the lowest
70%
60.0%
60%
50%
40%
30%
20%
10%
0%
16
14
12
10
8
6
4
2
0
52.0%
Top Marginal Tax Rate
Threshold for Top Marginal Tax Rate as multiple of AW
4.2
4.2
1.0
Consumption Taxation
12
16.0
10
14.0
12.0
10.0
8
8.0
6.0
6
4.0
2.0
0.0
Consumption Tax
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VAT
Consumption taxes low relative to EU average – hybrid measure also below average
VAT at 6 % of GDP also second lowest in 2011 (same share in 2012)
Commission identified consumption as a tax in Ireland as having potential for a ‘tax shift’
due to its low share of GDP (Tax Reforms Report)
GNP may not be the best base to measure the capacity to raise additional consumption tax
Other
 Property taxation
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1.3% of GDP - in line with the EU average
Above the EU average in terms of the share of total taxation (4% v 3.5%)
Recurring tax on immovable property in line with EU average (0.9% v 0.8%)
Below other English speaking OECD countries (3%)
Benefits of higher recurrent property taxation on immovable property include their
relatively stable source of revenue, which is important in small open economies with
volatile tax bases such as Ireland (Norregard, 2013)
The Theory – Microeconomic Principles
 Taxation creates deadweight costs

Conceptual framework – income and substitution effects

Optimal taxation theory – a ‘neutral’ tax treats similar activities in similar ways
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Earned and unearned income
Different rates of VAT on similar goods and services
Corporate debt and equity, owner occupied housing and other assets
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Departures from neutral taxes – remedy market failures
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Optimal taxation and redistribution
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Income tax system should be used for redistribution
Other taxes should focus on efficiency
Optimal tax theory not supportive of differentiated rates on consumption
The Theory – Macroeconomic Principles
 Distortions to decisions affects components of output and growth
Y = F(L, K, A)

Total Factor Productivity the key driver of long run growth in GDP per Capita

Endogenous Growth Models

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Explicitly models the process through which growth is generated
Models are results of choices of economic agents – taxation can influence these
choices
Human capital (Romer) – accumulation of human capital - taxation affects the
decision to undertake investment in education
Innovation (Aghion and Howitt 1992, 1998) – Schumpterian idea of ‘creative
destruction’, expenditure on R&D results in better quality inputs which are more
productive – effect of taxation on decision to innovate is key
Technology transfer – spillovers from human capital arising from FDI – tax impacts
on FDI decisions
How taxes affect the determinants of economic growth
Labour utilisation
 Employment
 Hours Worked
Taxes
 Corporation
 Labour
 Consumption
 Property
GDP per Capita
Labour productivity
 Physical capital
 Human capital
 TFP
 Taxes that have a smaller negative impact on the economic decisions of
individuals and firms are less negative for economic growth
 Research by the OECD suggests a hierarchy of harmful taxation exists
Property
Consumption
 Do not affect decision of economic
agents to supply labour, invest in
human capital, to produce, invest and
innovate
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Personal Income Tax
 Affect labour utilisation and
productivity
 Typically progressive – more harmful
than consumption
 Affects TFP by distorting factor prices
 Capital income taxation affect savings
and investment decisions
Neutral to savings and investment
Same impact on after tax wages as labour
taxes – public finance economists view!
But not the view of behavioural
economists (Blumkin et al. 2012, EER)
Differential rates can improve labour
supply for goods complementary to work
An inefficient form of redistribution
Corporate Income Tax
 Affects FDI and technology spillovers
 Affects productivity by distorting factor
prices
 Affects after tax return on investment
and R&D
Growth orientated reforms

Empirical and theoretical evidence suggests that there could be gains in terms of
long run GDP per capita from increasing the use of consumption and property
taxes relative to income tax without changing overall tax revenues (OECD, Tax
Policy Reform and Economic Growth, 2010)
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OECD, Tax Policy Reform and Economic Growth, 2010
Public Finances in EMU, 2008 and 2010, European Commission
Myles, Economic Growth and the Roles of Taxation - Theory, 2009
Arnold et al, Tax Policy for Economic Recovery and Growth, Economic Journal, 2011
“almost all the results support the claim that a move from income taxation to
consumption taxation will raise the rate of growth”. (Myles, Economic Growth and
the Role of Taxation-Theory, 2009)
Options for Ireland
 Scope for shift to consumption (European Commission, Tax Reforms,
2012 & 2013)
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Do not necessarily imply increases in the top rate of VAT
Could instead raise or eliminate reduced rates – inefficient means to achieve
redistributive outcomes
 Scope for further property tax (Abbas 2012)
 Very low entry point to top MTR (and very low effective tax rates) – shift
burden within labour
Simulation Results for Ireland
Labour to Property
HERMES
Revenue neutral shift of €1 bn
Years after reform
Year 1
Year 2
Year 3
Year 4
Year 5
0.00
0.00
0.00
0.17
0.11
-0.09
0.30
0.26
-0.17
0.42
0.41
-0.24
0.38
0.43
-0.21
Year 1
Year 2
Year 3
Year 4
Year 5
GDP (%)
0.00
0.16
0.26
0.32
0.32
Employment (%)
0.00
0.00
0.11
-0.07
0.26
-0.08
0.41
-0.12
0.43
-0.14
GDP
Employment
Unemployment rate
Labour to consumption
HERMES
Revenue neutral shift of €1bn
Years after reform
Unemployment rate
Concluding comments
 Presentation only addresses growth impacts of taxation
 Progressivity and redistribution also important

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Income tax highly progressive
Tax and transfer system highly redistributive (pre and post tax/transfer gini
coefficient)
Thank you!
Paper available at
http://taxpolicy.gov.ie/presentations/tax-conferencejune-2013/