The structure of Ireland’s tax system and options for growth enhancing reform Brendan O’Connor, 19 June 2013 Motivation  Economic strategy post Troika  Several straw-men arguments need to be analysed       Ireland’s tax burden is too low? No further scope exists for adjustment on the revenue side? Burden too low on high earner? Tax burden on labour is too high? Discussions and commentary around Budget time tend to focus on fairness, equity and progressivity concerns Limited focus on the potential for growth orientated reforms  Revenue neutral tax shifts – potential output gains? What does the burden of taxation look like in Ireland Total Taxes as % of GDP 60 50 40 36 29 30 20 10  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?  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 (Callan et al 2013)  IFAC hybrid measure of GNP + 40% of net factor flows What does the burden of taxation look like in Ireland Total Taxes as % of GDP 60 50 40 36 36 30 20 10  Using GNP, Ireland has a greater than average share  Using the IFAC Hybrid Measure Ireland approaching EU average 33 29 Other Issues – Social Insurance Contributions  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 40 30 23.9 20 10 24.8 Labour taxation comparisons also distorted by SSC 30 25 20 Labour Taxes as % of GDP 17 12 15 10  Share of GDP Ireland Ireland Rank in EU- EU Average 27 Labour including SSC 12% 23 17% Labour excluding SSC 7% 6% Distribution of tax burden Income Share of tax paid Top 1% of earners > €200,000 20% Top 5% of earners > €100,000 40% Top 23% > €50,000 77% Bottom 77% < €50,000 23% Income Tax and USC, all Tax Units, Cumulative, 2012 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 Share of Tax Units Share of Tax Paid 99% 81% 77% 59% 23% 95% Irish income tax system is one of most progressive in OECD 2.5 Progressivity Measure, Single Taxpayers Ratio of Effective Tax Rates 1.5 0.5  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 Low effective rates 0.6 0.5 Average Tax Rate Marginal Tax Rate 0.4 0.3 0.2 0.1 66% of AW 100% of AW 166% of AW Ireland 11.5% 18.0% 31.5% OECD average 21.1% 25.1% 30.5% Income tax (incl USC) and SSC Top MTR not the highest in OECD but entry point one of the lowest 0.7 60.0% 0.6 0.5 0.4 0.3 0.2 0.1 -0.1 16 14 12 10 Top Marginal Tax Rate 52.0% Threshold for Top Marginal Tax Rate as multiple of AW 4.2 4.2 1.0 Consumption Taxation 16 14 12.0 12 10.1 10 8 Consumption Tax VAT  Consumption taxes low relative to EU average – hybrid measure also below average  Share of taxation at 21% is within percentage point of EU average  VAT at % 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 Corporation Tax In line with EU average as share of GDP 2.7 Above average as a share of taxation 25 20 15 10 8.3 7.5 2.4 Other   Environmental taxes  At 2.6% of GDP equal to EU average in 2011  At 9% of total taxation, in excess of EU average of 7%, and sixth highest overall share Property taxation  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) Summary on Structure  Capacity for additional taxation depends on ones view of appropriate measure of economic output for the purposes of taxation taking into account the structure of the economy and the size of the foreign owned sector  Using IFAC hybrid measure, Ireland in line with EU-27 average  Low social security contributions explains the difference in GDP terms  Consumption low relative to EU average in GDP terms  Income taxation highly progressive  Effective tax rates low up to average wage but entry to top marginal tax rate happens very quickly 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  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 How taxes affect the determinants of economic growth  Research by the OECD suggests a hierarchy of harmful taxation exists Property  Do not affect decision of economic agents to supply labour, invest in human capital, to produce, invest and innovate Consumption   Neutral to savings and investment   But not the view of behavioural economists (Blumkin et al 2012, EER) Same impact on after tax wages as labour taxes – public finance economists view! Differential rates can improve labour supply for goods complementary to work  Personal Income Tax   Affect labour utilisation and productivity   Affects TFP by distorting factor prices Typically progressive – more harmful than consumption Capital income taxation affect savings and investment decisions 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, 2010)  Largest gains if reduction in MTR rather than increases in thresholds (though latter at expense of equality outcomes) Options for Ireland  Scope for shift to consumption (EC, 2012)  Scope for further property (relative to English speaking OECD countries)  Very low entry point to top MTR, (and very low effective tax rates) – shift burden within labour Shift within Labour  Reforms within labour taxation (Abbas 2012)  Phase out PAYE tax credit between minimum wage and average wage – positive income effects  Raise entry point to top MTR – positive substitution effects  Lower standard rate – positive substitution effects  Regressive in nature – but effective rates would still remain low vis OECD  But did not simulate the impact on GDP and employment Simulation Results for Ireland Labour to consumption QUEST III – Commission’s DSGE macrosimulation model (Public Finance in EMU, 2008) Revenue neutral shift of 1% of GDP Years after reform Year 1 Year 2 Year 3 Year 4 Year 5 GDP 0.12 0.17 0.19 0.2 0.2 Employment 0.14 0.22 0.24 0.25 0.25 HERMES – Structural model of supply side of Irish economy Revenue neutral shift of €1bn Years after reform GDP (%) Employment (%) Unemployment rate Year 1 Year 2 Year 3 Year 4 Year 5 0.00 0.16 0.26 0.32 0.32 0.00 0.11 0.26 0.41 0.43 0.00 -0.07 -0.08 -0.12 -0.14 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 GDP 0.00 0.17 0.30 0.42 0.38 Employment 0.00 0.11 0.26 0.41 0.43 Unemployment rate 0.00 -0.09 -0.17 -0.24 -0.21 Concluding comments  Presentation only addresses growth impacts of taxation  Progressivity and redistribution also important  Income tax highly progressive  Tax and transfer system highly redistributive (pre and post tax/transfer gini coefficient) Thank you! [...]... 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 GDP 0.00 0 .17 0.30 0.42 0.38 Employment 0.00 0.11 0.26 0.41 0.43 Unemployment rate 0.00 -0.09 -0 .17 -0.24 -0.21 Concluding comments  Presentation only addresses growth impacts of taxation  Progressivity and redistribution also important  Income tax highly progressive ... Labour to consumption QUEST III – Commission’s DSGE macrosimulation model (Public Finance in EMU, 2008) Revenue neutral shift of 1% of GDP Years after reform Year 1 Year 2 Year 3 Year 4 Year 5 GDP 0.12 0 .17 0.19 0.2 0.2 Employment 0.14 0.22 0.24 0.25 0.25 HERMES – Structural model of supply side of Irish economy Revenue neutral shift of €1bn Years after reform GDP (%) Employment (%) Unemployment rate Year 1... 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) Summary on Structure  Capacity for additional taxation depends on ones view of appropriate measure of economic output for the purposes of taxation taking into account the structure of the economy ... Year 2 Year 3 Year 4 Year 5 GDP 0.00 0 .17 0.30 0.42 0.38 Employment 0.00 0.11 0.26 0.41 0.43 Unemployment rate 0.00 -0.09 -0 .17 -0.24 -0.21 Concluding comments  Presentation only addresses growth... distorted by SSC 30 25 20 Labour Taxes as % of GDP 17 12 15 10  Share of GDP Ireland Ireland Rank in EU- EU Average 27 Labour including SSC 12% 23 17% Labour excluding SSC 7% 6% Distribution of tax... large and negative  2011 GDP represented 124% of GNP – second largest gap in EU (Callan et al 2013)  IFAC hybrid measure of GNP + 40% of net factor flows What does the burden of taxation look