The structure of Ireland’s tax system and options for growth enhancing reformBrendan 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

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

DK SE BE FR FI IT AT DE NL SI LU HU UKEU

-27 CY CZ MT PT EE PL EL ES

IE-GDP SK RO LV BG LT

0

10

20

30

40

50

6036

29

Total Taxes as % of GDP

What does the burden of taxation look like in Ireland

Using GNP, Ireland has a greater than average share

Using the IFAC Hybrid Measure Ireland approaching EU average

DK SE BE FR FI IT AT DE NL SI LU HUIE-

GNP UKEU

-27 CY CZ MT PT

IE-Hyb

rid EE PL EL ESIE-

GDP SK RO LV BG LT

0

10

20

30

40

50

60

36

36

3329

Total Taxes as % of GDP

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

DK SE FIIE

-GNP BE UK IT AT M

TIE

-Hyb

rid FR CY LUEU

Ave

rage

IE-G

DP PT HU NL DE SI EL PL EE BG ES RO CZ LV SK LT

0.0

10.0

20.0

30.0

40.0

50.0

25

24

Total Taxes excl SSC as % of GDP

Labour taxation comparisons also distorted by SSC

SE DK BE AT FR FI IT NL DE SI CZ HU ES EEEU

-27 LU

IE-GN

P UK PTIE-

Hybr

id LV LT SK CY PLIE-

GDP EL MT RO BG

0.0

5.0

10.0

15.0

20.0

25.0

30.0

17 12

Labour Taxes as % of GDP

 Share of GDP Ireland Ireland Rank in EU-

27

EU Average

Labour including SSC

12% 23 17%

Labour excluding SSC

7% 8 6%

Distribution of tax burden

Income Share of tax paidTop 1% of earners > €200,000 20%Top 5% of earners > €100,000 40%Top 23% > €50,000 77%Bottom 77% < €50,000 23%

<€10000

<€20000

<€30000

<€40000

<€50000

<€60000

<€70000

<€80000

<€90000

<€100000

<€120000

<€140000

<€160000

<€180000

<€200000

<€250000

>€2500000%

10%20%30%40%50%60%70%80%90%

100%

77%

95%99%

23%

59%

81%

Income Tax and USC, all Tax Units, Cumulative, 2012Share of Tax Units Share of Tax Paid

Irish income tax system is one of most progressive in OECD

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

Irelan

dIsr

ael

Portugal

Luxembourg

Australia

New Ze

aland

Finlan

dKorea

Swed

en

Switze

rland

Spain

Greece

United St

ates

OECD-A

verag

e

Netherl

ands

United Kingd

omCan

ada

Italy

Icelan

d

Czech Rep

ublic

Norway

Austria

Belgium

Slove

nia

Slova

k Rep

ublicFra

nceJap

an

German

yTu

rkey

Denmark

Estonia

Chile

Poland

Hungary

0%

50%

100%

150%

200%

250%

300%Progressivity Measure, Single Taxpayers

Ratio of Effective Tax Rates

Low effective rates

1003510036

1003716016

1601716499

1650018303

1830421708

2490832400

3280040000

5410864800

97200

100001

150000

2000000.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%Average Tax Rate Marginal Tax Rate

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%

Top MTR not the highest in OECD but entry point one of the lowest

Israe

lBe

lgium

Gree

ceSw

eden

Denm

ark

Finlan

dPo

rtuga

lSlo

venia

Irelan

d

Unite

d King

dom

Spain

Fran

ceNe

ther

lands

Cana

daNo

rway

Japan

Austr

alia

Germ

any

Italy

Icelan

dAu

stria

Unite

d Stat

esLu

xembo

urg

Kore

aSw

itzer

land

Chile

Hung

ary*

Polan

dTu

rkey

New Ze

aland

Mex

ico

Czec

h Rep

ublic

*

Slova

k Rep

ublic

*Es

tonia

*

0%

10%

20%

30%

40%

50%

60%

70%60.0% 52.0% Top Marginal Tax Rate

02468

10121416

4.2 4.2

1.0

Threshold for Top Marginal Tax Rate as multiple of AW

Consumption Taxation

Consumption taxes low relative to EU average – hybrid measure also below average Share of taxation at 21% is within 1 percentage point of EU 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

DK SE FI BG RO EE HU CY SI PT PL MT LT AT

EU A

vera

geIE-

GNP UK DE EL

IE_Hy

brid CZ FR BE NL SK LV LU IT IE ES

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0 1210

86

Consumption Tax VAT

Corporation TaxIn line with EU average as share of GDP

CY MT LU SE CZ PT UK BE DK FI

EU 2

7 DE SK IE AT FR IT NLRO EL PL BG ES SI LV EE HU LT

0.01.02.03.04.05.06.07.08.0

2.7 2.4

Above average as a share of taxation

CY MT LU CZ PT UK SK IE SE RO

E BG BE DE EL PL FI ES DK NL AT IT FR LV SI EE LT HU

0.0

5.0

10.0

15.0

20.0

25.0

8.3 7.5

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 growthY = 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

Labour utilisation Employment Hours Worked

Labour productivity Physical capital Human capital TFP

GDP per Capita Taxes Corporation Labour Consumption Property

Research by the OECD suggests a hierarchy of harmful taxation exists

Do not affect decision of economic agents to supply labour, invest in human capital, to produce, invest and innovate

Property Consumption

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

Personal Income Tax Corporate 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

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 consumptionQUEST 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 0.2Employment 0.14 0.22 0.24 0.25 0.25

HERMES – Structural model of supply side of Irish economyRevenue neutral shift of €1bnYears after reform Year 1 Year 2 Year 3 Year 4 Year 5

GDP (%) 0.00 0.16 0.26 0.32 0.32Employment (%) 0.00 0.11 0.26 0.41 0.43Unemployment rate 0.00 -0.07 -0.08 -0.12 -0.14

Simulation Results for Ireland

Labour to PropertyHERMESRevenue 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 0.38Employment 0.00 0.11 0.26 0.41 0.43Unemployment 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!