Boost the economy and improve income distribution by cutting VAT not taxes

Dr. Micheál Collins of the Nevin Economic Research Institute and a former member of the 3rd Commission on Taxation,  report available here, has produced a number of interesting papers on the (broader) tax burden. He is trying to widen the discussion to include indirect taxes, such as VAT & Excise. Or as Jimmy Crowley  sang in the Cork anti-conscription song, Salonika,  “they tax the pound of butter, they tax the h’penny bun”. Micheál has produced a number of papers, Total Direct & Indirect Tax Contributions of HouseholdsModelling the Distributive Effect of Indirect Tax Changes   and The Distribute effects of recent Vat changes on the issue.

The results of his research point out that those with lower incomes, who may pay little or no Income tax, actually pay a very high proportion of their income in other forms of taxation. In other words, VAT in particular, is a very regressive tax, hitting those on lower incomes far more than those in the upper income deciles.

It is worth discussing his research now because the Irish Government are likely to have a substantial additional resources available when sitting down to agree next year’s Budget and Expenditure plans.

The first quarter’s tax figures suggest that the Government will be at least €2,000M better off. They reflect a much higher level of growth and leave Ireland and Poland far ahead of other EU members in both 2015 & 2016. The end of May figures, due on 3rd June are likely to provide further good  news as the additional VAT yield from consumer spending but especially Car Sales and Corporate taxes from the US behemoths,  such as Microsoft & Pfizer, both with large Irish operations.  By that stage, the €2,000M estimate of spare cash may seem conservative. IBEC’s Quarterly Economic Outlook for Q12015 confirms that trend, suggesting  GNP growth of 5.1%  in 2015 & 4.4% in 2016.

The Irish Government is restricted in how much it can increase spending based on an EU Expenditure Benchmark. Even a slight loosening of that restriction on increasing expenditure will still leave a large amount of money available either to massively reduce borrowing, much more quickly than planned, or to adjust taxes. It is also clear that 2016 will show strong growth in taxes, if the suggested growth rates in the economy are maintained.   There is considerable pressure to cut Income Taxes, with little consideration for the distributive effects of such changes.  As 2016 is an election year, Michael Noonan will be mindful that  Ruairi Quinn lost the 1997 election by being prudent, leaving a surplus for his successor to throw into a pro-cyclical bonfire. The Irish Independent’s infamous banner headline of “Payback Time”  comes to mind and Chris John’s in this Irish Times column refers to John Major’s electoral success from Income Tax cuts.

Releasing a large amount of money into the economy by way of Income Tax cuts has other dangers. Using the money to cut  the standard rate of VAT from  23% is less dangerous and far more positive. It strongly improves the cash flow of businesses serving the indigenous economy, reduces prices for all, including non Income tax payers apart of course from schools, sports clubs and other exempt bodies, who cannot claim a refund of the VAT they pay. The benefits are far more diffuse than Income tax reductions, which makes them less popular with politicians.

Ireland has been here before. One of the side effects of the “I have it, so I will spend it” disaster was that the Fianna Fáil/PD Government failed to control inflation, It was not immediately visible to the public, other than on holidays,  until Tony Blair deliberately weakened sterling, leaving Ireland completed uncompetitive. In the subsequent eleven years, Irish inflation was higher than that of the UK  in ten out of the eleven.

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Ireland 2.2 2.5 5.2 4 4.7 4 2.3 2.2 2.7 2.8 3.1
UK 1.6 1.3 0.8 1.2 1.3 1.4 1.3 2.1 2.3 2.3 3.6

Sources: CSO Database www.cso.ie & for UK http://www.ons.gov.uk/ons/datasets-and-tables/data-selector.html?cdid=D7G7&dataset=mm23&table-id=1.2

 

The cumulative figures (1997 = 100) are Ireland 142.02 and the UK 120.93, a differential of 17.44%.

The Table below reflects the movement of sterling against the Euro over the same period;

chart
Source: Irish Central Bank  http://www.centralbank.ie/polstats/stats/exrates/Pages/default.aspx, exchange rate taken on first trading day of each year, e.g. 2009 = 2/1/2

The movement from the start of 1998 to 2nd January 2009 was 41.11%, which when taken with the failure to control inflation left the Irish state completely uncompetitive. Euro-Sterling is currently trading in the 0.72-0.73 range, it is likely that a new UK Government will want to weaken it rapidly to encourage exports. Cutting the Irish VAT rate will pre-empt any possible losses to Northern Ireland by keeping Irish prices competitive.

Let the Irish Government take action now and cut the standard VAT from 1st September. There is a large initial cost, but the benefits are considerable both to the public and to indigenous business. Large multi-national businesses do not benefit, but they are clearly not in need of additional forms of support.

Thanks to the answer received  to a written question put down in the name of Róisín Shortall, we have an idea of the full year cost,  which is summarised in the Table below.

In summary the VAT figures are as follows;

Proposed Adjustment Yield Cost
Vat from 23% to 15% €2,200M
Tobacco clawback € 85M
Petrol/Diesel €122M
Alcohol €75M €282M
Net cost €1,918M

She asked,  “the net cost of reducing the standard rate of VAT from 23% to 15%, assuming the following adjustments in excise duty rates, a full clawback of the reduction by increasing excise duties on tobacco and tobacco products to equal the value of the VAT reduction, a 3 cent increase per litre in fuel duties; a clawback of 25% of the VAT reduction on beers, spirits, ciders, and so on, but not on wine:”

The net cost of course does not include the yield from the knock on effects. Michael Noonan failed to provide any answer the second part of her question,

“the anticipated effect of such changes on the inflation rates, both CPI and HICP; the gains to the retail sector, in particular the retail sector close to the border with Northern Ireland; the gains to each of the following counties, namely Louth, Donegal, Sligo, Leitrim, Cavan and Monaghan; the Exchequer raised in tax and by the reduction of trade crossing the border into Northern Ireland; the Exchequer raised in tax from residents in Northern Ireland opting to shop here; the employment gains likely to be generated from such changes, considering the claims to the success of the earlier partial reduction of the lower VAT rate from 13.5% to 9%. “

The 2015 cost would be minimal as there is just the one VAT return due between 1st September and 31st December, perhaps no more than €300M, when the clawbacks are taken into account, still leaving the Government with very positive returns and at the same time giving the domestic economy a boost just as the dark evenings of Autumn arrive.

Cutting the standard rate of VAT in Ireland could leave Northern Ireland (further) stranded. Falls in Irish prices would quickly empty the car parks of Newry’s massive shopping centres or Banbridge’s Outlet, of all those southern registered vehicles. The hit in L’derry & Enniskillen would also be severe, not just from the lack of southerners, but also from the natives heading South (or West) to Letterkenny, Sligo & Dundalk. However, in the Irish context, it is a far more effective way of distributing tax reductions, with the added benefit of ensuring competitiveness whatever actions the incoming UK Government takes.

But in the Irish context, a substantial VAT cut now makes sense. It would reduce prices in a good way, benefit everyone by reducing their real tax liabilities, improve the cash flow of businesses. Their is no logical reason for Ireland to take the account of the position of the  “dreary steeples of Fermanagh and Tyrone” or any other part of Northern Ireland in making the right choices for its citizens.

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  • Kevin Breslin

    I fear I may be stating the obvious but VAT is a tax, and if you are going to cut VAT you need to raise other taxes (or greater tax revenue) to justify it.

    I largely would agree with VAT reductions as VAT does punish the poor more than the rich, the only good thing about VAT in some sense is that it’s there to Malthusian waste of resources. But if consumption stagnates who’s investing in the recycling or even the management of the waste of resources.

    After the Great Depression, Europe ran out of everything … it was only able to grow through fiscal stimulus and technologies based on sand (electronics) and carbon (plastics) rather than iron, copper, lead and so on.

    I’m not a fiscal expert but:

    Employers may be willing to accept a greater income tax on their workers if people who were working had a greater say in how they were governed. Productivity is stagnant in the UK, while better in Ireland and I feel it’s because workers are looking for greater autonomy and involvement in growing their country as well as company, but are mill-stoned by politicians themselves, not regulations but the arrogant culture they bask in and the distraction it provides. If the money was spent on a health and education service that assisted the company’s competitive advantage the taxation would have zero impact on their profits or production.

    I often think raising the income tax bracket is so that people on low incomes who don’t get taxed at all ensure that they are not the ones influencing the policy either. Income tax cuts turn potential social investors who feel they have a stake in government into mindless low wage consumers keeping a few shops afloat and never going beyond the village lifestyle.

    The funny thing is the shops are the ones then effectively having to deal with the tax issue, which is VAT on the commodities they sell. The mentality behind high VAT-low income tax paradigm is dogmatically overly simplistic … punish consumption, reward work …. but VAT does not have the effect of deterring consumption and what influence do the rewarded workers have?

    Most people would feel consumer rights are far better protected than worker’s rights these days. Most people would say we are great at economizing money, but rubbish at economizing everything else.

    If we want to cut consumption we need people investing their time and energy into work and recovery. Quite often the most resourceful and hard working people come from the bottom not the top. I do not know many inventors coming from old money, I don’t know many recyclers who come from old money. We have investors coming from old money and some with windfalls in the new but what do most know about making it?

    Cutting people off from feeling they contribute something to the state they live in is not an inspiring message to send. There is no plan for how productive and resourceful people are going to get the economy working, just states trying to make them work out of the fear of being on punished for taking welfare.

    We have structural employment problems with talent on the dole because know-it-all politicians want them to be court jesters to their kingdoms and perform on demand with no self-respect.

    Another supply-side orientated politics must be possible.

  • notimetoshine

    “If we want to cut consumption we need people investing their time and energy into work and recovery.”

    There could be nothing worse than cutting consumption. It is the back bone of our economy

  • Kevin Breslin

    Actually there is something worse than cutting consumption … cutting production of goods, which would include transport and trade.

  • Owen Smyth

    Or reduce government spending.

  • Kevin Breslin

    Fine you can cut VAT and reduce government spending to pay for it, but reducing government spending will not and has not under the current UK government produced any ipso facto rise in productivity, nor employment.

    The Irish Government has cut a lot of public spending with the private sector picking up some of the pace. Cuts to public spending in the north produce no obvious improvements to trade. How is the private sector here getting any incentive by the closing of schools or closing hospital buildings? If the money was harvested for capital investment it might be the case but it is not. Banks were nationalized in both islands and finance, they’ve re-floated but the finance available for growing SMEs haven’t materialized.

    The relaxation of constraints on zero-hour work has been the only job creator that the UK coalition parties have produced and that was tax-independent/tax neutral and independent of interest rates and currency rates pretty much too.

    We need people who don’t see Confidence in our Economy as a substitute for physical work but rather making people feel they are useful.

  • NMS

    Kevin, Apologies for not responding earlier. The Irish Government finds itself in the lucky position of receiving more taxes than it had estimated. It cannot spend it, because it is restricted from doing so by European level supervision, therefore it can reduce its borrowing or alternatively reduce taxation levels.

    In the Irish context, Income tax cuts are likely to be regressive, partly because those on low and moderate incomes do not pay a lot of tax by OECD standards. The overall Income Tax burden in Ireland is not too far out from the average. Where there is a substantial discrepancy is in PRSI, NICs in the UK. The Employer Rate in Ireland at 10.75% is very low by EU standards, where the average is well over 20%.

    VAT seems the logical tax to adjust. The added problem of UK fiscal policy can also be dealt with. I am not suggesting cutting expenditure, however increasing expenditure is not an option because of the expenditure controls in place from the European Commission.

    Indeed if you consider the location of the Outlet and the excessive numbers of retail units in Newry, they are there to take advantage of Irish spending not to serve the Northern Ireland market.

  • Kevin Breslin

    I am confused a bit here, if there’s an EU constraint on additional expenditure then effectively water charges are merely revenue raisers as under that scenario the constraint on any additional spend would mean capital investment in state owned water infrastructure would be forbidden.

    If this is a bailout condition you would have to question from more than an anti-austerity point of view but from a logistic, commercial and feasibility point of view how this is not just another universal social charge rather than an actual charge for water and everything associated with it? If infrastructure were improved that doesn’t mean necessarily that that investment would be detrimental to any bailout loan repayments, such assumptions would focus on trying to secure the most insecure heaviest windfalls avaliable ahead of a more secure revenue structure of repayments.

    Also giving workers need to drink to remain productive, is there not some rational to some in the opposition’s remark about using a small raise in income tax to supplement the costs. In the most silly and reductionist terms how much revenue might be lost to the idigenous because a worker doesn’t get his coffee?

  • NMS

    Kevin – Water is in a separate commercial company, which is not counted as direct State expenditure. This may be reversed if Eurostat view that it is not independent, i.e. that it does not draw the majority of its income from charges.