Saturday, March 8, 2008

Morally Taxing

You don't pay taxes - they take them!
Chris Rock
My daughter just started her first part-time job and all was going well until she got her first pay cheque and pay slip: then she had a Chris Rock moment. What followed was one of those awkward parent-child conversations where I found myself trying to explain why she was doing all the work but the Government was getting a big chunk of the money she was earning.

It did get me thinking about taxes and our attitudes towards them. By some measures we pay lower taxes in Ireland than in many other countries. Though personally I find this about as consoling as being told that our rainfall is much lower than that, say, in the Amazonian rain forest. Nevertheless, I think we are going to hear a lot more about taxes in Ireland over the coming months and years, not least because the economic cake is not expanding anything like as fast as before. So the bigger the slice of taxes that are taken the more people are going to notice how relatively little is left.

This year the Government is projecting that it will raise nearly €49 billion in taxes, though even this will not be enough to cover current and capital expenditure. Of course, much of this depends on how the economy fares this year: and with tax revenues in the first two months down €684 million on the same period last year, the Government's projection looks increasingly doubtful.

Some 60% of the Government's tax revenues come from just two sources: VAT and income tax. The former contributes about 31% of total revenues, the latter 29%. But already VAT revenues are down on last year (reflecting weakening consumer spending and falling prices in some sectors). The problem with VAT (for Finance Ministers) is that it is applied as a percentage (21% is the standard rate) to the original price. But if the original price falls (due to competition, price promotions etc) then the absolute value of VAT falls even if the percentage remains the same. Another reason why deflation is every Finance Minister's greatest nightmare (and inflation is their greatest friend, though they won't admit that in public of course).

This only leaves income taxes as the one tap they can turn on quickly if the overall tax take weakens. And sure enough, income tax revenues were up in the first two months of this year, even as revenues from capital gains taxes, stamp duties and corporation taxes were significantly down.

Ireland, in common with all OECD countries nowadays, operates a Pay-As-You-Earn (PAYE) sytem of income tax collection. In other words, the Government pays itself first out of your wage or salary (or rather your employer pays them on your behalf) before you get paid. As social innovations go, PAYE was an act of creative genius in the evolution of tax collection (or evil genius, depending on your point of view of course). PAYE was first used during the American Civil War in 1862, then dropped when the war ended before being resurrected in both the United States and the UK during World War II. Indeed, it would seem that war has been as much a spur to tax innovation as weapons innovation over the centuries. Though you won't read about that particular synergy when you visit the new Revenue Museum in Dublin Castle.

So expect the battle lines to be drawn on income tax as we approach the end of the year and Budget 2009 takes shape. The Government has a €56 billion spending programme to fund this year, and a projected €59 billion next year. There will be those calling for higher taxes - such as Cardinal Seán Brady, quoted recently in The Irish Times arguing that:
... the case needed to be made for tax increases in order to provide better social and health services for more vulnerable members of society. ... a better balance could be struck between the pursuit of individual wealth and our duty to the common good in the form of better education for children and better health services for children. We need to strike such a balance. We need to reawaken our duty to provide for the common good, while at the same time we would all like to see the best possible public services delivered.
In other words the Cardinal sees no problem with turning on the income tax tap as necessary to deliver the 'common good'. What is disturbing about the Cardinal's perspective is how ill-considered it actually is. He simply assumes that a) any such additional tax revenues will be as 'wisely' and 'effectively' spent as those raised before, and that b) increasing taxes on people on higher incomes will have no consequences for their behaviour (and therefore the total value of taxes paid).

This is dangerously naive thinking: but we are going to hear a lot more of it in the coming months. Here is a more considered view on taxes - from a Catholic think tank as it happens - which notes that:
Empirically, it’s well-established that low taxes diminish the rate of tax avoidance and tax evasion. This improves the quality of rule of law, a key ingredient for economic growth. An incidental effect is that those countries which have lowered their individual and corporate tax-rates in recent years, mainly through implementing flat taxes, have actually experienced increases in government revenues.

Low taxes also release more capital for productive investment, especially by reducing our need for tax lawyers and accountants. This benefits everyone over time, including the poor, by increasing living standards.

Capital is also freed up for private charity. When people keep more of their disposable income, they can be more generous instead of abdicating their responsibilities for their neighbor-in-need to politicians and bureaucrats. Lower taxes are not only just and economically smart; they’re good for our moral health as well.

There you go: Catholics for lower taxes - though it is unlikely we will hear any senior Irish Catholic figures propound a similar viewpoint. A pity really.

One thing I do expect to hear, however, is calls for more innovative approach to taxes that work for the tax payer, the Government and the wider society. Take the Flat Tax idea, for example. There have been heated debates between candidates in the US presidential primaries about the right approach to taxes: with every prospect that we will see some interesting tax innovations, including possibly a flat tax or similarly radical change, whomever becomes President next year.

Of course, don't forget our own General Election in a few years' time. My daughter will be old enough to vote by then, and I have suggested that she reflects on her own tax experience when she makes her mind up about who to vote for in the next election. I suspect that many of her generation will find themselves more on the side of Chris Rock than Cardinal Brady come the next election.

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