Are Irish workers undertaxed?

Recently, an ad for Liveline included an angry woman, decrying Ireland as a ‘high tax’ economy. Her argument was: “What’s the point in working if the government is just going to take all our money anyway?” That baffled me. As far as I knew, Ireland was certainly not a high-tax economy, certainly compared to some of the Scandinavian economies. I decided this was worth a closer look. Just how much of a low-tax economy is Ireland? And – given the €25bn gaping hole in the budget is going to have to be solved through a mixture of both expenditure cuts and tax increases – are Irish workers undertaxed?

The graph below shows the average “all-in” personal income tax rate levied on people who earn the average industrial wage, for a range of economies including Ireland, from 2000 on. The figure given is an average tax rate for four stylised households (a single worker with no children, a single worker with two children, a married couple with one earner and no children and a one-earner couple with two children). The figure for each economy includes family cash transfers, paid in respect of dependent children between five and twelve years of age. All figures come from the OECD.

Average 'all-in' personal tax rates, selected economies, 2000-2007

Average 'all-in' personal tax rates, selected economies, 2000-2007

Amazingly, in 2007, Ireland would have negatively taxed the four households, supplementing their income by 0.2% on average. Needless to say, negative tax is not the norm, certainly not for the average worker. Ireland is out of line with every other developed OECD economy. Our closest competitors, in terms of not taxing the average worker, are the Czech Republic and Korea – but both of those have an average tax rate for the four cases above of just over 10%.

Excluding child benefit, Ireland is still the lowest taxer, but the gap between us and the rest of the developed world narrows substantially. But including child benefit or excluding it, Ireland taxes its average worker the least of the 28 developed economies in the OECD in six of the seven different measures of average ‘all-in’ tax that the OECD produces. Only for single workers without children did one country, Korea, tax less than Ireland in 2007.

It could be argued that the use of manufacturing wages for Ireland – compared to a broader definition of ‘industrial average’ in most other OECD economies – could be affecting the result as it lowers Ireland’s average wage. That may be the case, and would affect the level of Ireland’s line in the graph above – but it wouldn’t substantially alter the trend. Ireland was already one of the lowest taxers in the OECD in 2000 and yet it cut its taxes by twice as much as any other economy.

This pattern since 2000 is important for where we are now, because a common explanation of how Ireland got into its fiscal mess is over-reliance on receipts from property taxes. That’s certainly true, but this wasn’t a passive over-reliance. This wasn’t a case of leaving the rest of the economy as-is and just not realising the once-off nature of the property tax windfall. This was very much an active over-reliance on property. The economy and the tax system was actively re-ordered based on a presumption that receipts from a property transaction tax and related sources would be the centre of the new economy. This was done with what seems like a reckless determination to tax workers less and less, without a due consideration of the sustainability of that policy.

I’m not saying that we should have high taxes for the sake of it. For one thing, direct taxation is only one part of the story – Ireland’s indirect tax rate (i.e. VAT) is one of the higher rates in the OECD (although it’s certainly not out of line). In fact, I’m not necessarily arguing that income tax rates need to go up. I can find only country in the OECD – the Netherlands – where the top rate of tax is above 50%. The Czech Republic, for example, which manages to get 10% in tax on the measure above, only taxes 32% at the top rate.

What I’m arguing is that we need to look again at our thresholds, i.e. at what point on the income scale do we start taxing people. We’ve got ourselves into this mess since 2000 and we certainly need to get ourselves back out.

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A €4bn Budget day suggestion – just how much could an Irish property tax raise?

Yesterday, the latest daft.ie report was released. More details here, but the overall gist is that asking prices fell 4.2% in the first few months of the year. Coupled with the falls in 2007 and 2008, this means that asking prices are now down 18% in two years. On the face of it, this may not have much to do the Budget being released today, which has to deal with more pressing issues of the public finances, unemployment and the banking crisis. However, to say that Ireland’s stock of wealth tied up in residential property should have no role in plugging Ireland’s E25bn public finances gap is myopic in the extreme, particularly given Irish wealth-holding tendencies. Even if we rule out a property tax, we should at least know how much we’re throwing away in potential tax revenues, and this blog post hopes to establish approximately this potential is.

No harm, first, to recap the fiscal crisis Ireland faces, outlined in the chart below. In 2007, the Irish government expected that in 2009, tax receipts would be in the region of €56bn. By last week, the expected revenues for the year had slid down to €34bn. This €22bn gaping hole is staggering, as it represents a collapse of 40% in revenues. Any organisation with a 40% collapse in revenues has to re-examine its entire business model and Ireland is no different. Fixing the €20bn-plus gap between income and expenditure will require taking more money in and spending less. My contribution on the debate about spending less is for another day – you can probably get some inkling of what I think here – but on raising more, we have to look again at property. Property taxes in Ireland are based on transactions – we now know, and probably deep down knew all along, that the huge amounts the government was taking in over the past few years were totally unsustainable.

Government estimates of Ireland's 2009 tax take over time

Government estimates of Ireland's 2009 tax take over time

If we don’t tax property transactions, how will we tax property? And what contribution to plugging our €20bn gap can property make? Recent articles by the Sunday Independent and the Irish News of the World have discussed the scale of how much has been wiped off Ireland’s property market, while the combined report by stockbrokers Davy, Goodbody and NCB mentioned the potential revenues that could be earned by introducing a property tax in Ireland. So just how big is Ireland’s property market? The answer is about €460bn, as is shown in the graph below. The graph uses 2006 Census data on the number of households in each county, Dept of the Environment figures on new houses built in each county since 2006 and daft.ie quarterly average house prices by county.

The value of Ireland's residential property, 2007-2009

The value of Ireland's residential property, 2007-2009

The graph also shows that the total value of Ireland’s residential property is about E100bn less than what it would be were no crash to have occurred. A similar amount has also been wiped off Ireland’s stock exchange, which is plotted on the same scale to allow comparison but whose remaining value is €30bn, compared to the €460bn still in Ireland’s homes.

Supposing the housing crash continues so that Ireland’s 1.6 million homes are worth perhaps E400bn by the time they bottom out. While well below the €600bn or so that it “could” have been, this still represents a huge potential stock of wealth that is largely untaxed. Simple maths says that a property tax that averages 1% could raise €4bn per annum. Assuming that the government will be aiming for a three-year correction to 2012 that lifts tax receipts by €10bn a year, while it cuts spending by €10bn a year over the same period, a property tax could solve 40% of Ireland’s tax woes. The average household’s annual tax bill would be less than €3,000 – or about €50 a week.

How would a property tax work? There are of course some significant issues that Ireland would have to iron out first, before a property tax could come in. For example:

  • Politically, older citizens have proved sensitive to the idea that the government might have access to some of the wealth stored in their homes, even if it’s to pay for their healthcare. The illiquidity of houses raises the prospect of retirees having to downsize to avoid tax bills. While this is normal in many places, particularly in the US, it would require a change in mindset here. Put more bluntly, the idea that people should be entitled to have any wealth stored away in property, as opposed to other forms of wealth, untouched by the government is out of date.
  • Recent purchasers would have to be given property tax credits, so that double-taxation through stamp duty and then the property tax would be avoided. Those who made particular purchases based on stamp duty arrangements that existed at the time may also feel hard done by.
  • Measurement of house prices would become even more important, as it would have tax implications. In this day and age, though, accurately measuring house prices should not be an arcane task. Measures such as the daft.ie and ESRI/ptsb series are both based on well established hedonic price methods, which could easily be adapted to official Revenue Commissioners data, if these data were made available as they are in most other countries.
  • An instant extra tax burden is probably not what the economy needs now. Phasing it in gradually over the coming 3/4 years would be advisable as it would allow adjustment to a new system, while also showing medium-term planning on the part of the government.

Nonetheless, there are significant advantages to a property tax:

  • It gives the government a steady generally acyclical revenue stream and has an automatic stabilizer effect – i.e. the tax burden households face goes down when prices slump and more than likely their confidence slumps too.
  • There is lots of potential in a property tax to achieve other goals as well as revenue-raising. (Indeed, for the purists, taxes should only be introduced when other aims will be served.) For example, the average of 1% could hide differences, if the government wanted to incentivize, for example, energy efficiency. Houses achieving carbon neutrality or some top level of energy efficiency could be exempt from property tax, or perhaps pay a minimal rate of 0.25%, while homes that incur a significant burden on the rest of society might have to pay signficantly more. (This would require significantly more planning and guidelines for consistent rating than the recent BER scheme.)

Given that we’re talking billions – perhaps even twice as much as the joint report by the main stockbrokers suggested – this should definitely be explored in more detail over the coming months.