Taxing our way out


With taxes for the middle-class expected to increase in the upcoming budget, Graeme O’Meara asks ‘Can we tax our way out of a recession?’

With Budget 2013 looming, it is anticipated that households could face an additional tax burden of over €3000 next year. Consultants at Grant Thornton predict a myriad of treats awaiting the taxpayer in the form of tax hikes right across the board. They forecast an increase in PRSI, DIRT and the Universal Social Charge, as well as reduced pension relief and the introduction of the much debated property tax.

It is predicted that annual outlays for families will increase by somewhere between €3000 to €9000, depending on salary levels and family circumstances, while the USC is expected to increase from 7% to 8%, and to 10% for incomes over €100,000. Tax relief on pensions and pension contributions is also predicted to fall from 41% to 20%, striking a blow to retirement incomes.

While the government may refrain from increasing income taxes directly, it may indirectly squeeze disposable income through these ancillary taxes. Experts at Grant Thornton have examined every possible scenario and conclude that an increased household tax bill of at least 10% is inevitable if the government is to fulfil targets set down by the Troika.

The ‘old reliables’ such as alcohol, tobacco and motor tax will inevitably also take a hit. The logic underlying heavy taxes on addictive substances such as alcohol and tobacco is that it aims to maximise revenue intake given that these products attract a high inelastic demand, while trying to achieve the social goal of discouraging their consumption by way of higher prices. What makes this form of taxation somewhat regressive is that lower income consumers tend to spend a higher proportion of their income on these addictives, and so they face a higher tax burden.

The tax on savings (DIRT) is also expected to rise, which may discourage domestic saving and encourage saving in foreign economies offering a more lucrative return. The Nationwide UK (Ireland) ESRI Saving Index recently reported that 42% of Irish people do not put any money away in banks or building societies; significantly ahead of the 36% level recorded a year ago. The proportion of people saving regularly has also decreased during 2012 and now stands at 34%. Widespread uncertainty regarding the economic climate is likely to cause consumers to be more frugal and induce a higher reluctance to spend. With interest rates hitting the floor and higher taxes on interest, is this government trying to discourage saving altogether?

Given that the economy is near stagnation, boasting 14.8% unemployment, a debt to GDP ratio of 111.5%, on an upward trajectory through 2015, and real GDP growth of 0.4%, these measures would have an effect on the economy over the next year. The first impact of this Gestapo tax regime would be the Christmas shopping spree. When the budget is announced on December 5th, taxpayers would likely internalise the effect of higher taxes on their household spending for the next year, and start cutting back sooner rather than later. Retailers geared up for what is generally the busiest season of the year may well find themselves at a party with no punch.

As with any government engaging in measures of austerity, this government is under the illusion that by imposing higher taxes on the slowly shrinking labour force, it can increase its revenues and improve the exchequer finances. This will only serve to aggravate what is already a very fragile situation: pulling money out of an ailing economy causes economic activity to contract even further. With less disposable income, consumers spend less and gradually put firms out of business, causing them to lay off workers and henceforth the economy is on a downward spiral.

Economists are sharply divided on the issue of austerity; on the one hand, fiscal tightening can signal economic stability and permit a return to international bond markets for raising funds; on the other, it inflicts pain on citizens and crowds out prospects for growth and employment. In his latest book, Nobel Prize winner Paul Krugman argues that economists and politicians influenced by the self-righteous allure of budget austerity are ignoring history and imperilling economic recovery. He passionately defends the Keynesian inheritance that a large fiscal stimulus would inject a boost into the economy and restore consumer demand, reversing the downward spiral. By creating jobs for the unemployed, economic activity would begin to gain motion again and the economy would start growing at a moderate pace. Unfortunately, this remedy is more likely to pertain to the US than Ireland, given that the US can freely borrow at low interest rates.

Other economists, such as Casey Mulligan at Chicago, the epicentre of the right wing school of economics, argue that the recession is a supply side problem: overly grandiose unemployment benefits are distorting people’s incentives to return to work. The problem is aggregate supply, not aggregate demand, and by cutting off support lines to unemployed workers by way of austerity, these lazy folk will be impelled to return to work. This theory does not fit the data, as last month the IMF publicly admitted its miscalculation of fiscal multipliers and the adverse effect of austerity on growth in 28 European countries. It was believed that for every $1 taken out of the economy, the loss of output was $0.50, when in fact the data showed the loss of output to be between $0.90 and $1.70.

With a potential €3.5 billion to be scrounged from the Irish economy, these speculated tax hikes would serve to exacerbate the current situation and promote greater tax evasion and longer queues at immigration and dole offices. The answer to the question posed above is unequivocally no, but this is no ordinary recession: a country does not surrender financial sovereignty in recessionary times.

While austerity may represent a deficit of common sense for countries like the US or the UK, the Irish economy is near insolvency and part of the reason for our predicament stems from too narrow a tax base in the first place. The government faces a trade-off: inflict pain today and gradually usher out the Troika, or do the honourable thing and let them wait.