Thursday, 16 September 2010

The bearable lightness of taxation

Michael Taft: In the run-up to the budget we will hear a lot about the ‘dangers of high taxation’. This will be used to justify a programme of spending cuts. Because, as everyone knows, high taxation stymies growth, job-creation and entrepreneurial élan.

No doubt we should be cautious about increasing taxation on low and average income earners next year. Average weekly incomes have fallen by 5 percent over the last two years; the new and increased levies represented a deflationary burden; for families, the cuts in Child Benefit and Early Childcare Supplement hit hard; mortgage owners will be facing interest increases over the next six to twelve months; while employers are demanding a long-term pay freeze which is tantamount to real pay cuts for the years ahead. Scatter-gun tax increases could provoke a new deflationary spiral.

But to the larger question – does ‘high taxation’ burden the economy? Let’s look at some evidence from the early to mid 1990s, when the Irish economy moved into strong numbers.

Between 1992 and 1997 the standard rate of tax remained at 27 percent, while the higher rate of tax was 48 percent. This compares to 20 percent and 41 percent today respectively.

Capital Gains tax was levied at 40 percent.

Corporation tax was levied at 40 percent, primarily for domestic enterprises (multi-nationals had enjoyed much lower tax rates for over a decade). This started falling after the corporate tax rate consolidation but in 1997 the corporate tax rate was still 36 percent.

Surely, this must have had a sluggish effect on the economy? Well, no. GDP growth during this period averaged nearly 7 percent while GNP growth averaged over 6 percent. Not much burden there.

Job creation wasn’t all that affected, either. Employment levels rose by over 18 percent – or an annual average of 3.5 percent. If we managed that trick over the next five years, we’d return to near full employment. Indeed, during this period the economy was still shedding agricultural jobs. The non-agricultural job increase was even higher – nearly 23 percent, or over 4.5 percent average annual growth rate.

What about profits? We get a lot of flak from spokespersons for ISME and the Small Firms Association about high taxation. Could you imagine what they were saying back then when the corporate tax rate was over three times what it is today? Still, it didn’t seem to hurt profitability. Over this period, profits more than doubled while tax receipts increased by even a faster rate – nearly 130 percent.

It could be argued that this profit increase mostly represents multi-nationals who had low-tax rates for a long time (the Export Sales Relief practically exempted most from tax). However, if we look at the distribution of profits in the Revenue tables we see a similar trend between large and small/medium enterprises. Unfortunately, detailed Revenue tables only allow us to examine the period 1995/6 to 1997/8 but these two years are instructive.

• Companies with adjusted profits above €1 million (where we would find most multi-nationals) saw their profits rise by 37 percent
• Companies with adjusted profits below €1 million (where most domestic companies would be found) experienced a profit rise of 31 percent

Even with a 40 percent tax ‘burden’ on domestic companies – profitability rose substantially.

What about capital gains? Those investors playing the market with a big 40 percent anchor tied to their speculative hips? Didn’t seem to harm tax revenue. Like corporate tax revenue, it increased by 130 percent over the five year period, suggesting a similar increase in actual capital gains.

So, ‘high taxes’ and high growth rate, strong employment growth, increasing profitability and capital gains; never mind rising wages, consumer spending and Government expenditure (a huge jump of 42 percent and, even so, debt was reduced by 30 percent of GNP); I’m not suggesting a cause-and-effect. But that works both ways. Substantially higher tax levels than exist today were no bar to building strong growth and prosperity.

If we can get rid of the ‘low-tax’ fetishism that dominates the current debate, then we might just be able to find a way out of this mess we find ourselves mired in.


Anonymous said...

Have you considered that the tax rates of the early 90s would have been seen many as being quite reasonable compared to the punitive, confiscatory rates of the 1980s?

48% would have seemed fine if one had paid a marginal rate in the of 65% or more only a decade previously.

Its obviously a whole different ballgame forcing higher rates on a culture in which low-to-medium have become deeply embedded.

Rory O'Farrell said...

Excellent point.

Done properly high tax is no impediment to growth, as shown in Sweden and Denmark.

Paul Hunt said...

No question that there is scope - and a requirement - for a huge shift in the incidence of taxation and an increase in the overall tax take, but the tide seems to have turned against the social democratic high tax and spend model in Denmark and Sweden - and seems to be gathering strength with the parliamentary representation of pretty ugly zenophobic parties (signifciant in Denmark and on the verge of a breakthrough in Sweden). The dysfunctional factionalism of Irish politics conceals the underlying popular majority against high tax and spend, but at least it tends to suppress ugly zenophobia.

Rory O'Farrell said...

@ Paul Hunt

The 'right' (not including the far right) in Denmark and Sweden would probably be to the 'left' in Ireland. Its all relative.

Paul Hunt said...

Indeed. But where would that place FF and FG?