Four-Year Plan: Tax Expenditure

Nat O'Connor: I'm going to call the National Recovery Plan "the four-year plan" because I believe we should encourage the next government to publish four-year budgetary plans every year, as part of the opening up and improvement of Ireland's economic and fiscal management.

Having got that point out of the way, this year's four-year plan has a fair bit to say about tax expenditures. And so do I.

While this post is relatively positive towards the plan's actions in relation to tax expenditure, they represent the few positive aspects of a plan that is otherwise weak on jobs and highly regressive on tax measures.

It is to be welcomed that measures in the four-year plan move towards reducing tax expenditure, but significantly more can be done in this area and it can be done quicker.

The decision to standard rate pension tax reliefs is something TASC has called for for years. Tax reliefs at the marginal rate were inherently unfair. An ESRI study shows that 80 per cent of the benefit has gone to the top 20 per cent of earners. The four-year plan estimates that these tax breaks cost the state over €2.5 billion per year. This can be compared to the €6.5 billion spent on the state pensions in 2010.*

* Figure is the rounded sum of the Contributory Pension (€3.4bn), Widow(er)s Contributory Pension (€1.3 bn), Non-Contributory Pension (€0.9 bn), Invalidity Pension (€0.7 bn) and Transitional Pension (€0.1 bn). Source: Revised Book of Estimates 2010.

However, the phasing out of tax relief at the marginal rate will only begin from 2012, so this proposal may yet be changed by the next government. The decision to lower pension tax relief to 20 per cent is (fortunately) also contrary to the recently announced new national pensions’ framework, which advocated relief at an anomalous rate of 33 per cent, so we must be conscious that implementing the move to 20 per cent pension relief will require additional revisions to be made to the national pensions’ framework.

It is important to note that TASC’s objection is not only to the inequality of the pension tax reliefs but to the failure of the system of private pension provision to provide secure incomes for people in retirement. The value of Irish pension funds suffered real losses of 37.5 per cent in 2008, which the OECD (2009) Pensions at a Glance describes as the worst performance across 30 OECD countries. The current system simply does not work, which is why TASC continues to call for the creation of a new social insurance (retirement) fund involving a mandatory defined benefit scheme. Details are available in TASC’s updated pension policy: Making Pensions Work for People.

I note a potentially confusing note in the four-year plan around who benefits from pension tax relief. The plan states: “It is not the case that only those on higher incomes benefit from pension relief. The bulk of employee/individual pension contributions attract tax relief at the marginal or 41% tax rate” (p. 94). The point that many people pay tax at the marginal rate (and can claim relief at that rate) is not in dispute, but the importance of the ESRI study is that it showed that the vast bulk (80 per cent) of the benefits from tax reliefs went to the top 20 per cent of income earners.

It is welcome that the four-year plan acknowledges the risk of abuse, when it states: “Pension tax expenditures will be kept under constant review to ensure that abusive tax sheltering does not take place” (p. 94).

There are other welcome changes to tax expenditure in the four-year plan. Specifically, the plan is to abolish ten income tax expenditures and curtail another six, saving €355 million per annum once implemented.

A further €400 million worth of legacy costs from property-based incentives are also being phased out. I argue that the remaining property-based tax incentives need to be immediately halted in order to avoid last-minute use of the incentives, and consequentially less than €400 million being saved in this area.

There is also a commitment that “reliefs and exemptions from CGT, CAT and Stamp Duty will either be abolished or greatly restricted to ensure that there is an adequate base for these taxes and that all of society makes a fair contribution to the correction of the public finances” (pp. 99-100). A conservative estimate of €145 million is given for this. To date, TASC has focused on tax expenditure on income tax and corporation tax (following available data). But for every tax, there are tax breaks in the Irish system. So changes to CGT, etc are welcome.

The Cost of Tax Expenditure
The four-year plan proposes to reduce tax expenditure by €1.7 billion by 2014 (see pp. 93-97). For reference, the plan states that the cost of pension tax relief is just over €2.5 billion. TASC estimated that tax expenditure on income tax and corporation tax alone cost the Irish Exchequer €7.4 billion in 2009. So, it seems obvious that more could be done to reduce this than €1.7 billion in four years.

The four-year plan is incorrect and misleading in its explanation of the OECD finding that tax expenditure cost €11.49 billion in 2005. The four-year plan states that “80% or €9.72 billion of all the tax expenditures relate to personal allowances / credits / bands, pensions and savings” (p. 95). The OECD’s figures do not include the effects of the income tax bands. In addition, the OECD calculation shows that €7.2 billon from income tax relief came from other sources than basic personal credits (i.e. Single Person’s Credit, Married Person’s Credit and Widowed Person’s Credit). In other words, 62 per cent of the €11.49 billion tax expenditure on income tax came from other credits and allowances, which are not ‘basic’ or part of the ‘baseline’ tax system. TASC explained and replicated the OECD findings with 2006 data in its pre-Budget proposals submitted to the Department of Finance (see pages 28-29).

In fairness, the four-year plan is correct that there is a lack of public understanding about tax expenditure; due in no small part to the inadequate data available on this area. When the €7.2 billion of ‘non-basic’ tax credits and allowances are examined, they contain a wide range of things, including inter alia: the PAYE tax credit, tax relief on private medical insurance and health expenses, the tax exempt status of Child Benefit, relief for investment in films and TV, tax relief for paying third-level fees, approved profit-sharing schemes, and the various pensions/savings reliefs.

The reform of this area is complex and demands a commitment to substantial overhaul of the tax system to make it simpler, transparent and equitable. In particular, the removal of some tax reliefs may require balancing changes to be made in areas of economic or social policy. For example, TASC’s proposals about pension tax relief are not just about removing an unjust relief, but they also put forward a system for ensuring everyone has a better, more secure pension.

Nevertheless, there is a need to look at the overall distributional effects from the combination of the taxation, tax reliefs and the welfare system; it is hard to justify benefits to middle income earners, if the alternative is cuts to payments and services on which more vulnerable people depend.

TASC has proposed that all current and proposed tax expenditure should be subject to an equality audit and economic efficiency audit. In addition, they should all be subject to an annual check and vote by the Oireachtas, as they constitute a major area of public spending. Most developed countries report systematically on tax expenditure every year. The World Bank associates the absence of such reporting with developing and transition countries.

Posted in: Taxation

Tagged with: tax breaks

Dr Nat O'Connor     @natpolicy

Nat O’Connor is a member of the Institute for Research in Social Sciences (IRiSS) and a Lecturer of Public Policy and Public Management in the School of Criminology, Politics and Social Policy at Ulster University.

Previously Director of TASC, Nat also led the research team in Dublin’s Homeless Agency.

Nat holds a PhD in Political Science from Trinity College Dublin (2008) and an MA in Political Science and Social Policy form the University of Dundee (1998). Nat’s primary research interest is in how research-informed public policy can achieve social justice and human wellbeing. Nat’s work has focused on economic inequality, housing and homelessness, democratic accountability and public policy analysis. His PhD focused on public access to information as part of democratic policy making.