Saturday, 14 May 2011

The proposed levy on pension funds

Jim Stewart: The levy on pension funds makes economic sense, but it has been very poorly presented, and it is inequitable in its proposed from.

The levy makes economic sense because the State has a large budget deficit (forecast at 10% of GDP for 2011), reducing this deficit without steps to improve economic growth would exacerbate the problem. At the same time the State cannot borrow on capital markets and borrowing from the ECB/EU is expensive.

The household savings rate for 2009 was estimated by the CSO to be 12% of income in 2009. The household sector held €105 billion in net financial assets in 2009, and an estimated €240 billion in housing (excluding land). It is likely that net financial assets have increased since then, and the value of the housing stock has fallen.

Thus the household sector in Ireland in aggregate, is not ‘bankrupt’ and cannot become ‘bankrupt’ in the context of a monetary union and integrated financial markets with no capital controls. The prediction by Morgan Kelly of ‘a prolonged and chaotic national bankruptcy’ is thus misleading. The analogy would be Orange County in the US which became bankrupt or insolvent in the sense that State employees, interest on debt etc. could not be paid, but the citizens of Orange County did not become bankrupt/insolvent.

Recent publicity given to the view that Ireland is bankrupt, and that a policy option is to leave the Euro causes further outflows, and helps bring about one aspect of that which has been predicted - the insolvency of the State.

An important economic issue is that most savings are held outside Ireland in the form of pension funds, and increasingly deposits. A solution to the budget deficit is to use these savings, by borrowing or by taxation. This is what has been proposed in relation to pension funds. It is in effect a form of wealth tax but it is a partial wealth tax which it is proposed to levy on some forms of pension assets (those pension assets that have benefited from tax relief), while ignoring those who have chosen to provide for their pension, via conventional savings or by property, and the implicit value of public sector pensions The partial nature of this levy is one of the reasons, as argued later, why it is inequitable.

But the case has been poorly presented. The vital jobs initiative is dependent on funding from this source. Yet some of the information issued is misleading, for example in relation to the decision not to impose the proposed tax on ARFs because it is argued that they were ‘closest in nature and an alternative to an annuity’. They are in fact closest in nature to a pension fund as that fund is operated in Ireland. But more important there is poor data on the value of pension fund assets. The former Minister for Finance stated in answer to a PQ (16th December) that there ‘was no data on the value of individual pension schemes’. There is also no recent data on the value of ARFs. The most recent estimate is for 2005 and the figure then was 6600 schemes held €1.1 billion in assets (Budget 2006, Internal Review of Certain Tax Schemes, G, p. 21).

The proposal as currently envisaged is inequitable. Employees in the public sector are more likely to have a pension than those in the private sector, and this pension is also likely to be larger. Yet the proposal envisages legislation which will enable funded schemes to ‘reduce the pension payable’ (Pension Fund Levy Q and A. Department of Finance). Some of those who are currently retired have extremely generous pensions, and will bear no extra tax burden, while a majority of the population aged over 65 have no occupational pension.

It is proposed not to impose a levy on ARFs yet the tax treatment of ARFs under certain circumstances is far more generous than pensions in payment.

A more equitable and hence acceptable proposal would be to extend the levy to all pension fund assets that have not been annuitised.

The proposed funding of the vital jobs initiative appears to have been poorly thought out. This may be partly explained by complications introduced into government policy making by negotiations with the EU/ECB/IMF. These bodies have conflicting views on policy, some policies proposed are incoherent. Key decision makers appear at times to be both ill informed and arrogant.

The Minister for Finance has given a commitment to ‘examine’ the issue of tax reliefs on pensions contained in the EU/IMF programme and any ‘scope for fiscally neutral changes’. The implication being that the levy on assets may result in a proposal for smaller reductions in announced tax reliefs. The implications of such changes need to be carefully considered so that existing inequities in the tax treatment of pensions are not exacerbated. Such an examination may show that further reducing tax reliefs for pension provision, increasing the pension contribution of high earners in the public sector and reducing tax allowances for those retired persons with large pensions is a more equitable and effective means of funding the vital jobs initiative .

The issue of the taxation of pension funds has been confused by the issue of high charges by pension funds. Tasc/TCD Pension Policy Research Group has long argued that pension fund charges are excessive and should be reduced. This should happen irrespective of the tax treatment of pension funds.

1 comment:

Anonymous said...

Stewart is to be congratulated for his constructive and well grounded contribution. While other academics come up with Dr.Kevorkian like proposals such as advocating that we eliminate the government deficit in one fell swoop thus ensuring the death of the Irish economy, Stewart’s contribution displays an understanding and a deep knowledge of real world economics and finance.

It is however very unfortunate that the credibility of Stewart’s valuable contribution is in danger of being undermined by the many other ill considered and erroneous claims emanating from academia. As Stewart himself so expertly demonstrates in relation to the recent assertion from an ivory tower economist of “a prolonged and chaotic national bankruptcy’ much of the discourse from academics is completely uninformed and reveals a lack of any serious understanding of the functioning of a modern economy.

Given that economists in such critical institutions as the ECB are so ignorant of Ireland and its economy it is doubly unfortunate that pronouncements from Irish economists should have the effect of leading to an even greater degree of ignorance on the part of ECB economists and others.

In addition there is the destructive effect of such ill- informed pronouncements from ivory tower academics in playing the role of self-fulfilling prophesy. As noted by Stewart, one such example is the impact on funds outflows.

Ivory tower economists need to realize that Ireland is not a laboratory to be played with. It consists of real people and real livelihoods. Playing games of whatever nature with Irish people and their livelihoods is not only irresponsible. It borders on the perverse.