It has been over a decade since the financial crash. During this period, Ireland has had three local elections and three general elections. There have been tax rises and expenditure cuts, followed by tax reductions and expenditure rises. But at no stage has there been a serious political debate on the structure of fiscal reform. Given that Ireland went through a decade of reckless fiscal policy, followed by almost ten years of austerity, it is remarkable that this conversation has not taken place.
The core social contract that exists in a democracy is the one that pertains to taxation. Democratically elected governments have the right to use the levers of the state to tax workers, business profits and consumers. In return, the government commits to spending this revenue on social security, public services, administering the state and capital infrastructure.
But how much should the government take in revenue from national income? Should we tax wealth? Should we generate new revenue for new public services? These are questions of structural fiscal reform that have not been addressed in any election.
Fiscal democracy was born in the aftermath of World War II when governments began to raise large amounts of revenue and commit to public service provision – in the form of healthcare, education and social security.
Before World War I, most governments only raised enough revenue to maintain the civil service and a standing army. But with the birth of mass democracy came the birth of fiscal democracy. Fiscal democracy was now premised on the government protecting society from market risks and investing in those public goods that the market was poorly equipped to deliver – health and education.
Social contract and healthcare
There is significant variation in how much governments raise in revenue. In the social democratic oriented economies of northern Europe, most governments take between 45-50 per cent of national income in revenue. In the more socially conservative continental European democracies, it is around 40-44 per cent. And in the more market-oriented economies of Britain, Ireland and Eastern and Central Europe, it is between 30-39 per cent. What is remarkable is that the tax to national income ratios have not changed much at all since the late 1970s.
There are only two ways a government can fund expenditure – taxes and public debt. All rich democracies use a combination of both. In terms of taxes, governments typically tax three things – consumption, income and capital. Taxing income and capital are referred to as direct forms of taxation. Taxing consumption is indirect.
Taxing labour income, corporate profit and domestic consumption makes up around 90 per cent of revenue generation for most countries. The largest tax take is on wage earnings.
Most countries also have local taxes for local government, which are aimed at providing local public services, and local infrastructure. Ireland is the odd one out here. Local government has very weak fiscal capacity. Almost all revenue in Ireland goes to the central exchequer, meaning that Ireland has one of the most centralised fiscal states in the western world.
In almost every OECD country, the government spends 80 per cent of revenue on three things – health, education and social security. And within social security, the major form of expenditure is on pensions. Hence, the social contract that underpins fiscal democracy is based on the public provision of healthcare, education and eldercare.
In countries with a higher tax intake, this also includes the public provision of universal childcare services. Countries that provide more public services have larger public sectors. That’s because most public service provision requires employing people to provide health and education services.
A government that takes in 35 per cent of national income has less fiscal capacity than a country that takes in 45 per cent. The first country will clearly have a much smaller public sector than the second, and will most likely depend more on the market for services.
Typically, countries with larger public sectors employ more women. In turn, they also tend to be the countries with the largest (unionised) female participation rates in the labour force.
The question as to how large the public sector should be, and how this is funded, is a crucial question for all rich democracies. It has not been debated in Ireland for over a decade. How much of national income do we want to dedicate to the provision of public services?
Tax from multinationals
In Ireland it is difficult to exactly measure the tax to income ratio because it is so hard to reliably measure national income. GDP in Ireland is €324 billion. This is massively over-inflated by the tax avoidance strategies of some multinationals.
Modified Gross National Income (GNI) is €197 billion, which is €124 billion lower. The tax to GDP ratio is around 20 per cent. The tax to GNI ratio is around 35 per cent. The modified GNI ratio is a much more accurate measure of the size of the social state. It is low when compared to northern and western European countries, but similar to Britain and eastern and central Europe.
Since the crisis in 2008, there have been two notable changes. First, income taxes have gone significantly up. In 2008, income taxes made up around 25 per cent of the total tax take. Today it is around 40 per cent. This sharp increase was a response to the previous decade of income tax cuts.
The second notable feature is the very sharp increase in corporate tax receipts. Almost 20 per cent of the total tax take now comes from corporate taxes. This is enormous. In most OECD countries, it is around 5 per cent. Relying on this boom in corporate taxes to cover expenditure is perhaps the biggest risk to the public finances.
Ireland has a very progressive income tax system. But this is because the income tax base is so narrow, 30 per cent of households pay almost 80 per cent of all income tax. Similarly, 30 per cent of households with earned income pay no income tax at all. On the one hand this shows the extent of the low wage earnings sector. But it is also a deliberate fiscal policy choice to exclude low earning households from the income tax bracket. The outcome is a very narrow income base, which is highly unusual when compared to the rest of Europe.
Ireland has two income tax rates. Most countries have three or more rates, broadly aimed at taxing low, middle and high income earners in progressively different ways. Since the crisis, there has not been a debate on widening the income tax base. The focus has been on removing more earners from the higher rate of tax, or abolishing the USC [Universal Social Charge] for lower earners.
New forms of revenue
Like all rich democracies, the Irish government spends most of its revenue on providing social security, delivering public services and investing in capital infrastructure. If we break these down, it is a 50/40/10 split. Social security expenditures account for 50 per cent. Wages and pensions account for 40 per cent. The remaining 10 per cent is spent on capital infrastructure.
Within social security, the largest component of expenditure is the contributory state pension. It is questionable whether tax flows are the best way to fund capital infrastructural investments. Perhaps the state ought to borrow at 0 per cent interest rates for this?
If the electorate want more and better services, it means more public sector workers. This means taking money away from somewhere else in government expenditure and/or raising new forms of revenue. At present, there are around 335,000 public sector workers in Ireland (mainly in health and education), and their wage bill amounts to around €18.5 billion. For a small open economy, this is actually comparatively small.
Public sector workers account for around 15 per cent of total employment in Ireland. In Denmark it is almost 35 per cent. In most small open economies in Northern Europe, it averages between 25-30 per cent.
It is perhaps no surprise that Ibec has been calling for an expansion of the state and the public sector, in order to meet new demographic and societal demands. Most people will favour an expansion of public services, but not necessarily the taxes to pay for this. Decreasing the tax to national income ratio while increasing the size of the public sector is simply not realistic. More public services will require new forms of revenue.
The reform of tax and spend policy is always conflictual. Different social groups and different parts of the electorate want different things from the government. This is directly observable in the fallout over water charges and the debate on carbon taxes.
In the recent election campaign, Sinn Féin promised tax giveaways to lower income earners and massive public investment. Fine Gael promised tax changes for higher earners and more public expenditure. It is interesting to note that it was only the centre-left parties that did not promise income tax cuts.
There was one glaring fiscal policy omission throughout this election though. The healthy position of the public finances is dependent on the boom in corporate tax receipts. For many international observers, this boom is just another indication that Ireland is a tax haven. But what will replace these corporate revenues when they decline? Any new government is going to have to answer this question. This should be an opportunity to have a robust debate about how to fund new public service provision for a 21st-century democratic state.
Central to this conversation should be wealth taxes. Wealth taxes make up less than 4 per cent of the total tax take in Ireland. Perhaps the time has come to shift the fiscal structure of revenue generation away from labour and wage income, toward net household wealth?