IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
This paper is excerpted from the forthcoming "IREF’s Yearbook on Taxation" 2012
In an unprecedented and historical move, the European Union forced the Irish government against its stated wishes to indebt itself in an € 85 billion international bailout comprising of the IMF, EU and bilateral loans. This bailout to ensure that the Irish government would continue to pay 100% of face value on maturing senior bonds in zombie banks will have increased government debt by over 40% of GDP by the time the bailout is completed in 2015. Despite such catastrophic economic conditions, the Irish economy is showing signs of recovery. In 2011, Ireland generated a record high annual trade surplus of just under € 44.7 billion, up by 3% on 2010. Regarding public finances, the 2011 budget saw a closing of the deficit by a further €6 billion. Budget adjustment over the period 2011-2014 is realized for two thirds through expenditure reductions and one third should be raised by taxation. It has been called the most “draconian” budget in the history of the state.
An Overview of the Irish Economic Situation
In 2008, the Republic of Ireland was the first country to declare itself in a recession. After nearly fifteen years of year-on-year growth ranging between 5-12%, Ireland suffered a dramatic reversal in 2008, with GDP contracting by 14% and unemployment levels rising from 4.5% in 2007 to over 14% by 2010. Economic growth fell from 4.7% in 2007 to -7.1% in 2009. When the housing and construction bubble burst, a sector which amounted to around 20% of GDP in 2007 was reduced to around 5% of a smaller GDP in 2010.
Between 2000 and 2008, public spending increased by over 140%, while the consumer price index increased by just 35%. Taxation was reduced and the proportion of income earners exempt from income tax increased from 34% in 2004 to an estimated 45% in 2010. All of this was made possible by the very large property-related tax intake during the boom years. Ireland ran budget surpluses in every year but one since Eurozone membership commenced in 1999 and was one of the few Eurozone countries that stayed within both the deficit and debt limits of the Stability and Growth Pact in every year up to 2007.
The Irish government responded to the financial crisis by nationalising a series of banks, bailing out senior bondholders and imposing austerity budgets. The Republic retained its AAA credit rating until August 2010 when in a matter of weeks borrowing rates for government bonds suddenly rose to unsustainable levels. In an unprecedented and historical move, the European Union forced the Irish government against its stated wishes to indebt itself in an € 85 billion international bailout comprising of the IMF, EU and bilateral loans. This bailout to ensure that the Irish government would continue to pay 100% of face value on maturing senior bonds in zombie banks will have increased government debt by over 40% of GDP by the time the bailout is completed in 2015.
Despite such catastrophic economic conditions, the Irish economy is showing signs of recovery. Ireland generated a record high annual trade surplus of just under € 44.7 billion in 2011, up by 3% on 2010. Such news brings hope for an export driven recovery.
According to the Irish government’s National Recovery Plan, two thirds of the required budgetary adjustment over the period 2011-2014 will be through expenditure reductions and one third should be raised by taxation. Tax revenues have fallen to such a degree that by 2015 the projected total tax revenue shall still remain below its 2007 peak by over €4 billion or 8.5% below the 2007 high. By this stage, the government projects that the deficit will be below 3% of GDP by 2015.”
Since 2007, Ireland’s national income (GNP) has fallen by 15% and tax revenues have been reduced from over €47 billion to €34.2 billion, back to 2003 levels. Tax revenues in 2011 saw a 7.6% increase on 2010 however. This return to growth follows on from year-on-year declines of 14% in 2008, 19% in 2009 and 4% in 2010. 2011’s General Government deficit, at 10.1% of GDP was also within the 10.6% target set as part of the EU/IMF Programme in contrast to a similar measure imposed on Greece.
At end-2007, General Government debt stood at 25% of GDP, well below the European average. By end-2011 it reached over 100% of GDP. General Government debt is projected to increase further, to 115% of GDP at end-2012, and to peak, in percentage of GDP terms, at 119% in 2013.
National Recovery Plan
The Plan to correct budgetary imbalances was as follows: - €15 billion budgetary correction over 4 years; - €10 billion in public expenditure, €5 billion in tax and revenue raising; - 40% or €6 billion will be front-loaded in 2011; - Deficit will be reduced to 9.1% of GDP in 2011 and to below 3% by 2014; - Debt to GDP ratio will peak at 102% in 2013 and will fall to 100% by 2014 Those figures were the government’s own projection. It was clearly markedly below what the ultimate figure turned out to be.
On 6th December 2010, then Minister for Finance Brian Lenihan announced the Irish budget for 2011. This budget saw a closing of the deficit by a further €6 billion through tax increases and spending cuts, being called the most “draconian” budget in the history of the state. As Finance Minister Lenihan stated as he introduced the budget in 2010 “Ireland’s underlying budget deficit has stabilised at 11.6% of GDP”. GDP decreased by 1% in 2010, making it the third consecutive year of negative growth.
Despite vociferous pressure from the European Union for a Common Consolidated Tax Base, Ireland has managed to continue its wealth generating primary corporate tax rate of 12.5%. This rate is typically cited as one of the primary reasons for the Irish economic boom. Furthermore, the three-year corporate tax exemption for new start up companies was extended for companies that commence trading in 2012, 2013 and 2014.
The key change in the 2011 budget for income tax was the integration of two new taxes raised during the recession into a large consolidated single tax. The income levy and the health levy have been consolidated into the new Universal Social Charge.
Furthermore, the value of bands and credits were reduced by 10% bringing more people into the tax net whilst the government “tackled over-generous reliefs on private pensions.”
The majority of revenue adjustments between 2008 and 2010 were achieved through increases in direct taxation. The marginal rate of taxation on income is now 52 per cent for PAYE workers and 55 per cent for the self-employed. The OECD has concluded that Ireland has the most progressive tax system of the EU members of its organization and Revenue records show that the top 5 per cent of income earners pay 44 per cent of income tax.
During the boom years, taxation was reduced and the proportion of income earners exempt from income tax increased from 34% in 2004 to an estimated 45% in 2011. In 2011 year, just 8%, earning €75,000 or more, paid 60% of all income tax while almost 80%, earning €50,000 or less contributed just 17%.
As part of the bailout package, the Government agreed with the IMF and the European authorities to increase VAT by 2% to a new level of 23%: 1 per cent in 2013 and 1 per cent in 2014. It should be borne in mind that most food, children clothes, oral medicines and other goods and services will remain at the zero VAT rate. A 13.5% rate that applies to home heating oil, residential housing, general repairs and maintenance will remain the same.
Excise was increased by 4 cent per litre on petrol and 2 cent per litre on auto-diesel. This follows a 2010 reduction in excise duty on alcohol products by 12 cent per pint of beer and cider; 14 cent per half glass of spirits; and 60 cent per standard bottle of wine. This was done to curb Irish shoppers buying cheaper alcohol in the Northern Ireland.
The capital gains tax did not increase in the 2011 budget. This is despite steady increases for a number of years.
Irish GDP per capita Ireland’s GDP per capita is 27% ahead of the EU average. However, GDP is typically recognised as being a meaningless statistic when referring to wealth in Ireland as up to 90% of exports are owned by foreign firms who repatriate their profits. Hence, Gross National Product is seen as a better indicator which places Ireland at the European average.