Tax is not a four letter word

Feb 05, 2018

Sunday Business Post, 4 February 2018
A US firm of tax return preparers, Jackson Hewitt, recently surveyed individual US taxpayers.  Remember there were tax changes for American individuals as well as changes for companies that have been grabbing the headlines over here, and a lot of those people will be filing their 2017 tax returns over the next few months.  It was reported that so keen were people on US tax reform that two out of every five surveyed thought the changes would help with their 2017 tax bills.  Sadly for them, they won’t benefit or at least not immediately – the changes only take effect for 2018.

That kind of enthusiasm for anything remotely resembling a tax cut is not unique to the US psyche; it’s a feature on this side of the Atlantic as well.  When it comes to people’s fondness for a tax break, economic predictions of the impact of tax changes falls down.  Economists are excellent at mapping tax yields to GDP growth, or predicting the impact on prices and inflation of changes here and there across the tax system.  A tax change however seems to have a disproportionate consequence on taxpayer behaviour, often far greater than a relatively modest rate change or tax allowance might suggest it should.

Official Aversion

One of the consequences of the great recession is an official aversion to tax incentives.  In the past tax breaks – big income tax reliefs for rented residential accommodation, renewal of cities and towns, holiday cottage incentives and student accommodation tax deals contributed to the property crash.  Many properties derived their value not from their location nor the accommodation they offered, but from the attraction of the tax relief. 

Housing Minister Eoghan Murphy gave us a stark reminder of this official aversion last week. His reported response to a suggestion from one of the major banks that the VAT rate on construction activities would be cut was less than welcoming.  The suggestion is that a reduction to the VAT rate of 13.5% on housing, comparable to the reduction extended to the hospitality sector in 2011, might boost the supply of housing units.  Such a move, according to a response to a Parliamentary Question from the Minister for Finance, might cost in the order of €240 million per annum.  It doesn’t seem to be the amount involved that presents the problem, as much as the very notion that a property incentive could be part of a solution to a current market failure.

Notorious

VAT reductions are notorious for being absorbed by the retailer to the benefit of their profit margin.  When Charlie McCreevy was Minister for Finance, he cut a percentage point off the lower VAT rate across the board for all industries.  The following year he reinstated it upwards again to its current level of 13.5%, citing evidence that few retailers had passed the benefit onto the consumer.  When the hospitality sector received a VAT reduction in 2011, many restauranteurs for example went to the trouble of clearly identifying how much the customer was saving when presenting their tab.  That clearly showed how the VAT reduction was being passed on; a practice perhaps not quite as evident now as it was at the start.  

I think lessons were learned when it comes to planning tax reliefs.  The Department of Finance’s own guidelines on the matter speak of tax incentives and reliefs having to be prompted by market failure, to be time bound, and to be re-evaluated on an ongoing basis to ensure that they continue to fulfil their intended purpose.  But it is not wise to close off from political discourse any possible solutions on ideological grounds.  It’s a problem for social reasons, not just economic reasons, that housing market supply is not closely matching the demand.

The Dancer and the Dance

Of course a property VAT rate reduction might not be effective in improving the supply of housing but it merits examination, if only because tax incentives can be introduced quite quickly and the housing problems demand an urgent solution.  A VAT rate reduction would attempt to address the supply side of the economic equation, rather than the demand side.  That’s in contrast to the recent changes to the tax system towards address the imbalance in the property market.  The “help to buy” scheme introduced some years back, and last year’s extension of mortgage interest relief, have primarily been directed towards the buyer rather than towards the vendor. 

As a former Finance Minister observed to me once, when interest groups put forward ideas for tax breaks, it can be hard to separate the dancer from the dance.  The most fervent advocates of tax reform are often those who will benefit most from it.  Nevertheless, there has to be room for debate and discussion on tax incentives.  Tax is not a four letter word.

Brian Keegan is Director of Public Policy and Taxation at Chartered Accountants Ireland