Despite external risks, domestic policy errors would do more harm

Originally posted on Business Post 5 November 2022. 

We live in very strange times if a key determinant of economic success is whether or not the weather will be cold in Europe over the winter. Yet that is the unavoidable consequence of the illegal Russian invasion of Ukraine and the chaos it has created.

Chaos is contagious, and dealing with it saps resources, but at least last week’s exchequer returns showed yet another bumper tax harvest in Ireland.

It used to be the case that tax yields could be predicted fairly accurately by reference to GDP. If GDP increased, say by 5 per cent, then tax yields would also increase by about 5 per cent. This year at budget time, the GDP growth forecast was 10 per cent – but the tax yield growth forecast, at 19.2 per cent, is almost twice that.

A few factors have put the sums askew in our favour. One is timing. A higher proportion of income tax and corporation tax gets collected in the last quarter of the year. Now that budget day routinely falls in October – and it was even earlier this year – predictions of the trend are more complicated.

Another factor was the pandemic, which threw all forms of straightforward comparisons with previous years out the window.

Thirdly, successive tax policies over the past ten years have narrowed the income tax base, meaning that fewer individuals pay the highest proportion of income tax. That makes calculating a reliable average tricky.

As well as all this, we taxed our way out of the great recession mainly through higher Vat rates, but we have forgotten to reduce them. The standard Vat rate of 23 per cent in this country is among the highest in Europe, so a surge in price inflation also means a surge in Vat receipts.

Corporation tax yields dominate the exchequer returns. Government never misses an opportunity to tell us how fragile that high yield might be, though there are good reasons for it. Many of the major companies established in Ireland are from the ICT or pharmaceutical sectors, which have shown extraordinary growth and profitability over the past several years.

International corporate tax reforms since 2012 have restricted or eliminated opportunities for multinational corporates to locate profits in very low tax regimes, resulting in more tax being paid in this country. In some cases, capital allowances to encourage companies to establish here have expired, leaving more profits within the annual charge to corporation tax.

So how might the current chaotic conditions really impact on government capacity to tax, and then spend? During the pandemic, those on higher wages were less likely to lose their jobs. However, this time there are clear signals that some jobs in the ICT sector are vulnerable. Twitter is letting staff go – as is Stripe, which has openly admitted it got it wrong on economic growth and cost management.

There are also legitimate fears that some jobs in the lower-end services sectors and hospitality could go, as inflation, higher fuel bills and higher interest rates squeeze consumer spending. This month’s exchequer figures neither confirm nor challenge consumer spending trends, as Vat is paid every two months – and this wasn’t one of them.

Despite this uncertainty, it does not automatically follow that the outlook for the Irish exchequer is bleak. International tax rules have not changed and are less likely to do so in an increasingly protectionist world. That is important for any small economy like Ireland’s that is dependent on foreign direct investment.

Any disruption to our reliance for tax revenue on the corporate sector, high-income individuals or consumer spend will most likely be caused by poor domestic political decisions, rather than by outside influences.

In a period of inflation, there tend to be greater opportunities for employment. It is counterintuitive, but there is an inverse relationship between inflation and the unemployment rate. Higher inflation leads to higher wages, leading to more attractive working conditions. This reality is borne out by a shortage of staff being felt across almost all sectors.

It is not going to be easy to get through the current inflationary, fuel security and monetary crises, and it is right to highlight the risks that are not of our own making. But it is not right to identify these external risks without acknowledging that we would do most harm to ourselves with domestic policy mistakes.

If we can improve our accommodation, health provision and migrant policy without recourse to increasing the national debt and without damaging confidence in the corporate and consumer sectors, we should be able to manage through the current chaos just fine.

Dr Brian Keegan is Director of Public Policy at Chartered Accountants Ireland