Taxation Once Again
The economist who drafted the Fine Gael taxation policy prior to the election argues that the budget deficit will have to be eliminated by means other than more indirect taxes in the 1982 budget. By Brendan Dowling
There are a number of dangerous myths which currently affect attitudes to the present pay negotiations. These include the implicit assumption that pay demands — and the acceptability of subsequent settlements — are based on relating movements in the consumer price index to gross pay regardless of movements in net take home pay; the belief that the 6 /2 per cent pay norm produced by the three wise men represents a counter in the bargaining strategy on public sector pay; and the conviction that the Exchequer has the capacity, if the Government had the will, to finance pay increases which compensated for past inflation.
The chorus of objections to the full — and in some cases partial — implementation of the Government's proposed tax package is based on a number of arguments. Some of these are valid but assume measures quite as unpalatable as the rise in prices stemming from the shift to indirect taxes. Other arguments are, however, specious and represent a significant degree of special pleading.
First let's examine the phony arguments. It is argued that by shifting from direct to indirect taxes the Government will make a pay settlement appropriate to our present economic condition impossible to achieve. At present pay demands are being pitched at 20 to 25 per cent for a 12 month period. If we assume that 3¼ per cent of that claim is in respect of the Government's intention to introduce its tax package then the range of claims, in the absence of a tax package, would fall to 16 /2 to 21 1/2 per cent.
There still remains a sizeable discrepancy between these sorts of claims and what the economy requires if employment is to be maintained and the internal and external value of the Irish pound sustained. If pay demands were running at 10 per cent then it might reasonably be asked whether the Government should go ahead with proposals which, if abandoned, might reduce claims to 6¼ per cent.
So the evidence at this stage is that the Government proposals would make only a marginal difference to the extent to which pay claims exceed the capacity of the economy to meet them at current exchange rates. Abandonment of the proposals is not a simple panacea to solve the divergence between reality and union demands.
Even if one accepted the case that higher indirect taxes led to pressure for higher pay the assumption that workers are indifferent to movements in net take-home pay is scarcely credible. Suppose that the Government took the advice of some Labour backbenchers and aban doned the tax proposals in full in return for the pay moderation that is promised (or more likely assumed) by these backbenchers. Assume pay moderation of the order of a 7 1/2 per cent increase.
As Table I shows take home family income would rise by only around 5 per cent for married couples earning between £100 and £160 per week — the vast majority of wage and salary earners. Single persons would fare marginally better.
Contrast that position with the rise in take home income if the Government's proposals were implemented along with a 7¼ per cent pay rise. Married couples would get increases from around 10 to 14 per cent over the relevant income ranges while single persons would have net of tax increases of 121/2 - l3 per cent. In general take home income would rise by 5 to 8 per cent more than under the existing income tax and social welfare system.
So if the Government's proposals were to add less than 5 per cent to consumer prices, average, and slightly below average, income earners would lose out if the Government does not proceed with its intended tax package. It is entirely possible that the real objection to the tax package stems from the belief that the Government will have to introduce the tax provisions because of the key role they played in the election campaign and therefore there is a political need to dissociate from the concomitant price increases. Certainly concern for the take home pay of ordinary workers or the need for pay moderation are not the grounds for abandoning the tax reforms.
Indeed suppose the unions reject — as they appear to have done — the pay norm as a useful concept and press to maintain current living standards. For the sake of argument assume that this requires a 15 per cent rise in after tax income between November 1981 and November 1982. Assuming Ireland remains within the EMS and not more than 4 per cent on the CPI due to indirect taxes in the January Budget this seems a plausible forecast for the 12 month inflation rate. In Table 2 it can be seen that workers would have to get pay increases of 18 to 22 1/2 to achieve a 15 per cent increase in take home income under present tax laws.
Under the Government's proposed tax system the required increase would be 8½ to l3V per cent with increases around 11 per cent being sufficient for most industrial workers.
Thus the absence of any direct tax changes will make it very difficult for workers to achieve take home income increases close to the likely rate of inflation over the 12 months to end 1982 without gross pay increases which would make a devaluation inevitable and push up prices more than 15 per cent.
Even if pay bargaining is made no easier by a withdrawal of the Government's commitment to increase indirect taxes to finance a direct tax cut there are valid, if unpleasant, reasons for urging a postponement of the tax reforms.
First it can be argued, as the IMF and Barry Desmond seem to argue, that the real tax burden must rise over the next couple of years. Failure to index the provisions of the income tax code would be one way to effect such a rising real tax burden without requiring Dáil approval. In addition increases in 1982 indirect tax levels will be required if the current deficit is to be reduced. Such increases would be impossible to impose if increases arising from the implementation of the Government's tax package were required.
The proponents of the higher tax burden argument do not, of course, stop at insisting on no relief on direct taxes. They also urge new, extensive taxes. For example the ESRI Quarterly Economic Commentary suggested a property tax yielding up to £250 million. Given that such a tax is likely to be included in the Consumer Price Index (as rates were) its attractions as an alternative to other indirect tax increases are wholly on equity grounds.
Indeed there are valid equity grounds for arguing that it would be unfair for the Government to proceed with the full implementation of the tax package given the need to reduce the current deficit and the scale of the indirect tax increases in the July Budget.
Put simply the equity objections to the Government's tax package viewed in isolation are not strong: the negative income tax aspect of the modification agreed in the Gaiety Theatre document will mean significant cash benefits for low income households.
However it is impossible to ignore the equity aspects of the July measures and possible additional January 1982 measures which are independent of the tax reform package.
If the Government, in the July Budget, had announced the indirect tax increases actually implemented as the financing component of the direct tax cuts in 1982, the 1982 opening Budget deficit would have been little different to the one that would have emerged had Fianna Fail been returned to power and done nothing or had the Fine Gael/Labour Coalition decided to postpone action until 1982. The July tax measures were mainly directed at raising 1982 revenues.
Suppose then the Government in January 1982 were faced with a reformed tax system (including a 259 standard tax rate, tax credits etc.) and a budget deficit of the size that was in prospect prior to the July measures. Would it be considered equitable to expect indirect tax measures to bear the entire burden of adjustment? Surely, it could be argued, the elimination of that deficit requires sacrifices all around. Thus a levy on income tax payments of the type used in 1975-77 might be practical.
If the Government does go ahead with implementing the full tax package and closes he deficit by indirect tax measures it will, in effect, be asking indirect taxes to bear the full burden of reducing the 1982 deficit left by the out going government. On equity grounds such a burden is excessive.
Whatever the fate of the tax proposals they are of relatively minor importance, from the macroeconomic standpoint, compared to the impact of high pay settlements in the economy. If the 61/2 per cent pay norm is significantly exceeded in the private sector then unemployment will rise and output growth slow. This could only be prevented by a sizeable and immediate devaluation of the Irish pound within the EMS which would, in turn, lead to higher inflation. The pay norm is the only mechanism available for avoiding either higher unemployment or higher inflation. A devaluation would have damaging side-effects on the confidence of foreign lenders in the economy and would raise the repayment burden of existing foreign debt.
However, it would be foolish to ignore reality and if significantly higher average settlements emerge an immediate devaluation would be preferable to a slow bleeding away of resources through the balance of payments deficit and rising un While a devaluation would do nothing to solve the underlying economic problems it would be a clear expression of the community's unwillingness to opt for lower inflation at the expense of even higher unemployment.
While devaluation might resolve the problems excessive pay increases would impose on the tradeable goods sector it would not resolve the present inability of the Exchequer to afford pay increases much above the norm without further heavy foreign borrowing in addi tion to the near £1 billion forecast for 1982 or further tax increases. Although high private sector pay settlements boost income tax revenue they reduce the real value of excise taxes and so the net revenue to the Exchequer from inflationary pay settlements is insufficient to finance similar increases for public sector workers.
In the past Governments have cried wolf so often that the present crisis in public finances is seen as a bargaining strategy. Nowhere is the insouciance to the state of public finances more obvious than in the public reaction to the proposed raising of the school entry age to 4 1/2 years.
It has been attacked as an expenditure saving proposal by editorialists who in later issues insist on the restoration of balance to the public finances. It is an expenditure saving measure and precisely the type of expenditure saving measure that is required. The implementation of the policy will not, according to educationalists, harm the children; the losers will be future applicants for teaching jobs. The State cannot have a fundamental obligation to guarantee a teaching job to every person who chooses to train for the position. If the teaching unions were genuine in their concern for future educational employment they would accept a small pay cut which would obviate the need to save money in the primary school system.
There are no painless ways to cut back the deficit. Higher taxes will reduce incomes and may do so unevenly especially if job losses accompany such an increase in net taxation. If existing levels of public sector employment are guaranteed then the burden of adjustment must fall more heavily on private sector employees — over 60,000 of whom have lost jobs in the last two years — and on future entrants to the labour market. Through the possibility of an exchange rate depreciation there is, over the short run, a choice between private sector employment and inflation. Given the state of the Exchequer finances the only choice is between a substantial fall in all real incomes through higher taxes or a decline in the real incomes ofthdse with secure public sector employment. If that choice is avoided, because of political problems, then the long run choice may be between real incomes of public sector workers and employment levels. Any serious difficulties created for the Government's foreign borrowing programme could result in the previously unthinkable — the wholesale dismissal of public sector employees. .
TABLE 1
IMPACT OF 7.5 PER CENT RISE IN GROSS EARNINGS ON TAKE HOME INCOME
% Change on take Home Income*
Single Persons Married Couple (2 Children) Married Couple (4 Children)
Earnings (£ per week) Under Existing Tax Structures After Proposed Tax Changes Under Existing Tax Structures After Proposed Tax Changes Under Existing Tax Structures After Proposed Tax Changes
100 6.1 12.6 5.1 10.4 5.5 9.8
130 5.7 13.5 5.5 12.4 5.1 11.0
160 6.0 12.7 5.8 5.5 5.5 12.4
*Take Home income includes children's allowances. Threshold for PRSI to rise in line with incomes.
TABLE 2
CHANGE IN GROSS EARNINGS REQUIRED TO GIVE 15 PER CENT INCREASE IN TAKE HOME INCOME
Required % Change in Gross Earnings
Single Persons Married Couple (2 Children) Married Couple (4 Children)
Earnings (£ per week) Under Existing Tax Structures After Proposed Tax Changes Under Existing Tax Structures After Proposed Tax Changes Under Existing Tax Structures After Proposed Tax Changes
100 18.5 10.1 22.2 13.5 22.4 14.6
130 17.6 8.1 20.6 10.6 21.8 12.7
160 22.3 10.7 19.5 8.9 20.6 10.6