We need a big tax cut, not a a rise

Date: 06 Dec 2010

If Ireland wants to keep its best workers, it can’t punish them, writes Professor Eamonn Walsh.

As we approach this week’s gruelling budget, it is worth reflecting upon a common misconception – that confiscating the income of our most talented and productive citizens is a socially desirable solution to our budget woes.

Many will remember the populism of the 1980s that gave rise to a brain drain and extortionate taxes on those who stayed behind. Many accumulations of wealth necessarily occurred under the radar of the Irish tax system. It was the age of the Ansbacher account and its retail equivalent, the “offshore” bank account. By the end of that decade, one in three college graduates was emigrating.

Today, emigration is estimated at 5,000 people a month. Unlike the 1980s, today’s emigrant further undermines our banking system and our national debt. Each departure is one less person to occupy a workplace and a home. Each emigrant is yet another impaired loan that will have to be financed by those that are left behind. Yes, emigration and the difficulties of our banking system are inextricably bound together.

Worse, who will stay in Ireland simply to have an opportunity to pay the bill for past excesses? Every ambitious 22-year old is likely to question the wisdom of remaining in a jurisdiction where 20% of their income is likely to be confiscated to pay for the excesses of 2005-2010.

Correctly formulated, Ireland could enjoy a brain gain. As countries across Europe increase income taxes to finance intergenerational transfers, Ireland should go the other way. It could tax all earned income at 12% - and operate a single higher rate of 40% on all unearned income. That would represent a simple tax system that does not require years of postgraduate study. There should be no deductions other than expenses wholly and exclusively incurred in the conduct of a trade or profession.

Such a system is likely to result in similar revenues to the existing one. For many, this will come as a surprise: our existing system of income tax collects only about 14% of all incomes. It is the complexity of that system that obscures the fairly poor yield from apparently high rates of income tax.

Current discussions centre upon applying higher rates of taxation to our most talented and productive citizens. It is high time that we ceased trying to achieve a multiplicity of policy objectives by over-engineering the tax system and made it simple and equitable.

More broadly applied, one could ensure that this simple system would also significantly reduce governmental expenditure. For example, take-home pay in the public sector, semi-state sector, public procurement and the guaranteed financial institutions could be adjusted so that it did not increase following a decline in the tax rate.

This would result in a significant decrease in public expenditure. In addition, all social welfare payments could be treated as earned income. Increasing our already high rates of income tax will only accelerate our fiscal difficulties. The most mobile will seek opportunities elsewhere.

Foreign investors will see little sense in paying Irish employees a premium to compensate for punitive domestic taxation. As they leave, impairments of loans secured on property will increase. Further difficulties in banking will give rise to further increases in taxation.

On the other hand, a proportionate tax applied to all residents would have upside potential. A simple, low tax rate is more likely to increase the income declared to the revenue, encourage our most talented people to remain in Ireland, and encourage talented outsiders to consider Ireland as an attractive base. Further, a cut in income tax rates may be a means of achieving the same ends as a currency devaluation. In short, serious consideration should be given to a proportionate tax rather than our current trajectory of increasing taxes and digging ourselves into an ever deeper hole.

Many will object that this is not “progressive”. However, the choice is stark: a return to the 1980s, with the added millstone of a zombie bank system, or we could take a brave step – bringing in a proportionate tax that everyone pays, allowing us to retain talent in Ireland and encouraging more to relocate to here. That would increase demand for real estate, and hence salvage our banking system and economy before it is too late.

Eamonn Walsh is professor of accounting at UCD Michael Smurfit Graduate Business School

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