Budget Perspectives 2008

ESRI/FFS BUDGET PERSPECTIVES 2008 CONFERENCEIntroduction: Frances RuanePAPERS:Fiscal Policy for a Slowing Economy Philip R. Lane (IIIS, TCD) In his paper presented at the ESRI/FFS Budget Perspectives 2008 Conference, Philip Lane (IIIS/TCD) asks What are the implications for fiscal policy of the current deceleration in output growth? Over 2003-2006, total government spending and total tax revenues have grown markedly faster than GDP, with revenues from capital gains taxes and stamp duties growing especially fast. The transition to a period of more modest output growth rate poses an adjustment problem, with the fiscal diagnosis sharply different for the capital and current budgets. Philip Lane points out that: The prolonged period of under-investment during the 1980s and early 1990s means that the level of public capital in Ireland remains below its optimal level and a high growth rate of public investment should be maintained. However, growth in current spending has to be considerably restricted. Moreover, in tackling the competitiveness problem that is a contributor to the current slowdown, a reduction in the growth of the public sector payroll can relieve labour cost pressures in the private sector and facilitate a re-balancing of the economy towards the export sector. Managing the transition to a slower pace of output growth and public sector expansion can be best achieved, Philip Lane says, in the context of a supportive socio-political environment. While social partnership proved to be effective in facilitating recovery from a crisis situation in the mid-1980s, the challenge for the social partners is to ensure that fiscal expectations are well managed during a phase of a moderate slowdown in economic growth. Pension Priorities: Getting the Balance Right Tim Callan (ESRI), Brian Nolan (UCD) and John Walsh (ESRI) The government's Green Paper highlights the question of whether tax incentives for pensions could be better targeted. At present, tax relief on pension contributions is offered at the full marginal rate, making the relief of greater value to those on higher incomes who pay at the top rate of tax. The Green Paper raises the question of whether tax relief should, instead, be paid at a single standardised rate for all taxpayers. Analysis by ESRI and UCD researchers shows that, under the current system, three quarters of the total value of tax relief on pension contributions goes to high income households (the richest 20%). They explore a policy option which involves standardisation of tax relief on pensions " along the lines of the standardisation of tax relief on mortgage interest introduced some years ago. Their analysis shows that if tax relief were standard-rated, this could raise substantial revenue " enough to finance an increase in the social welfare pension of the order of "50 per week. This would greatly reduce the risk of poverty for elderly persons. There would, on the other hand, be substantial income losses, but these would be confined to the richest 20% of households. While a number of issues relating to this policy option require further analysis, these initial results indicate that further investigation of the balance between tax relief on pensions and direct expenditure on social-welfare pensions could pay substantial dividends. Is EU Coordination Needed for Corporate Taxation? Albert van der Horst (Central Planning Bureau, Netherlands) andResponse: An Irish Perspective Frank Barry (TCD) Proposals by the EU Commission for a common, consolidated corporate tax base (CCCTB) have generated considerable controversy. A study by Albert van der Horst (of the Netherlands Central Planning Bureau) examines what effects might be expected if such proposals were implemented. His findings suggest that there would be little if any gain in terms of economic efficiency at the European level from the implementation of a CCCTB. Some countries would gain, but there would be counterbalancing losses elsewhere. If, however, consolidation of the tax base were combined with a harmonised tax rate, there could be small aggregate gains at the EU level (of the order of one tenth of one per cent of GDP). Even then, the effects vary across countries, with some countries gaining, and others, including Ireland, losing from such a reform. Responding to the paper, Professor Frank Barry (TCD) welcomed it as one of only a few studies to examine the economics of the common consolidated tax base proposals. A consolidated tax base would reduce compliance costs for multinational enterprises (MNEs), but would, as the study shows, cause firms to shift real production activities across borders in order to continue to reap the benefits of differences in tax rates. It would therefore aggravate tax competition. The inefficient reallocation of real activities across borders, as the paper suggests, could only be tackled by harmonising tax rates alongside consolidation of the tax base. However, this outcome is unlikely as each EU country retains a veto over any such proposals in the new EU treaty. Even if it were possible to get agreement by every country, this harmonisation with consolidation approach would, it is estimated, yield only a relatively small welfare gain to the EU as a whole (with some countries such as Ireland losing out), but this finding arguably ignores two key characteristics of global tax systems. The first is that larger, richer and less peripheral countries in Europe are particularly attractive to investors, and these countries exploit this factor by levying higher corporation tax rates than countries like Ireland or the new member states of Central and Eastern Europe. There are good reasons why some countries choose high tax rates and others choose low ones. Once this is recognised, it is clear that harmonisation could be detrimental to both groups of countries. A further related point concerns the specifics of the US tax system, which is particularly important for Ireland as it is the single most important source of inward FDI. The United States taxes income on a residence basis, meaning that American corporations owe taxes to the US government on all of their worldwide income. In order to avoid subjecting American MNEs to double taxation, the US provides a tax credit for aggregated income taxes paid abroad. There are no rebates for taxes paid abroad at rates in excess of the US rate however. This means that the existence of a low-tax jurisdiction like Ireland reduces the disincentives that US firms face in investing in high-tax economies such as Germany. This strengthens the earlier point: if EU countries have reasons to choose different corporation tax rates, then a low tax jurisdiction facilitates the higher tax jurisdiction in maintaining its inflow of FDI. Recent empirical evidence, which shows that the firms most likely to initiate operations in low-tax countries are those with growing activity in nearby high-tax regimes, supports this proposition. Macroeconomic Background for Budget 2008 Alan Barrettt, Ide Kearney and Martin O'Brien (ESRI) present the macroeconomic context for the Budget, drawing on the forecasts and assessment in the recently published Quarterly Economic Commentary, Autumn 2007. The analysis pays particular attention to the state of the public finances and the resulting expenditure options for Budget 2008.