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Time for automatic annual review of all tax expenditures
Social Justice Ireland believes that it is time for reform of Ireland's structure of tax reliefs. A key reform must be that each relief is at least subject to automatic periodic review. The preferable option would be for a sunset clause on each expenditure.
What are tax expenditures?
Tax reliefs - or tax expenditures, as they are sometimes known - are policy tools for reducing an individual's tax liability. They are usually used to encourage specific economic or social activity by giving a “tax break” to individuals engaging in certain types of behaviour. They can be politically appealing as they allow policymakers to encourage certain types of activity, or spending in a particular area, without increasing direct government expenditure or incurring an additional administrative burden.
For this reason, it is often forgotten that tax reliefs represent revenue to the government that is being foregone so there is always a cost attached. In 2016, tax reliefs amounted to approximately 10 per cent of total tax revenue and 9 per cent of government expenditure. This is very significant. However, unlike direct government expenditure, tax reliefs are not subject to annual assessment as part of the budgetary process. Social Justice Ireland considers it extraordinary that this is the case, given the significant cost.
Additionally problematic is the fact that, by their very nature, tax expenditures are regressive. Because government revenue is being foregone, this funding needs to be made up elsewhere in the tax system to maintain the same level of service provision, so the cost of tax reliefs are spread among all tax payers*. Yet not everyone can benefit from these reliefs, and it is almost always those with the greatest income that are best placed to avail of them.
For this reason, tax reliefs represent a departure from the equity principle of taxation, as they typically benefit higher earners to a much greater extent than lower earners. Tax reliefs/expenditures have even been shown to be regressive by the government’s own Commission on Taxation. Recommendation 8.3 of the Commission on Taxation's Report was that ‘in general, direct Exchequer expenditure should be used instead of tax expenditures’. The report justifies this asserton by going on to say that ‘to the extent that the beneficiaries of tax expenditures are those with higher incomes or substantial capital, this results in a transfer of financial resources to these beneficiaries by the rest of the taxpaying community, including those on low income. In other circumstances, tax expenditure not replaced by increased taxation may lead to reduced public expenditure on essential projects’.
Indeed tax reliefs are incapable of being progressive as they are of benefit only to those earning taxable income*, and usually the more taxable income earned the greater the benefit can be derived.
For these reasons it is important that tax reliefs - particularly the most costly ones - undergo proper administrative scrutiny and parliamentary debate to ensure they remain fit for purpose, cost effective, and do not outlive their usefulness. Though it is difficult to estimate the cost of many reliefs, it is still important that such calculations are carried out, even if the resulting estimation is only a rough one. Social Justice Ireland believes that as part of the budgetary process, the cost of tax reliefs (by type) for each past year should be published, as should the estimated cost of tax expenditures for the year ahead. Furthermore, when considering whether to implement a proposed tax relief, government should be obliged to state publicly:
- The objective the tax relief aims to achieve;
- The other options considered, and why the tax relief is deemed to be the best approach;
- The economic impact the tax relief is likely to have;
- The estimated cost.
There should also be, at the very least, scope for automatic periodic review of each tax relief. The preferable option would be for a sunset clause on each relief, so that the relief/expenditure can be reviewed and judged on its merits. Questions that should be asked include:
- How much did the tax relief cost?
- What was the impact of the tax relief?
- Was it efficient?
- Is the tax relief still relevant?
Examples of Tax Reliefs/Tax Expenditures
One important (and costly) example of tax reliefs in action are those related to the private pension industry.
The government incentivises people to invest in private pension plans using tax reliefs which employees receive at source if they contribute to a pension plan. Each individual receives relief at their marginal rate, so those who pay tax only at the lower 20 per cent rate receive relief at that rate, while those who earn income that is taxed at 40 per cent receive relief on all their contributions at 40 per cent - double the rate of their lower paid colleagues. Investment returns to pension funds are also fully exempt from tax, and a substantial part of the fund (up to €200,000) is also exempt from tax upon drawdown at retirement.
Research by Micheál Collins and Gerry Hughes suggests that the employee and individual contribution element of this relief cost the Exchequer around €664 million in 2014. If the various other reliefs and exemptions related to private pensions were included, this figure would run into the billions** but for now we will concentrate on this personal income tax-related relief.
This system of incentivisation is extremely regressive. Higher earners receive the relief at double the rate of lower earners, while Collins and Hughes estimated that in Ireland in 2014, between 72 per cent and 74 per cent (depending on whether or not employer contributions are included) of pension tax reliefs accrued to individuals in the top 20 per cent of the income distribution.
In the past the ESRI has noted several studies that indicate significant deadweight loss associated with tax incentives for pensions and suggest that only small fractions of the amounts saved in pension schemes represent new savings. The corollary is that these tax reliefs are an expensive means of supplementing saving that would have taken place anyway, particularly so for those on higher incomes.
Despite this, the impression one gets when engaging with policymakers on the issue of private pension-related tax relief is that not only is the cost or efficiency of this policy not being reviewed on a regular basis but it isn’t even open for discussion. There is a need for systematic review and evaluation of tax expenditures which have such a high cost to the Excehequer.
Another example of tax reliefs in action are those related to Research & Development (R&D) in the corporate sector.
Subject to certain criteria, a company can qualify for a Research & Development (R&D) Tax Credit. The company must be paying corporation tax in Ireland and carrying out R&D activities here in the fields of science or technology. The credit was introduced in 2004 and provides for a 25 per cent refund of qualifying R&D expenditure against the corporation tax liability of the company.
It makes sense to encourage firms to invest in R&D, particularly as scientific R&D often has beneficial spill-over effects for the rest of the economy. However the Irish Government Economic and Evaluation Service (IGEES) estimates that only 60 per cent of the R&D funded under the scheme is new research that would not have taken place anyway, which means 40 per cent of the expenditure is deadweight. This credit has been estimated to cost the Exchequer around €700 million each year.
How much of these tax reliefs is considered value for money is debatable. It would certainly appear that the pension-related expenditures are poor value for money, acting to subsidise savings that would generally take place anyway and redistributing income in a regressive manner. They are also extremely costly.
As part of the European Commission's (EC) Country Specific Recommendations for Ireland in 2018 (and in previous years), the EC has called for a limit to the scope and number of tax reliefs/expenditures. Tax reliefs are essentially financial subsidies from the Exchequer (i.e. the taxpayer) to the beneficiary and require higher taxes among the non-recipients to make up the difference. Implementation of the recommendations above should be the very least Irish taxpayers can expect.
*It is worth noting that while not all people have taxable income, almost everyone in Ireland is a taxpayer in some respect - an 8 year old child buying a chocolate bar pays VAT at 23 per cent - and therefore feels, in some way, the increased burden of taxation that results from the implementation of tax reliefs directed at certain individuals.
** A decade ago, these exemptions were estimated to cost the Exchequer around €3 billion per annum in total. This amount has since probably fallen to somewhere between €2 billion and €2.5 billion per annum.
This article drew heavily on information contained in the Parliamentary Budget Office’s recent report on tax expenditures, available in full here.