Monday, 3 June 2013

With the property tax deadline now passed I felt it was time to put pen to paper regarding the tax.

            Anyone who has read or listened to the national media in recent months will be aware that the tax is deeply unpopular, with people feeling that they are at a wits end financially. This tax it is claimed will push many over the edge… The strange thing is, most people have also said that they would be far less hostile to a similar increase in income tax. Why is that? Well let’s say the average property tax bill for the year will be 250 – the amount can be paid in many ways, it can be taken directly from pay, a direct debit can be set up or it can be paid off in one go. Furthermore, reports have suggested, that the government may be ready to, decrease the level of austerity, given the recent wins with the promissory notes and the extension of the bailout loans. So what if the government were to decrease the average earner’s income tax by 250, effectively rendering the net tax effect as 0, would this reduce the hostility?

I don’t believe so; the reason for the hostility is that this is a new tax, which can and undoubtedly will rise in the future. The government’s plan is primarily to get people registered and used to paying the tax. Once people have given into paying the first time, it will become part of the norm and another source of much needed funds for the country. So while the net effect this year may be 0 (at least for those with a job) the fact will remain that the government has a new instrument, which they can use to extract money from individuals.

So let’s look at a world with no property tax. The government undoubtedly needs to raise more money, which they can do in one of two ways. They can cut spending or they can decide to raise the tax take. One of the most lucrative ways of increasing tax intake is by increasing income tax. There are three lose brackets of society that they may tax, those on the lowest incomes who pay little or no tax (although it is increasing), due to the tax free allowance, those on middle incomes who pay tax at the lower level and some at the higher level and the wealthy, who pay most of their tax at the highest level. Most governments, and especially a coalition including the Labour party, will want to avoid taxing the lowest paid. The middle class are less vulnerable but, with the majority of people at this level already suffering from severe austerity fatigue, a move such as this may drive voters - in a key demographic - towards other political parties. That leaves the wealthiest, there are few in society who would feel that the rich should not contribute more and most governments will agree. Rich people though are unlikely to agree, and in an increasingly globalized world they can easily move themselves and their money out of the government’s reach. For an illustration of this, look at the amount of wealthy French people fleeing to London. Closer to home, U2 are tax resident in the Netherlands. Undoubtedly both the middle class and the wealthy will bare the brunt but raising taxes will only work up to a point.

What about other taxes such as corporation tax? Well, as has become clear in recent weeks the low level of corporation tax in Ireland is a huge part of the government’s strategy on jobs. Given the unwillingness of banks to lend and the lack of confidence amongst SMEs, it would seem that in the immediate future foreign direct investment will be the biggest source of employment growth. So it is highly unlikely that the government gave any thought to raising the rate of this tax. The government could also raise the level of VAT but as this would directly effect consumer spending in a negative way this is also unlikely to have been discussed. As well as this Ireland is trying very hard to attract tourists, on the basis that it is a lot more affordable to come here now, raising VAT would not help this strategy which is another focus of the job creation plan.


The Benefits of the Property Tax

The problem with raising income taxes is it also raises the cost of employment, in an increasingly competitive world and, with Ireland’s unemployment rate standing at over 13%, is increasing tax on labour really a sensible strategy? The answer to this is no, nonetheless, without a raise in income tax the government still has the problem of needing to raise more cash. VAT and capital gains taxes also have their limitations as discussed, as they penalize businesses and startups disproportionally. So, where does the government turn? The obvious answer is to a new form of tax that is not easy to avoid – the property tax. It also has a benefit in that it has no impact on the cost of employment. Therefore, as per the prospect raised earlier, if the government lowers the income tax by €250 labour will become cheaper and in theory employment should rise.

The Drawbacks

            At a time when the property market is showing tentative signs of stabilization this tax may cause another wobble in property prices. The buy to let market is already in dire straights, with a huge number of these properties in arrears. This tax may push buy to let owners over the precipice, which could lead to a large increase in the supply of housing. If this supply outstrips demand the price of property will take another fall. As demand is a function of mortgage lending and, as mortgage lending is weak, this possibility is very real. Another factor to consider is that building inspectors are now beginning to do inspections on houses - that were converted to apartments - during and preceding the boom years. There are many that will not be up to scratch e.g. having no windows in a bedroom, and these properties will either need to be invested in or more likely sold which will add to the glut in the market. Clearly it is in everyone’s interests for the price of property to start rising again so the timing of this tax may be questioned in years to come. However, as I outline below, Ireland is behind the curve in introducing a tax of this type and, so is merely catching up with other nations, albeit at a difficult time economically.

The Alternatives To Tax

So what are the alternatives? Well as discussed the tax alternatives are highly unpopular and likely to do more damage to the fragile economy. The other option therefore is spending cuts. This is a viable option and many economists would claim that this is the way out of recession, lower taxes to stimulate employment and activity, and a cut spending to reduce the government’s role in the economy and allow private enterprise to kick start growth. There is no doubt that there are savings to be made in areas such as healthcare and social welfare, but as has been seen in the Croke Park/Haddington Road negotiations cutting people’s wages is not easy. Cutting benefits would also lead to an outcry from the less well off. Our neighbors Britain have championed the idea of cutting spending and although a lot of pain was felt initially there, it seems that there are green shoots of growth now appearing. The British have the benefit of their own currency, but nonetheless they have wielded the knife on the bloated public services sector and, have clamped down on benefits. Britain is increasing the tax-free allowance, is increasing the tax bands on income, has lowered the top rate of income tax and is lowering the rate of corporation tax.

The other aspect of this is the fact that it is important to cut the right type of spending. Cutting current spending e.g. wages and benefits is a priority however cutting capital spending e.g. roads, broadband infrastructure etc. can be more harm than good as this type of spending boosts the economy and creates employment.

The final option left to the government would be to declare bankruptcy or restructure it’s debt. This, may be viewed by many, as being the ideal scenario, after all the average guy on the street did not decide to bail out the banks. He has however had to pay for it, face savage spending cuts, massive tax hikes and has seen his family and friends emigrate in their droves. Would bankruptcy change this? Had the government decided to allow the banks to fail in 08/09 there would have been chaos, savings would have been wiped out and there would be no Irish banks left to make loans. Without credit the economy would rapidly have declined.  However, it would in time have bounced back and may even be in a better state than it is today. Our international credibility would have taken a big blow however. I have no doubt that at this stage of the game Ireland is better off sticking to it’s current plan as the economy and housing market seem to be slowly turning around. 

If you would like an illustration, of an example of a country that underwent bankruptcy look no further than Iceland, the country is doing quite well, and with it’s low levels of debt, will be well positioned when the global economy starts to grow again. On the other hand, Argentina which defaulted in the early noughties is still feeling the affects with no sign of it recovering any time soon.


In Conclusion

To give the government it’s due they are only catching up with most other European countries. Take a look at the UK, in London someone who lives in the borough of Islington in a modestly sized one bedroom apartment would be expected to fork out about £1,200 a year in council tax (a property tax by any other name). The council tax is decided individually by each of the 32 borough councils so your neighbor could be paying significantly more or less than you if you happen to live on a boundary. This tax has been around since 1990! This tax does cover services like bin charges and other council amenities, but it is still a lot higher than the Irish property tax.


If as is expected the government cuts income taxes for the average earner, then I believe this will tax will become more palatable, the ultimate aim is to restore the faith in the country, and reducing out deficit is a key aspect of this. With water charges to come there is no doubt that there is more pain to come for the people of Ireland, but in time I am confident that this pain will pay off.