A. Introduction

1. Ireland has experienced a persistent reduction in its tax yield in recent years. This has largely reflected tax cuts, which coincided with an extended period of rapid economic growth. However, a recent sharp reduction in actual and prospective growth, as well as increased demands for higher fiscal expenditures, has likely precluded further tax cuts—indeed, as discussed in the staff report, possibilities for revenue increases may need to be explored.

2. Against this background, this note examines Ireland’s tax effort from an international perspective. It notes that its tax revenues are comparatively low, and have been declining over the past two decades. This pattern reflects a combination of both developments in the size of relative tax bases, labor, capital and consumption, as well as in average effective tax rates. Ireland is seen to tax both labor and capital relatively lightly, while consumption is relatively heavily burdened. The note concludes with some background on specific tax measures as discussed in the staff report, including reducing tax expenditures; eliminating VAT zero rating and unifying the remaining rates; and introducing a local property tax.

B. Ireland’s Comparative Tax Effort

3. Ireland has a comparatively low tax yield among advanced economies, expressed as a share of GDP (Figure 3.1). Its tax yield, at slightly above 30 percent on average over 1996–2000, is well below both the European Union and OECD Europe averages. Its share is more comparable to yields of other Anglophone economies—Canada, the United Kingdom, Australia, and the United States—than to its EU continental partners. Also its tax yield may reflect with a lag Ireland’s until recently lower-than-average per capita income within the EU, as tax yields are generally positively correlated with income levels.²

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Ireland: International Comparisons of Tax Revenue, 1995–2000

(1995–2000 Averages; Percent of GDP)

Citation: IMF Staff Country Reports 2002, 171; 10.5089/9781451818796.002.A003

Source: OECD Revenue Statistics.1/ 1995–19992/ 1998–2000

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4. The composition of Ireland’s tax revenues also differs from EU patterns in a number of respects. It relies to a somewhat greater degree on direct taxes, especially personal income taxes, while a much smaller share of tax revenues come from social insurance contributions (Figure 3.2). The latter is consistent with Ireland’s lower social security expenditures (as a share of GDP)—a feature of other Anglophone economies—compared with continental Europe. However, Ireland also derives a large share of revenues from indirect taxes, accounting for some 35 percent of the total, compared to 30 percent in the EU and OECD in general. This comprises both a greater reliance on the VAT, as well as large excise revenues. Despite these differences, the five largest taxes, on households’ and corporations’ incomes, social insurance contributions, and general indirect taxes (including VAT) and excises account for about 90 percent of all tax revenues in Ireland and in the EU and OECD averages.

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Ireland: Tax Compostion—International Comparisons, 1965–1999

(Percent of Total Tax Revenue)

Citation: IMF Staff Country Reports 2002, 171; 10.5089/9781451818796.002.A003

Source: OECD Revenue Statistics.

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5. Ireland’s tax yield has varied substantially in recent decades (Figure 3.3). Since the late 1980s, and following a sharp increase in the tax burden, Ireland has enjoyed a “virtuous circle” of economic prosperity, burgeoning revenues, declining government debt (as a share of GDP), and falling debt servicing costs. This has allowed for a reduction in the tax effort by about 6 percentage points of GDP in the last 15 years.

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Ireland: Tax Revenue, 1965–1999

(Share of GDP)

Citation: IMF Staff Country Reports 2002, 171; 10.5089/9781451818796.002.A003

Source: OECD Revenue Statistics.

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6. This note uses the average effective tax ratios (AETRs) initially proposed by Mendoza, Razin and Tesar (MRT, 1994) to assess Ireland’s tax effort from a cross-country perspective. This approach has become increasingly popular as a proxy for effective marginal tax rates chiefly because of its simplicity: it uses internationally comparable national aggregate revenue data and proxies tax bases with internationally comparable national accounts data. Data sources and methodology underlying the AETR calculating are given in the Annex. Thus, it reflects actual revenue generated from potentially vastly different tax systems, effectively accounting for a multitude of details regarding various deductions, statutory tax rates, allowances and credits.

7. The AETR approach, nevertheless, has a number of drawbacks as a proxy for effective marginal tax rates, which are thought to have a more important influence on economic decisions.³ Among the more important implicit assumptions, which may not hold, are: (i) that the taxes are borne by those paying them (i.e., not shifted to others), (ii) that the calculated (backward-looking) average tax rates are good proxies for expected future marginal tax rates; (iii) that national accounts-based tax bases are good proxies for actual bases (e.g., capital gains are included in many tax receipts, but not in national accounts tax bases, thereby overstating tax rates); (iv) and that loss carryforwards are not significant. Nevertheless, they remain a good “first brush” measure of economies’ relative tax reliance. Subsequent work has suggested further refinements (see the references in footnote 3), but in most cases the variations in tax rates over time within a country, and relative country rankings over the most recent period using alternate tax estimates tend to be highly correlated.

Tax base comparisons and developments

8. About 90 percent of Ireland’s total tax revenues can be allocated to the three broad tax bases, labor, capital and consumption. Therefore, differences in its tax effort over time, or compared to that of other economies, should largely reflect differences among, and changes in, the size of these component tax bases and average effective tax rates. As seen in Figure 3.4, Ireland’s wage share of GDP is roughly equal to the EU average and slightly below the OECD average. In sharp contrast, Ireland’s net operating surplus as a share of GDP is second only to Greece’s among OECD countries, and more than 10 percentage points of GDP (or well over one standard deviation) above the EU15/OECD averages. This largely reflects the growing importance of foreign direct investment activity in Ireland over the past decades. Foreign factor incomes (the overwhelming bulk of which are returns to capital) accounted for more than 13 percent of GDP during 1996–2000⁴ Ireland’s consumption tax base is among the smallest in the OECD (and slightly more than one standard deviation below the EU15/OECD averages); likely reflecting the low economic share of household incomes (comprising an average wage share and a relatively low share for unincorporated operating surpluses), as well as a relatively small government.⁵

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Ireland: Relative Tax Bases—International Comparisons

(1996–2000 Averages)

Citation: IMF Staff Country Reports 2002, 171; 10.5089/9781451818796.002.A003

Sources: Carey and Robesona (2002); OECD (2001); and staff calculations.1/ 1996–1999.2/ 1996–1998.

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9. Ireland’s main tax bases have shown surprising variation over time (Figure 3.5). Broadly speaking, capital’s income share has increased at the expense of labor, to the point where they are now about equal at slightly less than 40 percent of GDP each, compared to labor’s share being two-thirds larger than capital’s share twenty years ago. The share of private and public non-wage consumption has declined as a share of output. These patterns are also apparent, though somewhat attenuated, when expressed as a share of GNP.⁶ However, it should be noted that because foreign direct investment can be taxed, GDP rather than GNP is the appropriate tax base.

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Ireland: Tax Base Developments, 1977–2000

Citation: IMF Staff Country Reports 2002, 171; 10.5089/9781451818796.002.A003

Sources: OECD; and staff calculations.

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10. On the basis of the relative size of Ireland’s major tax bases, and assuming that its tax rates were comparable to those of other countries, one would likely expect that Ireland’s tax yield would fall somewhere in the middle. While its wage share of GDP was broadly comparable to the OECD average, its net operating surplus was among the highest, and its consumption share was among the lowest. However, its actual tax effort depends upon its relative AETRs, and their interaction with the relative tax bases.

Tax rate comparisons and developments

11. As noted, effective tax rates reflect the complicated interaction of statutory tax rates, as well as various exemptions, allowances, deductions and credits. Figure 3.6 compares Ireland’s average effective tax rates, based on the original MRT (1994) equations (as discussed in the Annex), with those of other OECD economies (and separates the AETRs on labor and consumption into its major components). Other, more sophisticated estimates of AETRs are found to suggest broadly comparable levels, patterns, and relative tax rates across countries.⁷

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Ireland: Average Effective Tax Ratios—International Comparisons

(1996–2000 Averages)

Citation: IMF Staff Country Reports 2002, 171; 10.5089/9781451818796.002.A003

Sources: Carey and Robesona (2002); and staff calculations.1/ 1996–1999.2/ 1996–1998.3/ Split between personal income tax and payroll tax/social security contributions not available.

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12. The results suggest that Ireland taxes direct income from both labor and capital comparatively lightly, while taxing consumption relatively heavily. Its low rate of labor income taxation (more than one standard deviation below both EU and OECD averages) reflects mainly low social insurance contributions which, abstracting from those countries that do not have payroll-financed social security systems (Australia and New Zealand), is among the lowest in the OECD. However, Ireland’s social security contributions are not far out of line with those of countries like the United States and the United Kingdom which, like Ireland, have low social security expenditures compared with continental European countries. More recently, Ireland has further cut personal income taxes, broadened the zero-and lower-rate brackets, reduced the upper rate to 42 percent, and introduced individualization of taxation. Ireland’s low rate of capital income taxation has been an explicit policy choice, which has resulted in a statutory and effective tax rate far less than international averages, but has yielded—aided especially by large foreign direct investment—revenue comparable to those of other OECD economies (Figure 3.2). Ireland’s average effective consumption tax share, in contrast, is among the highest of OECD economies (slightly less than one standard deviation above country averages). While VAT effective rates are close to EU averages, excise efforts are more ambitious.⁸

13. Ireland’s AETRs have varied somewhat over time, but taxes on labor and capital have been broadly stable since the mid-1980s (Figure 3.7). Taxes on labor and consumption both rose in the early 1980s, and the latter, after falling somewhat over the next decade, has been rising again since the early 1990s. Similar patterns were seen in Carey and Rabesona’s AETRs as well.

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Ireland: Average Effective Tax Ratios, 1975–2000

Citation: IMF Staff Country Reports 2002, 171; 10.5089/9781451818796.002.A003

Sources: Carey and Rabesona (2002).

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C. Selected Taxes in Ireland: Some Stylized Facts

15. This section provides background on three areas identified in the staff report from which increased revenues could be obtained: (i) reducing tax expenditures (e.g., limiting personal income tax deductions, including those for mortgage interest payments); (ii) unifying the VAT rate; and (iii) introducing a local property tax.

16. The personal income tax has recently undergone a number of reforms, extending the zero- and lower-rate brackets, lowering statutory rates, and introducing individualization of tax liabilities, which have significantly reduced the exceptionally progressive nature of the personal tax structure and increased work incentives (OECD 2001). A number of tax exemptions, allowances and credits exist, but their impact on revenues is difficult to judge without a comprehensive assessment of tax expenditures. Nevertheless, tax credits against mortgage interest payments may be a potentially significant tax expenditure. Given concerns about the impact of an immediate elimination of this credit on housing prices, the credit could be frozen in nominal terms or phased out over a period of years. This would, however, limit its revenue impact.

17. Ireland administers a VAT system with a relatively high standard rate, at 21 percent, a 12½ percent lower rate and a zero rate bracket. The standard rate applies to about one-half of all private consumption, yielding about two-thirds of revenues, while the lower rate covers almost 40 percent of consumption and yields the remaining one-third of revenues. The zero rate applies to a relatively broad category of goods, including food, oral medicine and children’s clothing, covering about 10 percent of total expenditures. Ireland’s effective VAT rate, defined as the ratio of the actual VAT revenue to that which would obtain from applying the statutory rate to the consumption base, is about 60 percent, placing it in the middle of EU and OECD efforts (OECD 2001).

18. Although Ireland’s average effective tax rate on consumption is already relatively high, increased effort in this area could be achieved with likely fewer distortions than would result from higher direct taxation. As an (unrealistic) upper bound, a static calculation of unifying all VAT rates at the standard rate suggests that revenues could be increased by about one-third, or about 3 percentage points of GDP. More realistically, unifying the rate at a lower standard rate (with adjustments made as well for excise rates, where necessary) would generate additional revenues and be less distortionary than the present system. Aside from a temporary impact inflation rate price level, there would be two arguments against unifying the rates. First, there may be concerns about the potential regressive nature of a single rate VAT. However, such concerns need to be weighed against the argument that zero rating is usually a highly inefficient way to address equity concerns. Although zero-rating has a proportionally larger impact on lower income households, the benefits in absolute terms accrue mainly to upper-income groups, given their larger absolute expenditures on zero-rated items compared with lower income households (see Ebrill and others, 2001). It would in fact be more efficient to offset any adverse effects on the poor directly through targeted transfers, including possibly through the use of earned income tax credits. Second, given VAT zero-rating on similar items in the United Kingdom, there is the possibility of revenue leakages from increased or reverse cross-border purchases.

19. Ireland’s local tax effort, generating just two percent of total tax revenue, is second lowest of all OECD economies, and well below an unweighted average of 13.3 percent of all revenues among unitary (i.e., nonfederal) fiscal systems (OECD 2001). The benefits to greater local authority in revenue generation are well known, including greater accountability to local citizens and greater potential flexibility in setting the level of public services in light of local preferences. As local taxes are also often in the form of property taxes, preferences regarding tax progressivity could also be incorporated.