| A flat rate tax is not a new idea, but it is an idea with a head of steam behind it these days. What relevance does it have to Ireland? May we stumble into having it anyway? Would its adoption elsewhere in the EU affect us? |
What is it?
A flat rate tax can sometimes be a slogan, and therefore can mean whatever the politician using the expression wishes it to mean. But usually the idea is that tax should be paid by everybody, and on all forms of income or gains as the case may be, at the same rate and without any reliefs or exemptions from the tax. What is advocated is equality in tax, or, one man, one rate.
The suggested advantages include:
• Cutting administration costs by simplifying the structure of tax
• Providing an incentive to work harder and to take risks
• Reducing distortion of the economy due to interference with market forces by elements of the tax system
• Potentially increasing revenues.
The idea has been about in the USA for decades. It was the principal plank in the platform of the Republican multi millionaire Forbes when he ran for the Republican nomination in 1996. It is thought to be favoured by some elements in the CDU in Germany. It has been receiving a lot of favourable press recently.
No more interference?
An obvious implication of a low flat rate of tax combined with no reliefs or exemptions is that the power of the government to interfere in the economy by means of the tax code would be significantly reduced. Free market economists might applaud the notion but there is no mistaking the fact that interference in our economy through the tax code has been a central plank of government policy for the last 60 years in Ireland and that our prosperity for the last 15 years is in no small part due to such inspired interference.
A flat rate tax would not have permitted urban renewal reliefs. A flat rate tax would not have permitted export sales relief or manufacturing relief. A flat rate tax would have been inconsistent with tax breaks for Shannon or the IFSC. A flat rate tax in its purest form would be inconsistent with tax breaks for research and development, or for film making or for cr?ches.
The attractiveness of the flat rate tax in its purest form for some elements in America is obvious, but it is less obvious that it would have been a suitable policy for Ireland, at least in the past.
And what about equity?
‘Equity’ tends to be a rather meaningless phrase but for many, it is inextricably linked with the notion of progressive personal tax rates. Put another way, it signifies that the rich should suffer! That the poor should benefit is usually seen as much less important.
Most flat rate tax advocates do not advocate a single rate of tax to apply to all income. They would usually accept that a certain level of income has to be entirely exempt from tax. Thus flat rate tax usually means a dual rate of tax, with the lower rate being zero, and the higher rate being some positive rate. In that sense a flat rate tax preserves the notion of progression in tax rates.
Progression in tax rates is something of a holy cow. How much progression is necessary? Would anyone today suggest top tax rates in the upper 90 per cent, along the lines implemented by the post war Labour Government in the UK? Would anyone advocate a return to the 65 per cent rate inflicted on the country by the Government of Garret Fitzgerald? Or even to the 53 per cent top rate which we suffered as recently as 1991?
So perhaps there is nothing very sacred about a 42 per cent top rate, and if there is nothing sacred about any particular level of top rate, logically there should be nothing sacred about having a top rate.
In one curious way, a flat rate tax combined with the abolition of all reliefs and exemptions could actually bring about a situation which might be closer to some commentators’ definition of ‘equity’. It ought to result in a situation where everybody earning the same income would pay the same tax. At present of course that is not the case since the amount of tax paid depends heavily on what reliefs and exemptions the taxpayer avails of, and on even such matters as the source of his income. For example, a person earning ?60,000 a year entirely from encashment of unit trusts, and from deposit interest, might pay tax at no more than a rate of 23 per cent whereas a taxpayer with identical income from employment might pay a top rate of 42 per cent.
There is currently a review in progress of many tax incentives which can be used by taxpayers to reduce their tax burden, and therefore to produce an unequal tax burden as between taxpayers with identical income. That review, if it did lead to the elimination of many or most tax reliefs and exemptions, could give us one side of a flat rate tax – the elimination of reliefs, without giving us the corresponding benefit of a reduced and single rate of tax. It would be a very Irish solution!
A threat?
Would the adoption of a flat rate tax abroad impact on Ireland? Ireland has many attractions to a multinational as a location for inward investment. But our headline rate of corporation tax and trading income - 121⁄2 per cent - is the jewel in our crown in that respect. The adoption of flat rate tax for business tax purposes abroad would have the effect of abolishing the high headline rates of tax in those countries adopting the flat rate tax, while at the same time eliminating most of the various tax breaks and reliefs that in reality give an effective lower tax burden than the headline rate would suggest.
For many businesses operating in, say, Germany, the abolition of all tax breaks for business combined with a cut in the headline tax rate for business might leave their effective tax burden unchanged, especially if they have been actively availing of those reliefs and tax breaks that exist at present. To that extent it might seem that Ireland’s competitive position in terms of tax rates would not have been affected.
However the stark contrast between Ireland’s headline rate of 121⁄2 per cent, and the high headline rates in our Continental neighbours, and in the UK and in the USA would be blunted. To compare a 121⁄2 per cent rate with 40 per cent is stark, but to compare it with 25 per cent, although still highlighting a real difference, makes a less powerful statement.
The adoption of flat rate taxes abroad probably would hurt Ireland while at the same time it is highly unlikely Ireland could ever bring itself to face the trauma of abolishing all our precious tax reliefs – our principal private residence relief from capital gains tax, our relief for contributions to pensions, for donations to charities, our relief for upkeep of heritage houses, to name but a few – in order to embrace the brave new world of flat rate tax. |
Conor O’Brien is a tax partner at KPMG
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| Article appeared in the November 2005 issue.
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