Dáil Éireann Debate, Tuesday - 18 February 2014
178. Deputy Brendan Griffin asked the Minister for Finance the expected increase in indirect taxes such as VAT from which the State will benefit as a result of every €1 million cut in income tax; and if he will make a statement on the matter. [7759/14]
View answerIn analysing the economy and in producing economic forecasts, my Department models household disposable income in aggregate terms and projects how this income is allocated between spending and savings. The impact of these decisions on tax revenue and employment is also modelled.
When assessing the potential impact on the economy of such a measure, my Department must weigh the short-term benefits on economic output against the impact on the public finances. In this regard research produced by the ESRI as part of its Medium-Term Review of July 2013 is informative. Using the HERMES macroeconomic model, the ESRI tested the economic impact of a series of fiscal shocks to the economy. It includes simulations of the impact of a €1 billion adjustment in income tax.
The results of the research suggest an income tax multiplier of -0.6 that is, a €1 billion reduction in income tax results in additional GDP of about €600m million over the forecast horizon.
The relatively low GDP multiplier likely reflects the open nature of Ireland's economy and the fact that increased demand would 'leak out' through imports. The simulations also include the assumption that some part of a reduced tax burden would be saved rather than spent by households. This positive impact on output must be balanced against the impact on the public finances exerted through lower tax revenues. In addition, the Revenue Commissioners estimated that 856,000 tax units which equates to just over 39% of the tax base will be exempt from income tax in 2014. It is also worth pointing out that it is generally accepted that low income earners spend a greater proportion of their disposable income in the economy. Therefore, any cut in the income tax burden would have no effect on the spending habits of these tax units as they would not benefit from the change.
When discussing the merits of such a measure it is important not to lose sight of the current fiscal position. Despite the considerable progress made in recent years, Ireland's budget deficit remains one of the highest in Europe. In this context the opportunity cost of any large-scale revenue stimulus would be considerable. Moreover, any revenue shortfalls would have to be made up from alternative measures in order to continue to meet our deficit targets.
In relation to the ESRI example, the simulations suggest that the deficit would increase by 0.5 percentage points of GDP and general government debt by just over 2 per cent of GDP, both by the end of the forecast horizon. Therefore, in relation, to the specific scenario put forward by the Deputy the increase in indirect taxes would not be sufficient to cover the loss in income tax revenue.
Finally I would say that while there is a clear need to address the fiscal imbalances of the State, this Government is cognisant of the pitfalls of excessively taxing labour. Reflecting this, the Programme for Government contained commitments to not increase the marginal rate of tax. My first three Budgets have achieved these commitments, which further demonstrate our commitment to encouraging labour supply and supporting employment growth into the future.
