Ireland's tax burden is below the OECD average - but personal income taxes are higher

How are we going to cope when the non-tax revenue the State has come to rely on starts to wind down over the next few years?

This is an important question, and it’s raised by Central Bank economists Ronan Hickey and Diarmaid Smyth in a paper published today in the latest Central Bank Quarterly Bulletin.

Non-tax revenue is money that flows into the state coffers from sources other than tax, and it’s rocketed in recent years – going from €0.6bn in 2007 to €3bn last year – thanks to the bank bailout.

That’s right – the State makes money from the bank bailout.

How? It charges the banks a fee for the support it gave them, and it gets interest on loans and preference shares.

The CSO estimates the inflows between 2008 and 2014 at €12.9bn. This breaks down as: Bank Guarantee fee income €4.3bn, interest income €5.3bn, and dividends €2.3bn.

Most of the dividends come from the Central Bank’s holding of bonds that were issued to replace the promissory notes that were used to bail out Anglo Irish Bank and Irish Nationwide.

The coupon on the bonds is paid to the Central Bank, which books a profit and pays a dividend back to the State at the end of the year.

As the last of the bonds is not due to be repaid until 2053, the Central Bank could keep earning for quite some time, although there is a sell-off schedule built into the deal to assuage the ECB that it does not amount to monetary financing of a government (in Breach of the EU treaties).

Before that the Central Bank made money from lending banks money under the Emergency Liquidity Assistance (ELA) facility. That is now just a fraction of what it was, and is back at pre-crisis levels, so not much money there.

Even so, there is money coming back as part of the deal. Earlier this week the Comptroller and Auditor General reported that the sale of €1.5bn worth of IBRC bonds yielded a profit to the Central Bank of €560m, because the price of Irish sovereign bonds has risen so much since 2013.

Indeed the C&AG reckons there are some €9bn of unrealised gains in the IBRC bonds held by the Central Bank.

But all good things come to an end. The Central Bank’s days as the most profitable bank in Ireland are coming to an end, as the banking system “normalises” and the IBRC bonds are sold off (usually to the NTMA, which then cancels them).

The twelve-fold rise in Central Bank dividends since 2007 is a sign that that source of non-tax revenue will be a declining one.  So the state better not get used to it.

The Bank guarantee – the ELG scheme – ran from 2009 to 2013 (replacing the original 2008 Guarantee). There are still some deposits covered by the State guarantee, but they will be all out of guarantee by 2018, so that is no longer really a source of much revenue.

Interest income comes from investments in the banks, notably through preference shares and contingent convertible bonds (CoCos).  But these are being repaid by the banks, so they too are a diminishing source of revenue.

Needless to say the money that has been earned by the state from the bailouts is dwarfed by the money it spent on the bailout in the first place.

The central Bank estimates it at about €57.5bn (a bit lower than the C&AG). Cumulatively it says the bailout amounted to 28% of GDP. A further 6% of GDP is directly attributable to the extra interest cost of the money borrowed for the bailout.

The Central Bank estimates that around one fifth of the Gross Government debt at the end of 2014 was attributable to the bank bailout (which obviously would mean that around 80% of the government debt was NOT due to the bailout).

The most recent Stability Programme Update in April said the Government would get €3.4bn in non-tax revenues this year. However, it says this will fall to €2.1bn in 2020.

This drop in revenue is going to require careful management, warns the bank (after all, the difference between this year and 2020 is about the same as the “fiscal space” for tax cuts and spending rises in next year’s budget, so it’s not a trivial sum).

Hickey and Smyth say these non-tax revenues should be regarded as windfalls, which have helped to cushion the effects of the fall in ordinary revenues from the crisis.

They argue these windfall gains should be used to reduce the State’s debt ratio, rather than be used to support ordinary budget policy – after all they only arise as a result of debt increasing activity – i.e. the bailout.

They point out that high public debt is associated with lower GDP growth, and it requires a larger portion of a country’s resources to service interest payments – money that could be better spent elsewhere.

A faster reduction of the state’s debt would leave it less vulnerable to future economic shocks, and would free up more fiscal space for dealing with another recession – i.e. a borrowing capacity to fund deficits to pay for social welfare etc in the face of a downturn in revenues.

This is part of the Counter Cyclical policy that the ESRI, OECD, EU, the Government itself have been banking on about for several years now.

In that vein, the authors note that the shape of regular tax revenues has changed dramatically since the crisis. In 2006 income tax accounted for just 25% of revenues, as large numbers of workers were removed from the tax net.

Since then the introduction of USC and changes to the Income tax system has grown its share of revenue to 41%. Income tax is now yielding the same amount of cash to the state that it did before the crisis – the only tax head to have been brought back to its pre-crisis state.

Of the €17bn in income tax raised last year, USC was responsible for 20% of it – showing just how difficult it would be to abolish this tax.

Almost 40% of the increase in Income Tax between 2010 and 2014 came from USC.  Changes in PAYE drove about half the increase during this period.

“Other taxes” have had the weakest recovery and were still less than half of their 2007 value last year.  The contribution of the “other taxes” head would have been even worse were it not for the Pension levy and the residential property tax.

The authors say its “interesting” that VAT and “other taxes” (stamps, CAT, CGT etc) are now back to their share of total revenue they held in the early 2000s.

They say it’s a good thing that a stable source of revenue like income tax takes the lion’s share of revenue, rather than the unreliable predominance of taxes related to housing transactions, as was the case in the mid-noughties.

But if non-tax revenues – which are more than twice as high in Ireland than the EU average – are a declining source of funding, and USC is such a big source of the stable funding, then how are we going to cope with the inevitable demise of non-tax revenues, the rising demands for expenditure and investment (some of it driven by demographics, so unavoidable), and the apparent unpopularity of USC?

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