❄ Design a Simple Tax System?

This post is prompted by the current Irish conundrum. In 2008 the Irish government of the time—since repudiated—made the colossal mistake of committing to back all deposits and debts of Ireland’s banks. Deposits: fine. But money borrowed by the banks from elsewhere (such as German banks), then lent to fantasists, and by them squandered on projects steeped in risk: no.

So sovereign Ireland was ‘bailed out’. It finds itself with massive obligations and its economic policy subject to the requirements of the ‘troika’ (European Union, European Central Bank, and International Monetary Fund). To work its way out it must cut government spending and increase government revenue. The Irish public already pays taxes, but because so many are out of work and so many businesses in difficulty, revenue from existing taxes is insufficient.

The Problem

Tax revenue can be increased by fostering activity that increases the tax yield, raising existing tax rates (provided that doing so does not cause people to flee from the activity taxed), or by instituting new taxes. The IMF observed that other ‘advanced’ countries collect property taxes and is pressing Ireland to do so, at a suggested rate of half of one percent of value per year. A homeowner whose house was valued at €200,000 would pay €1000. Irish government ministers have said that’s too much and have floated a quarter of one percent as a possible tax.

No one knows what the ‘market value’ of Irish residential and commercial property might be, since until recently rectified there was no public record of the transaction price when property changed hands. The price was a secret. Buyers were at the mercy of sellers and—it has to be said—property agents.

The Questions

In Ireland’s circumstances, does levying a property tax make sense? If it does, how would property be valued and the tax collected?

And more broadly, what changes in Irish taxes would do the job, with the least unacceptable bad consequences for its citizens and social life?

Approaches

One approach is to avoid property taxes altogether. The problem is that already-tapped sources, with one exception, are already taxed high. Typical sources are income, auto (registration and initial fee), goods and services (VAT or ‘sales tax’), capital gains, and fees for specific purposes (health, education, water, television). In many countries, wealth and property are taxed. But Irish income tax is already high; VAT can run to 23%; the initial auto registration fee would be thought prohibitive in many countries; and families typically contribute to the costs of K-16+ education. On the other hand, Ireland has attracted foreign companies by charging only 12.5% tax on corporate profits.

A second approach would tax residential and commercial property. Taxing commercial property would undermine the intent in charging only 12.5% on profits. Turning to residences—which Ireland already divides into ‘principal residences’ and ‘non-principal personal residences’, imposing a modest fee on the latter (second homes and investment properties), we meet the obstacle that there is no register of house values. Moreover, prices in and near Dublin are ‘high’ while those in the most rural areas distant from Dublin are ‘low’ The talk is of ‘self-assessment’, which opens the door to undervaluation and a nightmare of enforcement. Or Ireland could pay an army of assessors to look at every home in the state. I’ve been told that combining self-assessment with an adjustment when the property was next actually sold would solve the knot of valuation, truth-telling, enforcement, and collection. This way: under-assess, and you will need to pay more, with interest and penalties, when you go to market and sell.

A very different approach was offered by Nicholas Grubb in a letter to the Irish Times. [Note 2] “Simply apply,” he recommends, “a levy to the utilities, water/sewage, oil, gas and electricity. The larger the property or the more persons using it, the higher the take.” He points out that this would provide a built-in inducement to be frugal in using utilities, consistent with European and Irish environmental obligations. Households are already billed by utilities; moreover, households could anticipate and control their costs. By contrast, a scheme that brought in market value some years hence would put homeowners in uncertainty about how much their resultant levy might be.

However you procede in shaping a solution to Ireland’s problem, there are some elementals about tax that you must take into account:

[1] all money is make-believe:

that is, its utility lies in the holder’s believing that he or she will be able to convert it to goods or services in the future … of type and quantity that justifies electing to ‘save’ now and postpone consumption.

[2] taxes are merely conventional:

that is, it is purely a matter of political choice where and how much tax will be levied. Usually it is at either (i) a point in a transaction convenient for collection or (ii) where money is at rest. VAT, taxes on financial transfers (as some propose), and an estate tax all take from the stream of transactions. A wealth tax or property tax takes from value at rest.

[3] taxes are more readily collected if taxpayers believe they are ‘fair’:

‘fair’ may mean that the reasons for the tax make sense to taxpayers, and that the tax is designed to be applied equitably (within the conditions given in imposing it).

[4] public services must be paid for:

which does not mean that their recipients should be the only ones to contribute to them, since almost all public services contribute to stable expectations, are dormant benefits for those who may later call on them, and have indirect benefits to all. Consider the degree to which non-users, or those not users today, benefit from highways and airports, medical services, schools, public sanitation, and utilities.

[5] you cannot squeeze blood out of a stone:

that is, if households are overwhelmed by the combined effects of income tax, property tax, motor tax, school-related costs and fees for services—and for many the crushing effects of job loss—they will simply be forced to forego some purchases and activities and in turn state revenue will be lost.

I’m reminded of a proposal drafted by the economist Thomas Balogh in response to a request from the government of India. [Note 1] As I recall it, Balogh proposed a tightly interconnected tax system based on tracking income, expenditure and wealth, but applying only to the richest 2% in India. Picture it this way. You begin the tax year with a declared wealth (say, bank deposits). During the year you earn some income. You must declare that income because the firm or person paying you will declare it as an expense. The numbers must match. Moreover, the firm or individual employer has a strong incentive to declare expenditures, because otherwise he will appear to have income not offset by expenditure, to be added to wealth. Each—income, expenditure, wealth— could be taxed, but in Balogh’s proposal money held in bank accounts that the bank could in turn lend to promote entrepreneurial activity or economic development would not be taxed. So the best thing for everyone in Balogh’s world is to report income, report expenditure, and save liquid wealth in accounts enabling lending for India’s economic development.

A virtue of Grubb’s proposal is that moneys invested in maintenance of a residential property are not directly taxed, so the incentive remains for a family to enhance their home and it’s value.


NOTES

[Note 1] I haven’t been able to find a copy of Balogh’s report. I read it more than 50 years ago, so my summary could be a bit off-center. I’d appreciate anyone who has the citation posting it in a comment.

[Note 2] Nicholas Grubb, Letter, “Coming to terms with property tax,” Irish Times, 2012.09.14.

[Bruce’s Blog: 2012.09.29. Post A39. Short Link p=489. Front Door Index: http://design.learnworld.com/. Permalink: http://www.learnworld.com/DESIGN/uncategorized/taxation-made-simple/]


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