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Analyzing
the Irish tax model.
Why the Celtic Tiger meets the
Challenges of Globalization and Ageing.
Never
In the last 30 years has the World economy been booming like
in 2004: an average growth rate of 5 pct. China
and India have fabulous growth, and the US and Japan continue their
remarkable recovery.
Meanwhile Europe slides further
into stagnation, possibly even recession. Europe's weak growth
undermines
the fundaments of its social system. Europe's demotivating fiscal
burden is the fundamental cause. Europe's
overall tax burden is 15% higher than in the American and Japanese, and
9%
higher than the OECD average. Extreme
tax burdens are demotivating, and
withhold essential resources from the private sector to the
advantage
of an increasingly inefficient government apparatus. |
Yet
Europe also knows remarkable exceptions. Luxembourg,
Portugal and particularly Ireland. Ireland
bas been booming at
an average growt rate of 5.6% over the last 20 year.
In barely half a generation Ireland evolved from the second poorest to
the second richest country of Europe. The Irish success is attributed
to its fair-tax system: a low
overall tax burden
combined with a balanced distribution of the tax burden
over
direct and indirect taxes. Ireland has demonstrated that its
alternative model works and leads
to economic and social success. The Irish model is realistic and
applicable in the rest of Europe. Where does one wait for?
Luc Van Braekel
interviews the people of WorkForAll
on their remarkable investigation.
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Very
impressive performance indeed. How does such a turnaround to a
production policy happen in practice?
Fundamentally,
such production-stimulating policy consists of a substantial reduction
of the tax burden on labour and on profit; in other words a decrease of
direct taxes. This motivates people to go back to work: it
stimulates to entrepreneurship, to dare to take risks, to perform some
overtime or to delay retirement. Of course, this does not work
with a vague promise for a minor tax cut sometime in the far future
as is customary in many countries. Cuts must be felt immediately
and they must be substantial.
Between 1985 and 2001 Ireland lowered the
tax burden on wages from 37%
in 1985 to 19.3% in 2001. They roughly halved the burden. In
Belgium the burden on labour even slightly continued to rise from 46%
in
1985 until 47.9% in 2001. Today the Belgian burden on wages
is 2.5 times as high as the Irish. Does it surprises anyone that
in Belgium nobody wants to do an hour overtime, and that
businesses run away from the country in an ever faster rate?
However, it was the cut of the rates on
company profits that led to the
greatest improvement of the entrepreneurial climate. When Ireland
was at
the bottom its crisis in 1985 tax burden on company profits amounted
to no less than 50%. In 2002, Ireland had reduced that tariff to
16%.
Belgian rate cuts on the contrary were
marginal, and clearly insufficient to raise
any effect at all. The recent decrease of their tax rates had to
be
"budgetary neutral" and were compensated by the limitations of many
deductions. In fact, the cut was meant at dressing up
internationally published
rate tariffs, and had in fact no effect at all.
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However, tax
cuts mainly profit the rich is it not?
This is
exactly the misunderstanding of the ideologists of envy in many
countries! Under a production stimulating policy, everyone is
better off, and certainly not in the least the worker, unemployed or
disadvantaged. Look at job creation and social expenditures.
Since 1985 Ireland crated 31,2%
new jobs. In Belgium with its so called social policies and
its innumerable expensive employment measures they barely created
7,6%, and for a large part in government employments.
Does a rate cut
not lead to a cutback of the social spending?
A
first misunderstanding is to suppose that rate cuts lead to lower tax
receipts. Nothing is less true. Here the Laffer-effect
comes into play. Every rate cut broadens the tax base because tax
evasion and fraud becomes less profitable. The Flamisch government had
already a small taste of the benefits of this Laffer-effect. Since they
lowered inheritance rates, their tax receipts from inheritances have
dramatically risen.
Morover one should remark that
lowering inheritance rates does not motivate to die early. If
governments cut rates on incomes however, they may expect the
supplementary benefits of the
so-called Armey-effects. Low rates on income motivate people to go back
to work, to perform some overtime, to start their own business, or to
delay retirement. This broadens the tax base still further. Moreover,
the financial resources that flow back to
the private sector are invested much more productively there than in
the public sector.
Ireland has demonstrated the effectivity of the combined Laffer-Armey
effects on direct taxes all to well. Its tax receipts have
continued to rise as the tax burden went down.
A second miscalculation is to underestimate the dynamics of
growth. As the percentage of the GDP Irish social spending
roughly remained constant, just as as the case in Belgium, but the
dynamics
growth lead to an increase social spending in real terms with 118%
between 1980 and 1998. In Belgium, this was barely 43%.
Such a difference is felt all to well in the purse of the
disadvantaged! Ireland has demonstrated that production-stimulating
policy is in reality much more social than the Keynesian alternative,
meant at boosting consumption.
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Did
Ireland create jobs in all sectors?
Over
all sectors, Ireland created 31% new jobs between 1985 and 2002.
In Belgium this was that barely 7,6%. The highest increase was in
services: +106% opposite to +15.8% in Belgium. However, most
remarkably even in industry, Ireland achieved to create 32% new jobs
between 1980 and 2003. In Belgium the industrial employment in
1999 caved in to 75% of the 1980 level. Ever since Belgium has
apparetly discontinued to communicate its figures to the OECD. However
In
agriculture the same evolution took place in both countries: a gradual
decrease of the employment. However, agricultural employment
today has a lower impact.
It is widely believed that European
de-industrialization is an
unavoidable phenomenon. Ireland has proven that this is not a fatality,
and that even an European country can still increase its industrial
employment. Even notorious Professor De Grauwe now accepts
de-industrialization, and soothes that this is barely a problem as job
losses in industry will be absorbed by new jobs in the service
sector.
The big question is of course to whom
service sector will
sell its services. Architects will not have to design many
factories. Factory floor will not need cleaning, consultants will not
have to advise many enterprises, banks won't finance many exports, and
even the treasury will not have to control
in many places. Sell services to the unemployed or abroad?
Services are much more labour-intensive still than industry, and please
do not believe that Europeans have more brain cells than an average
Indian or Chinese.
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However,
many countries still face a huge public debt, their policy margin is
very limited.
The
gigantic state debt in many countries is the logical consequence of
years of fruitless "deficit spending" and sterile Keynesian policies.
In Belgium this
has culminated under the disastrous administration of socialist
minister of budget MATHOT, who went so far as to state publicly that
deficits had come by themselves, and would go the same way. Of course,
building up such a debt was economic insanity, and a moral injustice to
the coming generations. One must get rid of these
state debts. The only question is how.
One can of course try to reimburse it as fast as
possible. In
Belgium, even with their huge savings rate of 14% this would take 8.85
years when
they spend all savings on debt reduction. But then nothing remains to
invest. Not a single machine, not a single house. They
could also spread it over 17.7 years, but also then they would need to
halve investment with disastrous consequences for the competiviness and
the prosperity. Paying back public debt in this manner is much
too slow, and always goes at the expense of investment.
An alternative manner to reduce the proportion
Debts/GDP is to focus on
the denominator of this fracture, and not on the counter. In
other words, one must aim at a serious growth. This is exactly
what the Irish have done.
In 1986, Irish public debt amounted to 111% of GDP,
almost
just as bad as in Belgium with 124%. The Irish tax cuts however
boosted growth to an average 5.6% between 1985 and 2002. Belgium
focused on the counter of the fracture: handing in on almost everything
to pay off public debt. This policy had a deflationary effect and
their growth stagnated at 1,9%.
After 17 year an exponential growth rate
differential of over 3% works
out to a gigantic difference: Ireland raised its GDP by a factor 2.67;
Belgium with a factor 1.42. In other words Ireland increased the
denominator of the fracture public debt / GDP with that factor 2.67,
Belgium with that factor 1.42. This way Irish debt will be reduced to
30% GDP in 2005. With much effort and many new taxes, the Belgian
government debt will still be at 98% of the GDP. |
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What about
unemployment under a offer-boosting policy ?
In many countries a very tough
misunderstanding persists that available work is a limited static
quantity that one should have to share. Nothing is less
true. Tax cuts are the motor to creativity, to new initiatives
and to job creation in the productive sector. One can notice so
in the Irish unemployment statistics. In 1985, Irish unemployment
was much worse than in Belgium: 17% unemployed as compared to
10%. In 2003 Ireland had reduced the figure to 4,6%. In
reality, this means this that Irish employers are permanently in
search of workers, staff and employees, and not the other way around as
is the case in Belgium.
The fear that low rates on
profits and low social contributions take away enterprises from other
countries
is based on the very same misunderstanding. This reasoning
assumes that the number of enterprises
and their size are invariable quantities that should be shared among
nations. This reasoning assumes that the enthusiasm to work or
start one's own business is insensitive to the tax burden. One should
know better. When a larger share of the fruit of their labour is
allocated to people, their readiness to productive contribution
immediately increases. Low tax burden motivates to work, to
perform
an hour overtime, to dare the risk of an own business, or to postpone
retirement. Politicians who cannot understand this should visit China.
On their way home they can have a look at the economic and
ecological disasters left behind by the Soviet regime.
Just as competition between businesses leads to
creativity and optimal
use of scarce resources, tax competition between nations leads to
optimizing the administration. Each form of tax cartel between
nations is as harmful to employment and wealth as monopolies and cartel
agreements
between businesses are harmful to the size of their sales market. It
may be feared that the proposed European constitution will allow
imposing by majority rule minimal tax rates on the member states.
Countries wanting to adopt similar growth policies as Ireland might
find themselves very limitited in their national autonomy to execute
economic policies such as decided democratically by their peoples.
Under such a European constitution and such a system of minimal tax
rates
Europe risks perpetuating its stagnant
growth which has already lasted for decades now.
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Yet it appears
contradictory that social spending can rise when tax burden decreases.
The
figures of the social expenditure are publicly known on the OECD
website! First
misunderstanding is that tax receipts fall when tax-burden falls. For
direct taxes the combined Laffer and Armey effects are extremely
strong, and Ireland has proven this.
The tax receipts continued to rise under
falling tax burden.
A second miscalculation is to look at the
relative share of the
social expenditures as a percentage of GDP; Look at the absolute
figures. How many benefits do people really receive? This
is what interests the citizens. In all large sectors of social
security the real benefits have raised more in Ireland than in Belgium,
except of in the unemployment, but this is due to the drop of the Irish
unemployment to one third. Per unemployed, benefits are now also
larger in Ireland than in Belgium.
Irish are absolute champions in family
benefits, in which the child
allowances are the main single item. In 18 years family benefits
rose in Ireland by no less than 262%; In Belgium family allowances even
slightly went down. Belgians continued to focus on a shrinkage
scenario; savings on welfare reimbursements: they are on the highway to
gradual destruction of their social security system.
If European nations want to preserve their
generous social security
system in an
age of graying population it can only be don by growth, growth, growth
once more. Even the Belgian socialist minister of the budget has
now realized this. Unfortunately, he does not understand that
growth can only be achieved through a lightening of the tax
burden.
He now wants to force growth by raising the participation
rate; shifting the retirement age and measures like that. Again a
further cutback on social achievements, and basically a cure of the
symptom only. If one wants to cure Belgian's desease of low
participation one should tackle the cause which is nothing less than
total demotivation due to the laming tax burden.
The Belgian minister does not ask questions
who will create the jobs to
absorb the higher participation and the raised labour offer. He does
not
seem to understand that there are no starters any more and
that this due to the extreme bad entrepreneurial climate. He does not
seem to realize that this due to the high taxation and the relative
generosity of the easy and risk free alternatives.
He does not seem to realize that existing
businesses are de-localizing
at an ever faster rate. Belgium -and Europe are running
empty-. Under Schroeder, German unemployment increased to over 5
million, just as much as in the 1929 depression. Under these
deflationary shrinkage scenarios, Europe is heading for total
collapse.
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An other idea of
yours is to shift the tax burden from direct taxes to consumption.
This
is not is just another idea! This also is one of the main
conclusions from our regression-analysis. We found that countries
with higher consumption taxes grow much faster than countries with a
higher share of direct taxes. We therefore fully applaud the
basic ideas of the Belgian political party VIVANT who made it one of
its prime objectives, and also the recent European initiative of
Belgian Prime Minister Verhofstadt.
The problem is that government expenditures
grew explosively since the
sixties. Direct taxes and taxes on business profits have taken
the entire burden of this growth. Family income taxes in Belgium
doubled since 1965; taxes on consumption barely changed at all.
When our social security model was
designed, the proportion between
direct and indirect tax was balanced. However, in the course of the
time, the structure of tax receipts is complete distorted. Much
too high direct taxes de-motivate productive contribution to the
system, and relatively low
consumption taxes boost consumption to the disadvantage of
investment. An additional advantage of a consumption tax is that
the domestic production no longer bears the whole burden of the social
security system, but also products produced abroad are bearing an equal
share in the burden.
A shift of the tax burden can indeed help
to boost growth, but the main
objective must remain a substantial lightening of the total tax
burden. The IMF comes to the same conclusions in their study of
July 2004. http://www.fma.gv...
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But Is
Belgium is now on good track under the liberal-socialist government
isn't it?
Some say so indeed. However, let us look at
real figures. Growth is stagnating around 2%,
and the
authorities still take over 50% of the Belgian wealth creation. This
figure belongs to the very highest in the world. Alarming is that
the government spending exclusive interests on state debt has continued
to rise from 42.9% in 2000 to 46.1% GDP in 2005. In other words,
the advantage of low interest rates was completely consumed again in
all sorts of new expenditures.
Without any cut in the budget Belgians
could have taken advantage from
the evolution on the interest market to decrease Government by more
than 3%. However, one has chosen again for new expenditures. .
One can spend a Euro only once of course.
If the authorities chose to
do that on all sorts of amusing but unproductive projects, they
withhold resources from the private sector, where these resources could
be used for more productive uses such as investments in new machinery,
new factories, energy efficient houses, or research in new products for
instance. When authorities continue to find ever-new public
initiatives, they will of course never be able to lower the tax
burden.
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A quite controversial
result from your research project is that low interests do not help to
stimulate growth.
We
were quite surprised by this regression
result ourselves indeed, and at first thought that we made a mistake
somewhere. Yet after extensive controls we found that low
interest policies had not a single positive effect on the growth
whatsoever in the examined EU countries.
Apparently, we do not stand alone with this
observation. One notices
that fifteen years of near zero interest rates in Japan were not able
to boost Japan's extremely poor growth rate. One notices the same
in Switzerland, which had the poorest growth rate in Europe in spite of
the permanently lowest interest rates.
The explanation must be found in the fact that
lowering interest rates
has in countries such as Belgium -besides a positive effect on consumer
spending and potential investment - , also very negative effects.
Low interests causes savers' income to go down, and
also the external
balance of payments suffers, as countries like Belgium's receive much
more interest from abroad than they pay. Easy-money-policies
moreover always increase of the wealth consuming inflation.
Either consumer prices or asset rise will rise; in many cases
both.
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Inflation
is under controll int'it ?
The price level of the consumer goods has indeed
remained
under control so far. Europe thanks this to the blessings of
globalization and the massive supply of cheap consumer goods from
low-wage countries. However, prices of goods and especially
services locally produced have been rising rapidly: repair services,
health care and care for the elderly for instance.
Nevertheless, one underestimates particularly the
negative impact on
wealth of the "asset inflation". Assets now take too big a share
in family budgets, and that consumes our wealth. Think of the prices of
building lots, houses and industrial lots for instance.
In addition, bonds and shares have now reached price
levels where
returns are on historical lows. None of these things are of course
found in the consumer index of the ECB. We are still making additional
research on this matter. This fascinating result from out our
regression analysis is quite fundamental. If confirmed it would
mean that the low-interest policy of the European Central Bank is
contra productive to the wealth development of Europeans.
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WorkForAll
also pleads in favor of decentralized administration structures.
We
indeed also checked whether size of countries was affecting growth rate
and the job creation. We found that nations with smaller
populations significantly perform better than large countries. We
certainly found no advantages of scale in our research as one could
anticipate. This conclusion is confirmed in much other relevant
research. "The Size of Nations" (PDF),
It is
widely believed that over-centralized administration in large
countries leads to "on size fits all" measures that have negative
effects for particular sub regions. We therefore conclude to
decentralized administration and have serious doubts about of the
benefits of delegating ever more powers to centralized European Union
Authotities.
When
so much evidence demonstrates that a production stimulating policy is
beneficial to both wealth growth and job creation, why are
governments not applying these policies everywhere?
The
historical and scientific evidence is indeed overwhelming. Such
production-stimulating policies have simply worked everywhere where
they were applied. That was the case in the U.S. under Reagan,
that the case in Iceland under Oddson, this is the case in Ireland now,
and even German's "Wirtschaftswunder" under Erhard was a model of
production stimulating policy characterized by robust tax cuts.
Ultimately, the principle is based on the
simplest economical
principle: A family that spends more then it earns becomes poor.
That is a fact households and that is a fact for nations. A
country that produces more than it consumes becomes wealthy. If
one wants wealth one should boost production and not
consumption. The principle is in fact as simple is that.
Why is this not applied
everywhere? For a fundamental policy
change, a political majority is needed, and our politicians think
short-term and often still in terms of ideology and conflict of
classes. They seldom think of the common interest, and yet less
of the interest of the next generation. They simply do not know
the figures and are not conscious of the impact of wrong policy
choices.
If Belgium had chosen in 1985 the same
policies that Ireland chose,
their population would be twice as wealthy today. Their government debt
would now have been reduced to 35% of the GDP, and their employers
would be struggling for employees. Every day delay costs them
employment and prosperity. To convince a majority of such facts needs a
political leader with view and especially acting power. They have
simply lost 20 years of progress.
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You also reproach conservatism to the
press and the education.
The responsibility of education and press is
overwhelming. Even today in our universities the Keynes-doctrine
is
still taught as a brilliant manner to boost the economy. One
forgets
that the theory is seventy years old, and that the ideology stems from
an era of plan-economical thinking. Can you imagine our doctors
to go
through today with the medical knowledge and equipment of the thirties?
The present generation of politicians and
journalists were raised with
the Keynes-doctrine, and do not realize that a new generation of
economists has arisen since. In modern research the
Keynes-doctrine
has been countered with overwhelming empirical evidence.
Politicians
and journalists do not realize that since they graduated the economy
has come to a new understanding. Many have possibly never heard
of
Hayek, Laffer, Armey, Friedman or the Austrian school. It may
last
another generation before this becomes evident to the decision levels.
Hopefully Europe won't live on an industrial graveyard under a
dictatorship by then.
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