The governments of poor countries tend to depend more on expenditure taxes than on taxes on income. One of the reasons for this is the dominance of agriculture in their economies and the difficulty of taxing farmers, many of whom, at an early stage, operate on a subsistence basis, writes Garret FitzGerald
So it was inevitable that 40 years ago, when Ireland was a poor, predominantly agricultural country, our governments drew over twice as much of their revenue from expenditure taxes as from taxes on income. But, despite the introduction of turnover taxes in the 1960s and VAT in the 1970s, the role of taxes on expenditure in our public finances declined steadily as we became better off.
Between 1962 and 1987 the expenditure tax proportion of the total raised by way of the four key taxes - excise duties, VAT, income tax and social welfare contributions - declined steadily, from 69 per cent to 41 per cent. In this respect our society was gradually becoming more equitable.
However, the gradual substitution of progressive taxes on income for regressive expenditure taxes during the quarter of a century from the early 1960s was halted in 1987.
Since 1993 this process has been steadily reversed. The result is that the ratio of the two expenditure taxes to the two taxes on income has increased again by almost one-fifth during the following decade, from 41 per cent to 49 per cent, and the proportion of GNI taken by VAT has increased by a quarter. All the progress in the previous 25 years in improving the relationship between these two kinds of taxes has thus been lost in the past decade of increasing inequity in our society.
Of course, we all know that high direct taxes may have a disincentive effect, and that, beyond a certain level, high taxes can drive some wealthy people to locate themselves elsewhere. Thus it has to be accepted that it was necessary to reduce the very high top income-tax rate of the 1980s crisis years: our direct income taxes cannot be significantly higher than our neighbours' without sapping the willingness of people with skills to come here and to stay here.
But what is open to question is whether we need to have gone quite as far as we have done towards creating a haven for the rich. Might we not have done more to offset by some redistributive measures the negative impact on the less well off of our economics-dominated tax policy?
The single-minded Government obsession with low personal income taxation at the cost of a sharp reversal of the socially beneficial long-term decline in the proportion of revenue derived from expenditure taxes, and especially from VAT, appears to me to have been the product of a strong ideological bias, rather than the outcome of a rational and objective analysis of how to optimise our tax system in both economic and social terms.
The problem is that in Ireland in recent years we have become obsessed with maximising the growth of national output rather than optimising such growth, as other states try to do. This obsession seems to derive from the fact that, due to a temporary coincidence of favourable factors, we were able during the Celtic Tiger years to expand our workforce almost five times faster than the rest of Europe - and thus to achieve over an eight-year period an economic growth rate never before seen on our continent.
That quite exceptional, but very temporary, growth in the number of Irish people available for work, supplemented by some immigrants bringing with them skills in short supply here, enabled us during those years to escape briefly from the labour supply constraint on growth. It is this constraint that, in periods of general economic expansion, imposes a limit on the capacity of individual states to achieve a higher rate of economic growth without inflation.
That Irish experience during the 1990s seems to have led our Government to believe that we had become permanently exempt from labour-supply constraints on non-inflationary growth, and thus to ignore the fact that we have a real choice to make between two alternative policies.
On the one hand we can adopt a society-orientated approach: seeking to grow our economy at a rate that will provide remunerative employment in Ireland for successive generations of our people, while drawing in from abroad and warmly welcoming whatever additional skills may be necessary. On the other hand we can choose to give absolute priority to maximising the volume of output for its own sake, regardless of the impact this may have upon our society.
In view of the present demographically determined decline in the flow of Irish job-seekers into our labour market, this latter approach must necessarily involve much greater reliance on employment-linked immigration than would be required by a growth optimisation policy.
This in turn will necessarily impose a considerable strain on our resources through having to build more houses, schools, hospitals, roads etc for the additional immigrants over and above those we need to help us ensure a prosperous Irish society. And that can only lead to inflationary pressures.
And there is a further downside. Those who advocate growth maximisation constantly use this as a reason for postponing indefinitely the tackling of our social problems. We are persistently told by the economy-obsessed authors of this strategy that we cannot afford to deal with our social problems or to tackle the unique inequity of our society because to do so might slow our economic growth.
Not alone is the argument that social progress slows economic growth dubious in its own right: in my view the objective of maximising economic growth for its own sake is itself misguided.
For, on the one hand, growth maximisation will require a much higher level of immigration than is needed for skill supplementation and will create inflationary pressures that will ultimately undermine our competitiveness.
And on the other hand, the low-tax strategy employed to maximise growth will prevent us from securing public services comparable with those of our neighbours and will ensure a continued high level of social inequity.
The issue is a pragmatic one: what combination of policies, in relation to taxation as well as other issues, will be optimal for this and future generations?