Notes on the Front

Social Justice Ireland has produced a well-argued proposal for refundable tax credits – a long-standing demand to make the tax system more equitable. In essence, as SJI describes it:

‘A refundable tax credit is one where, in the event that the income of an individual is insufficient to use up all of his or her tax credit, the remaining credit is paid to the individual by means of a cash transfer.’

Let explain this by example: Mary earns €15,000 a year. Her gross tax liability is €3,000 (20 percent of her earnings). Her tax credit is €3,600. This offsets any tax liability. But – and this is the key issue behind refundable tax credits – she has €600 of ‘unused’ credits.

A tax credit is, in effect, a cash subsidy – one that is delivered by reducing one’s tax bill. Anyone above the income tax threshold, by definition, uses up all their credits. But those below the income tax threshold don’t. Therefore, they don’t get the full subsidy. What SJI proposes in simplicity itself –return the ‘unused’ portion of the tax credits to the worker in the form of a cash transfer. This is nothing more or less than treating all taxpayers equally.

Such a programme – costing €140 million – would benefit low-income workers and families. SJI estimates that over 113,000 low-income workers would get a refundable tax credit. Of this, 40 percent of the beneficiaries (recipients and dependents) would come from below-poverty line households. The average returned credit would amount to nearly €24 per week – a substantial boost to low-incomes.

SJI rightly poses this proposal in terms of tax justice and social equity. However, there is more: refundable tax credits make economic common-sense. It will increase demand and consumption, raise tax revenues, help protect jobs and boost the GDP. The net effect on the Exchequer will be plus. In other words, this is a great stimulus programme. Let’s churn some numbers with an old friend – the marginal propensity to consume.

We can reasonably assume that low-income earners will consume most of any extra income they receive. Let’s say the marginal propensity to consume (MPC) for low-income earners is 0.75 – that is, they earners spend 75 percent of an extra Euro. If this holds for the entire refundable tax credit, low-income earners will spend €105 million (75 percent of the total cost of €140 million).

There are two positive benefits to this:

• First is the multiplier effect: spending increases businesses cash flow which in turns helps secure jobs. The IMF suggests that ‘targeted transfers’ (to what they call ‘hand-to-mouth’ households) are the second most effective form to boosting economic growth, even if temporary; the first being capital spending.

• Second, the Exchequer – through increased tax revenues.

Conservatively, if we assume that households will spend 75 percent of the refunded tax credit and that of the spend, 12 percent represents indirect taxation as per the ESRI / Combat Poverty Agency, then the Exchequer will receive a boost of €13 million. This, of course, excludes any extra revenue arising from the general boost to GDP growth (business taxes, their purchases arising from increased sales, etc.).

At the other end, if we assume that in the first year GDP will increase by a multiplier of 1.2 (that is, GDP grows by €168 million from the total cost of the refundable tax credit) and further assume that the GDP / tax ratio holds (approximately 30 percent), the Exchequer will benefit by €50 million.

In real life, the boost to revenue will lie somewhere between €13 and €50 million.

So how do we pay for this? It is far, far preferable to pay for such measures – which don’t embed an asset into the economy as would be done with capital spending – out of current resources. But we’re broke! How do we do this? Simple: take money from those who have a low MPC (i.e. high income groups) and give it to people with a high MPC – the IMF’s ‘hand-to-mouth’ households. No borrowing, no fuss.

I have a small suggestion. According to Fine Gael, those who receive income via rental and dividend income are exempt from the Health Contribution Levy. This amounts to a taxpayers’ subsidy worth €89 million. Therefore, remove the subsidy by applying the levy to this income. If we were to apply the 4 percent levy to net capital gains and inheritances, we could raise another €92 million.

These are not ‘soak the rich’ proposals – merely treating all income equally. And it would raise €181 million. This would pay for the refundable tax credit and leave some change over to reduce the deficit (or invest it into a capital spend projects to get people back to work, raise more tax revenue and reduce unemployment costs).

There’s another boost to the economy. By taking money off high-income groups, we are not only reducing the deflationary impact of increased taxes, we may even be reducing import-dense consumer spending. High income groups’ spending is likely to contain more imports. For instance, 76 percent of all hotel expenditure abroad, which helps other economies but not ours, comes from the top 20 percent of households. Those on lower-incomes are likely to spend more on domestically produced products.

So if we take money off high income groups and give it to the low-income groups, not only do we boost economic growth, increase tax revenue – we reduce ‘leakage’ and ensure more of our spending stays in the economy.

All this to say – proposals like the SJI’s refundable tax credit are not only fair, but good for the economy in all sorts of ways. While the Government is dreaming up ways to take more money off the low-paid, we should be working on creative ways to invest in income equality, public services, poverty-reduction, etc. These are not luxuries, these are absolutely essential to a prosperous economy and sustainable growth.

In other words, people and their living standards are not an obstacle to economic growth, they are the solution. When we understand that, we will begin to understand how we get out of this mess.