Writing for Business & Finance Magazine, Constantin Gurdgiev of Trinity College makes a strong point why Ireland should move from current two-fold progressive income tax code toward a single, zero-tax deduction flat rate on personal income. Ireland already has a single 12,5 percent tax rate on corporate income. Consequently, supply-side tax reduction enormously enhanced the inflow of foreign direct investment into Ireland and benefited the overall Irish economy respectively.
One of the essential standpoints in adopting the flat rate on productive behavior such as labor supply in this particular case, is the point of compliance costs which occur as a consequence of complicated tax code which penalizes the productive engine of the firm by forcing it to accept cost-push drifts to comply and pass annual tax liabilities. In almost all case of adopting the flat rate on labor income, compliance costs were reduced by 75-95 percent. And since these costs run on average between 5-10 percent of the payroll costs, these savings amount to € 1390-2780 per working Irish person per annum.
Since a single and supposedly low rate on labor income no longer produces cost-push shock such as increasing incentives to favor tax evasion but, instead, broadly strenghtens the tax base and tax liabilities no longer end in adding burden to productive behavior such as investment, risk-taking, labor supply and entrepreneurship. Supply-side reductions of tax burden are based on the correct assumption extracting from the Laffer Curve which states that, the higher the tax rate, the lower the amount of taxable income as tax basis is tightly decreased accordingly and there is also a common empirical evidence that high tax burden levied by taxpayers, ends in the spiral of disincentives to work, save and invest. In the age of global economy, competitive fiscal stance is a crucial issue, since revenue-neutral taxation of labor income no longer wedges addition unit of earned income.
Also by removing the negative side-off of the progressive tax creeps, flat tax stimulates productivity-adjusted increases in market labor supply as well as the single rate removes the incentives to shift the labor supply to informal economy. Ventura (1999) showed that, in the U.S case, due to highly positive effects on individual incentives to supply and invest, in human capital and labor supply productivity, a revenue-neutral system of the flat rate adds a 9 percent increase to aggregate efficiency of labor force.
However, there remains much opposition to revenue-neutral flat rate on individual income, emerging from egalitarian myths among which Slovenian socialists are the staunchest supporters of the progressive income tax. It is not difficult to disapprove these myths. Zero-tax deduction significantly benefits the poor by leaving them into the space of zero-tax liabilities in accordance with the size of personal deduction. Disregarding the ratio between zero-tax deduction and the flat rate on individual income, the higher the income the individual earns, the higher the income tax liability which an individual has to bear and the same effect is achieved without negative side-effects, such as disincentives to labor supply, complex tax code, loopholes, preferred deductions, exemptions, and tax evasion, all of which generate the enormous size of compliance costs.
There are estimated three possible scenarios in Irish case for tax reform:
- 25 percent flat rate and € 20 000 standard personal deduction
- 25 percent flat rate and € 25 000 standard personal deduction
- 20 percent flat rate and € 20 000 standard personal deduction
Irish 'status quo' currently stands at two different progressive rates on personal income; 20 and 42 percent where the standard deduction is € 2870.
It is important to note that even before factoring the effects of growth, saving and greater investment in knowledge-intensive areas, the poor would significantly benefit and gain respectively under the expectations of the flat tax reform. Every economist admits that capital formation is a key to economic growth. Existent tax codes pose severe risk to invest in human capital, to save and take risk and to boost the engine of productive behavior. Progressive taxation, which was originally proposed by Karl Marx, penalizes additional units of value-added and thus implicitly create disincentives to invest in human capital and assets to further spread the entrepreneurship and social mobility.
Small and open economies vastly depend on innovation and investment in knowledge-intensive source of supply and that's why the question of tax burden is evenly crucial as it situates them whether competitively or uncompetitively on the global competitiveness map. Thus, flat tax is not a pundit of luxury but a neccessity which Irish economy deserves to stay in line with greater international competitiveness and competitive fiscal management.
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Ken Griffin: British tax reform plans could affect Ireland, Sunday Tribune;
Luc Van Braekel: Analyzing the Irish tax model. Celtic Tiger ready to meet the Challenges of Globalization and Ageing, Work for All;
EU: Causes of Growth differentials in EuropeTowards a Tax Policy for Growth and Jobs;
Benjamin Powell: Markets created a pot of gold in Ireland, Cato Institute/Fox News Online;
Low-tax policies created the tiger, Sunday Independent;
Sean Dorgan: How Ireland Became the Celtic Tiger, Heritage Foundation;
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