Matthew Sinclair: When countries are serious about a need for revenue, they go for low taxes

Ireland's economy lies crippled by the disaster of the euro.  The bailout it has received is obviously not going to work, it just "kicks the can down the road" to give French and German banks some time at the expense of crippling austerity in Ireland.  But it looks like Greece will default well before 2013.  As Andrew Lilico has written recently, the European Central Bank itself may need a bailout, and we'll have to make sure that British taxpayers aren't asked to put more money at stake backing more bad debts.

With the scale of their fiscal crisis, the Irish are taking very tough measures to try and balance the books.  Outright cutting pay for senior staff in the public sector for example, as we have recommended.  There are two things they aren't doing though: hiking corporate tax rates or tobacco taxes.  At the moment, it looks like they'll win their fight with France and Germany to keep their low corporate tax rate, and tobacco taxes are frozen.  The reasons why a country with so much pressure on its finances isn't hiking those taxes are instructive, they hint at what a country like us, big enough to get away with making mistakes, should be doing.

Ireland's low corporate tax rate of 12.5 per cent has been a brilliant way of attracting foreign investment, boosting the economy enough that a lower rate means higher revenue.  Acres of research, including a dynamic model that the TPA commissioned the CEBR to put together, show that the results from a cut in corporate taxes could be impressive, and quickly increase revenue.  This is an opportunity that we are leaving on the table: in Ireland their leaders - normally such good Europeans - attach such importance to their low rate that they have fought a tough battle to keep it.  The Government here are cutting corporate tax rates a bit, but they can go further and faster.

Taxes on cigarettes are another example.  In Ireland they froze the rate in Budget 2010.  Brian Lenihan explained why:

I have decided not to make any changes to excise on tobacco in this Budget because I believe the high price is now giving rise to massive cigarette smuggling. My responsibility as Minister for Finance is to protect the tax base. I have full confidence in the effectiveness of the current multi-agency approach but early in the New Year I want to explore what further measures we may need to stem the illegal flow of cigarettes into this country.

That statement isn't just empty rhetoric.  It is based on a study by researchers at the Research and Analytics Branch of the Irish Revenue.  That study found:

The consumption variable in this study is the consumption of taxed cigarettes.1 So the price elasticity estimated refers to taxed cigarettes: a 1 per cent increase in price leads to a 3.6 decrease in consumption of taxed cigarettes. The most reasonable theory to explain such a large decrease in taxed consumption is that only part of the reduction is caused by lower smoking levels, the remainder must be caused by smokers switching to substitute cigarettes.

The most likely substitutes in the case of taxed cigarettes are non-Irish taxed cigarettes (i.e., purchased legally outside Ireland and brought into the country) or untaxed cigarettes (produced in or smuggled into Ireland and purchased illegally).

It is recognised that the consumption of untaxed cigarettes has become an increasingly important issue. Revenue estimates that currently around 20 per cent of cigarettes consumed in Ireland are not Irish taxed and this figure has been increasing in recent years. It is driven by several factors but the main cause is the price differential between cigarettes on the Irish market and elsewhere.

Given the current high cigarette price level in Ireland, the incentive for substitution to untaxed tobacco is greater in Ireland than it otherwise would be. This probably explains the  high price elasticity estimate – higher prices will likely increase untaxed consumption.

Can we really have confidence that the same thing isn't happening here?

We've got a huge border and, with taxes making up the vast majority of the price of a packet of cigarettes, the margins are more than good enough for smugglers to lose containers of them at the border and still make a healthy return.  Putting cigarettes in plain packages, as the Government plans to, will make things even harder as customers won't know what they're getting, even if they do want to avoid illegal cigarettes.

The burden of corporate tax falls on workers, not Monopoly-board caricature capitalists.  And cigarettes don't pay taxes, squeezed middle smokers do.  But even someone like me who works for a non-profit and doesn't smoke pays the price for taxes high enough to reduce revenue.  We need more rational tax policy, hopefully the 2020 Tax Commission the TaxPayers' Alliance is running with the Institute of Directors can get us there.