Here's my Sunday Times article from April 22, 2012 (unedited version, as usual):
Years ago, I quipped that Ireland doesn’t do evidence-based
policies, instead we do policies-based evidence. Current whirlwind of taxation
initiatives is the case in point. These include the household charge and its
planned successor a property tax, plus the water charge and its twin meter
installation charge. These policy instruments are poorly structured, rushed in
nature, and are not based on hard economic analysis.
Water is a scarce resource, even in Ireland. On the supply
side, we have abundant water resources in some locations and bottlenecks where
population concentrations are the highest and where the bulk of our economic
activity takes place. Reallocation of water to reflect demand/supply imbalances
is a political issue, and creation of a monopolized system of water provision
is not an answer to this. More effective would be to encourage local authorities
to sell surplus water into a unified distribution system. Coupled with a structural
reform and consolidation of the local authorities, this approach will
incentivise productive economic activity in water-rich, less developed regions
and provide competitive pricing of water.
Water delivery infrastructure is free of political constraints,
but faces huge capital investment and operational problems. These factors are
determined by treatment and transmission systems, and water quality monitoring
capacity in the system. Chronic underinvestment in these areas means that
Ireland’s quality of water supply is poor and water losses within the system
are staggeringly high. Delivering this investment is not necessarily best
served by a centralized monopoly of water provision. Only pipe infrastructure
should be a monopoly asset, charging the transit fee that will reflect capital
investment and maintenance needs of the system. Treatment and part of
monitoring network can be retained at the local level to provide for local jobs
and income.
Water charges are the best tool for demand management, a
system of incentives to conserve water at the household and business level, as
well as the revenue raising to sustain water infrastructure. In this context, a
water charge is the best policy tool.
Currently, we pay for residential water via general taxation.
If the policy objective is to improve water supply systems and create more
sustainable demand, water charges should replace existent tax expenditure. In
addition, higher level of collections is warranted to allow for investment
uplift. Current price tag is estimated around €1.2 billion. Of these, ca €200
million come from business rates which feature a low level of compliance.
Assuming half the normal rate of M&A efficiencies from consolidating the
system of local water authorities, factoring in a 50% uplift on businesses
rates compliance and allowing for a 25% investment buffer, annual revenues from
residential water supply system should be around €900-950 million. This is the
target for revenues and at least 1/3 of this target should go to reduce the
overall burden of income taxation.
To deliver on the above target, we can either conceive a Byzantine,
and thus open to abuse and mismanagement, system of differential allowances,
rates and exemptions. Alternatively, we can take the existent volume of
residential water demand and extract from this current price per litre of water.
This rate should allow a 10-15% surcharge to incentivise future water
conservation and to finance investment in water supply networks. Use this
system for 3 to 5 years transition period. Thereafter, the market between the
local authorities will set the price.
The charge, should apply to all households consuming
publicly-supplied water. For poor households who cannot afford the charge,
means-tested social welfare payments should be increased to cover water
allowance based on the family size and characteristics. Savings generated by some
households should be left in their budgets. The resulting system will be
‘equitable’, and economically and environmentally sustainable.
A complicated pricing structure of exemptions and
allowances, backed by a quango and a state water monopoly, will not deliver on
any the above objectives.
A different thinking is also needed when it comes to
structuring a property tax. The latest instalment in the on-going debate on
this matter is contained in the ESRI report published this week. In the
nutshell, the ESRI report does two things. First, it proposes an annual tax on
the value of the property while applying exemptions for those with incomes below
specific thresholds. Second, the ESRI report attacks the idea of a site value
tax as being infeasible.
Both points lead to an economically worst-case outcome of a
property tax that falls most heavily on younger highly indebted families, thus
replicating the distortionary effects of the already highly progressive income
tax.
An economically effective system of property or site-value
taxes should be universal, covering all types of property and land, regardless
of ability to pay. Why? Because a property or a site value tax offers the means
for capturing the benefits of public amenities and infrastructure that accrue
to private owners. These benefits accrue regardless of the households’ ability
to pay. Low-income household facing an undue hardship in paying the rates can
be allowed to roll up their tax liability until the time when the property is
sold.
My own recent research clearly shows that a site value tax
imposed on all types of land, including agricultural and public land,
represents a more economically efficient and transparent means for capturing
private gains from public investments. It is also the least economically
distortionary compared to all other forms of property taxation. This is so
because a land value tax increases incentives for most efficient use of land
and decreases incentives to hoard land for speculative purposes. A traditional
property tax, in line with that proposed by the ESRI, does the opposite.
With a deferral of tax liability for those unable to pay, a
land value tax will bring into the tax net those who hold significant land
banks and/or own large parcel properties, but who are not investing in these
lands and are not using them efficiently. The system will allow older
households to retain their homes, but will charge fair fees on the property
value that has nothing to do with these households own efforts when the gains
are realized either at sale or in the process of inheritance.
The ESRI argument against implementing a site value tax is
that the lack of data and a small number of land transactions in the economy
prevent proper valuation. This argument is an excuse to arrive at the desired
conclusion of infeasibility of the site value tax. Ireland is starting property
valuation system virtually from scratch. Thus, unlike other countries, we have
the luxury of doing it right from the start. Compiling a database for land
valuations is easier than for property valuations precisely because sites have
much less heterogeneity than the properties that occupy these sites. In simple
terms, value of property is determined by the value of buildings located on it,
plus the value of the site. The former is much harder to value than the latter.
The value of a specific site can be backed easily out of an average or
representative value of the properties located within the vicinity of the site,
plus by referencing directly specific attributes of the site.
As with the water charges, the property tax system must be
designed not from the premise that the Government needs a quick hit-and-run
revenue fix, but from the premise that we need a new approach to taxation. Such
an approach should aim to reduce the burden of taxation that penalises skills,
work effort, entrepreneurship and discourages households from investing in
their own human capital and properties. Instead, the burden of taxation should
be shifted on paying for specific benefits received and on privately accruing
gains from public investments and amenities. In this context – both water
charges and a property or a site value tax represent a step in the right
direction. But to be effective, these policies must be structured right.
Box-out:
Just when you thought the taxpayers can breath easier when
it comes to the banks, the latest data from the Irish, Spanish and Italian
authorities shows that the banks of the European ‘periphery’ have dramatically
ramped up their holdings of their countries’ Government bonds. In 3 months
through February 2012, Irish banks increased their holdings of Government bonds
by 21%, Spanish – by 26%, Italian – by 31%. Back in late 2008 I warned that the
banking crisis will go from the stage where sovereign debt increases will be
required to sustain zombified banking systems, to the stage when the banks will
be used as tools for financing over-indebted sovereigns, to the final stage
when the weak nations’ sovereign debt will become fully concentrated within the
banking systems they have nationalized. Sadly, this prediction is now becoming
a reality. As GIPS’ banks increased their risk exposures to the Governments
that underwrite them, German and French banks have been aggressively
deleveraging out of the riskiest sovereign bonds. In Q1 2012, Portugal ranked
as the second most risky Sovereign debtor in the world in CMA Global Sovereign
Credit Risk Report, Ireland ranked seventh and Spain ranked tenth, with Greece
de-listed from the ratings due to its recent default. This concentration of
risk on already sick balancesheets of the largely insolvent banks is a problem
that can reignite the Eurozone banking crisis.
