Gavin R. Putland,  BE PhD

Friday, April 12, 2013 (Comment)

Full employment: how the euro can work for Ireland, not against it

By eliminating taxes on employer-employee transactions, one can reduce the marginal cost of labour for employers — so that they hire more workers — without reducing nominal after-tax wages or widening after-tax wage inequalities.

In Ireland, the easiest way to do this is to let employers retain the PAYE income tax and Pay Related Social Insurance (PRSI) that they currently withhold from wages, while continuing to credit workers for the withheld tax as if it had been paid to the government, and to abolish employers' contributions to PRSI. For convenience I shall refer to all these imposts as PAYE tax.

Some of the lost revenue from PAYE tax would need to be replaced (some, but not all, because the rise in employment would reduce welfare expenditure). If it were replaced by an alternative tax paid by employers, the new tax would be paid out of the same pool of income as the old one, so employers would not need to raise prices. If the alternative tax were on anything but labour, it would not undo the reduction of the marginal cost of labour for employers.

These conclusions hold even if the "alternative tax" is an increase in the VAT. Whenever it is said that replacing personal income tax by VAT would raise prices, it is assumed that the personal income tax currently withheld by employers would instead be paid out in gross wages, so that the income needed to pay the VAT would need to come from elsewhere, namely higher prices. But if the PAYE tax were retained by employers as proposed here, it would be available to pay the VAT, so there would be no overall rise in prices of goods and services produced within the country.

This together with the preservation of nominal after-tax wages and the rise in employment would raise employees' aggregate demand for the products of their labour. Demand from overseas would also rise, because Irish exports would become cheaper: the fall in production costs due to removal of PAYE tax on labour would not be offset by the increase in VAT, because VAT is not applied to exports.

Of course the VAT would raise retail prices of imports. This is a small price to pay for the increased earning opportunities. It is austerity of the desirable sort — austerity that gets you out of debt by inhibiting spending but not earning.

In a country with its own currency, such as Australia, a tax reform that promotes exports over imports would have its effect partly offset by a rise in the currency. That can't happen in Ireland, whose trade outside the eurozone is too small to affect significantly the value of the euro. If that means my idea gets more traction in Ireland than in Australia, so be it.

[Last modified 13 April 2013.  P.S.: See also Maximalist ‘fiscal devaluations’ for Greece and Australia.]

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