Tuesday 27 September 2016

We must raise taxes – but new 'middle rate' is the smart way

Published 17/04/2014 | 02:30

Raising taxes without altering the tax system is the worst way to do it
Raising taxes without altering the tax system is the worst way to do it

I wonder, do they read the popular press down in those think tanks? Or do they just devour raw data, like Alan Greenspan in the bath (much good it did him). If the boffins who prepare the annual OECD report on taxation ever look at the Irish newspapers, they must be tempted to have another look at their data.

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The steady drone of complaint about Irish taxes being unfair, or too high, appears to come from a different country than the one portrayed in the OECD's 'Taxing Wages 2014', published last week.

The obvious reaction is to dismiss the complaints about tax as media whingeing. But, as is usually the case, the press is onto something. What exactly it is onto is not easy to discern, and even more difficult to explain. And the more one discerns, the more troubling the question of the Irish tax system becomes.

One begins to see why there is such a divergence between the apparent facts as set out in the OECD analysis and the general debate on taxation. As for those facts, the report shows – as it has done for years – that an Irish one-earner family on the average wage of about €40,000 a year has the second lowest 'tax wedge' (the difference between the gross cost to the employer and take-home pay) in the 34-nation OECD.

The Irish tax system is also among the most 'progressive' – an awkwardly double-meaning word which implies both 'direction of movement' (as in this case), and a 'jolly good thing' (which is a matter of political opinion).

Whatever one's views, the figures say that an Irish single worker on two-thirds of the average wage has a tax wedge of 21pc, which compares with an average of 32pc in the OECD.

Deductions are 27pc for a worker on average wages, rising to 38pc for someone earning two-thirds more than average – about €65,000 a year. That is highly progressive by international standards – mainly because deductions are so small for those on low earnings.

Comparisons with supposedly low-tax Britain are certainly instructive.

Even for a family on average earnings, the UK deductions of 23.5pc compare with an Irish figure of 13.5pc. The UK is the opposite of progressive: at all incomes, those at the lower end have higher deductions than nearly all OECD countries – and certainly more than in Ireland.

Countries such as France and Sweden, which would be regarded as most progressive, in the 'jolly good thing' sense of the word, also impose higher taxes than Ireland on low incomes. Those on six-figure salaries pay a similar 40pc or so in most countries, so the Irish system actually has the steepest increase as earnings rise.

That is certainly not how we see the situation. I wish I could say this was just a problem of perception and the best thing would be to ignore it.

There are problems of perception but there are also problems which are both deep and intractable.

Perception is certainly influenced by the steep increase in taxation since the crash.

The report shows what might be called the 'squeezed middle' – a two-income family earning about €55,000 has seen deductions rise from less than 9pc to more than 13pc since 2006.

The real problem in making comparisons with other countries comes from the particular structure of the Irish tax system. The early entry into the top-rate band, at €32,800, is the feature which gets most attention.

Raising it appears to be central to any government plans to cut (or at any rate alter) income tax in the next Budget.

Less attention is paid to the enormous jump from one band to another – from 20pc to 41pc.

Yet this is as much of the problem as the entry point. It partly explains why income tax on low earners is so much below the OECD average.

If that issue is obscure, the next one is all but invisible. This is the fact that employers pay much less in social security levies than they do pretty much anywhere else.

This means the OECD report requires careful reading. Because employers' share of the tax take is smaller, the proportion paid by workers through income tax and levies is higher. The tax wedge comparisons understate the actual burden on Irish employees.

There is no disputing that Ireland raises relatively little in labour taxes but increasing that revenue by levying more on employers, or standard rate payers, seems politically impossible.

It may not even be a good idea. Even those who think it might be are reluctant to say so. The argument that higher employer levies would destroy jobs is just too powerful – and would certainly be made powerfully by employers.

They are probably right, but only because the damage has already been done. National income has to be shared out. It would be no surprise if some of the money saved by modest social security contributions from employers ended up as higher wages for workers.

This is in fact what we see: high Irish wages compared with other countries, but much more favourable labour costs, which include employer levies.

It seems even more out of the question to raise more taxes from the two-thirds of workers on the standard 20pc rate, even were it accepted that they fare pretty well compared with many countries.

But this is not accepted at all. On the contrary, the general belief is that they are hard done by and, if anything, that they should pay less tax.

They are being hard done by in other ways. The limitations of the tax system mean that much of the budget deficit is being closed by charges, fees and higher prices from state companies. That may well impinge more on lower-income groups than a progressive rise in income tax.

A small start might be made, by not just increasing the top-rate band but introducing a new middle rate (let's split the difference and say 30pc) between the present €38,000 and a new, top-rate entry point.

For the same revenue cost, more people would fall out of the top rate and see their marginal rate decline by 11 percentage points, but each individual saving would be less.

It can only be a small start. Even in the doubtful event that the Government meets its long-term spending targets, taxes are going to have to increase, despite all the howls that no such thing can be accommodated.

Raising them without changing the system will be the most damaging way to do it.

It is an intriguing question whether we have had any great benefit from the low rate of employer contributions and the generous treatment of children at all incomes.

The employment bounce in a very modest recovery suggests we are getting something right.

If we are to stick with the present parameters, we should at least try to understand what they are and stop having futile arguments which have little basis in reality.

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