Saturday 20 January 2018

Strange Irish tax system does little for the 'squeezed middle'

'When it comes to tax, fairness is very much in the eye of the beholder'
'When it comes to tax, fairness is very much in the eye of the beholder'
Brendan Keenan

Brendan Keenan

I see they're still working on Charlie McCreevy's "individualisation" of tax allowances, 15 years on. When he brought it in, as a response to a Supreme Court ruling, I was among the small minority who thought it was fairer that one person should pay more tax than two people earning the same amount of money between them.

When it comes to tax, fairness is very much in the eye of the beholder.

This particular plan proved too complicated to be applied completely, with the tax band still only partially transferable between spouses.

To compensate, the Home Carer Credit (HCC) was introduced where one spouse works primarily in the home in order to care for dependants, adding another layer to the system.

Now comes a new bit of plastering, with government plans to abolish the PAYE tax credit for higher earners.

Those earning more than €70,000 a year could have their tax bills increased by a maximum of €1,650. The logic seems strange, but it turns out that logic has little to do with it, and everything to do with the abolition of the hated Universal Service Charge (USC).

With commendable honesty, Finance Minister Michael Noonan explained that, because higher earners would benefit more from the end of USC, they would have to give some of it back.

He seemed unimpressed by any suggestion that, because higher earners were hit harder by USC, they ought to enjoy a bigger gain from its disappearance.

Of course, the disappearance must be paid for. There is also honesty in the Programme for Government when it says the phasing out of USC will be covered, not just by removing the PAYE tax credit for high earners, but by not indexing personal tax credits and bands against inflation. There is less honesty in the conclusion that these measures will ensure the tax system remains "fair and progressive."

They are also at variance with the stated objective to lower "marginal tax rates" - the highest rate an individual pays. Non-indexation increases the marginal rate for more people, while the tax credit proposal could see deductions of over 60pc on part of the income of those higher earners.

In the face of such complaints, politicians spring to the defence of middle-income earners; known in media jargon as the "squeezed middle". But there is little evidence that this supposedly oppressed group will get much out of the plans.

To have a middle, there must be a top and a bottom. Less than 20pc of Irish taxpayers earn more than €70,000 (although they contribute around half of income taxes), so they are definitely part of the top, but not all of it.

Defining the bottom is not simple either. Presumably, it is the near 40pc of earners who pay no income tax.

Before USC, most of them had no liability at all. That leaves almost half the workforce in the supposed middle, which is a strange definition of middle.

The Irish income tax system is indeed strange, as well as extraordinarily complicated for something with just two rates. As the Institute of Taxation noted, there are also five USC rates, one employee PRSI rate and two employer rates, plus different entry points, bands and credits for income tax, PRSI and USC.

For once, we have plenty of official analysis to help make a judgement on policy on this jumble. The Department of Finance has published a series of documents on the tax system, culminating in last month's Tax Reform Plan.

It's an impressive piece of work, although one might quibble with its choice of comparator countries Denmark and Germany.

They have the highest income taxes in the EU, so almost anywhere is going to look good in terms of total taxation.

Ireland looks particularly good, but the striking thing about the comparison is not the difference in taxation but the very different way in which it falls.

Nowhere else in the EU - or most of the world for that matter - does the bottom third escape taxation as it does in Ireland. In Germany and Denmark, the tax take starts at 30pc and rises to 40pc for those on average earnings in Germany. In its analysis, Finance uses a single earner with no children. Irish families fare even better.

If we take bottom, middle and top as meaning, not numbers, but those who learn less than 80pc of the average, those who get between that and 160pc of average, and those who earn more than that, then the "squeezed middle" pay less tax than Britons or Americans, while the top tier pay more and are taxed pretty much the same as the French.

It requires no great insight to see that an income tax system which collects so little from so many is bound to impose high marginal rates on the rest.

As the department drily put it: "This comparison suggests that Irish employers could face difficulties in seeking to attract mobile international talent from certain competitor jurisdictions, all other factors being equal."

The IMF also leapt to the defence of the squeezed middle in its analysis of the tax system last week but still left the waters pretty muddy.

It complained of a large burden on middle-income households which undermined female labour force participation, created welfare traps for low-skilled workers, and discouraged high-skilled worker migration to Ireland.

There's a lot of middle there. What they seem to have in mind is the move for a married couple with one earner into the top rate tax band at €42,800, which is about average earnings.

On the other hand, if the partner - still usually female - does take work outside the home, the top band applies at a more reasonable €67,600, although USC of close to 5pc must be added.

The IMF complained that increasing the entry point for USC had narrowed the tax base. In plain language, that means the unusually light burden on the lower-paid had been lightened some more and the IMF does not think that was a good idea.

But nobody uses plain language, and the policy of every party is to make it even lighter, and the Irish system even odder.

With revenues now covering both government spending and debt interest, one cannot say that Ireland is under-taxed overall. But no one will say that the mantra that those on lower earnings should pay little or no income tax may not be to their benefit, given the resulting reliance on indirect taxes like Vat, which bear hardest on the poor.

Nor is there any recognition that the refusal to countenance significant property tax will be paid for through higher marginal income tax rates for the middle and upper income groups.

The now standard political ploy of portraying normal fiscal management as an endless process of tax "cuts" does not help rational debate or optimal policy. The Finance analysis suggests that keeping the present entry bands for USC and cutting rates would bring most benefit to the famous middle.

Despite all the crocodile tears over its plight, I'll believe it when I see it.

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