Wilbur Mills who was Chair of the powerful US House of Representatives Ways and Means Committee for 17 years said “Don’t tax him. Don’t tax me. Tax the man behind the tree” to describe his experience of people making spending proposals to him that others would pay for. As we are now in the fiscal equivalent of the “marching season” there is a debate about where adjustments to the tax system should be made. Decisions on this are the essence of politics and are ultimately a matter for political judgement. What is the evidence that might help inform this political judgement ?
The first step is to set the level of Government borrowing for 2015. Government borrowing is likely to be less than€ 7 billion or 4% of GDP in 2014. Under EU rules we are committed to reducing this to less than 3% of GDP (less than €6 billion) in 2015 and to eliminate it by 2018.
One of the successes of the Irish adjustment programme has been that we have set realistic targets for the level of borrowing and come in ahead of them, unlike some other countries who have repeatedly missed their targets. This has helped to regain the confidence of financial markets and enabled us to fund our borrowing requirement at much improved interest rates. All this suggests that we should aim for a deficit below 3 per cent with some margin in case circumstances are adverse.
Progressivity of Income Tax
Much of the debate has centred around income tax. In a recent speech the Taoiseach said
“the Government has agreed that the next priority ……is to reduce the 52% income tax rate on low- and middle-income earners. The 52% marginal tax rate, comprising income tax, PRSI and the Universal Social Charge, is – I believe – anti-enterprise, anti-investment and anti-jobs.” .
Ireland has the most progressive income tax system (including employee social insurance contributions) in the EU. The tax paid by a single person on half average earnings(average earnings are just under €36,000) is the second lowest in the OECD (out of 34 countries) and is less than one-thirteenth that in Denmark while the tax paid by a single person on two and a half times average earnings is the 9th highest in the OECD. At average income levels we are the 27th highest in OECD. A single worker on an income of about €36,000 pays almost €13,000 in income tax and social insurance contributions in Denmark compared to under €5,000 in Ireland a difference of €8,000.
The evidence is that the top rate of tax in Ireland at 52 % (55% for self-employed) is not out of line with other EU and OECD countries. What is unusual is that it applies at a very low level of income by international standards.
A major reason for the relatively low direct tax burden in Ireland is that PRSI is lower here. In many countries PRSI funds pay-related unemployment and pension benefits while the Irish system provides flat-rate benefits only. Irish employees (and their employers) have to fund supplementary pensions separately. For example, Irish employees pay about €2 billion (after tax relief) towards their pensions annually. In many high tax countries such as Sweden and Belgium, these are funded through the tax system.
If we look at the tax burden (excluding PRSI), the tax paid by a single person on half average earnings in Ireland is 25th highest in the OECD while the tax paid by a single person on two and a half times average earnings is the 5th highest in the OECD. At average income levels we are the 15th highest in OECD. At the top level our tax is below that in Denmark and Iceland but ahead of that in Norway, Sweden and Finland and is over one-fifth higher than the UK.
Some commentators point to the “Nordic Model” of relatively high taxes and public expenditure as one we should aspire to. To reach Nordic levels of income taxation (including PRSI) everybody in Ireland would have to pay more but the increase would bear most heavily on the bottom half of the income distribution. For example, if the tax rates in Ireland were at the average of the 5 Nordic countries a single person on half average earnings would pay an additional €3,200 per year and a single individual on two and a half times average earnings would pay about € 2,000 more.
When resources are limited difficult choices must be made. How much more the better off should pay in taxes is a matter of political choice. However, fairness requires that people on the same income in the same circumstances should pay the same tax. This suggests that employees and self-employed should be entitled to the same tax credits. The denial of the PAYE tax credit bears particularly heavily on self-employed people with low incomes. For example, a self-employed person on income of €15,000 pays almost 6 times as much in tax as an employee on the same income. The liability of the self-employed person on that income is €2,350 compared to €400 for the employee. In addition, a higher rate of USC applies to those who have non-PAYE income that exceeds €100,000 in a year. The rate of tax that applies should be determined by the amount of income rather than the form in which it arises..