Fine Gael would plan to cut income tax if it got back into office after the next general election, Paschal Donohoe, the Minister for Finance said on Wednesday. Or at least it would increase the income level at which people become liable for the top 47 per cent rate. But do we pay too much income tax in this country? And is planning to reduce it a practical goal, at a time when there are so many pressures to increase spending?
What we pay – the facts: The income tax burden here compared with other countries has always been a point of debate. Recent OECD data provide some clarity. The OECD data have typically shown that the income tax burden here is lower than the international average. However, as UCC economist Séamus Coffey pointed out in a recent blog, the OECD has now decided to take a higher figure for the Irish " average" wage. And this changes the outcome.
Previously, the Irish average used by the OECD was just over €35,000 – but this did not exclude part-time employees ( because the Republic wasn’t able to supply the data). It also didn’t count in better-paid managerial and supervisory staff. For its latest publication – Taxing Wages 2019 –these issues are dealt with and the average wage used rises to just under €47,800, which is more in line with Irish data.
So what does this show? It shows that the average take on single people's incomes from tax, USC and PRSI in Ireland is 25.4 per cent, as near as makes no difference to the OECD average at 25.5 per cent.
When you add in employers’ PRSI to look at the entire tax wedge – the gap between what an employer pays and and an employee takes home – the Irish figures is 32.7 per cent, compared with 36.1 per cent for the OECD average. This is because employers’ PRSI is higher on average in other countries. What is paid for employer and employee PRSI internationally and what benefits employees get in return varies hugely – in some countries these payments entitle employees to much more significant benefits than they do in Ireland.
But in terms of what the average employee pays, we are right on the OECD norm.
How the burden is spread: When you dig into the data, the Irish tax system is unusual in the way it spreads the burden. As Coffey summaries it: "Ireland has below average tax rates on below average wages, average tax rates on average wages and above average tax rates on above average wages."
This seems intuitively correct – we know that the numbers of people excluded from the tax net entirely are high here, and also that the higher 40 per cent income tax rate applies at relatively low incomes. And the OECD data backs this up, though there is a twist for families with children.
Less well-off employees benefit from high entry points to the income tax net and low levy rates on a significant portion of their incomes. So income tax, USC and PRSI takes 15.9 per cent of the gross income of a single employee on two-thirds of the average wage (€31,300), compared with 21 per cent in the OECD and 23.5 per cent in Europe. At the far end of the spectrum, for a single employee earning two-thirds more than the average (€78,000), the Irish tax take is 35.1 per cent, versus 30.7 per cent in the OECD and 33.8 per cent in Europe.
Children attract more generous treatment than the average in the Irish tax code and so a couple with two children and one earner on the average wage pay 15.5 per cent of their income in tax, versus the OECD average of 20.1 per cent. For a two-income couple, one on the average wage and one earning two-thirds of the average, the tax bill is 20.8 per cent versus an OECD figure of 21.9 per cent.
Interestingly, the OECD figures suggest that on the basis of the average earnings figures they use and the tax burdens in different countries, after tax incomes here compare well with the average. A single employee here ends up with around €40,250 after tax, compared with €30,500 on average in the OECD. The Irish figure is ahead of the US, UK and France. Of course to get a proper measure of living standards, you would need to look at prices, too, and here Ireland is relatively high cost, as we know.
For a representative relatively well-off two-earner couple, Irish tax home pay averages €90,000 versus under €70,000 in the OECD.
What are the policy lessons? Taxes should be equitable, efficient – in the sense that they do as little damage as possible to the economy – and enforceable. Fairness if, of course, a political decision. It is quite legitimate to make a political decision that in Ireland, we want to maintain a more progressive tax system than the norm – in other words to have a bigger gap than the average between what the less well-off and better-off pay. And helping lower earners may well have been a goal of tax cuts since the crisis, where increases in the entry point to the USC in particular had this impact.
However, politically this was also a way to help large groups of people for a relatively low cost. A question for reform in future is whether this has narrowed the base too much by excluding large numbers from the tax net entirely. At the far end of the spectrum, a measure which would have hit higher earners – restricting their access to the PAYE tax credit – was promised in the Programme for Government to help fund cuts for middle earners. But it never happened.
The second question is efficiency. The price of a low tax burden on many earners is that those on above-average incomes pay a bit more. In particular, Irish earners enter the higher 40 per cent tax rate at relatively low income levels – €35,300 for a single employee and €44,300 for a couple with one earner. The OECD data show the marginal tax rate – the rate on the next euro of income – here is one of the highest on average earnings internationally.
As well as squeezing many middle earners, this also affects people’s incentives to work and makes it more expensive for employers to reward employees. It means the tax burden here rises very quickly at relatively modest income levels. So these are reasons for Donohoe to make it a target for change.
The final question is affordability. We have seen in the term of this Government how spending increases have taken precedence over tax cuts in the use of the additional resources created by growth. While the tax band has been increased along with some other cuts, the ESRI has pointed out that the fact that the tax system has not been adjusted for inflation each year has meant a creeping rise in the burden.
So here again there is a choice. The ESRI estimates that adjusting for wage and price increases in the tax and welfare systems would cost €1.5 billion a year. This would leave less cash for spending. Meanwhile the Fine Gael goal of increasing the entry point to the higher rate to €50,000 for a single employee would cost over €2.3 billion – also a big chunk of budget resources, even if phased in over a period of years.
There is no right or wrong answer here – but there is a big political choice. Given spending demands, do we also aim to cut income tax in the years ahead? And if we do is some of it paid for by tax increases elsewhere – for example on carbon, property or wherever? As we have seen over the last few years, even when the exchequer finances are flush both tax cuts and tax reform are difficult.
