Demise of bonuses skews income tax returns

Aggregate tax take is vulnerable to any shock which affects a small number of highly-paid individuals and a number of such shocks recently have taken their toll Dan McLaughlin writes

The Revenue Commissioners publish an annual "Statistical Report", which includes a detailed breakdown of tax paid by income group. The latest available is the 2000 report and, although it refers to the 1998/99 tax year, it helps to throw some light on this year's income tax shortfall which has been somewhat of a puzzle, and has added more than the usual degree of uncertainty to the upcoming Budget for 2003.

Total tax receipts grew by 2.3 per cent in the year to October, which is not only well below the 8.5 per cent target set in the Budget for the full year but is also much weaker than the growth of the tax base: GDP grew by 13.4 per cent in the year to the second quarter, split evenly between real growth of 6.5 per cent and inflation of the same amount.

It is true that the expenditure tax headings are broadly on track (excise duty) or running ahead of the Budget target (VAT), so the aggregate revenue undershoot is largely down to a number of specific direct tax headings, specifically corporation tax and income tax.

The former was projected to rise by over 29 per cent by the Finance Minister last December, and although receipts under this heading tend to be unevenly distributed over the course of the year, the 7.2 per cent rise in the year to October implies that the target will not be met. Business spending on capital investment is still falling which is consistent with sluggish profits so it is not that surprising that corporation tax is weak.

However, the shortfall in income tax receipts is not consistent with other available macro economic information, suggesting the need for explanations relating to the distribution of taxable income.

The 2002 Budget included personal tax cuts worth €500 million, but still projected a €350 million rise in income tax receipts on the previous year's out-turn to give a total of €9.4 billion. The tax base was expected to rise, of course, which explains the forecast increase, and changes in the tax base depend on wages and employment.

The Quarterly Household survey is only available to May, but it shows employment growth of 1.9 per cent and, although wage inflation has decelerated (on the limited data available), a 6 per cent rise in earnings is plausible. In other words, the tax base probably rose by around 8 per cent in 2002. This alongside the tax cuts would yield an income tax total of €9.3 billion, yet the figure to end- October points to a probable outturn of some €8.5 billion.

Even allowing for up to €500 million for the SSIAs, which comes out of the income tax pot, we are left with a total of €9 billion, still well short of our €9.3 billion figure.

The 1998/99 tax tables gives us a possible explanation for the missing €300 million, as the figures show how skewed the total income tax take is to a relatively small number of taxpayers. For example, some 11,200 taxpayers, out of a total of over 1.5 million, accounted for a massive 14.5 per cent of the total income tax paid that year. Moreover, just 35,000 people paid a quarter of the tax revenue raised. So €1.3 billion of income tax receipts depended on just 35,000 taxpayers, with €760 million depending on just over 11,000 workers.

Clearly then, the aggregate tax take is vulnerable to any shock which affects a small number of highly-paid individuals, and a number of such shocks over the last two years may well help to explain the income tax shortfall.

Bonuses may well have inflated the earnings data in the latter part of the 1990s but these may have slowed sharply or disappeared altogether for those exposed to the harsher post-Millennium economic landscape.

A bull market in equities has also given way to an unusually long bear market, so far fewer share options may be cashed in.

Finally, one particular sector of manufacturing has been particularly hard hit of late, that of ICT, leading to either the disappearance of some of the taxpayers noted above, or their reappearance at lower income levels and hence lower tax brackets.

This fragility may be a surprise to some but is clearly evident from the data, old as it is. Indeed the tax changes in the last two Budgets have probably added to the skewed nature of the income tax base.

A single person on €25 000 per annum in 1999, for example, paid over 29 per cent of the total to the Revenue Commissioners, but this had fallen to only 16 per cent in 2002. For a married couple on the same income, the average income tax rate is now only 2.6 per cent against 13.5 per cent three years earlier.

Great news for them, but in the aggregate the Government may have had an exaggerated notion of the strength of the tax base back in the 1990s, because of the buoyancy at the top of the income scale, leaving it more exposed than expected to what has been a relatively mild economic deceleration.

Dr Dan McLaughlin, chief economist, Bank of Ireland