Individualisation becoming reality by stealth

Economics:As Budget day approaches, so does the seventh anniversary of one of the most controversial events in Ireland's fiscal history, an event that prompted an outbreak of wailing and caterwauling on a scale not heard since Ernest Blythe sliced a shilling off the old age pension, except perhaps when John Bruton raised the VAT rate on shoes for women with small feet only to catch children in the net as well.

I am referring to Charlie McCreevy's individualisation initiative in budget 2000 when he broke with the long-standing formula of fixing the standard rate tax band for all married couples at twice that for single taxpayers.

Instead, he created a distinction between one-earner and two-earner marrieds, with the latter retaining a standard rate band twice that of singles but the former obtaining rather less than double. Specifically, what McCreevy proposed for the 2000 tax year were bands of £17,000, £28,000 and £34,000 for single, one-earner marrieds and two-earner marrieds respectively. He also announced his intention to move, in the following two budgets, to full individualisation of the band - to a situation where it would be the same for singles and one-earner marrieds, and twice that value for two-earner marrieds.

There were two principal motives for McCreevy's individualisation idea. One was to encourage greater labour force participation on the part of married women, by reducing the marginal tax rate they faced. The other was to eliminate a form of discrimination against single people and two-earner married couples that he perceived to exist in the tax code.

Opponents of the move saw things rather differently. The encouragement of married women to work outside the home was read as an under-valuation of the work of women in the home, while the new configuration of tax bands was seen as discriminating against one-earner married households. To compound the felony, as it were, the moves towards individualisation, together with the cuts in tax rates announced in the same budget, generated disposable income gains that were steeply slanted towards the better paid.

So vociferous were the protests that, within a week, McCreevy was forced to bring in a package of countervailing measures, including a freshly minted £3,000 tax-free allowance for married couples where one spouse stayed at home to mind children or other dependents. The package was probably the quickest supplementary budget in the history of public finance and, embarrassingly, the new £3,000 allowance had the effect of greatly diluting the incentive effects of the changes to the tax bands unveiled a week earlier. (It hasn't been mentioned, much less raised, in the six budgets since.)

Chastened by the experience, the following year, instead of making a further bold advance towards full individualisation, McCreevy delivered little more than a passing nod in that direction.

And so, one might have thought, the individualisation project was quietly shelved and the objectives it was designed to progress quietly forgotten about. But that's not what's happened at all. The baton of individualisation has instead been passed from the standard rate band to what used to be called the PAYE allowance, and is now called the Employee Tax Credit. In this connection, the beauty of the credit is that it is granted to all employees regardless of marital status. As a result, a two-earner married couple taxed under PAYE attracts two Employee Tax Credits; a one-earner couple just one.

Since 2000, the Employee Tax Credit has been far and away the fastest-growing piece in the income tax jigsaw. Since 2002, its status as the minister for finance's most favoured feature of the system has been especially conspicuous. During this period, neither the basic personal tax credit nor the one-earner married tax band has kept pace with inflation, and the two-earner married tax band has just about done so. In marked contrast, the value of the Employee Tax Credit has increased by 126 per cent in nominal terms and has more than doubled in real terms. (It was €660 in 2002; it is €1,490 this year.)

The result is that whatever modest reduction in the overall burden of income-related taxes has occurred under this Government has been exclusively concentrated among single persons and two-earner married couples taxed under PAYE. Thus, since 2002, average tax rates for single people have fallen across the entire income spectrum, with the reductions ranging from about 2.6 percentage points at half average industrial earnings to about 1.6 points at the average to 0.1 points at around three times the average. Over the same period, average tax rates for two-earner married couples have fallen by amounts ranging from about four percentage points at the level of average earnings to 0.2 of a point at income levels three times that. In contrast, in the case of single-earner married couples taxed under PAYE, average tax rates have risen at virtually all points on the income spectrum since 2002, albeit modestly. At income levels between 1½ times and twice the industrial average, for example, the increases have been of the order of one percentage point.

I guess if the Government had announced five years ago that this was the kind of income tax policy it was going to pursue, there would have been a fair measure of protest, if not howls of outrage. Presumably, the reason why it has got away with it is because the year-to-year changes in the Employee Tax Credit have been relatively small and have passed without being much noticed by commentators. The cumulative change over time has been substantial, however. It will be interesting to see whether and to what extent this strategy of individualisation by stealth is further advanced next week.

An interesting corollary of these changes is that average tax rates have increased for the great majority of Schedule D taxpayers, irrespective of marital status and the labour force status of the second spouse. This is because they do not receive the Employee Tax Credit at all. Consequently, the penalty suffered by such taxpayers has been raised significantly in recent years. I have yet to find an explanation of the logic behind this.

Jim O'Leary lectures in economics at NUI-Maynooth

jim.oleary@nuim.ie