Getting income tax rates right

The challenge facing the Government as it prepares the 2014 budget is how best to balance spending and taxation while continuing to reduce the fiscal deficit. The Economic and Social Research Institute (ESRI), in a study of some of the policy options for the budget, has helped both to keep the Government fully informed and to raise the level of public debate about income tax rates and levels. It has set out clearly how Ireland compares with other European countries on this aspect of taxation.

Here, despite the rise in rates and forms of tax since the onset of the recession, overall tax revenues as a share of national income remain among the lowest in the euro area. That might well suggest the tax burden is light. And it might also suggest the Government now has scope to raise taxes on the wealthy. Certainly, Social Justice Ireland, and its director, Fr Seán Healy, in a pre-budget call for higher taxes, think so. However, the ESRI study concludes otherwise.

Ireland takes less in tax than other more advanced European economies, which also levy high taxes on general income – including income tax, and the social insurance contributions of employers and employees. In these countries, the extra tax revenue comes more from applying higher income tax rates at lower levels of income, and not just from high marginal tax rates. Here, as the ESRI study points out, those on lower and middle incomes in Ireland pay less in income tax than their European counterparts.

However, here the top rate of tax is paid at a much lower level of income than elsewhere. This means, as the study states, that “higher earners face a higher incentive to earn more, through increased work hours or work effort”. Were a new 48 per cent income tax rate introduced for those earning over €100,000, the top tax rate would rise to 59 per cent – including USC and PRSI. And that would be higher than 13 of the other 14 members of the EU-15 group. However, it would raise an estimated €365 million in revenue, or just 0.3 per cent of gross national product (GNP). And as the study points out, that would do very little to raise Ireland’s tax to national income ratio. Such a move could, however, do much to discourage initiative and enterprise.

Ireland's difficulty is not merely the relatively high marginal tax rate, but that it applies at a low level of income – close to the average industrial wage. In the United Kingdom, for example, the top rate of income tax applies at four times the average wage, and in Spain at 12 times the average. If, as the ESRI study concludes, "Irish income taxes were to approach European levels, it is likely that marginal tax rates in low to middle-income ranges would have to rise".

A very unlikely budget prospect.