Inflationary stealth tax will eat into Budget 2018 gains

Wage increases will mean that many people end up paying as much tax as a proportion of their income next year as they did this year, despite the budget day changes. The failure to index the tax system fully for wage inflation means a bit more of any wage increase will go in tax.

The budget did introduce cuts in USC and an increase in the standard rate income tax band, which means employees enter the higher rate at an increased income level. These changes delivered €5 a week or so to many single middle income earners and €10 or more to middle to higher income dual income couples, based on current earnings levels.

However with wages rising in many sectors, the net impact for many next year will be that the amount of their income paid in tax, USC and PRSI stays the same, or even rises slightly. This is because – apart from the increase in the standard rate band – the rest of the system was not altered to account for wage inflation.

The non-indexation of the system means that the tax take on incomes automatically increases if wages rise – a kind of inflationary stealth tax. Not increasing tax credits and bands for inflation each year is specifically mentioned in the agreed programme for government as a way to fund other tax concessions.

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Annual gain

The impact is made clear in example cases contained in documents published with the budget. One example shows a public servant earning €60,000 receiving a €752 wage increase next year under the terms of the agreement with public sector unions. However the annual gain in after tax income is reduced to €622, after the tax take is counted in. The tax take as a percentage of income from this public servant remains just below 27 per cent in both years.

In a similar example from the private sector, an employee on the same €60,000 income level is assumed to get a 2 per cent wage increase. This delivers €1,200 in extra cash, but after tax the gain is reduced to €882. Tax as a percentage of gross income remains about 29 per cent in both years.

The story is the same at lower income levels. A public servant earning €38,000 and gaining €476 from negotiated pay rises will see a €455 rise in after tax income. An employee in the private sector on the same salary and receiving a 2 per cent rise will see a gross income gain of €760 reduced to an after tax rise of €615.

Standard rate band

The Government did decide this year to push up the standard rate band by €750 this year, arguing that employees enter the higher 40 per cent rate at below average incomes.

The Budget 2018 tax package will cost €350 million in a full year, of which €150 million relates to the extension of the standard rate band. The previous minister for finance, Michael Noonan, estimated that non-indexation of the bands and credits in the 2017 budget yielded €345 million for the exchequer this year and €400 million in a full year.