Opinion:At a time when the UK, our closest competitor in the inward investment game, is sharpening its tax strategy and strengthening its "invest in Britain" message, it would be unwise and short-sighted for Ireland to increase its marginal rate for higher earners to 55 per cent by way of an increase in the universal social contribution from 7 per cent to 10 per cent.
With our current marginal rate of 52 per cent for PAYE workers, Ireland is already ranked joint 10th highest in the Organisation for Economic Co-operation and Development in terms of marginal income tax rates. An increase to 55 per cent would make our marginal rate higher than the UK’s (52 per cent) and it would send us beyond the rates which apply in other EU countries including Germany (47.5 per cent), France (50.5 per cent) and Luxembourg (43.5 per cent).
The Economist Intelligence Unit has already issued a strong cautionary message for Ireland on this very issue. Its 2012 report, Investing in Ireland – A Survey of Foreign Direct Investors, praises our pool of domestic and foreign workers, but says income taxes could be discouraging senior talent. Investors are concerned about what they see as imbalances in our personal tax system; a large gap between the average all-in tax rate paid by the typical worker, which is among the lowest in the OECD, and the marginal tax rate for top earners, which is among the highest.
They believe that these high marginal rates will make it less attractive for senior executives to settle here.
The fact that high earners in our competitor countries can earn much more before they enter the higher-income tax brackets brings the proposal for a USC increase into even sharper focus.
Just a 50-minute flight away in London, the highly skilled and highly mobile can earn a salary of £150,000 (€187,000) before they enter the top rate of income tax. In Germany, workers can earn more than €250,000 before entering the top rate, while in Spain the threshold is €175,000.
High-tech industry
The new global trend towards lower corporate tax rates, a key element of Ireland’s tax strategy to date, means that international investors are concentrating on other taxes and income tax is coming into sharper profile. It is no longer good enough to just have a competitive corporate tax regime.
London is making serious play of its corporate tax rate reduction and is putting its marginal rate cut from 50p to 45p up in lights. Others are following where the UK has headed. There are now nine EU countries with corporation tax rates below 20 per cent, while outside the EU Singapore is tending towards reducing corporate tax and Israel has introduced an array of tax measures, with a particular focus on high-tech industry.
The upshot is that income tax rates are playing a greater role in determining the location of jobs and so recent suggestions that a 10 per cent rate of USC is “not really an income tax increase” are worrying.
There is no doubt but that the USC is a tax; it is one of the bluntest tax instruments in the State’s armoury, reducing net pay while yielding €3.1 billion for the exchequer in 2011. Combined with the 41 per cent income tax rate and a 4 per cent PRSI rate, the USC brings our marginal rate for PAYE workers to 52 per cent.
Its bluntness means that a 1 per cent increase in the USC rate cuts a lot deeper than a 1 per cent increase in the marginal income tax rate, operating as it does on a much wider base of income. The impact of the USC is felt once a taxpayer reaches the income threshold of €10,036 and its sweep reaches all of the taxpayer’s gross income, with no deference to the credits or deductible expenses that apply in the case of personal income tax.
Those proposing an increase to the USC argue on the grounds of fairness and tax yield, but there are important facts on both accounts.
The Department of Finance, in its own published review of the USC in November 2011, said that the abolition of the PRSI ceiling, together with the introduction of the USC, brought about a more progressive and equitable combination of charges. The tax reforms of recent years mean that Ireland now has the most progressive tax system in the European Union.
Regarding the impact on exchequer yields, it is accepted universally that income tax-rate changes affect taxpayer behaviour, and the expected windfall from increasing rates does not always materialise.
The UK recently found this out, to its cost, when it introduced an additional 50 per cent rate of income tax in 2010. The experience prompted the UK government to rapidly reverse course and the rate is set to be reduced to 45 per cent from April 2013. So what went wrong?
The UK tax authorities reviewed the impact of the increase and found that the additional rate was “a highly distortionary form of taxation” which elicited “a considerable behavioural response” among taxpayers. Revenue generated from the higher rate was much lower than had been expected and officials found that the higher rate may actually have had a negative effect on tax revenues.
The tax take from labour is already higher than it has ever been in Ireland, with income tax projected to yield €15.3 billion in 2012, 42 per cent of the overall tax take.
Job creation
It is remarkable that we are collecting more income tax now than we were in 2007, when it yielded €13.5 billion. The statistic is all the more remarkable in the context of a significant fall in the number of people in employment, down from 2.1 million in 2007 to 1.8 million in 2012, and widespread pay reductions.
Increasing taxes on labour damages job creation – it is well established and widely accepted. The OECD believes that taxes on labour are detrimental to an economy which is trying to grow.
There is already discrimination against the self-employed, who pay a 10 per cent USC rate at the margin, despite being our hope for future job creation. So why choose to hurt ourselves further?
Risking our tax competitiveness and our international attractiveness as an investment location would be a high price to pay in budget 2013. At a time when winning points in the international jobs game is tough, throwing away any home advantage must be seriously questioned.
Martin Phelan is president of the Irish Tax Institute