Economic league tables need to be treated with caution – much of their contents are inevitably subjective. But a recent ranking of international tax regimes by a US-based think tank – the Tax Foundation – was striking in putting Ireland 31st of 38 countries measured for “tax competitiveness”.
The main reason for Ireland’s low ranking was the income-tax system. The foundation is coming from a particular place ideologically, favouring low and simple tax systems which it argues are economically efficient and promote economic growth.
But its findings are worth examining as they throw interesting light on tax in Ireland at a time when the tax burden is on the rise.
The background
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Tax systems are judged on various criteria. Adam Smith’s goals in The Wealth of Nations, published in 1776, are often quoted: fairness, certainty, efficiency and convenience. Ireland’s system is generally seen to score highly on one aspect of fairness, in that it collects a lot more income from higher-income people, with some of this cash redistributed via welfare payments.
Using data from the Organisation for Economic Co-operation and Development (OECD), the Department of Finance has said that the Irish tax and welfare system does more to reduce income inequality than any other industrialised country. One point to note is that before these taxes and transfers take place, income inequality here is high.
Structuring the income-tax system in a way that takes significantly more from higher earners is a policy choice. Most countries take this progressive approach to some extent, but the details vary significantly.
The Irish tax system relies more on taxes from personal and corporate income than the average. It also relies less on tax from sales – such as VAT – and social insurance.
Its other distinguishing feature is a lower burden than average on those on more modest earnings. Around 30 per cent of earners – more than one million taxpayers – pay no income tax or universal social charge (USC). This is made up for by higher taxes on middle and particularly higher earners.
Lower social insurance charges than in other countries are another important factor in assessing the total tax burden.
The trade-offs
Exempting many earners from income tax and the USC altogether means a bit more is taken from middle and higher earners. This is one of the trade-offs in the Irish system. The impact of this is why the Tax Foundation rates Ireland lowly in terms of its income tax system – it is ranked 33rd out of the 38 nations for this area. The Tax Foundation is also critical of the way company dividends are taxed here. Looking at total individual taxes, including personal and capital tax charges, it rates Ireland as 37th out of 38 countries.
Ireland’s top income tax rate of 40 per cent is not particularly high by international standards. The maximum total tax “take”, which is generally 52 per cent when pay related social insurance (PRSI) and the USC are added (for self-employed people earning over €100,000, this rises to 55 per cent), ranks joint 13th highest out of the 38 countries.
However, Ireland is particularly out of line when it comes to the rate at which the higher income-tax rate kicks in. The higher rate of 40 per cent here applies at just-over-average incomes, according to the analysis used by the foundation, based on OECD data.
Apart from Belgium, this is the lowest level at which the higher rate applies in comparison to average incomes across what might be called normal progressive EU tax structures. (Hungary and some of the Baltic countries have flatter systems). Social security contributions will change the take-home pay picture in some cases, but the low level at which the high income-tax rate kicks in is notable here.
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The Tax Foundation points out that high marginal income tax rates – the rate which applies on the next euro of income earned – is important. It has an impact on people’s decisions to work extra hours and the general efficiency of the tax system.
In terms of fairness, it also means that middle earners get hit by high marginal tax charges in Ireland. The flipside is lower social security than many other countries, though in turn this often offers more significant benefits in many developed EU countries than is the case here.
Together with a relatively high capital gains tax rate of 33 per cent and the way in which dividend income is taxed, this is why it rates the Irish tax system as being at the lower end of the competitive ladder.
It is also critical of the structure of the VAT system which has a relatively high 23 per cent rate. This is, however, applied on a relatively small base of goods with many exclusions. In contrast, Ireland’s corporate tax system, with a relatively low rate, is ranked as fifth most competitive of the 38 countries measured.
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The Budget
The analysis in the report provides some context to the decisions taken in Budget 2026. The Government decided to direct the resources in the tax package to reductions in VAT on hospitality and new apartment building and some other smaller measures. Tax bands and credits were left untouched.
However, as wage inflation pushes average earnings higher, continuing this approach of non-indexation means the higher income-tax rate of 40 per cent will apply to more and more earnings.
Minister for Finance Paschal Donohoe has promised to resume the increase in bands and credits in future budgets, if the figures remain strong.
However, analysis by the Central Bank showed that between 2019 and 2023 the adjustments made accounted for around 80 per cent of wage inflation. In other words, the proportion of Irish earnings to which the higher rate applies had already been creeping higher and this will accelerate in 2026.
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The Tax Burden
The other key point to note from the budget is that the burden of tax on the Irish economy will rise a bit next year as more resources go to Government spending.
This may seem strange as the Government announced a €1.3 billion tax “package” on budget day – reduced at the last minute from the planned €1.5 billion. But budget figures are complicated by the need to renew measures that are expiring – such as the lower VAT rate on energy bills – and the impact of inflation on the tax take.
Before the Oireachtas Committee on Budgetary Oversight this week, Irish Business and Employers Confederation (IBEC) chief economist Gerard Brady pointed out that when rollovers of existing schemes are excluded and the €1.2 billion bill from the non-indexation of personal income tax bands and credits are counted in, “the tax package in net terms, is contractionary – taking in €400 million”.
On top of this, he said “pre-announced additional contributions and tax decisions including changes in PRSI and pensions autoenrollment . . . will raise in the region of €1.4 billion in 2026″.
Meanwhile, the Department of Finance estimates that a hike in the corporate tax rate paid by the biggest companies will raise an additional €3 billion, on Department of Finance estimates, with IBEC feeling the take could be even greater.
In other words, the budget presentation is confusing. The tax burden on the Irish economy is set to rise next year, despite the reductions in certain areas announced on budget day. And this will have some costs in terms of competitiveness.
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The longer term
The Government may choose to give some income tax relief in future budgets, though whether this is enough to account for the impact of inflation remains to be seen.
But the signs are clear that the budget numbers will tighten during this Government’s term, even if corporate tax does outperform again next year. Apart from the threats from Donald Trump’s policies, Ireland faces significant spending pressures from an ageing population and from dealing with climate change.
Huge costs also lie ahead in building up the State’s key infrastructure. All this indicates that, rather than falling, the tax burden is set to rise further. Again, money given in one area is likely to be more than taken back somewhere else.
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Relying on income tax to pay for the bulk of this would be risky, given that a relatively small number of more highly-paid people already pay the vast bulk of income tax.
Those earning over €100,000 – single people and jointly-assessed married couples – pay two-thirds of all income tax and USC. From a political standpoint, raising taxes elsewhere is difficult. The Government has yet to outline its spending plans for its term in office – and perhaps the delay is because this will leave one big question open. How will it all be paid for?
