It is that time of year again. Like in the neighbouring island we drive on the left hand side of the road (as a general rule) and have an Annual Big Day (known as Budget Day) when the Minister for Finance announces the budget for the coming year. There is a lead in of many months of discussion in which various groups make ‘submissions’ on what should be prioritised by way of spending or revenue or borrowing as the case may be. The precise timing and sequencing of events has been modified by what technical people refer to as the European Semester process.
As the Republic of Ireland emerges from forced fiscal ‘correction’ under the watchful eye of the ‘Troika’ it now finds itself in the ‘preventive’ phase where budgetary decisions and statements of intent are scrutinised at home and abroad to see if they are compatible with ‘fiscal rules’ laid down at EU level but enshrined in domestic Irish law. The process is heavy and in many ways predictable when various civil society groups have their say. Typically, various interests line up on traditional fault lines such as:
- More spending versus lots of more spending
- Tax cuts versus lots of more tax cuts.
The stage is set and the questions are predetermined like a menu of options when you phone in to a company or public organisation (you might be given 6 options but the very one you want is none of them and you can’t, in practice, speak to anyone even though you get an online customer survey emailed to you with the subject line ‘How are we doing?’!). Heaven forbid anyone should mention tax increases and/or seek to reframe the entire discussion. Tax increases are only for recessions while tax cuts are natural once the economy gets going again (Keynes is truly dead). And we all pay far too much tax anyway – so the consensus thinking goes.
The highly contrived and arcane measure of ‘fiscal space’ is used to concentrate discussion on the equivalent of just a little more than 1% of total public spending in any one year. In other words, for every €100 of spending on schools, hospitals, roads, teachers, Garda, pensions, child benefit etc. the public debate is concentrated on the one Euro of spending at the margin. Even then, the public are led down a little pathway of ‘tax cuts’ versus ‘spending increases’. People divide themselves up into the ‘extremists’ who don’t want any tax cuts and those more ‘reasonable’ folk who want 50:50, 2:1 or 90:10 as the case may be. In practice such discussions are vacuous and misleading because they do not start from the larger question of how well do we spend what we spend and what level of overall spending (and therefore revenue) is needed to provide the level of public service we want. We get what we pay for. The bulk of day-to-day spending goes on three areas:
- Social protection to pay the pensions and various social welfare allowances without which the Republic of Ireland would have catastrophic levels of poverty (it has a very large degree of income inequality before social welfare is paid)
Under the headings of health and education as well as other areas of spending a majority of what is spent goes on staff costs to pay for teachers, special needs assistants, nurses, doctors, welfare officers, psychologists and general administrative staff.
That there is a connection between what we spend and what we as a society collect through taxation seems to have largely escaped attention though the tenor of public discussions since the early part of this year gives grounds for cautious hope. The view universally shared is that ‘I’ pay too much tax or ‘we’ pay too much tax and ‘they’ ought to pay more, or, ‘we’ should all pay less tax and stop throwing money at people on bloated public sector pensions or living off the dole – as the assumed truth goes. The latter objections are rarely substantiated with reference to statistics. I have reviewed many of these issues in previous Monday Blogs. Given that it is ‘that time of year again’ I would like to slay some myths in this week’s blog and in the coming weeks.
Lets start with
Myth Number One
“We all pay too much tax” .
The only and most reliable way of testing this claim is to extract data from the OECD Tax-Benefit Modeller. I have also addressed this matter in a previous Monday Blog [ These truths we hold to be self-evident ]. Here, I update the comparison to include data for 2014 – the latest available data from OECD for this comparison. To keep things simple I produce here data for single persons (and with no children) earning the average wage as calculated and reported by the OECD. The data represent ‘headline’ tax rates based on standard tax credits (if any) and relevant rates of social insurance (if applicable). Included in Chart 1, 2,3 and 4 below is the combined total of 'income tax', USC and PRSI. Actual tax paid may differ to the extent that various tax reliefs apply and lower the amount of tax on income due. Chart 1 shows that, for single persons on the average in production, the Republic of Ireland had the second lowest rate of taxation on income among EU member states for which the OECD provided information. The countries with the highest average income tax rates included (not surprisingly) the Nordic countries as well as countries such as Belgium and Germany. The UK (and Northern Ireland which as the exact same provisions in regard to income tax and social insurance) had a higher average effective tax rate as did the USA, Canada and Australia – countries where many Irish citizens have gone to work. Of course it must be pointed out that average tax rates have been reduced a bit since 2014 due two successive budgets containing tax cuts.
But, what about very relatively high-paid workers?
Myth Number Two
“Ireland is not competitive when it comes to income tax especially on average to above average incomes”.
The OECD provides a number of benchmarks. However, the highest level of pay used in the comparison is one anchored on 200% of the average wage. In the case of the Republic of Ireland this represents a level of pay equal to €68,356 in 2014. Remember all those claims from various quarters that Irish income tax rates on above-average wage employees is driving talent away from Ireland? Chart 2 tells a different story (once again I am using the case of single persons to keep things simple). True, the average effective tax rate moves up sharply from just over 20% for a single person in the Republic of Ireland earning €34,178 per annum to just over 36% at an income of €68,356. At 36%, the Republic of Ireland is about mid-ways on the OECD comparison. Many successful and high-productivity countries such as Germany, Belgium, the Netherlands, Finland and Sweden have higher rates of taxation on income (the excess is explained in large part by significantly higher employee social insurance contributions). It will be pointed out that the UK, USA, Canada, New Zealand and Australia have lower average effective tax rates than the Republic of Ireland and that this matters at the upper end of the pay spectrum where competition for certain categories of high-skill workers is significant. A number of caveats are in order here:
We do not know the actual amount of income tax paid (see point above about tax reliefs). Higher paid persons tend to avail of such reliefs (e.g. on pensions or health insurance spending) much more than lower paid workers.
The OECD comparison, unfortunately, does not extend to very high earners in the top 5 or 1% income brackets.
Disposable income is not the only factor to be considered by employers or employees in attracting workers from abroad - the quality of life, the quality of public services and the ‘cost of living’ (transport, housing, childcare, hospital treatment, etc) are also very important. Let’s call these latter public goods the ‘social wage’. Countries that focus on low income tax rates frequently (though not always) under-perform on many aspects of the ‘social wage’.
What about relatively low paid workers?
Myth Number Three
“The way to win the hearts of lower paid workers is to give them tax cuts”
Fortunately, the OECD does facilitate comparisons at below the average wage. I will use the following cut-off points – 50% of the average wage in Chart 3 (= €17,089 in the Republic of Ireland) and 67% of the average wage in Chart 4 (=€22,899).
Chart 3 speaks for itself. At 3.7% of gross income relatively low paid workers, in the Republic of Ireland pay very little tax on income. By contrast, in Denmark workers at 50% of the average wage (and earning just over €25,000 per annum or 200,000 Danish Kroner) pay a total of 35% of their income on taxes. Not only are relatively low paid workers paid higher wages (wages are much more equally distributed in Denmark) but they enjoy a range of social services and payments including provision for unemployment as part of their very imperfect flexicurity arrangement. The Republic of Ireland is way off the scale in European terms. However, public policy in the Republic of Ireland has little option to have low taxes on low-paid workers because wages are so poor and the social wage so limited. Various tax credits and thresholds apply to remove employees from the tax net or greatly limit tax paid. It should be pointed out that individuals and households spend a very significant proportion of their gross income on value added tax and excise duties although few people think about this much.
Myth Number Four
“Ireland has the most progressive tax system in the world”
Have you ever wondered about the often repeated claim that the Republic of Ireland has the ‘most progressive tax system in the world’. This claim is based on two very limited premises:
- No account of taken of indirect taxes when making this claim.
- The comparison is, typically, based on those at 67% and 167% of the average wage and uses headline tax rates.
To complete this week’s myth-busting I look at those at 67% of the average wage (Chart 4). The overall picture is not hugely different from that of lower paid workers (Chart 3). To be noted is the fairly steep rise in average tax rates in the Republic of Ireland from a very low 4% for those at €17,000 per annum to 14% for those at €23,000. The rate climbs to 20% for those at €34,000 and 36% for those at €68,000.
An advantage of using average effective tax rates is that the data summarises the total amount of income tax paid and relates it to gross income. Those pursuing a tax-reduction agenda typically focus their data comparisons on (a) ‘marginal’ headline tax rates (how much extra you pay for an extra Euro of income between income, USC and PRSI taxes) and (b) comparisons of the Republic of Ireland the UK. There is some merit in comparing marginal rates because these are relevant to incentives ‘at the margin’. Comparisons with the UK have a rationale but we should recall that there other countries, nowadays, where people travel to for work.
It is not uncommon to have relatively high marginal rates and dramatically lower average rates (due to the application of tax credits as well as tax reliefs). Both perspectives are relevant to an analysis but the overriding question is how much do people pay in income tax and how does this compare across countries.
What conclusions can be drawn?
- The Republic of Ireland is a low-tax country no matter what way you measure it (whether by reference to overall revenue as a percentage of GDP or GNI or by reference to estimated average tax paid by different individual or household types).
- Relatively high-income earners do not pay more in income tax than is the average across the OECD
- Relatively low-income earners pay much less income tax than is the case elsewhere but this is undoubtedly linked to the fact that the Republic of Ireland has a much more unequal distribution of income and a relatively poor social wage.
How can social policy move on? It is tied up with a transformation of enterprise and work over the coming decades. Work that pays and a narrowing of income differentials would facilitate a better use of public funds to target those at risk of poverty as well as offer greater security by way of universal public goods to all members of society. If some of us want to entice ‘middle Ireland’ (however defined and measured!) to support a new type of social contract then we need to start having honest, fact-based conversations.