Nat O'Connor: There has been a flurry of calculations about the effect of Budget 2011. One technical, but important, point is that our income tax system (inclusive of PRSI and USC) is now less progressive than it was last year.
Nearly everyone pays more tax due to Budget 2011 (except for the self-employed earning over €200,000) but the extent to which 'those who have more will pay more' is lessened.
Some ESRI economists argue that the cumulative effect of now four austerity budgets since the crisis began has hit higher earners more.
Their chart, invisible on the online version, looks like this:
Q1, Q2, etc stands for the income quintiles. The chart shows that those in the lowest quintile are hit most in 2011, but the authors' argument is that higher quintiles have been hit more when all four budgets' effects are combined.
There is an important caveat in the Irish Times article: "Our analysis does not include the wage or employment effects of the reduction in the minimum national minimum wage." This obviously matters a lot to people in the lowest quintile, and potentially to some in the second quintile, whose earnings are linked with the minimum wage.
This example highlights that any model or calculation of the budgetary effects rests on a number of assumptions. The Irish Times article only skims the surface of the technical details of their analysis, but one question which I raise below is the extent to which they assume tax reliefs that already erode the progressivity of the income tax system. They state that they include changes to pension tax relief, among other variables, which is open to challenge.
Similarly, the official Budget documentation provides 12 example household types and how they are affected by tax changes (in Annex A). However, these examples are neither complete nor balanced.
For example, there are no examples of married couples with two earners, and the tables stop at earnings over €175,000; thus failing to illustrate that self-employed people on over €200,000 are in fact better off after tax and social insurance changes in Budget 2011. Also, an unrealistic assumption is made that a six per cent pension contribution is made by workers, regardless of their income. Firstly, the evidence shows that less than half of Irish workers have a private pension. Secondly, it is unrealistic to assume that workers on low gross incomes can afford to save anything, in the context of the current cost of living. Therefore, the examples and the changes in net income they illustrate must be regarded as inaccurate and misleading, which is a serious concern when it occurs in the official Budget documentation.
One way to get to the bottom of this, is to identify the 'baseline' tax system; that is, the bare bones of the tax system.
In the case of income tax, I argue that the baseline system is composed of three elements: the rates (20% and 41%), the bands (e.g. single people pay 41% from €32,800 upwards) and the basic credits (e.g. single person 1,650). I also add in the basic PRSI, USC, etc rates.
Everything else is an addition or modification of the baseline tax system, including the PAYE tax credit, pension tax relief, etc. A problem with the ESRI-SWITCH and Budget calculations of income change from the budget is that a number of tax reliefs have been 'absorbed' into the baseline tax system. In fairness, the SILC data used in the SWITCH model may have an empirical basis for who uses what tax reliefs, but making these assumptions can easily include normative judgements about what's 'normal' tax relief versus what is in effect a 'bonus'.
I argue that tax reliefs (beyond the basic single person or married credits) are a bonus. Someone using reliefs is paying less than the full amount of tax they should otherwise be paying, based on their income level. This, in turn, lessens the progressivity of the tax system. As such, the loss of a tax relief bonus is not the same thing as an actual increase in someone’s tax liability, such as occurred with the rate and band changes in Budget 2011.
Progressivity in the baseline tax system can be simply measured as to whether someone on a higher income pays not just more tax, but a proportionately higher part of their income. And, as the figure below illustrates, this is indeed the case (blue triangles for 2011, red squares for 2010).
Of course, what the curves illustrate is only the baseline, theoretical progressivity of the tax system. When people use tax reliefs, additional credits, etc. the level of effective tax they pay is reduced and progressivity in the tax system is likewise reduced. And we use a great deal of tax relief in Ireland.
What the figure also illustrates is that, with Budget 2011, the curve is slightly flatter in 2011 than in the previous year. That is, the overall effect of income tax (including USC and PRSI) is less progressive. Everyone pays more tax, and a higher proportion of their incomes, but those on higher incomes see their proportion rise by less than those on lower incomes. For example, someone on €40,000 pays 3.6 per cent more in tax/charges, whereas someone on €200,000 only pays an extra 2.2 per cent.
And at a certain point in time, percentage increases and decreases are not useful comparators. For example, a ten per cent income cut for someone on €200,000 is €20,000; whereas ten per cent for someone on €20,000 is €2,000. Yet, the person on the lower income might suffer more hardship than the person who remains on a very high income of €180,000. Hence, we need to move beyond comparing the percentage changes for different income groups and start asking how much money do people need to live a decent life.
The data used in my line chart is as follows. The 2010 position (single PAYE workers, with no children, paying the income levy, health levy, PRSI and income tax):
The 2011 position (single PAYE workers, with no children, paying the Universal Social Charge, PRSI and income tax):
A further point is that many of the real, material effects of Budget 2011 do not manifest as changes to income. Economic equality can be measured as the combined effect of wealth, income, costs and public services on a person’s total net ‘benefit’ from the economy. Budget 2011 affects all four dimensions of economic equality, but some of the Budget’s implications are not immediately obvious. For example, while the Budget makes immediate changes to tax and social welfare, changing people’s incomes, it also sets the available resources for different Government Departments. It will only be as 2011 progresses that people will see the erosion of local services, such as libraries, roads, public transport, as well as a reduction in the resources available to community groups, etc. These cuts to public spending will impinge upon economic equality, with those on the lowest incomes again most badly affected, because they are more reliant on public services.
There is a lack of distributional analysis in the Budget documentation, which is a major flaw. More sophisticated analysis is required to guage the full extent to which budgetary changes affect different people in society.