Wednesday, 22 April 2015

More on Income Taxes and Social Charges – Proposals for Reform

Paul Sweeney: According to economists Thomas Piketty and Emanual Saez 

The job of economists should be to make a top rate tax level of 80% at least "thinkable" again.”

Not long ago, Ireland had top tax rates - on high incomes - of over 60 and 65% - plus social charges.  In a recent blog, I showed that today’s top rate of income tax is at is lowest rate everLast year TASC sought modestly to just retain the 41% rate, but it was reduced to 40%. Oisin Gilmore demonstrated the lack of evidence for 'disincentive effects' of higher taxes on high incomes in this Blog.

Why is a higher top rate of tax unthinkable for many policy leaders in Ireland today?

The government, elected during the worst economic hurricane experienced in Ireland since the Famine in 1845, promised not to raise the top rate of income tax. In fact, it cut the top rate slightly by 1% last year. More importantly, it increased taxes on consumption – paid by all - by 2% (which is equivalent to a relatively high 10% on the then 21% rate).

As the economy recovers, further cuts in the top rate of income tax are being promised. Everyone pays VAT, but less than 20% of those at work pay at the top rate. And most do not pay much tax at that rate, with three quarters of all earning less than €50,000, thus paying only the difference between the two rates on that sum which exceeds their threshold.

If the Government is “giving something back” why only give it to the top 20% of earners which is a much smaller fraction of the population?

The possible answers are that:
  1. the top tax rate comes in at too low an income (over €32,800 for single person) 
  2. it is popular with the media. Politicians know that most people are blind to the fact that giving tax back means less public services.
  3. It is argued that foreign investors look [only] at the top tax rate in comparing countries.
The first two points are correct, but the third is not. Foreign investment is not made solely on taxes in spite of the assertions by some and investors would not be so naïve as not to consider employer and employee social charges too as well as a myriad of other factors.

Interestingly, last year’s 1% cut in the top tax rate cost €234m compared to a what might have been a cost of €280 for a 1% cut in the top rate of VAT of 23%. The reason is that only a third of activity is taxed at this rate. To reduce the three main VAT rates (the lower rates at 13.5% and 9% are probably reasonable or maybe low) would cost a total of €650m. This is why cutting VAT is not popular with those in government.

The big economic issue is growing inequality. Taxation, welfare and good jobs reduce inequality. To its credit, the government has largely preserved Ireland’s welfare system - in spite of the economic hurricane. It also boosted taxes on capital substantially. This demonstrated a strong commitment to the reduction in inequality. This was achieved in spite of the economic collapse and the demands of the Troika and others.

Social Charges
There were a great number of different social charges - PRSI, USC, Youth, Income, Health and Employment Levies over the years. Assessing their impact is further complicated by the fact that these levies were imposed on different levels of income, with some floors and many ceilings.

A major progressive reform in the levies was made some years ago. Most levies were not charged on high incomes – they were cut off at a ceiling and thus were regressive. The abolition of this ceiling was is a major reform and was long overdue.

  • Employees pay 4% PRSI on all income.
  • They also pay 1.5% USC up to €12,000;
  • 3.5% from that to €17,600;
  • 7% from €17,600 to €70,000 and
  • 8% on the income above that sum.

Thus the USC is very progressive and importantly, it applies to incomes from all sources, including unearned like dividends and rents. Micheal Collins in a recent informative paper here on income taxes and charges found that the USC is a progressive charge. In one of his tables (7) and in Chart 3 he demonstrates this unequivocally across income groups, though some reform around low income groups (inserting additional rates and bands and perhaps merging it with PRSI as originally envisaged) would improve it. We saw that cut in the top rate will cost around €230m but a cut of 1% in the 7% USC rate would cost more than twice that - at €500m (own estimates based on 2013 data).

Thus today’s levies total 11% (4% PRSI and 7% USC) for most people, ie on middle incomes, but are higher for high paid and self-employed people. Thus the average on the top tax rate will have a deduction of 51% - but only from the top of their income. The average income tax and levies will be well below - this depending in income.

But people do not realise this and hence their, the media and the government ‘s focus on the top income tax rate.

The government is promising / threatening to cut the top income tax rate again, and also to reduce the levies on the self-employed.

Helping the Self Employed
But the additional charges on the self-employed are there for two reasons. First, they are allowed to deduct a great deal of expenses incurred which do not apply to the PAYE worker. Secondly, they have the opportunity to evade taxes. Most PAYE workers have little opportunity to evade taxes.

Thus, if there were to be any reduction in the levies for the self-employed, such a cut must be accompanied by a substantial increase in staffing in the Audit branch in Revenue in order to reduce evasion and in its activity. Tax evasion is a huge cost to the state.

But there is a counter case for increasing the levies on the self-employed – for their benefit. It is argued that the self-employed should have access to unemployment benefit. This is both acceptable and desirable. However, they must not be subsidised by the PAYE workers. Therefore they would have to pay their fair share in funding the system, which they do not do at present. Employees and employers contribute considerably more in social charges than do the self-employed, hence the lower entitlements for the Schedule D taxpayers.

Best Equitable Tax Reforms 
The best way reform the income tax system is to introduce a third rate of income tax on high incomes and simultaneously reform the levies on employees and employers.

The proposals from the Congress of Trade Unions and some political parties for a higher rate of 48% on individual incomes of over €100,000 is reasonable and progressive. This 48% rate was the top rate when the Rainbow Government fell in 1997. It had been 58% ten years earlier and was higher before that.

Only 7% of all income tax payers would pay at the new rate of 48% and they would be the very top earners. However, because income inequality is so great, it is estimated as that this minority of earners pay 66% of all income tax in the state. So an extra 8% on such high earners would not be penal, being far less than was paid by high earners in the past. It would help reduce our high inequality. 

However, should be accompanied by expanding the band for the 40% rate which would also benefit the high earners. A €5,000 rise in the band would cost  €800m.

Suggested Tax Reforms around Income
  1. Bring back the 3rd rate of income tax at 48% over €100,000 for individuals.
  2. Widen the 20% rate band by €3-5000.
  3. Reform the USC and levies, with some reductions, new rates, bands.
  4.  Increase Employers’ Social Charges
  5. Give more cover to self-employed, provided they contribute fully for additional benefits.

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