Not actually a flat tax
This first thing to point out is that what they are proposing is not actually a flat tax. It is a single rate income tax with a progressive effective rate. While it is not as regressive as a pure flat income tax, it is far less progressive than our current system.
In their model, effective rates of income tax range from 7.8% for anyone under €20,000 to 23% above €70,000 for a single person. The change in the effective rate between €20,000 and €70,000 is gradually progressive. This is caused by their ‘basic income’ component - which isn’t a basic income at all, it is a graduated tax credit.
Simplification of the tax system is to be welcomed - as complexity benefits those who can understand and exploit the loopholes. While the flat tax does simplify the tax system somewhat, the calculation of your “basic income” credit in the RENUA model is still complex.
Nevertheless, there are some positives. Firstly it removes all manner of tax credits and exemptions which tend to favour higher earners. In this way it is more like the USC than income tax.
Secondly, for some families there is an element of a negative income tax i.e. they get part of their tax credit refunded if it isn’t used. And finally lone parents are treated the same as couples i.e. they get twice the tax credit that a single person gets. This is a recognition of the costs faced by lone parents.
Of course these changes could just as easily be applied to a progressive system. Indeed, if RENUA is serious about these elements they could advocate for them in our current system.
Effect on Inequality
In looking at the figures we see the impact of the flat tax system on inequality. The difference in tax paid and effective tax rates for a single person between the current system and the RENUA flat tax are as follows:
The changes in tax rates and tax paid at the bottom and at the top are highly unequal. In particular, the fact that those under €20,000 will be required to pay more tax (without compensation of improved services - see below) is significant given that this would affect 35% of tax cases.
TASC has repeatedly shown how Ireland has the highest level of market income inequality in the OECD. In this context, dramatically reducing the progressivity of our tax system through this flat tax would lead to an increase in net income inequality.
Perhaps the biggest mystery of the flat tax model is how it will affect government revenue and its ability to provide public services. RENUA steadfastly claim that it is ‘revenue neutral’.
By my calculation the effect of reducing the income tax, USC and PRSI for those over €70,000 to 23% would cost at least €4.6 billion. If you also add in the tax cut for everyone between €20,000 and €70,000 (1.2 million tax cases, currently accounting for €7bn in tax and USC), and the abolition of PRSI, that is a dramatic and significant shortfall in government revenue.
RENUA claim that this will come back to government through increased spending, reductions in black market activity and unnamed “dynamic effects”. Increased consumption will increase VAT receipts to some extent, but not if people save their money or leaks out i.e. when it is spent on foreign holidays. While there may be some bounce from cutting the tax rate, expecting it to make up such a massive shortfall is scarcely credible.
In particular, the fact that PAYE workers pay tax at source means that those individuals are not suddenly going declare more income because it is taxed at a lower rate.
The belief that this rate is ‘revenue neutral’ has no basis in fact. Given that the recent introduction of the USC and the raising of personal tax rates under the progressive system from 2011 to 2013 led to tax receipts increasing it is clear that we are not currently at a “Laffer” optimal tax level. And even if such a thing did exist, it is certainly is not somewhere down near 23%.
Ireland’s high level of market inequality requires us to have a progressive tax system if we are to retain even average levels of net-income inequality. TASC’s analysis has also argued that we should be raising more revenue from tax than we currently do in order to provide much needed universal services that can reduce inequality.
A flat tax, even with some progressive elements, will lead to an increase in the tax paid by the bottom 1/3rd (who currently earn less than a living wage), with reduction in overall revenue for public services.
The fact that this will be financed by significant tax cut for high earners means that inequality will dramatically increase.
Cormac Staunton is Senior Policy Analyst at TASC. You can follow him on Twitter @Cormac_Staunton