Taxes and Incentives

The media reports suggest that ICTU has proposed a new top income tax rate of 48 percent. If various levies are added to that, the effective marginal income tax rate for high-ish earners could exceed 50 percent.

I am interested in the views of this blog’s readership on the extent to which a top tax rate in this range might adversely affect economic performance, in the specific context of the Irish economy and the Irish labour market.   For myself, I think it is important that the top tax rate in Ireland does not deviate too much from the UK top rate, which is due to be raised to 45 percent after the next election, in view of the high labour mobility between Ireland and the UK.

17 thoughts on “Taxes and Incentives”

  1. The top rate of tax at present (if you include levies,PRSI) is 49.5%. This applies to self-employed and certain company directors who do not have a PRSI earnings ceiling. If income tax rate goes to 48% then top rate for these taxpayers is 56.5% for other high earners it would be 53.5%.

  2. Philip,

    I fee you preloaded the question by looking for the adverse effects on the economy. Considering our low tax base then is this an acceptable temporary soloution.

    Current rate is 42% going to 48 plus levy is 50%

    But as pointed out on other threads the cost of living is going down and could drop about 3% (IIRC). That was used as Justification to freeze transfer payments. Following on in that vein this is only a 5% increase.
    Or does this type of logic only apply to the minimum wage and social welfare recipients.

    Labour mobility between Ireland and Britain will surely be lower over the next few years.
    As regards Labour mobility between the two parts of Ireland then maybe thats higher but considering the high unemployment in the border region any who can take a job in the north will, irregardless of the taxes.

    If i read you correctly then you would be happy with a rate around 45-47 (inc. levy).

  3. In responding to Jer, indeed my focus is on the potential negative effects of an overly-high top marginal rate. The potential downside costs are not receiving much prominence in the current debate. So, while I do not believe there would be a major incentive problem in moving to a top rate (all levies included) of 45-47 percent [given that the UK is moving in that direction, plus also major tax hikes in the US], it may be more efficient to seek tax revenues elsewhere (including cutting of tax breaks that favour the well off) rather than driving the top rate north of 50 percent.

  4. I agree with Philip that the place to look for distortions is in terms of peoples’ locational choices, and not in terms of their labour-leisure tradeoffs or other such considerations. As he said at that conference, the fact that the British are raising their top marginal rates will thus lower the costs to us of raising our top rates.

    But the real bottom line to me is that these considerations are a major reason why property needs to be properly taxed here, since it has nowhere to go. If the Irish administration can’t figure out how to do this, they can get foreigners to do it for them.

  5. I really think there is a bit of naivete about what will happen next. I really don’t think there are going to be all that many people left earning 100k + in the PAYE system next year, to apply this new tax to. A lot of the money in that bracket comes from bonuses and the like. For non-PAYE people, they can restructure to recognise the money as a capital gain rather than as income.

    That said, I think it makes sense to have a higher tax rate and thereby avoid introducing silly means tests on the various allowances. All these means tests do is generate bureaucracy.

    I think that we should be trying to lead the world with our whole government system in terms of simplicity, clarity and coherence.

  6. Agree with Philip that tax break restrictions are better than rate hikes. One issue here is that — by far– the biggest and most costly of these breaks is pensions. Already the restructions here in the 09 budget have exacterbated the already large divide between the top levels in the public and private sector in this area. So in equity could we — for the sake of argument — standard rate pension relief for private sector employees while at the same time leaving public sector pensions unreformed ( even with the small contribution muted in the discussions) ?

    Many of the property tax breaks are already on the way out, but there is undoubtedly room to cut or restrict other tax expenditures. Surely better to try to get whatever money we can here and aim for a simple system with rates as low as possible ( even if they are slightly higher than now)

  7. Given the state of other possible destinations’ economies at the moment, I think that mobility is unlikely to be a huge issue for the next year or two. A problem might arise, though, if (when?) we lag behind other economies in recovering, they then become a magnet for high skill workers, and it’s politically and economically infeasible to cut our tax rate back again at that stage.

    I’d be more concerned by the fact that a high tax rate is more likely to affect women’s behaviour than men’s. Participation elasticities have been falling, but they’re still much higher than men’s – so in this sense I disagree with Kevin that the labour-leisure trade-off isn’t an issue. Women dropping out of the labour market entails a depreciation of human capital that we could do without encouraging.

    Of course, wage cuts also reduce female participation probabilities, but cuts in take-home pay due to increasing taxes rather than wage cuts will – because of the partial transferability of tax credits and the standard rate band – impact disproportionately on second earners, mostly women, who are also the group who are most sensitive to changes.

  8. As someone who is earning over 100k. Two issues I have with the current thinking on higher rates of tax and reducing pension relief. 1) I bought a family home in 2005 on which I have a massive mortgage – currently just about affordable and on which I have already paid a penal level of stamp duty. A lot of the people making decisions on the high earnings have their homes for a lot longer and mortgage repayments are not necessarily a consideration. Care needs to be taken in the assumption that all high earners have a lot of disposable income. 2) I have a defined contribution pension on which I have put a lot of money since starting work 14 years ago. The pension relief is the only thing that has kept the losses on my contributions to date at any sort of a reasonable level and I can’t see how the pension will pay for my future. Standard rate relief would be no good. Additionally to many of the decision makers on high earnings they are not paying €1,000 a month plus in pension contributions as they are defined benefit. Whilst I have relief it is a further strain on disposable income. Standard rate relief will further widen the gap. A way needs to be found for the Public Sector to fund their pensions more appropriately. Also pensiosn should be indexed linked and not to current salary levels.

  9. I think a tax rate at this level provides plenty of incentives for every possible element of avoidance, perhaps even evasion. Taxing people who earn more totally disregards their outgoings, it assumes that as as percentage that they have similar outgoings as a person earning less.

    This doesn’t take into account things like mortgages, cars, etc. they also use less of the social services that lower level tax payers use preferring the option of paying privately for things like healthcare etc.

    Higher earners are not necessarily a nefarious group of hoarders either and their spending contributes disproportionately to the economy, taxing them and putting these funds in the hands of the state does not ensure that this money will flow naturally through the economy. It will likely mean they do start to hoard for fear of what comes next and this is the inverse of what we need.

    @Jer: VAT is higher now so you need to consider that when talking about increased buying power due to deflation, then the fact that many people are taking wage cuts anyway also needs to be a factor.

    34% of people in Ireland within the workforce pay 0% tax, that cannot be overlooked, I think that aiming to hammer those who are successful financially is an easy, yet not fully thought out concept because there will be unforeseen repercussions as well as discouraging capital flow through the economy efficiently [I don’t have faith the state can match the market in that respect].

  10. I find it hard to believe that so much attention is being paid to the possible inefficiency effects of an increase in the income tax rate. Unemployment might be 15% by the end of this year. There might be 3 million people unemployed in the UK. Does anybody seriously expect a significant movement of people in that scenario? A labour supply elasticity that might have been relevant 5 years ago has little or no relevance for the next few years.

    The idea that high wages are always a signal of high value should be one that is seriously questioned in the light of the past few months. Here are some numbers for the compensation received in 2006 by the CEO’s of certain firms in the US:

    Bear Stearns: $34 million for CEO James Cayne.
    Lehman Brothers: $27 million for CEO Richard Fuld.
    Citigroup: $25 million for CEO Charles Prince.
    Countrywide Financial: $43 million for CEO Angelo Mozilo.

    (See http://www.econbrowser.com/archives/2009/01/executive_compe.html)

    I am sure that had anybody questioned those numbers in 2006 they would have been told that those wages are a fair reflection of the value of those CEO’s to the company in question.

    In Ireland we have allowed certain public sector salaries to grow very rapidly through the implementation of the Buckley reviews. These increases were granted without any performance review of the individuals concerned. So for example the fact that some top academics were being courted by the private sector led to large increases for all professors even though many of them would have struggled to find a job with a high salary in the private sector.

    Many people have commentated on the blog about the need for any cuts in public sector wages to be matched by measures that would make sure that people who benefitted most by the economic boom would also pay pay their share. Yet we don’t seem to have many good ideas about how to implement this goal.

    If we just focus on taxes, there are 4 ways in which extra taxes can be raised in a progressive way. One is a higher income tax rate for incomes over a certain level. A second is taxes on luxury items. It is difficult to think of any example of this that might be effective in raising much additional revenue. A third is property tax. This could be implemented on worldwide property (with offsetting credit for any property tax paid in foreign countries). The problem with this is that it is very hard to see any such tax being implemented this year and to paraphrase Bart Simpson we need the money NOW! The fourth is the standard rating of all tax deductions. According to the CORI submission to the Commission on Taxation this could raise up to €2 billion. A significant advantage of standard rating pension contributions is that it would provide immediate increases in revenue for the Government.

  11. It’s true that economic prospects are also poor in the UK and the US, and so there would be little advantage to the average person in moving out of Ireland. But those who are still earning well in this climate – the ones who would pay up under a 50%+ marginal income tax regime – they will have much better prospects abroad and the very real option of leaving Ireland for tax reasons.

    Now that the banking and property bubbles have burst, a larger fraction of the (remaining) high earners are people who add real productive value to the economy. These are people engaged in the kind of work that the government is hoping will be the cornerstone of a new “knowledge economy.” And the plan is to tax them out of the country?

  12. Standard-rating of the tax deductibility of pension contributions would require, if symmetric treatment of funded and unfunded schemes is to be retained, imputation of contributions to unfunded schemes (almost all in the public service mowadays) and their exposure to tax as benefit-in-kind. Failure to do so would see tax planners arrange the return of unfunded private sector schemes for proprietor/managers. There is nothing simple in the taxation of pensions.

  13. Responding to Brendan, I think the key issue is whether increases in the top rate are perceived to be temporary or permanent. I agree that the behaviourial response to a high top rate is more limited during tough times but increases in tax rates are hard to reverse and a high top rate might remain even once recovery takes hold.

    This is why the current levy has its attractions, in that it is easier to cancel the levy than to seek to overturn any hike in the top marginal rate.

  14. Just kicking the idea around here – why not incentivize high earners to invest in our economy somehow?

    I was in Singapore (working for about 7 months) during their last downturn in 2001. (Now, the setup there is quite different. There isn’t a social welfare system as such. Families are expected to provide support. Each individual’s PRSI (CPF) payment goes into an individual fund, which can be drawn upon during lean times and for retirement). So what they did was issue the ‘Singapore Share’. The deal was that if you needed the dough, you could cash it right away. But if you didn’t, you could hang on to it, and it would pay out a yield of 3 percent after six years. (http://www.iht.com/articles/2001/10/17/singstock_ed3_.php)

    So the idea was that low earners would have these shares as a cushion, but those who were better off would have an incentive to hang on to them.

    (Now they did some other seemingly unfeasible things during the year – they cut the tax rate retrospectively – I thought the accountant was winding me up -.)

    So here’s the plan. We convert the training levy (on all income) into an Ireland Bond investment levy. We add a 5 percent levy for high earners. It’s a bond. The bond pays ECB+1% tax free. You get 2012, 2014 and 2016 bonds – the dates of redemption if you want to get the full benefit. Now, if someone really needs the money, they can cash the bond, or sell it to someone else. If they can afford to keep it, then they are better off doing that.

    Now the immediate likely reaction to this is to think that people will cash the damned thing and spend it. Well, they won’t. The mood has just changed. Those days are over, and won’t be back for a while.

    We could also see if there’s a way to get these high rollers to invest in important stuff on some similar basis. Remember Smyth’s initiative on the Children’s Hospital? We need to see more of that.

  15. The question is when will the top rate of tax kick in? I remember the old days of 48% income tax and it kicked in rather fast. It made getting a bonus pretty unexciting expecially when you added in the then levies. Back then despite high unemployment elsewhere most my peers left the country after qualifying from university or accountancy exams. There was the basic question “why bother working hard just to hand most your money over in tax”.

    A high level of tax encourages tax evasion. I suspect the Revenue are better at catching people today than back in the 1980s but the temptation is going to be higher.

    The other problem we must have vis a vis other countries is our very low corporation tax rate. No one is going to suggest raising this and yet that limits the room to manoeuvre and the lower tax collected here has to come from income tax.(We can’t raise sales tax any further.) The same argument holds about people moving. If Corporation tax went up to 15% would this really persuade foreign companies to move out.

    I agree with a previous blogger, we need to catch the people who are high earners and yet pay no tax at all.

    Some ideas
    1. Limit the amount of income that can be sheltered by tax incentive schemes to say 50% of income.
    2. The zero rate of tax for artists and horse breeders etc should be limited to the first €250k of earnings.
    3. Tax second homes (non rented) at 1% of value (worldwide).
    4. All reliefs at standard rate. Actually investing in a pension fund even in the good days only makes sense due to the tax relief. Pension funds are particularly useless at making returns in excess of the market index.
    5. Increase corporation tax to 15%
    6. Increase CGT to 25% – won’t have much effect initially. Not many gains happening and plenty of losses to carry forward.
    7. Increase PRSI ceiling to €100k
    8. Cut public service numbers by 10%. Offer 3-5 year breaks. Some might even go off and try and set up a business with the knowledge they have a job to go back to in 5 years.
    9. Make public servants contribute 5% to pension.
    10. Fire 90% of consultants working for the government (isn’t that what the civil service is for?). Slash advertising budgets, halve travel budgets (make them stay at home on Patrick’s Day), get rid of unwanted gov properties (won’t be easy), reduce perks, sick days and number of holidays
    10. New rate of 45% tax to kick in at €250k
    11. Reintroduce university fees – we had them in the 80s and we survived. The fee system could be reformed to allow those under a certain income and capital level exemptions.

    How to do it – mini budget now with new tax rates kicking in from 1/1/09

    Too radical? – I believe in the short sharp shock rather than a decade of medium level pain. You see I really do remember the 80s.

  16. Shock Horror! Broaden the tax net by TAXING FARMERS they have given us the perpetual poor mouth for so long and are on auto pilot in an effort to sniff out and eliminate any possible taxation coming their way. They seem to know full well the power of propaganda. Restore some small confidence in government by getting rid of every single quango. Make a bonfire of the vanities, you won’t save much money in terms of the the current budget deficit however, the government by so doing might, I repeat, might, save themselves. Get rid of tax breaks for commercial properties that are left to rot and lie idle. There should be no writing off losses from non rented shops and commercial units. This idea in business, that a loss is as effective as a profit has to stop! If your premises is not rented or leased, then you should be loosing money and you should be forced to find a client at current market rates ASAP. Business people have been denied access to rent and lease properties because it is more “tax efficient” to let them lie idle and claim the “losses” this is madness!

    Cut the big ticket items of capital expenditure programs to the bone. Put the money into labour intensive schemes. There should be a database of all properties, in each county, that are empty, idle or grossly underutilized these need to be made productive. A few men on excavators and diggers making roads is simply not labour intensive enough but gobbles up huge amounts of capital expenditure all of which we have to borrow at ever increasing interest rates. We have enough roads people have stopped buying cars has anyone noticed. We need to get rid of stamp duty and reduce VAT to compete with VAT rates in the North of Ireland. Half the country will be unemployed soon if the government keeps doing the same thing it has been doing and the roads will be empty except for those leading to NI. The mantra for capital spending should be how many jobs does this create! If it does not create jobs, then it should not happen full stop. Transport 21 is now a dead duck in the water and we should admit it. We did not do it when the money was there and now the money is not there, too bad! It can be discussed some other time. Our government needs reality therapy, what is stopping them from acting? We need to bring our private wealth creators into the government to tackle problems Mr. Quinn (despite his Anglo Fiasco) Mr. Desmond, Michael O’leary the people who have proved their mettle! The penal taxes should be aimed at people who think they can hoard and hold on to assets which in other peoples hands would be productive! The banks should be made to get rid of its assets that are non performing, in a slow methodical way that will not deflate prices even further. I could go on and on however, I will end on a farming and fishing note. Where in Dublin or anywhere in Ireland, can you go, any day of the week and find a cornucopia of fish and vegetables that are caught off our shores and grown in our fields? There is no such place! Farmers love to talk about quotas, headage schemes, quotas grant schemes anything if fact except growing crops and making money the hard way by growing things. Taxation is only possible when you have something or someone to tax. You cannot ‘get blood out of a turnip’ the government needs to create incomes and wealth then tax it. The land in this country needs to be made productive. Our Central bank governor Mr. John Hurley’s ideas of trying to grab money by taxing peoples homes, trying to make pensioners pay for bus journeys, students pay for education and water taxation shows us that the central bank is absolutely bankrupt of ideas! Thank God for the Euro. Imagine these guys running our punt currency! Hurley’s ideas are a re-run of the budget that the people have already rejected. That is one problem the government genuinely have i.e. the paucity of ideas coming from the ERSI the Central Bank the ESB An Board Gais etc You will not get problems solved by asking anyone in these quango’s. We need to create wealth, then tax it!

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