When addressing the issue of raising income taxes, two objections tend to come up. The first is that the combined marginal tax rate (including PRSI and levies) is already up to 54% (see page 161 of the Commission on Taxation Report) and this marginal tax rate kicks in at fairly low incomes. Further increases in this marginal tax rate are likely to trigger increased tax avoidance and can also have negative side effects in terms of work incentives.
The second objection is that we don’t want to raise taxes on low earners because they already don’t make much money and we have to be careful about not creating poverty traps in which people are better off earning unemployment benefit than working (Suzanne Kelly’s Irish Times article on this presented some interesting calculations.)
One way to address these objections is to introduce a flax tax with a large exemption limit. This would keep the lower paid out of the tax net and keep marginal tax rates from reaching dangerously high levels. But this approach could raise additional revenue, essentially because it would abolish the 20% tax band.
Here‘s another version of the Revenue Commissioner income distribution spreadsheet from 2006 to illustrate a flat income tax with an exemption of €25,000 and a rate of 41% (the current marginal income tax rate – the spreadsheet does not include PRSI or levies). As with my last spreadsheet, I fully acknowledge that this isn’t exactly the right way to do this. To be done correctly, the calculations would have to be done separately for single, married and widowed people and I just didn’t have the time.
That caveat registered, the spreadsheet shows that, based on 2006 incomes, this flat tax system would raise an additional €2.5 billion in revenue. Relative to the current system, people earning under €30,000 would pay less tax while the rest would pay more. People in the middle income bands would be hit hardest by this approach but their average tax rates would still be pretty low by international standards (see here.)
I don’t necessarily put this forward as an explicit proposal. An increase in taxes of seven percent at one go for middle earners would be pretty painful (like hitting all middle-income earners with a public service pension levy!) so this particular scheme would have grave difficulties getting off the ground.
But the spreadsheet does at least show that one can raise additional money without worsening the poverty traps at the low end of the income distribution or hiking marginal tax rates up to self-defeating levels. More realistic might be a flat 38% rate, which would raise an additional €1.4 billion and would not involve as big a hike in average tax rates for middle earners.
One political problem that a flax tax scheme would have is the objection that the rich should not pay the same tax rate as those on middle incomes. The spreadsheet should make clear that this objection is pretty spurious because it confuses marginal and average tax rates. The average tax rates under this system increase considerably with income, so the household with the average income level pays an average tax rate of 13.6% while those on over €275,000 pay an average tax rate of 39.5%. And this system can be made as progressive as you want via adjustments of the exemption level and the flat rate.
21 replies on “A Flat Tax for Ireland?”
Poverty traps are a function of wages, wedges and subsidies/benefits.
I think more than marginal tax rates need to be addressed in Ireland’s labour market.
I agree with the basice model though. Obtain the progressivity that most people accept as a good thing via a compromise marginal rate kicking in at a reasonably high level.
@Karl
A less radical proposal that would share some of the same advantages in terms of squeezing more out of shelter-happy richies, would be to simply beef up the minimum effective tax rate measure announced in Budget 2006.
By reducing the threshold somewhat, and increasing the minimum rate from 20% to somewhere in the high 30s, we’d get some extra revenue and keep the more reasonable class-warriors happy, all without increasing the marginal rates to counter-productive levels.
How much extra yield there would be is impossible to tell from those revenue data, as we don’t know the deviation around the average effective tax rates in the various brackets. But there’s at least anecdotal evidence of some ultra-high earners who previously paid virtually no tax but have been forced up to 20% by the alternative minimum mechanism.
Karl,
Suppose we add a further pivot to your 38% flat tax, something like 43% after €50,000. This would raise further revenue and be more progressive.
It’s also remarkably like our current tax system, but with different thresholds and marginal rates.
So to what extent is your plan a mere “progressive-ish” approach to a tweaking of the thresholds and marginal rates?
This is quite possibly too philosophical for an economics board but I can’t think of anywhere else to ask the question – what do people think are the moral justifications for charging a higher rate of tax from the higher earning? The head of the electrical workers union recently said that higher workers should be on “punitive” levels of tax – presuming most people on this board don’t feel that higher earners need to be ‘punished’, why the dogmatic belief that this earnings imbalance should be redressed through tax?
I’m not necessarily expressing my own beliefs but really looking for a justification for 2 or 3 rates of tax at all – please feel free to ignore this if it’s regarded as off topic
Jack, there is indeed a serious philosophical question there. I’m not sure this is the place for it, though,
The economic justification, if you wish to call it that, is that there is overwhelming evidence that the second derivative of happiness with respect to income is negative. In other words, a poor guy “enjoys” one extra euro more than a rich guy does and thus total happiness in the world is greater when you transfer that euro from rich to poor.
I don’t worry about income tax rates so much as the base. Integrate DIRT, integrate benefits and pensions, erase social/industrial policy tax exemptions and start fresh.
From the IT: “The taxing of child benefit is a nightmare to implement, due to the absence of a common database for revenue and social welfare”
What a load of crap. There is a common database key – the PPSN. SW sends Revenue a comma separated text file with PPSNs, amounts paid and names for error queries and sends a receipt to the beneficiary to add to their tax return. The end.
The challenge would be integrating DIRT because bank accounts do not have linked PPSNs at present and therefore they might need to add a field to their databases. When I opened a bank account in Canada one of the first required fields was a Social Insurance Number so it could be printed on my year end interest statement.
Wasn’t all this argued out in the 1980s Commission on Taxation?
With what effect?
What is new and different about our socio-economic culture now that the powers-that-be will consider anything other than survival of the status quo, with as little adjustment as possible?
@Mark
re. the use of a PPS number.
The Health Information and Quality Authority (HIQA) issued a report, recently, arguing for a different UHI
“The National Health Information Strategy (NHIS) states that a system for
unique identification within the health sector is required to promote the
quality and safety of client/patient care. The NHIS proposed that unique
identifi cation within the health sector be based on the Personal Public
Service (PPS) Number(1). Building a Culture of Patient Safety: Report
of the Commission of Patient Safety and Quality Assurance (2008)
also recommends the introduction of a unique health identifi er (UHI)
highlighting the contribution it could make to improved patient safety
and quality(2). The forthcoming Health Information Bill will allow for the
introduction of a UHI(3).”
http://www.hiqa.ie/media/pdfs/Unique_Health_Identifier_Report.pdf
How many Personal Identity Numbers (PIN) does Irish public administration need to govern and manage the 4.2m people who live in this Republic?
What is the experience on PIN in other countries with similar or larger populations?
A Flat Tax would appear to be the simple(est)? one to apply – all pay a fixed rate on all income, with no allowances, deductions, write-offs, etc. of any sort. There are real problems with this approach But they might be solvable.
Thus, I am advocating radical tax reform – which is very, very improbable – but who knows!
So, let us decide on the General Principal first: Reform or no-Reform? – but no messing about at the margins! This matter is genuinely worthy of a meaningful debate. The aim is Reform, the objectives are – How Reform?
If its Reform, then set out the options. Otherwise visit your local OL and get yourself a case of exceptional – whatever!
B Peter
@Donal
I’ve never understood the desire for a separate set of numbers for each different use. Eventually, you have to tie them all together, so why not just use one number. There might be some chance of people remembering it then…
Mind you, I’ve never understood the civil liberty crowd’s objection to these numbers. Or to the sharing of information between departments.
Instead of a flat tax, why not scrap pension conts tax relief, mortgage interest tax relief, and most other tax reliefs? There are dozens of tax reliefs, allowing very high income earners to dramatically reduce their ATR. Also abolish the PRSI exemption. In return, abolish the income levy, and maybe the health levy. Bring the top MTR to well under 50%. Introduce 3 tax rates: 20 – 30 – 40, with maybe 5-6% PRSI.
Could the Flat Tax idea for individuals be expanded to simply say – here’s your tax free allowance, it’s calculated based on the number of adult and child dependents you have and that’s it – after that you pay x% of all other income to the State, regardless of how much you earn. No messing around with allowances and reliefs except, perhaps, limited tax deductible pension contributions to encourage people to save for their futures. No child allowance either, it’s built into the tax free allowance.
It’s simple and easy to understand, no loopholes or exceptions. You could probably cut the Revenue staff numbers for good measure.
But has any politician ever advocated it?
Pointless. Only a tiny amount of happiness will be increased.
It will not address why Irish shoppers pay much more for the same goods nor address the leakage at the top.
The clue is in the tinkering.
Abolish social welfare and pay a stipend, weekly, to all. Then tax all earnings at whatever rate. Pay to dependants will be less, if under age. Incentive to work restored!
The entire system is set up for complexity and, therefore, evasion. GF in today’s Irish Times berates FF for successive budgets that reduced the burden on taxation on middle income earners. As if these average people had these low tax rates foisted on them under huge protest. Who remembers the street marches demanding these tax cuts be reversed?
The reason they can’t tax child benefit is that only a tiny minority of taxpayers submit a tax return. All the government has to do is tax child benfit at the marginal rate and pass a law compelling everyone to submit a tax return. What’s so difficult about that? Ah sure, you wouldn’t want the average Joe filling out a form every year would you? We don’t have the systems to cope with that now. All those fellas actually having to put signatures to tax evasion?
As KW points out there are sound reasons for a flat tax.
However, there can never be a flat tax in Ireland. For resons of social solidarity the coping classes must be made pay for their good fortune or hard work. The fact that this might lead to a sub optimal solution does not enter into to it.
Fr Sean, the public sector unions (are there private sector unions left?) and the the Labour party under the reformed (?) communist cadre have ordained this. KW can take his falt tax proposal and put it with his bank reform proposal.
It does depend on getting rid of all the other allowances. And in turn, it also requires charging for use of services which may be accepted as free perks at the moment. The ‘hidden benefits’ need to get knocked out to make it any way fair. For example, if you had this, it would make sense to get rid of the allowance for commuter tickets, and at the same time introduce charging for employee car parking.
It is disappointing (to me anyway) that the the commission on taxation did not look at these issues. It might not be a good idea to go as far as a flat tax, but there are a lot of good ideas which might suggest themselves from the flat tax idea.
@Enda, who asserts that there is justification for so-called “progressive taxation” by saying:
“The economic justification, if you wish to call it that, is that there is overwhelming evidence that the second derivative of happiness with respect to income is negative. In other words, a poor guy “enjoys” one extra euro more than a rich guy does and thus total happiness in the world is greater when you transfer that euro from rich to poor.”
There is no overwhelming evidence. There is a hypothesis, originally (IIRC) from one of the Bernoulli brothers. There are also multiple demonstrable exceptions to the hypothesis. Even if the evidence were there, it would be a support of plain theft just as much as it would support progressive taxation. It was one of the principles of Lean Manufacturing in Japan that waste is worse than theft, because at least in theft the thief was happy, whereas with waste no-one was happy. Does this mean theft is good, or acceptable? Ehm, no.
Just quickly taking a couple of extra points….not meant to be perfect or MECE ..
Secondly, there is no argument that high tax rates on highly valued/skilled activities depress the amount of the activity which is performed, if nothing else because it disproportionately reduces the return on the investment required to acquire skills that are highly valued, e.g. fewer life-saving surgeries are performed because it’s not worth the surgeon’s investment to do the extra training if he’s going to get taxed so much on the resulting surgical income. This is bad…especially for people on lower incomes. (Oh, this is also not an imaginary case. I know people who have lived this…particularly when the effect is combined with high social welfare rates and minimum wages.)
Thirdly, it goes against equality and justice to charge two people different tax rates for the same additional work if one has been working hard and the other hasn’t. Mostly no-one in politics cares about this, but it’s true nonetheless and it’s what “progressive” taxation does.
Fourthly (although related to #2), progressive taxes aggravate the problem of barter arbitrage in the economy. It becomes significantly more tax efficient for highly skilled people to do low skilled work themselves rather than earn and pay. This is true with any moderate to high income tax system, but progressive taxation is particularly bad.
Fifthly, progressive taxes ignore effects of income volatility and existing wealth – with further unjust consequences in both cases.
Sixthly, progressive taxation means that a larger proportion of the population has no interest in reducing government waste, since they don’t feel they pay for it. See the point above on theft and waste. Progressive taxation is itself theft and it encourages tolerance of waste – a double whammy.
Seventhly progressive taxation – particularly combined with non universal benefits – results in a breakdown of society or the social contract, if such a thing exists at all, since the non equal treatment of citizens by the state becomes very clear and creates a clear moral justification for group and individual “cheating”. There’s lots more, but this is a comment on a blog.
Flat taxes are economically efficient, reduce distortions, are simple, and are just. The justice point is usually neglected because discussions of justice and taxation are hardly ever linked.
“Progressive” taxes are nothing more than theft with pontification.
Above a certain (low) exempt amount, everyone should pay the same tax rate. All citizens should get the same exemption, potentially including minor children whose exempt amount could be set against household income. The tax rate should be the same on all kinds of income. Tax should be paid on income only once (as much as that is possible). All efforts to eliminate tax loopholes should be made to ensure that availability for the wealthy of better tax advice cannot reduce marginal tax rates.
Unfortunately there is empirical evidence that political systems have no incentive to simplify the taxation system, nor to reduce state spending, so no progress should be expected any time soon.
@Hugh,
“There is no overwhelming evidence.”
Well, there is. It is simply not a case that it is a mere hypothesis from 1700. For example, Angelescu and Easterlin (2009) find no significant relationship between GDP growth and improvement happiness in 17 developed, 9 developing and 11 transition countries. “Macro data that’s not Ireland”, I hear you cry. Fair enough. Looking at the Living in Ireland survey, two European Social Survey waves and SHARE, Delaney (2009) finds that “[t]he effect of income itself is not large in any specification” and in a fixed effect model finds a declining increase (again, second derivatives) in the socio-economic gradient. I can list more: Di Tella, Haisken–De New, and MacCulloch (2007); Deaton (2008). To my mind, only a biased individual could reject study after study and claim that satisfaction is linear in income.
Therein lies the beauty of your next line: “Even if the evidence were there, it would be a support of plain theft just as much as it would support progressive taxation.” This essentially translates as “I’m going to ignore the evidence anyway and conclude you want my money.” Unfortunately this is not the case, Hugh. I did not say progressive taxation could be ethically justified, I outlined the economic justification for it. It would have been nice had you quoted the first sentence of my post, i.e. the bit where I said that there is a debate about the ethical justification of progressive taxation. Oh well.
For a man who denies the existence of evidence as to my assertion, you’re not slow to throw in statements like “All citizens *should* get the same exemption” (emphasis mine), and “reduc[ing] state spending” would be “progress”.
Where is your evidence for those?
@Enda, first, I didn’t suggest that the you were saying that the Bernouilli hypothesis was an ethical justification for “progressive” taxation, I quoted your whole paragraph on the purported economic justification for it and then moved on to discuss both economics and ethics. Read my post again. If you feel that I should have quoted your whole post then that’s something we’ll just have to live with.
In any case, even as an economic justification the hypothesis is dubious, poorly supported, often contradicted and more importantly it only addresses a single aspect of the overall question. As an ethical justification it stinks royally and it *is* often used as the ethical justification, even if you didn’t and don’t.
As far as I can see, the studies you mention don’t ask whether or not disproportionate state seizure of assets from some people increases happiness. They seem to be variants of Easterlin, who’s been saying the same thing for a while and who has as many detractors as admirers.
(Oh, I love the “only a biased individual” line too. It’s a classic “only right thinking people” insult. Thanks for that.)
In any case, I do not say that the increase in satisfaction is always linear with income.
I say that happiness’ relationship with income depends on many things and may be linear, declining, increasing, or may have step changes at thresholds depending on personal circumstances and choices. A man who needs a life-changing product or service but whose ability to buy it is prevented by high tax rates on the income he needs to pay for it will not be pleased to find those monies taken from him in pursuit of some dubious societal goal, even if the recipient is happy to receive the money.
Satisfaction may also be driven by pre-existing wealth, family status, children, etc. Could we therefore construct an economic justification for taking children by force from families that have several and giving them to families that have none? Or from families that are having triplets and giving them to families that are having only a singleton? I’m sure that you could construct data to show that there’s a negative second derivative of happiness with respect to the number of children a couple has. Surely number 12 doesn’t cause the same dramatic increase in happiness as number one, so forcing transfers of children at birth from large families to small families could therefore increase overall happiness. In my view this would not constitute an economic (or ethical) basis for a taxation policy. Would you really say that it did – even on economic grounds?
So, yes. I disagree that the economic justification you mention is valid, nor do I think that such an isolated and dubious justification is sufficient to counter any of the real economic problems that progressive taxation causes – only a few of which I mentioned and which you have ignored.
Looking briefly at the economic argument as the basis for an ethical argument or discussion, as is widely done… as you might guess, I feel that it is indeed indefensible.
Importantly, I feel this is the case whether or not there is data to support the single economic point and even if we were to ignore all the other economic points I mentioned.
Once income or wealth have surpassed some low minimum required to prevent inter-generational traps and to allow truly “common good” effects to take place (and we could debate that for a long time) I still come back to my description that progressive taxation is merely “theft with pontification”.
As for the last points, I get the feeling that you’re trying to twist what I said.
On the first twist, my view that all citizens should be treated equally is – for me – an axiom along the lines of the US “We hold that all men are created equal”. I cannot and could not produce evidence for that. It’s untrue anyway, so you can certainly accuse me of doublethink. However, I retain the view that the state should treat all citizens as equally as possible. Would you assert otherwise?
Further, from where we are today, I do think that reducing state spending would be progress. This does not mean I think minimizing state spending in all circumstances would be progress. That’s another separate long argument. It means that I think state spending in Ireland is too high today. If you feel that reducing state spending In Ireland today would not count as progress then I don’t know where to start.
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