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.