Income tax revenue would drop 20% if USC abolished, study finds

Getting rid of the universal social charge (USC) would reduce income tax receipts in Ireland by 20 per cent, severely restricting Government expenditure, the European Commission has warned.

In a research paper on the Irish tax system, the commission said the Government faces a difficult task in trying to reduce high marginal tax rates while generating a similar level of tax revenue and maintaining progressivity.

The warning comes just days after Minister for Finance Paschal Donohoe appeared to ditch a long-standing Government plan to phase out the USC in favour of merging it with pay-related social insurance (PRSI) to create a single social-insurance payment.

The commission’s report simulates the impact on tax revenue here from various reform scenarios using a specific tax-modelling tool.

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A complete abolition of the USC with the two standard income tax rates held constant would come “at a very high price for public finances”, it said.

In money terms it would reduce Government revenue from income tax by 20 per cent or €4 billion. An alternative scenario would be to remove USC while simultaneously increasing the higher tax band from 40 per cent to 45 per cent. However, the report suggests this would only recover a third of the lost revenues from the previous scenario.

Other options

Another option for the Government as well as removing USC and hiking the top income tax rate would be to reduce the main €1,650 tax credit afforded PAYE workers to €1,350. Under this scenario the Government would recoup 70 per cent of the losses from simply removing the USC on its own. However, a single earner would still face the highest marginal tax rate (49 per cent) among OECD countries.

Another option, in addition to these changes, would be to introduce a third, intermediate tax band at a rate of 35 per cent targeting incomes between €29,800 and €37,800, a scenario, which would recover 80 per cent of losses envisaged by simply abolishing the USC.

Overall the commission's study, entitled Personal Income Tax in Ireland: The Future of the Universal Social Charge, said its analysis illustrated "the difficulty of designing reform that simultaneously reduces high marginal rates and is revenue neutral without being regressive".

It said there was an unavoidable trade-off between these objectives if authorities restrict themselves to taxing income.

It would only be possible to recover a substantial part of the revenue losses was by lowering the entry-point to the tax system via a reduction in tax credits and the introduction of a third, intermediate tax band.

“Overall, the solution to Ireland’s tax trilemma might lie in looking beyond changes to the income tax system, including to other direct and indirect tax heads,” it concluded.