The great tax debate: Would cuts in Budget 2024 be worth the risks?

Government parties are already jockeying for position for who can be seen to be the taxpayer’s best friends. Fine Gael have floated the possibility of a 30 per cent tax rate, a re-examination of tax band thresholds and the possibility of amalgamating USC and PRSI, among other ideas.

But the jury is out on whether Ireland is a high personal tax country. After all, we do not pay water charges or the variety of other local taxes that apply to our neighbours in Britain and the rest of Europe. Are we really comparing like with like when we look at headline tax rates and does the discussion need to be broadened along with the tax base?

Economist Austin Hughes notes that the exchequer is in a very different position to usual as Budget 2024 approaches. “The usual discussion would begin with saying resources are limited,” says Hughes, who was previously KBC’s chief economist. “That is economics 101 – but that doesn’t apply in the current circumstances. Resources are plentiful and that is quite a shift – we are far away from the land where economists live, which is one of scarce resources.”

The reality, according to Hughes, is that there is “ample room for tax cuts” when looking at the current and prospective state of the public finances. “If there are tax breaks it doesn’t mean there won’t be scope to give a decent increase in social welfare or significantly increase spending on investment and economic and social infrastructure,” he says.

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The argument that putting more money in people’s pockets will worsen inflation – or affect our competitiveness – may contain a grain of truth, says Hughes, but overall he feels the benefits outweigh the risks. “There are some risks of overheating in the economy but I don’t think a single budget including tax cuts will have a material impact on changing the inflation dynamic,” he adds.

Indeed, the benefits are potentially much more significant, Hughes says. As the author of the recent Credit Union Consumer Sentiment Index report, he points out that consumer spending is up just under 2 per cent in the last three-year period. “There isn’t a boom going on. If anything, demand is a little bit lacklustre in many sectors. Most households have seen a significant hit to their standard of living – offering support to families seems eminently sensible and almost impossible to deny,” he says.

What Hughes thinks should happen is not dramatic, but rather a simple widening of the tax bands relative to inflation indexation. “It’s about keeping it simple and ensuring that the most benefit accrues to the widest number of workers,” he says.

Given that a not-insignificant proportion of the working population pays no tax, the question of broadening the tax base is one that crops up each year. While Hughes says there is a case to be made for adjusting it, he personally doesn’t believe it is in Ireland’s best interests. “Our society is ageing and we will need more workers and more people willing to work, so any taxation measure that acts as a disincentive to work or a disincentive to come to Ireland to work seems to me to be misguided,” he says. And while there is the view that tax-band increases should go to those on the lowest pay, Hughes cites the need to nurture a tax environment that incentivises those on “above-average salaries” too.

Economist Jim Power says he has always favoured “as broad a tax base as possible with as low marginal rates as possible”, which he believes provides more incentive for workers. “At least some tax contribution on the income tax side is good for social solidarity because if you are paying tax it should focus your mind on how the country is being run and you become a stakeholder as such.” Yet such a change in the tax base, to bring in more workers, is “probably not on the table”, he admits.

Power has strong views on Ireland’s progressive tax system. He – like the OECD – says that we have “one of the most progressive income tax systems in the world”. “The statistics are quite staggering; 80 per cent of income tax is paid by the top 25 per cent of earners. The top one per cent of earners pay 20 per cent of income tax and 25 per cent of workers’ pay little or no income tax,” he says. “It is the most dramatic, progressive income tax system that you could find.”

But not all observers agree with our progressive tax system. Olive O’Donoghue, tax partner within KPMG’s People Services tax practice, says that while a high degree of progressiveness is important in terms of ensuring an inclusive society that functions effectively, KPMG has concerns that the level we have may not be sustainable over the longer term.

Highly concentrated tax base

“The income tax base is highly concentrated and this gives rise to a significant structural risk for the tax system,” says O’Donoghue. “Previous economic shocks highlight the instability that such a highly progressive personal tax system can create.”

According to O’Donoghue, with fewer people paying tax in Ireland the situation has reached a point where there is an over-reliance on a relatively small share of the population to fund a significant proportion of the annual tax take.

“The high personal tax burden has left us with a regime that does not adequately encourage entrepreneurship and an offering that is not as attractive as it needs to be for high earners in a post-pandemic world,” she says. “We would welcome the introduction of an intermediate income tax rate band that would sit below the 40 per cent rate and which would allow the entry point for the 40 per cent rate to be increased.”

On the latter point, Power is in agreement; since the early 2000s he has called for the introduction of a middle tax rate of around 30 per cent. “I have always argued that one of the biggest problems with the income tax system is the relatively low level of income at which you move on to the top marginal rate of tax,” he explains.

In contrast, Hughes is not in favour of an intermediate tax band. “The difficulty with another tax band at this point in time when there are a lot of moving parts in the economy is maybe you end up creating another stumbling point for people on the tax spectrum,” he says. “That one needs a little bit more thought.”

Last year the standard cut-off rate for the top tax rate was increased from €36,800 to €40,000. Power says a similar rise in the standard cut-off band in the October Budget would be a good move because it “directly pours money back into people’s pockets”.

I am 100 per cent in favour of water charges. It was total political cowardice not to bring them in

—  Jim Power

Like Hughes, he does not see giving people more spending power as a problem in the current environment. “I think it’s good for effort and incentive in the economy,” he says.

“Within the personal tax system, the bulk of tax is paid by people in the top 20 per cent,” says Aebhric McGibney, director of public and international affairs with Dublin Chamber. “Increases in the standard rate band over the past two decades have not kept pace with wage growth, which means that more and more people slip into the higher rate of income tax at low levels of earnings. If the standard rate band had been indexed with wage growth, it would be nearly €15,000 higher than it actually is. Dublin Chamber sees a need to take more people out of the higher rate of income tax by increasing the standard rate band.”

What can the self-employed and SME sectors expect?

According to Power, one cohort of taxpayers has been consistently let down in recent budgets. “The earned income credit for self-employed people and the SME sector should be increased because this sector has not been treated fairly by the Government in budgets going back years – I think the tax system has got to be improved to the point where it encourages SMEs,” he says. “To date, SME owners have been treated unfairly relative to personal taxpayers.”

O’Donoghue agrees, noting that the self-employed are subject to an additional 3 per cent USC surcharge on income above €100,000. “This unfairly penalises entrepreneurs and self-employed individuals,” she says.

KPMG is also calling for reform of the PRSI system, noting the cost to employers as well as employees. Most employees pay PRSI at a rate of 4 per cent on all of their earnings, while the top rate of employers’ PRSI is currently set at 11.05 per cent. KPMG would like to see PRSI reformed by capping the earnings base subject to employees’ PRSI at €75,000 and capping the earnings base subject to employers’ PRSI at €100,000.

“In many competitor countries, the level of earnings upon which a social insurance charge is imposed is capped,” O’Donoghue notes. “In addition, some countries provide an income tax deduction for employee social security contributions.”

Of course, Irish taxpayers are not subject to the wide variety of local taxes and other charges that apply in many of our neighbouring countries. Water charges are standard across Europe, yet were famously rejected by the Irish public. “I am 100 per cent in favour of water charges,” Power says. “It was total political cowardice not to bring them in – it was a major opportunity missed.”

Hughes believes that some of our other taxes will have to be increased as time goes on. “Sooner or later, we will probably need to have a more extensive and expensive property tax,” he asserts. “Proper pricing of carbon will also mean higher taxes on energy usage, and we may see a bit of that in this upcoming budget. There may have to be some stick to go with the carrot.”