As the top rate is at its lowest for decades, as the graph shows, why is it a government priority to reduce it? (The promise in the Government Programme was not to raise income taxes, but the top rate has been cut - with more cuts now promised).
The answer may be that tax is complex. Many people think income tax is THE only tax and after six long hard years, some think cuts for those on the very top rates is the way to “give something back”.
Yet you pay almost as much in other taxes as you pay in income tax. For every €100 the average person paid in income tax in 2013, s/he will pay an additional €93 in taxes on consumption or spending taxes. The government is trying to address people’s and the media’s obsession with the top rate of tax. One right-wing commentator regularly derides rates above today’s as “eye-watering”.
The following graph shows that back in the 1980s the top rate of tax was 65%. This is comparison to the 40% rate today.
Source: Revenue.
Today’s rate, reduced again last year from 41% is the lowest ever. In contrast to this cut in income tax, there was a rise in the VAT rate few years ago of 2% - equivalent to a rise of almost 10% on the then 21%. The 23% rate is now one of the highest in the world and yet there is no promise to reduce it. At almost one quarter of the price of most goods and services, virtually all citizens must pay it, whereas only a small proportion of adults pay the top rate of income tax. And most middle earners don’t pay very much tax at the top rate.
In 1984 there were six rates of tax, compared to only 2 rates today. The lowest was 25%, then 35, 45, 50, 60 and 65%. Only the very high paid were on the top rate.
The graph shows that there have been only two rates of income tax since 1993, twenty two years ago. While six rates is complicated, three is generally seen as reasonable, effective and can be progressive. Two rates are less progressive.
The tax rate does not determine how much tax you will pay. It is the interaction of a) the tax rate, b) the bands and c) the tax credits which determine how much income tax is paid. Cutting the rate one and not changing another the band or credit may have little or no effect on how much tax paid. Indeed, cutting the top rate and doing nothing with the credits and bands mainly benefits high income earners.
The graph does demonstrate however how little is paid by people on big incomes compared to the past. For if there is a progressive income tax system, which Ireland has to a degree ie at the lower to middle income levels, high tax credits ensure the low paid pay little and the width of the bands can largely determine how much the middle pay.
But if there are only two rates - as we have had for more than two decades – then the really high income earners do not pay a lot because the tax credits and the bands matter less and less to them as their incomes rise.
High earners pay proportionally more in income taxes than in spending taxes and low earners will pay less income tax. Income taxes are generally progressive and spending taxes are not.
Many people think that the top rate is the average or effective rate. It is not. To find it divide your income into the income tax paid. The average of effective rates paid by most middle earners is well below the top or marginal rate.
40% is perhaps “eye-wateringly low” compared to the rates imposed by all governments in the past. Thus there is a strong case for a third tax rate on high incomes and increasing the band so that the new middle rate takes less tax from middle earners. But what is the optimum top rate?
When social charges are added, then the overall deductions rise. There have been many different social charges over the years and they are complex, with minimum and maximum thresholds, differing rates and so on. In the next blog, I will briefly examine these and offer one person’s view on an optimal (best) tax and social charge rate.
Paul Sweeney is Chair of TASC's Economists' Network.
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