Sheila Killian: The 2012 Estimates published over the weekend make for interesting reading in the context of what has already been leaked from the budget. In particular, the tax forecasts raise two or three questions. With luck, answers will be provided when we get more details on the budget proposals next week.
The first thing to note is that for all taxes the take in 2012 is predicted to be at least as high, if not higher, than that in 2011. The msot striking prediction is on Income Tax. Despite Leo Varadkar's promise that there will be no tax change affecting people's incomes, the take is predicted to rise from 13.8 billion to ust over 15 billion. That's a 9% increase. If there's really no change to Income Tax, that could mean that what's being forecast here is some combination of nine per cent more people working and paying in tax in Ireland, or nine per cent pay increases across the board. Neither of these seems likely in 2012, especially in light of the predicted increase in Corporation Tax - presumably mirroring company profits in Ireland - of less than 2%. Perhaps the tax take will be increased by changes to the Universal Social Charge, the bands or a reduction in credits. Or perhaps the base is being broadened, or avoidance is to be tackled in a very significant way. Either way, it will be interesting to learn how this increase is revenue is to be achieved.
The take from Capital Acquisitions Tax is expected to rise by 6%, following a reform of the rules. Capital Gains Tax revenue is expected to stay static, despite a widely-flagged rate increase. This isn't surprising, given the scarcity of gains these days. Nonetheless, a higher rate will eventually bring in more revenue, and should also dampen the enthusiasm for tax schemes based around re-characterising income as gains. Customs, Excise and Stamp Duties are also predicted to remain fairly flat in 2012.
On VAT, despite the 2% increase to the top rate promised in the leaked documents, the overall take in 2012 is expected remain fairly steady at 9.76 billion, increasing by less than 1%. This makes a certain amount of sense - when prices rise, people wil buy less. Still, it begs a more fundamental question, why bother with a regressive and controversial change that is not expected to bring in much-needed revenue? I think we may return to this question, after the clarification of the budget speeches.
Showing posts with label income tax. Show all posts
Showing posts with label income tax. Show all posts
Sunday, 4 December 2011
Friday, 10 September 2010
Seven Principles for Progressive Income Tax
Nat O'Connor: On an earlier post about indirect tax, I was asked to sketch out some principles about income tax.
Specifically, the questions were "how much income tax should everybody pay, and what proportion should that income tax be of the total tax intake? ... (a) at what point on the income scale should a person start paying tax, and at what rate and (b) at what point on the scale should the maximum rate kick in and at what rate ... So what do you propose in relation to entry level tax rates, and top tax rates?"
This is not meant to be a complete policy on income tax, as I'd need a lot more data (and time!) for that. But I am going to answer these questions in four parts. Firstly, I am going to set out some general principles for taxation. Secondly, I respond to the issue of people on high and low incomes not paying enough (or any) income tax. Thirdly, I am going to give some illustration of the effect of changing tax credits and bands. And then, finally, I am going to consider the question of how much tax someone should pay.
Part 1
Seven principles for taxation are that it should be stable, sustainable, adequate, progressive, efficient, transparent and responsive to economic, social and environmental externalities.
Stable – A stable tax system should be based on sources of revenue that do not fluctuate excessively as part of economic cycles. For example, this will require taxes on wealth, as well as income and consumption. Taxes on wealth (such as property tax) tend to be more stable during a recession. Property tax is common in many countries and is used to fund local government.
Sustainable – A sustainable tax is drawn from a source that will not become exhausted. Similarly, a sustainable tax system is not undermined by excessive tax expenditure.
Adequate –A country’s tax system must provide sufficient revenue to pay for the level of public services that people want, as well as other state liabilities, such as servicing the national debt.
Progressive – A progressive tax system is one where those who gain more from the economy (in terms of wealth and income) make a proportionately larger contribution. This should be the net effect across the whole tax system, not just income tax. Public services are one way of making the net benefit from the economy more progressive for people on lower incomes.
Efficient – Economically efficient tax is one which minimises economic distortion. The tax system should seek to encourage economic activity.
Transparent – All taxes, and to whom they apply, should be clear. In addition, all exemptions, tax relief, etc. should be transparent.
Responsive – The tax system also has role to play in influencing behaviour, by being responsive to market failure/externalities. Taxes can be used as policy tools to achieve economic, social and environmental goals. For example, carbon taxes discourage carbon-heavy activity such as burning of fossil fuels.
Note, sometimes these principles may be in tension. For example, responsiveness to externalities can conflict with progressivity, and hence something like carbon tax may need to be balanced with other measures, so that regressive effects do not occur which cost low income households disproportionately more of their income.
Part 2
In relation to income tax, the comment was made that "As things stand we have a very skewed tax take. The lower 50% of citizens pay no income tax, at the other end of the scale, neither do 4,000 individuals earning €100,000 +."
Sarah Carey claims that the facts about high earners not paying any tax are misunderstood, if not exaggerated. In particular, she refers to Section 23 of the Finance Act 2010, which increases the minimum rate of tax ('effective tax') from 20 per cent to 30 per cent that certain high earners must pay if they qualify for and use certain tax relief measures.
However, she misses the point that this only applies to "certain reliefs". Upon checking the relevant section (485C) in the latest Tax Consolidation Act guidance notes on Revenue's website, page 60, unrestricted reliefs (e.g. business expenses, other unnamed unrestricted reliefs) are always taken into account before restricted reliefs. Hence, there is some scope for someone to shrink their taxable income before the 30 per cent effective tax rate applies.
On the question of low paid people not paying income tax, the principle of progressivity requires the whole tax system to be progressive. So, there is not necessarily any problem with people on low incomes not paying income tax, if this compensates for the higher proportions of their incomes they pay in indirect taxation (like VAT), as I argue in the previous post. Also, as the worked examples below show, a single PAYE worker on €20,000 pays a small amount of income tax; so I don't think it can be true that 50 per cent of citizens pay no income tax, unless you are counting pensioners and people on social welfare. Certainly, most workers pay income tax; only those near the minimum wage do not.
However, the principle of adequacy requires that, if people want European levels of public services, then these have to be paid for. So, in order for the tax system to be adequate, everyone may need to pay more – although, in line with the principle of progressivity, those who benefit more from the economy should pay proportionately more.
Part 3
For reference, the current rates are 20 per cent on all income up to €36,400, and 41 per cent as the marginal rate. A single person gets €1,830 in personal tax credits. PAYE workers get an additional €1,830 (Citizens Information). For example, single PAYE workers on €20,000, €40,000, €60,000 and €80,000 would pay income tax as follows:
Obviously, this simplified example excludes income levy, PRSI, etc, as well as other possible tax credits or reliefs.
The Minister for Finance has announced Budget Day will be Tuesday 7 December. With all the talk of 'broadening the tax base', I guess that he will consider lowering tax credits and band thresholds, but not rates, in order to increase income tax on lower paid workers.
For example, if the single credit and PAYE credit were reduced to €1,500 each, our PAYE workers would now pay as follows:
Note, that this has the effect of tripling the proportion of the lowest income (€20,000) that is paid in income tax, while having proportionately less effect for those with higher incomes.
If the Minister instead chose to lower the marginal rate of 41 per cent to those earning over €33,000, a similar result would occur for those earning €40,000 or more, without increasingly the tax yield from those earning €20,000, as follows:
Obviously, this measure would generate less extra revenue overall. To maximise revenue, without raising rates, the Minister could combine both measures:
Now, all this is speculation, as I don't know what the Minister is going to propose. But I think it is worth pointing out the effects of changing credits and bands, as these kind of changes are often less obvious to people than rate changes, while they can have just as significant an effect.
Also, these examples give some facts and figures for illustration of the original question: how much income tax should people pay?
Part 4
I don't think increasing income tax is the best policy for Budget 2011, except maybe for those earning €100,000 plus. Instead, I'd prefer to see some kind of progressive system of property tax, as that would bring wealth into the equation as well as earned income. Since there are relatively few taxes on wealth in Ireland, that would be more progressive than simply increasing income tax.
In principle, in the medium term, as direct income tax (with higher marginal rates for higher earners) is more progressive than (flat rate) indirect tax, I'd prefer to see more tax on income and less VAT in the overall balance. Although, actually, I think any future increase on direct tax should be to address the low level of social insurance paid by employers and employees.
The last Budget unilaterly cut the amount of time people receive unemployment benefits for, as well as the amount paid, which shows how vulnerable the social insurance system is to political decisions. I'd prefer social insurance increases to income tax increases, alongside a more robust legal structure that gives people stronger guarantees about what level of benefit they receive when unemployed. In this context, I'd be quite happy to see much higher levels of unemployment benefit, which should be subject to income tax. But, as above, Budget 2011 is dealing with a jobs crisis, so it is not the time to increase social insurance, as to do so would increase labour costs and discourage job creation.
Income tax could be made more progressive. For example, Ireland is unusual in only having two bands (20 per cent and 41 per cent). There would be scope to have a third band, say 48 per cent, for incomes over €100,000. I would consider splitting up the existing bands too to have more bands with less difference between them. If the Government was to increase the standard rate of income tax, I think it would be important to increase personal credits, so that people on lower incomes are not made worse off.
Overall, I can't say what level income tax should be without access to a lot more data, namely costs for efficiently implementing West European standards of public services in Ireland, alongside data on the distribution of wealth and incomes. Such data would make it possible to calculate how much those services are going to cost (along with the banks and servicing the national debt). But we would be looking at moving towards Government tax revenue and expenditure at 45 per cent of GDP (which is still only average in Europe). The debt and banks may actually raise this much higher in the medium-term.
To conclude, I reiterate that everyone in Ireland pays tax – including indirect tax (VAT, excise, etc) – so I'll continue to dispute that only income tax counts when discussing 'broadening the taxbase'. As well as indirect taxes, new taxes on wealth (such as property tax) could have a significant role to play.
Ultimately, the taxation discussion should begin with what kind of public services people in Ireland really want. And when we can calculate the likely cost of these services, we can present people with a realistic tax model for how we can afford to pay for them.
It's at that point that democratic politics should provide people with real choice, depending on their preferences and how well or badly they'd do under each model. The conservative parties might continue to peddle low taxes, while they really mean returning public service spending to 35 per cent of GDP or less once the recession is over and the bank debt paid off. Progressive parties should be able to present a model of moving towards European norms at 45 per cent of GDP.
Specifically, the questions were "how much income tax should everybody pay, and what proportion should that income tax be of the total tax intake? ... (a) at what point on the income scale should a person start paying tax, and at what rate and (b) at what point on the scale should the maximum rate kick in and at what rate ... So what do you propose in relation to entry level tax rates, and top tax rates?"
This is not meant to be a complete policy on income tax, as I'd need a lot more data (and time!) for that. But I am going to answer these questions in four parts. Firstly, I am going to set out some general principles for taxation. Secondly, I respond to the issue of people on high and low incomes not paying enough (or any) income tax. Thirdly, I am going to give some illustration of the effect of changing tax credits and bands. And then, finally, I am going to consider the question of how much tax someone should pay.
Part 1
Seven principles for taxation are that it should be stable, sustainable, adequate, progressive, efficient, transparent and responsive to economic, social and environmental externalities.
Stable – A stable tax system should be based on sources of revenue that do not fluctuate excessively as part of economic cycles. For example, this will require taxes on wealth, as well as income and consumption. Taxes on wealth (such as property tax) tend to be more stable during a recession. Property tax is common in many countries and is used to fund local government.
Sustainable – A sustainable tax is drawn from a source that will not become exhausted. Similarly, a sustainable tax system is not undermined by excessive tax expenditure.
Adequate –A country’s tax system must provide sufficient revenue to pay for the level of public services that people want, as well as other state liabilities, such as servicing the national debt.
Progressive – A progressive tax system is one where those who gain more from the economy (in terms of wealth and income) make a proportionately larger contribution. This should be the net effect across the whole tax system, not just income tax. Public services are one way of making the net benefit from the economy more progressive for people on lower incomes.
Efficient – Economically efficient tax is one which minimises economic distortion. The tax system should seek to encourage economic activity.
Transparent – All taxes, and to whom they apply, should be clear. In addition, all exemptions, tax relief, etc. should be transparent.
Responsive – The tax system also has role to play in influencing behaviour, by being responsive to market failure/externalities. Taxes can be used as policy tools to achieve economic, social and environmental goals. For example, carbon taxes discourage carbon-heavy activity such as burning of fossil fuels.
Note, sometimes these principles may be in tension. For example, responsiveness to externalities can conflict with progressivity, and hence something like carbon tax may need to be balanced with other measures, so that regressive effects do not occur which cost low income households disproportionately more of their income.
Part 2
In relation to income tax, the comment was made that "As things stand we have a very skewed tax take. The lower 50% of citizens pay no income tax, at the other end of the scale, neither do 4,000 individuals earning €100,000 +."
Sarah Carey claims that the facts about high earners not paying any tax are misunderstood, if not exaggerated. In particular, she refers to Section 23 of the Finance Act 2010, which increases the minimum rate of tax ('effective tax') from 20 per cent to 30 per cent that certain high earners must pay if they qualify for and use certain tax relief measures.
However, she misses the point that this only applies to "certain reliefs". Upon checking the relevant section (485C) in the latest Tax Consolidation Act guidance notes on Revenue's website, page 60, unrestricted reliefs (e.g. business expenses, other unnamed unrestricted reliefs) are always taken into account before restricted reliefs. Hence, there is some scope for someone to shrink their taxable income before the 30 per cent effective tax rate applies.
On the question of low paid people not paying income tax, the principle of progressivity requires the whole tax system to be progressive. So, there is not necessarily any problem with people on low incomes not paying income tax, if this compensates for the higher proportions of their incomes they pay in indirect taxation (like VAT), as I argue in the previous post. Also, as the worked examples below show, a single PAYE worker on €20,000 pays a small amount of income tax; so I don't think it can be true that 50 per cent of citizens pay no income tax, unless you are counting pensioners and people on social welfare. Certainly, most workers pay income tax; only those near the minimum wage do not.
However, the principle of adequacy requires that, if people want European levels of public services, then these have to be paid for. So, in order for the tax system to be adequate, everyone may need to pay more – although, in line with the principle of progressivity, those who benefit more from the economy should pay proportionately more.
Part 3
For reference, the current rates are 20 per cent on all income up to €36,400, and 41 per cent as the marginal rate. A single person gets €1,830 in personal tax credits. PAYE workers get an additional €1,830 (Citizens Information). For example, single PAYE workers on €20,000, €40,000, €60,000 and €80,000 would pay income tax as follows:
The Minister for Finance has announced Budget Day will be Tuesday 7 December. With all the talk of 'broadening the tax base', I guess that he will consider lowering tax credits and band thresholds, but not rates, in order to increase income tax on lower paid workers.
For example, if the single credit and PAYE credit were reduced to €1,500 each, our PAYE workers would now pay as follows:
If the Minister instead chose to lower the marginal rate of 41 per cent to those earning over €33,000, a similar result would occur for those earning €40,000 or more, without increasingly the tax yield from those earning €20,000, as follows:
Obviously, this measure would generate less extra revenue overall. To maximise revenue, without raising rates, the Minister could combine both measures:
Now, all this is speculation, as I don't know what the Minister is going to propose. But I think it is worth pointing out the effects of changing credits and bands, as these kind of changes are often less obvious to people than rate changes, while they can have just as significant an effect.
Also, these examples give some facts and figures for illustration of the original question: how much income tax should people pay?
Part 4
I don't think increasing income tax is the best policy for Budget 2011, except maybe for those earning €100,000 plus. Instead, I'd prefer to see some kind of progressive system of property tax, as that would bring wealth into the equation as well as earned income. Since there are relatively few taxes on wealth in Ireland, that would be more progressive than simply increasing income tax.
In principle, in the medium term, as direct income tax (with higher marginal rates for higher earners) is more progressive than (flat rate) indirect tax, I'd prefer to see more tax on income and less VAT in the overall balance. Although, actually, I think any future increase on direct tax should be to address the low level of social insurance paid by employers and employees.
The last Budget unilaterly cut the amount of time people receive unemployment benefits for, as well as the amount paid, which shows how vulnerable the social insurance system is to political decisions. I'd prefer social insurance increases to income tax increases, alongside a more robust legal structure that gives people stronger guarantees about what level of benefit they receive when unemployed. In this context, I'd be quite happy to see much higher levels of unemployment benefit, which should be subject to income tax. But, as above, Budget 2011 is dealing with a jobs crisis, so it is not the time to increase social insurance, as to do so would increase labour costs and discourage job creation.
Income tax could be made more progressive. For example, Ireland is unusual in only having two bands (20 per cent and 41 per cent). There would be scope to have a third band, say 48 per cent, for incomes over €100,000. I would consider splitting up the existing bands too to have more bands with less difference between them. If the Government was to increase the standard rate of income tax, I think it would be important to increase personal credits, so that people on lower incomes are not made worse off.
Overall, I can't say what level income tax should be without access to a lot more data, namely costs for efficiently implementing West European standards of public services in Ireland, alongside data on the distribution of wealth and incomes. Such data would make it possible to calculate how much those services are going to cost (along with the banks and servicing the national debt). But we would be looking at moving towards Government tax revenue and expenditure at 45 per cent of GDP (which is still only average in Europe). The debt and banks may actually raise this much higher in the medium-term.
To conclude, I reiterate that everyone in Ireland pays tax – including indirect tax (VAT, excise, etc) – so I'll continue to dispute that only income tax counts when discussing 'broadening the taxbase'. As well as indirect taxes, new taxes on wealth (such as property tax) could have a significant role to play.
Ultimately, the taxation discussion should begin with what kind of public services people in Ireland really want. And when we can calculate the likely cost of these services, we can present people with a realistic tax model for how we can afford to pay for them.
It's at that point that democratic politics should provide people with real choice, depending on their preferences and how well or badly they'd do under each model. The conservative parties might continue to peddle low taxes, while they really mean returning public service spending to 35 per cent of GDP or less once the recession is over and the bank debt paid off. Progressive parties should be able to present a model of moving towards European norms at 45 per cent of GDP.
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