Talking taxes

Income taxes that is.

Deep recessions following boomy booms almost invariable entail nice big fat public deficits. What usually happens has now happened again; our elected public representatives fool themselves into thinking that the tax revenue windfall associated with a monetary bubble are genuine, when in fact they are transient. When economies correct, the fact that politic ans have been spending far beyond the country's (i.e. tax payers') means is revealed and large deficits appear.

The economic concept is that governments may have been running significant cyclically adjusted deficits. Simply, the public balance (tax less spending) adjusted for economic output above (or below) its long run potential may be quite different to headline numbers.

And when we get deficits like this, tax rates are in the firing line. The UK Chancellor has announced a nice juicy new 50% top marginal tax rate (up from 40%). Ireland is incurring a raft of new taxes levied on income. The US is threatened with similar. The affect in Ireland is quite phenomenal, talking from personal experience. What, I would argues, is an extremely unbalanced income tax regime, raising the massive majority of incomes tax from a narrow band of earners, is becoming almost unbearable.

Consequently, I thought I might look at how Ireland's income tax system sits relative to others.

What follows is a brief look at some of the marginal and effective average tax rates that apply to Ireland and compared with the US and UK. This is only one abbreviated way to look at the data, given the fact that their is an almost infinite number of ways to cut things, given that most regimes treat different people in different ways for tax purposes (married versus single for example). But what follows looks at rates that apply to single earners and ignore any manner of tax concession that might apply. I would suggest that the extent to which different classes of tax payers receive significantly different treatment represents a failing on the part of a tax system.

Here is exhibit #1. Marginal rates that apply, including national insurance contributions in Ireland and the UK. Note for the US, these are Federal rates only, so they are good for Texas for example.

The X axis is local currency units, £, $ and €. Ireland starts with low marginal rates kicking in at relatively high minimum earnings levels. The US has low rates throughout, but more grades. The UK has higher rates kicking in lower down the earning scale. Both the UK and Ireland have much higher top marginal rates that take affect much earlier than in the US.

Also note some of the quirks. Irish (and UK) tax rates jump to very high levels very quickly. 50% of marginal income going in tax is a lot. Beyond that the government is effectively saying there is some income over which you don't have the right to keep even half. Note the spike in the UK marginal rate, which is an artifact of National Insurance rates hitting a ceiling.

While these lines appear on the same chart, they are not of much use for cross country comparison. We need some way to compare different income levels across countries. The way I propose to do that is to adjust the scale to a common currency (Euros), using a Purchasing Power Parity rate of exchange. I have used consumer expenditure PPPs and I lift these from the OECD and the most recent data is for 2007. If we do that we can compare $ and £ to Euros on the basis that we have tried to adjust the numeraire to a basis of common purchasing power.

If we do that the chart looks like this:



















I have added some vertical lines to denote where Irish median (and 150% and 200%) earnings fall.

What you first notice is the shift in the lines. The top rate of tax in Ireland clearly begins to bite at a much lower level of income than in the UK. In fact it kicks in at the median earnings - so by definition half the income earners in the country should pay some tax at this rate of 50%. Let's now compute what this would imply for average rates of tax paid across the earnings scale:

Now this is the money shot, so to speak. This is the average rate of tax that would be paid under the marginal rates shown above. Here are some of the striking characterstics of the Irish structure, especially compared with the US and UK:

• There is no tax paid until someone earns at least 50% of median earnings. Not even a token 5%, that might encourage some sense of social contribution.
• By the time someone earns the median wage (nearly €38,000 per annum), they will pay less than 15% in tax. Note that this is before any types of legal tax avoidance measures that are available.
• Beyond the median, income tax burdens rise at a dramatic rate. at 150% of the median you will pay around 25% of you earnings in tax.
• The pace of increase slows only marginally beyond that and at a mere 200% of median earning it has increased to 33% of earnings in tax. That means someone earning twice the median earnings (€75,000) pays nearly 5 times as much tax as someone on median earnings.

Now personally, I would favour something more in the style of the US. It is progressive, in that the higher your earnings, the higher the proportion you pay in tax. But it is not massively progressive as evident in Ireland.

Secondly, A larger proportion of earners pay something and something material relative to everyone else. Low to median earners might pay 5-10% of their income in tax, compared with 20-25% for those on 2 or 3 times median.

One thing is clear from this. Ireland is no "low tax" country.