Abstract
Selected Issues
Personal Income Tax Reform: Past and Present1
Ireland’s personal income tax has undergone significant changes in the last fifteen years. From reductions during the boom, through introduction during the crisis of an additional tax - the Universal Social Charge that broadened the tax base and increased revenues -, to tax reductions with tax base narrowing in the recent recovery years. These changes resulted in a currently less efficient personal income tax system, with a high administrative burden and narrow tax base. Consideration should be given to an income tax reform, aiming at a broader tax base, reduced disincentives to work more, while preserving the overall tax yield and progressivity.
A. Introduction
1. Personal income in Ireland is taxed under two distinct schemes. These are the Income Tax and the Universal Social Change (USC). In 2017, the income tax yielded 9.5 percent of GNI*, while the USC collected an additional 2 percent of GNI*. Overall, Ireland ranks among EU countries with a higher share of income tax to GDP, above the EU average by several percentage points (Figure 1).
Personal Income Taxes
Personal income taxation in Ireland is above EU average.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
Sources: Eurostatand IMF staff.2. Changes in Ireland’s personal income taxation have been procyclical and created vulnerabilities to public finances. This was in part the result of the interplay of corporate (CIT) and personal income taxes. During upswings, corporate profits increased and so did CIT receipts, which have been used in part to reduce personal income taxes, and vice versa during slowdowns (Figure 2). This tax policy tends to increase the volatility of the business cycle, since much of the corporate profits flow to non-residents, while changes in personal taxes directly feed into domestic demand through consumption and investment (Figure 3). In addition, the dependency on uncertain CIT revenues that are highly concentrated, and possibly not permanent, creates vulnerabilities to public finances.
Income Taxes
Personal income taxes tend to behave procyclically.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
Source: CSO and IMf staffPersonal Income Taxes
Personal income tax policy deepens the economic cycle.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
Sources: IMF staff.3. The reduction in personal income taxes during the boom has been broad based, albeit more for low-income taxpayers. During 2004-2007, effective tax rates were cut practically to zero for an increasing share of the lower tier of the income distribution and lowered by several percentage points for median income earners. This has gradually shifted the income tax burden towards higher income earners. While in 2004 the top 5 percent income earners paid 20 percent of total income tax revenue, in 2007 this had risen to 40 percent.
4. With somewhat shrinking corporate profits during the crisis, personal income taxation was increased.2 The weaker CIT revenues and declines in other transactional taxes put pressure on personal income tax collection. Reversing the income tax reductions from the boom was not enough, due to reduced incomes during the crisis, and so an additional personal income tax, the USC, was introduced in 2011. The USC was a revenue-raising measure aimed also at tax broadening.
5. The recovery has seen a bounce back of CIT revenues, and personal income taxation has been gradually reduced again. By 2014, the USC was seen as the most hated tax in Ireland and was gradually lowered during 2015-19 by reducing rates and widening bands.3 As a result, the tax-broadening effect of the USC has been largely erased, taxing the same base as the Income Tax. Its yield has been reduced from about a third of the combined Income Tax and USC in 2011, to an estimated 14 percent in 2019.4
6. A reformed income tax may be beneficial in several ways, in line with principles of good taxation (AICPA, 2017):
It could save undue costs for tax collection and administrative burden, by replacing the USC with somewhat increased tax rates of the current Income Tax to preserve current yield of personal income taxes; and
An introduction of additional tax bands and rates to Income Tax and appropriately calibrating their tax rates would allow preserving the progressiveness of the system, while broadening the tax base, and reducing disincentives to work more. When combined with means-tested cash transfers for low income households, it would assure a robust, incentive-compatible and equitable tax system.
7. The reformed income tax would reduce the vulnerability of public finances to CIT revenues and reduce procyclicality. A robust, stable income tax system performs a stabilizing role over the business cycle, while the additional CIT revenues during booms could be saved as buffers to be used for smoothing downturns or to reduce the still high public debt.
B. The Income Tax
8. The Income Tax is levied on total income, according to four social circumstances, and taxed in two bands (20 percent and 40 percent). Taxable income is subject to allowances and credits according to social circumstances (single, married, etc.). Each social circumstance category also determines the upper threshold for income that is taxed at the 20 percent rate and income above the threshold is taxed at 40 percent (Table A1). The calculated tax is then adjusted for tax credits - Personal, Age, Home Carer’s and Rent credits, allowances, and reliefs, and the adjusted final tax is due. The extensive use of tax credits and just two tax bands make the Irish Income Tax progressive relative to OECD peers (see IMF 2018 for an international comparison).
9. Lowering income taxes during 2005-09 added to the boom and took place through three ways:
Increasing the threshold for the higher tax rate. Between 2005 and 2009, thresholds have increased by €7000 uniformly across tax groups, that is, about 20 percent. This ended with their reductions in 2011, to the level of 2006 (Figure 4).
Reducing the higher tax rate. In 2008, the higher tax rate was reduced from 42 percent to 41 percent. This decline was not reversed during the 2011 adjustments.
Increasing tax credits. Tax credits have been increased rapidly during the boom of 2005-09 (Figure 5). The increase in tax reductions was between €250 and €560, depending on the social circumstances. Credits have been reduced across the board in 2011, to their level in 2006.
Income Tax Thresholds
Thresholds for the income tax have been recently increased.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
1/ Prior the balance was taxed at 42 percent; since 2008 at 41 percent and since 2015 at 40 percent.Sources: Office of the Revenue Commissioners.Income Tax Credits
Home carer’s tax credit has recently increased.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
Source: Office of the Revenue Commissions.10. Post-2014, income taxes have been reduced again, fueling the recovery in domestic demand. This time by reducing the higher tax rate to 40 percent in 2014; increasing the thresholds for the higher tax rate; and increasing the Home Carer’s tax credit (Figures 4 and 5).
C. The Universal Social Charge
11. The USC was introduced as a crisis measure in 2011. Instead of reforming the Income Tax, the USC replaced the Health Levy and Income Levy. It was meant to broaden the tax base by individualizing the tax, lowering the entry point, and taxing all income with minimum exclusions and no tax credits.
12. The USC is an individualized tax payable on total income. If total income exceeds €13,000, the USC taxes the full income. Total income includes employment income, taxable employer benefits, self-employed income, rental income, share option gains, and dividend income, while payments from the Department of Employment Affairs and Social Protection and deposit interest subjected to the Deposit Interest Retention Tax are exempt. Capital allowances for plant and machinery and certain buildings are allowed as a deduction before USC is calculated. There is no relief from USC for employee pension contributions. As introduced in 2011, the USC was a very effective and efficient tax.5
13. However, post-2014 changes to the USC bands and rates have reduced its initial benefits. A sequence of changes to the USC design, including increased entry-point and reduced rates and widening bands (see Table A2), have reduced the effective USC tax rate for low- and medium-income earners, while increasing it for the highest earners (Figure 6). At the same time, these changes have narrowed the tax base.
USC Effective Rates
The USC effective tax rates have been significantly reduced.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
Sources: CSOand IMF staff.14. Consequently, the USC yield has declined significantly. While in 2012, the USC collected more than a third of the combined Income Tax and the USC, in 2016 it was only 20 percent and by 2019, this share is estimated to decline further to about 14 percent (Figure 7).
The Role of USC
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
15. In addition, the USC no longer materially increases the tax base compared to the Income Tax. According to the cumulative density functions of tax paid by percentiles of tax cases in 2016, there seems to be effectively no difference between the USC and Income Tax in terms of spreading the tax burden (Figure 7).6
16. Given its current calibration, the USC could be usefully replaced by a reformed Income Tax. This could simplify the tax system, while preserving the overall personal income tax yield. A reformed Income Tax could possibly also broaden the tax base and reduce disincentives to work more for low income earners. If accompanied by means-tested cash transfers for low-income households, it would preserve the major benefits of the tax redistribution system that serves Ireland well.
D. Replacing the USC with a Re-calibrated Income Tax
17. The USC increases the effective tax rates and progressivity of personal income taxes. Effective tax rates for the combined yield from the USC and the Income Tax show a steeper increase with income compared to the Income Tax alone (Figure 8). This suggests that merging the USC with Income Tax would necessitate higher Income Tax rates to preserve yield and progressivity of the current system.
Effective Rates Comparison
The USC increasese the effective tax rate, more for higher incomes.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
Sources: CSO and IMF staff.18. A re-calibration of the current Income Tax to absorb the USC is possible, nevertheless with some distributional changes. Within the current two-rate Income Tax system, a re-calibration would necessitate rates of 24.4 and 48 percent for the base rate and higher rate, respectively, to preserve the current yield from both the USC and the Income Tax.7 However, these rates are practically equal to the combined current effective rates applied in the two tax schedules. Thus, the major benefit of such unification is the simplification of the personal income tax system. Reducing the administrative burden comes at a price of canceling tax individualization and distributional changes of actual tax payments in the higher income groups (Figure 9).8
Re-calibrated Income Tax
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
E. A More Substantial Reform Could Yield Additional Benefits
19. The Income Tax could be further amended to enhance incentives to work, while safeguarding the progressivity of the system. Thanks to the current level of tax credits, earnings up to €17,000 are practically free of income tax. At the same time, beyond that threshold income earners pay effectively 24.4 cents on every additional euro earned (Figure 10). Therefore, some tax payers may be disincentivized to work more by the sudden progressivity of the tax rate.
Marginal Effective Tax Rates
The marginal effective tax rate increases very steeply at the low income mode.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
20. A combination of the following changes could deliver a more work-incentive compatible and equitable personal income tax system:9
Introducing more tax bands and rates (similarly to the USC) would allow for smoothing the progressiveness of income taxes at lower incomes, hereby marginally improving the vertical equity (making sure that tax payers that should pay more tax actually have the ability to do so).
Recalibrating tax credits may also help smoothing progressiveness at the low income mode and broaden the tax base, thereby minimizing the deadweight loss from income tax,10 when incentives to work more are hampered by the high marginal effective tax rate; and
Individualizing the system (similarly to the USC) may improve horizontal tax equity and may incentivize female employment (Figure 11).
Effective Tax Rates
Income taxation differs significantly for singles and married tax payers.
Citation: IMF Staff Country Reports 2019, 165; 10.5089/9781498319904.002.A001
21. At the same time, changes to personal income taxation ought to be neutral in terms of the overall progressiveness, redistribution, and current overall tax yield:
Progressivity. Ireland has one of the most progressive personal income tax systems among OECD countries (Giustiniani, 2017), which is an important and effective component for addressing the high market inequality (IMF, 2018).
Redistribution. Ireland’s tax-benefit system is effective in redistributing income and alleviating poverty (Giustiniani, 2017). Therefore, tax broadening and smoothing of the progressivity at low income quartiles could be accompanied by means-tested cash transfers to continue to protect the low-income households.
Tax yield. The current level of combined Income Tax and USC yield relative to GNI* is close to the 10 year-average (Figure 3), which seems to be a useful benchmark for calibrating a sustainable share of personal income taxes in national income.
22. And finally, future changes to the personal income tax system should be strictly disconnected from CIT or other cyclical revenues. In this way, the personal income tax system could fulfill its business cycle stabilization role, maintaining a steady yield as a share of GNI*. Any future abundant CIT or other revenues during booms should be saved and eventually used during downturns to smooth the business cycle.
F. Conclusions
23. Ireland’s personal income tax system has undergone significant changes in the last decade and half. These included lowering taxes during booms, especially for lower income earners and introducing the USC during the crisis. This procyclicality seems to be connected in part to the performance of CIT revenues. More recently, income taxes have been reduced again, making the current Income Tax-USC system less efficient and steeply progressive at low incomes with negative implications for incentives to work more for a large cohort of tax payers. Nevertheless, the overall high progressivity of personal income taxation by international standards, combined with the benefits system, has been found efficient in income redistribution and alleviating poverty (Giustiniani, 2017), and is worthy to preserve.
24. Reforming the Income Tax and canceling the USC appears to be potentially beneficial, especially to reduce the administrative burden and align work incentives. A reform should, however, preserve the overall income tax progressivity and tax yield, which could be achieved by a broader tax base, more tax bands and higher tax rates. Any undesired impact of spreading the tax burden more broadly could be mitigated by means-tested cash transfers for low income households. The reformed Income Tax should aim at providing a stable source of tax revenues throughout the business cycle and avoid procyclicality.
Annex 1. Personal Income Tax Changes
Selected years for Income Tax Thresholds for 20 Percent Tax Rate; balance taxed at 40 percent
Selected years for Income Tax Thresholds for 20 Percent Tax Rate; balance taxed at 40 percent
| 2005 | 2008 | 2010 |
|
2014 | 2018 | 2019 | |
|---|---|---|---|---|---|---|---|
| Single, widowed or a surviving civil partner without qualifying children | €29,400 | €35,400 | €36,400 |
|
€32,800 | €34,550 | €35,300 |
| Single, widowed or a surviving civil partner qualifying, Single Person Child | €33,400 | €39,400 | €40,400 |
|
€36,800 | €38,550 | €39,300 |
| Carer Credit (2014) | |||||||
| Married or in a civil partnership (one spouse or civil partner with income) | €38,400 | €44,400 | €45,400 |
|
€41,800 | €43,550 | €44,300 |
| Increase for married or in a civil partnership (both spouses or civil partners with income) max | €20,400 | €26,400 | €27,400 |
|
€23,800 | €25,550 | €26,300 |
| The higher tax rate (percent) | 42 | 41 | 41 | 41 | 40 | 40 | 40 |
Selected years for Income Tax Thresholds for 20 Percent Tax Rate; balance taxed at 40 percent
| 2005 | 2008 | 2010 |
|
2014 | 2018 | 2019 | |
|---|---|---|---|---|---|---|---|
| Single, widowed or a surviving civil partner without qualifying children | €29,400 | €35,400 | €36,400 |
|
€32,800 | €34,550 | €35,300 |
| Single, widowed or a surviving civil partner qualifying, Single Person Child | €33,400 | €39,400 | €40,400 |
|
€36,800 | €38,550 | €39,300 |
| Carer Credit (2014) | |||||||
| Married or in a civil partnership (one spouse or civil partner with income) | €38,400 | €44,400 | €45,400 |
|
€41,800 | €43,550 | €44,300 |
| Increase for married or in a civil partnership (both spouses or civil partners with income) max | €20,400 | €26,400 | €27,400 |
|
€23,800 | €25,550 | €26,300 |
| The higher tax rate (percent) | 42 | 41 | 41 | 41 | 40 | 40 | 40 |
Evolution of the Universal Social Charge
Evolution of the Universal Social Charge
| 2011-14 | 2015 | 2016 | 2017 | 2018 | 2019 | |
|---|---|---|---|---|---|---|
| First €10,036 | 2% | |||||
| First €12,012 | 1.50% | 1% | 0.50% | 0.50% | 0.50% | |
| Next €5,564 | 3.50% | |||||
| Next €5,980 | 4% | |||||
| Next €6,656 | 3% | |||||
| Next €6,760 | 2.50% | |||||
| Next €7,360 | 2% | |||||
| Next €7,862 | 2% | |||||
| Next €50,170 | 4.50% | |||||
| Next €50,672 | 4.75% | |||||
| Next €51,272 | 5% | |||||
| Next €51,376 | 5.50% | |||||
| Next €52,468 | 7% | |||||
| Balance | 7% | 8% | 8% | 8% | 8% | 8% |
Evolution of the Universal Social Charge
| 2011-14 | 2015 | 2016 | 2017 | 2018 | 2019 | |
|---|---|---|---|---|---|---|
| First €10,036 | 2% | |||||
| First €12,012 | 1.50% | 1% | 0.50% | 0.50% | 0.50% | |
| Next €5,564 | 3.50% | |||||
| Next €5,980 | 4% | |||||
| Next €6,656 | 3% | |||||
| Next €6,760 | 2.50% | |||||
| Next €7,360 | 2% | |||||
| Next €7,862 | 2% | |||||
| Next €50,170 | 4.50% | |||||
| Next €50,672 | 4.75% | |||||
| Next €51,272 | 5% | |||||
| Next €51,376 | 5.50% | |||||
| Next €52,468 | 7% | |||||
| Balance | 7% | 8% | 8% | 8% | 8% | 8% |
References
AICPA, 2017, “Guiding Principles of Good Tax Policy: A Framework for Evaluating Tax Proposals”, Tax Policy Statement 1, Association of International Certified Professional Accountants.
De Mooij, Ruud, Michael Keen, 2014, “Taxing Principles: Making The Best of Necessary Evil,” Finance and Development, International Monetary Fund, December 2014.
Finn, Christina, 2016, “Ireland’s Much-hated Tax That Just Won’t Go Away: The Universal Social Charge, It’s difficult to remember a time when those three letters weren’t on your payslip”, thejournal.ie October. https://www.thejournal.ie/universal-social-charge-2-3013364-Oct2016/
Giustiniani, Alessandro, 2017, “Income Inequality And The Welfare System in Ireland: An Overview”, Selected Issues Paper, International Monetary Fund, June 2017.
IMF, 2018, “Taxation Of Labor Income”, Annex IV: Staff Report For The 2078 Article IV Consultation, International Monetary Fund, June 2018.
McConnell, Daniel, 2014, “Ireland’s Most Hated Tax: Universal Social Charge, The penalty tax is loved by officials, but hated by everyone else”, Independent.ie, December. https://www.independent.ie/irish-news/politics/irelands-most-hated-tax-universal-social-charge-30804972.html
Prepared by Jiří Podpiera. This chapter has benefitted from comments by the discussant Joe Cullen, other participants at the Central Bank of Ireland’s Workshop on May 7, 2019, in Dublin, and Barra Roantree.
In addition, transactional taxes, especially stamp duties, have been abundant during the boom and allowed income tax reductions. During the crisis, they declined substantially and aggravated the need for income tax increases.
“Ireland’s Most Hater Tax: Universal Social Charge”, Independent.ie; “Ireland’s Much-hated Tax That Just Won’t Go Away: The Universal Social Charge”, thejournal.ie.
Although there is still a difference in the tax base for the USC and Income Tax, in effectively collected tax, the two schedules tax the same tax payers.
Although the initial USC schedule inducedjumps in the average tax rate, raising equity concerns.
The tax base for USC and IT differs in the legal definition, however, in the amount of actual tax collected, the difference is currently very minimal. The USC tax base had been reduced between 2011 and 2016, but has stayed unchanged since then.
Assuming that the higher income tax rates are not circumvented by increased pension contributions when paid through the re-calibrated IT schedule.
The distributional analysis doesn’t take into account the interaction of the tax and welfare systems.
Abstracting from the effects of the PRSI and the PRSI credit. A reformed IT schedule should also be considered with respect to the PRSI effects on the marginal effective tax rates.
The steep marginal tax rate at a certain income level reduces incentives to work more for that income cohort, which leads to a reduced economic activity compared to a situation with more gradual marginal tax. This is referred to as the deadweight loss.
References
Barrett, D., Golden, B. and Godfrey, B. “New Data Collection on Special Purpose Vehicles in Ireland: Initial Findings and Measuring Shadow Banking.” Central Bank of Ireland Quarterly Bulletin, 4 2016, 71–94;
Central Bank of Ireland, Macro-Financial Review, 2018:II, 2018:I, 2017:II.
Cortes, Fabio, Peter H. Lindert, Sheheryar Malik, and Miguel Segoviano Basurto. “A comprehensive multi-sector tool for analysis of systemic risk and interconnectedness (SyRIN).” 2018;
Daly, Pierce, and Kitty Moloney. “Liquidity & Risk Management: Results of a Survey of Large Irish-Domiciled Funds.” Central Bank of Ireland Quarterly Bulletin 3 (2017): 48–62;
Fiedor, Pawel, and Petros Katsoulis. An Lonn Dubh: A Framework for Macroprudential Stress Test of Investment Funds. No. 2/FS/19. Central Bank of Ireland, 2019;
Golden, Brian, and Patrick Hughes. “Shining a light on Special Purpose Entities in Ireland”. No. 11/EL/18. Central Bank of Ireland, 2018.
International Monetary Fund, Financial Sector Assessment Program, “Technical Note - Asset Management and Financial Stability”, 2016.
Prepared by Anna Shabunina. This chapter has benefittedfrom comments by the discussant Kitty Moloney and other participants at the Central Bank of Ireland’s Workshop on May 7, 2019, in Dublin.
Irish regulated funds are exempt from Irish tax on income and capital gains derived from their investments and are not subject to any Irish tax on their net asset value. There are additionally no net asset, transfer or capital taxes on the issue, transfer or redemption of units owned by non-Irish resident investors. The provision of management, administration andcustody services to an Irish regulated fund is exempt from Irish VAT. Other services, such as legal and accounting services, can result in an Irish VATliability, but this may be offset, depending on the fund’s VAT recovery position. Exit tax is paid by Irish resident investors on exiting the fund. (Source: Irish Funds)
E.g., “New Data Collection on Special Purpose Vehicles in Ireland: Initial Findings and Measuring Shadow Banking”; “Shining a light on special purpose entities in Ireland”; and “Liquidity Analysis of Bond Funds and MMFs”.
Golden and Hughes(2018) define an SPE as a legal entity, with little or no physical presence and narrow, specific, and/or ring-fenced objectives, such as the segregation of risks, assets and/or liabilities, or as a cash conduit. An SPE is often, though not exclusively, a satellite company of another financial entity and forms an ancillary part of the associated entity’s business by warehousing assets or risks.
This largely reflects the creation of securitization SPEs by banks.
Retained securitization is the process by which a bank establishes an SPE to purchase a portfolio of its assets, in this case residential mortgages. The purchase is funded through the issuance of residential mortgage-backed securities (RMBS), which are listed on the stock exchange. Unlike standard securitization the RMBS are not purchased by third parties, but by the same originating bank. This process allows the creation of a consolidated asset from a portfolio of illiquid loans. The primary goal of retained securitization is to access ECB liquidity operations by pledging the above RMBS as collateral, provided the asset meets the necessary requirements as an eligible asset.
