Volatile tax system drives wedge between singles and married

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By Cormac Lucey

Back in the dark and distant days of the 1980s, Ireland’s tax burden on workers was very large and was a significant impediment to employment. High income taxes were a key factor in the soaring levels of unemployment at the time.

In the intervening years, thankfully, that situation has improved dramatically. A new report by the Organisation for Economic Co-operation and Development (OECD) analyses the income taxes paid by workers, their social security contributions and the family benefits they get from the state, plus the social security contributions and payroll taxes paid by employers.

What does the report, Taxing Wages 2018, tell us about wage taxation in Ireland? The first item highlighted in relation to Ireland is the relatively low tax “wedge” here. This measures the gap between what an employer must pay for staff and the net amount that workers actually receive, measured as a percentage of labour cost.

It is formally defined as the ratio between the taxes paid by a single worker without children on average earnings, and the corresponding total labour cost for the employer. The average tax wedge measures the extent to which tax on labour income discourages employment.

According to the OECD, Ireland had the 29th lowest tax wedge among the 35 OECD member countries in 2017. The average single worker in Ireland faced a tax wedge of 27.2% in 2017, compared with the OECD average of 35.9%.

This is good news and proves the state has learnt and retained some of the key lessons from past crises. An implication of Ireland enjoying a lower tax wedge than the OECD average is that wages are taxed less here then elsewhere.

This is borne out when one examines the average rate of income tax and social security deductions minus cash benefits paid by single workers with no children and one-earner couples with two children in 2017. The average single worker in Ireland pays less than 20% of their income in tax, compared with more than 30% across the OECD. The average married couple in Ireland, meanwhile, make a tiny net contribution compared with nearly 15% in other developed world economies.

In its report, the OECD focuses on the difference in tax rates faced by single workers without children compared with married workers with children. This is because child-related benefits and tax provisions tend to cut the tax wedge for workers with children over the average single worker.

In Ireland in 2017, this reduction (16.4 percentage points) was significantly greater than the OECD average (9.8 percentage points). It contributed to the situation where Ireland had the 31st lowest tax wedge in the OECD for an average married worker with two children at 10.8%, compared with the OECD average of 26.1%.

While people in Ireland pay lower rates of tax than the OECD average, an examination of tax trends since 2000 shows three distinct periods of differing Irish tax policy. Between 2000 and 2007, tax levels in Ireland dropped, and the tax wedge on a single worker dropped with them.

Over that period the tax wedge across the OECD barely budged, only falling from 37.0% to 36.2%. In Ireland, under the guidance of finance minister Charlie McCreevy, it fell from 28.9% to 22.2%.

Between 2008 and 2014, as McCreevy’s successors grappled with the dire impact of the economic crisis on the public finances, the tax wedge on the average worker grew from 22.3% to 27.9%. Since 2014, as the public finances have improved and there has been limited tax relief, the tax wedge has fallen to 27.2%. By contrast, the average tax wedge across the OECD has stayed relatively steady and last year was 35.9%.

Another interesting trend thrown up by the OECD report is the change in the average Irish wage compared with the average OECD wage. Back in 2000, gross earnings here equalled 95% of the developed world average, while net earnings in Ireland were 103% of the average in the developed world.

By 2017, average gross incomes here had climbed to 103% of the OECD average and net incomes to 113%. This is tangible proof that our strategy of using a low corporate tax rate to attract foreign direct investment is working very well.

One area where the Irish system is not working so well is in marginal rates of income taxation. The marginal rate of taxation for a single worker here is now 48.75%, compared with an OECD average of just 44.4%.

Yet an Irish couple with two children, where one partner earns the average wage and the other earns a third of the average wage, face a marginal rate of income tax of 35.9%, well down on a developed world average of 43.5%.

It is when we consider the distributional impact of the Irish tax and welfare systems that the morphing of Catholic social teaching into reflexive soft-left thinking can be fully seen.

People earning over the average wage, meanwhile, must pay much more extra tax than is normal in the developed world. Consider single people: when they earn two-thirds of the average wage in Ireland, they must pay 12.5% of their income in total contributions.

When they earn one-and-a-third times the average wage, they must pay 31.3%, a rise of 18.8 percentage points. The average OECD hike for the same move up the income scale is just 9.5 points.

By exposing the contrast between the volatility of the Irish tax wedge and its stability across the OECD, the OECD report also underlines the fact that, as a small open economy, Ireland is more exposed to the ups and downs of the global economic cycle than most other developed economies.

It is true that, between 2008 and 2014, we had to cope with a deflating property bubble. And, given that total credit across the Irish economy has shrunk significantly since 2008, it is unlikely that we will be hit be another property cataclysm any time soon.

However, we are still mightily exposed to the cycle of international economic activity. Any global economic downturn would have a speedy impact on our public finances — and, most likely, our tax rates.

Published in The Sunday Times (Ireland edition)
May 6th 2018