Income tax breaks in run-up to crash eroded tax base, ESRI finds

Changes to income tax in the run-up to the crash eroded the government’s tax base, prompting an even greater level of austerity during the financial crisis, a study by the Economic and Social Research Institute (ESRI) has shown.

Throughout the boom, workers here benefited from a series of rate cuts and band changes despite the fact that wages were rising and the economy was showing signs of overheating.

Even as late as 2008, with signs of a major economic reversal on the way, the then government increased income tax credits, effectively cutting the tax burden.

The ESRI study found that discretionary tax policy was relatively revenue-reducing in the period up to 2008.

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“In other words, if the tax system had been left unchanged during the 2000s, more revenue would have been automatically generated than was actually the case,” it said.

The ESRI’s study examines how changes to income levels in the economy affects the Government’s tax revenue from income tax and the universal social charge (USC).

Income tax, including the USC component, is the largest individual source of tax revenue for the Government, accounting for over 35 per cent of the total, therefore fluctuations in the source of revenue have a significant bearing on Government finances.

USC revenue

The study found income tax revenue automatically increases by 2 per cent for every 1 per cent increase in taxable income. Revenue from USC, however, rises by only 1.2 per cent for every 1 per cent increase in taxable income.

The results imply that income tax revenues are more sensitive to economic fluctuations than the revenue arising from USC. It also indicates that income is more progressive than the USC.

The finding can be explained by the role of tax credits. “Tax credits increase progressivity because they result in low average tax rates at low income levels. The higher the level of tax credits, the higher the income required before a positive tax liability is generated,” the ESRI said.

The research also found that mortgage interest relief, one of the most common income tax reliefs, is more progressive in Ireland than in other jurisdictions because of the high level of home ownership.

Hence those at middle- and lower-income levels tend to benefit proportionally more from it than those at higher-income levels, albeit those at higher-income levels benefit more in absolute terms.