COMMENT:Further increases in taxes on earnings will not inspire confidence to increase spending and will most likely have the opposite effect
ONE OF THE biggest policy challenges facing Government is how to stimulate the economy when tax increases on income have eroded both spending power and the ability of many to service mortgage and other debt obligations.
Since 2008, most Irish households have suffered a significant drop in gross income and net wealth. But they have seen little or no reduction in their debt obligations. Thus suggestions that a family on a given level of income can afford to pay yet more taxes on income warrant greater analysis. Such suggestions appear to ignore both the real debt servicing costs of households and the significant increases in taxation already borne by them. The “ability to pay” debate, so often expressed by reference to gross income before tax, needs to take into account the obligations of taxpayers. Inevitably these comprise mortgages and, in many cases, business and investment loans taken out in the boom years based on incomes that have now fallen – both before tax and because of increases in taxes on income.
Whilst the Government is to be commended for its clear statement of intent to leave rates of income tax and related bands and tax credits unchanged, this is only part of the total picture. We must also take into account PRSI and the universal social charge. Too much of the debate about tax on earnings focuses solely on income tax. Other taxes on earnings have precisely the same impact – reducing both net pay and spending power. Taxpayers do not appreciate any lack of candour on this point.
Thus greater transparency is required in the quality of information which Government provides and on which public debate is based. This needs to include both pre- and net of tax earnings in order that all stakeholders can understand the effect of taxes on reducing the net pay of households across all levels of earnings.
The cumulative effect of changes since 2008 has meant households across the board have reduced net income in 2012 compared to 2008.
For example, a married person, aged 45 to 49 (one income household) earning €50,000 in 2008 took home net pay of €41,534 but only €38,409 in 2012. This is an annual reduction of €3,125 in net pay (or a 7.5 per cent reduction of 2008 net pay). The combined effective rate of taxes on income borne by this household increased from 17 per cent to 23 per cent in the period.
The same type of household earning €100,000 in 2008 took home net pay of €68,034. By 2012, the household faced a reduction in net pay of €5,625 compared to 2008 when its 2012 take home pay reduced to €62,409. Net pay in 2012 in this example is 8.3 per cent less than in 2008. This is as a result of the increase in the combined effective rate of tax on the household’s earnings from 32 per cent in 2008 to 37.6 per cent in 2012.
The impact on spending and debt servicing ability is clear.
Take a more complex situation, with the same individual, age 45 to 49 and married, but this time a high earner with profits from their business each year of €500,000 and setting aside €40,000 to provide a pension (ignoring the increased funding required as a result of the pension levy).
The individual’s earnings net of tax and pension provision in 2008 were €257,385. By 2012, taking the same income levels and monies set aside for pension, the individual’s net take-home earnings had reduced to €212,547. This is an annual reduction of €44,838 or a 17.4 per cent reduction in their after-tax earnings compared to 2008. The effective rate of taxes on income for this high earner household increased from 40.5 per cent in 2008 to 49.5 per cent in 2012 and the after-tax cost of pension provision also increased.
These examples of households with a wide range of earnings and debt levels tell the same story and pose the same policy dilemma – how do we cure rather than kill the patient that is the Irish economy? The combined rate of the different taxes on income has reached a tipping point – with a grave risk to fragile consumer confidence and attracting and keeping increasingly mobile investment.
Additionally, very high taxes on high earners in a small peripheral economy are likely to be the least yield-enhancing. Indeed, they run the risk of individuals either choosing not to locate here or leaving, taking both their individual tax contributions and those of their employees and businesses.
There is also an obvious implication with respect to their indirect tax contribution and the negative multiplier effect of the loss of their spending power.
The conclusion that the tipping point on personal taxes in Ireland has been reached, if not exceeded, is evidenced by academic studies*; the views in 2012 of Ireland’s National Competitiveness Council as referred to below and the views of a diverse range of Irish and international business.
When looking to preserve and expand our access to highly skilled workers, we also need to be acutely aware of our competitive position in the international marketplace. In a 2012 report on competitiveness, the National Competitiveness Council reviewed the impact of labour tax changes from 2008 to 2012. In its view, the reductions in net pay caused by increased taxes over that period mean Ireland does not have scope to increase taxes on labour if seeking to stay in the competition for mobile workers with highly valued skills.
To regain a competitive position, Ireland’s tax regime needs to be improved to appeal to and retain mobile talent with the skills we need. Key individuals who can attract and drive job creation are needed. Ireland has nothing to lose by committing to the certainty of a stable and, in the case of skilled executives coming to Ireland, attractive tax environment.
The message is clear – further increases in taxes on earnings will not inspire confidence to increase spending and will most likely have the opposite effect. The implications in terms of debt servicing capabilities are also significant.
Our policymakers need to be mindful of the combined burden of taxes on earnings, the complexity of the “ability to pay” argument and the impact on employment and consumer confidence as they set tax policy for the years ahead.
Shaun Murphy is head of tax at KPMG
* Including How Do Laffer Curves Differ Across Countries? By Mathias Trabandt and Harald Uhlig – Board of Governors of the Federal Reserve System International Finance Discussion Papers, Number 1048 – May 2012 iti.ms/TGfBDm
