The final shape of the 1999 Budget tax package is still in the melting pot and will be sorted out today in discussions between senior Ministers and officials. One issue on which there has been considerable pre-Budget discussion is whether the system of income tax allowances should be reformed and a step taken towards introducing tax credits.
All the signs are that the Minister for Finance, Mr McCreevy, will make some commitment to fundamental changes in the allowances system, although it remains unclear how much change will be introduced in the next tax year, which starts in April 1999.
The reason for change is that, under the current system, increasing income tax allowances gives greater benefit to the better off. Income tax allowances are deducted from gross income to arrive at taxable income, the amount of money on which tax is levied. So increasing allowances is of greater benefit to the person who pays some tax at the higher 46 per cent rate than it is to those who are just taxed at the standard 24 per cent. A £1,000 increase in tax allowances is, in itself, worth £460 to the higher rate taxpayer, but just £240 to those paying only at the standard rate. However, it must be remembered that the tax system is complex and, as pointed out by ESRI economists Tim Callan, Brian Nolan and John Walsh in a recent paper, measures such as how the standard rate income tax band is adjusted must also be taken into account in calculating the overall gains and losses.
Because of the complexity of the current system, there is a case for moving to what are known as tax credits. Under a tax credit system, allowances disappear and the income tax charge is based on the individual's total income. Tax credits - the same set cash amount for each taxpayer - are then deducted at the end of the calculation to give the total tax due. Tax credits are simpler (though the changeover to such a system would be complicated) and could, depending on other reforms that accompany them, be a catalyst to fundamental and radical reform of the tax system. As the paper referred to above points out, they are not in themselves the answer to all the faults of the tax system and other reforms could have a similar impact on introducing credits. But the clarity of the credits system has considerable advantages and has attracted support from senior Government ministers, including the Tanaiste, Ms Harney. The tax system has already started to move in the direction of credits. In recent years, taxpayers have only been allowed to claim mortgage income tax relief and VHI relief at the standard income tax rate. An allowance which can only be claimed at the standard rate is similar to a tax credit, as it is worth the same to all taxpayers. Mr McCreevy may indicate a move of more allowances to the standard rate in this week's Budget. There is speculation that he could immediately rule that the £800-a-year PAYE tax allowance can only be claimed at 26 per cent. To ensure that the better off do not lose from this move and that the less well-off gain, he could roughly double the size of the allowance to between £1,500 and £1,600. This would give a cash boost to lower earners in particular, while it would also make it more attractive for spouses with earning partners to return to the workforce.
A move on the big £3,150 personal income tax allowance would be more dramatic. A substantial increase in this allowance is certain, but it is unclear whether the move towards standard-rating it will be started in the next tax year. A wholesale reform of the tax allowance system would allow the Government to introduce substantial further tax changes.
