The major political parties have adopted disparate tax strategies to address weaknesses in the system as it evolved since 2002, writes Paul Tansey.

In fashioning tax packages that might tempt the electorate on voting day, the major political parties have targeted quite different constituencies and have devised distinctive tax strategies. Fianna Fáil is pursuing low and middle-income earners. Fine Gael and Labour are seeking to steer one-income families in their direction.

Of course, there is much common ground. The three major parties are all committed to reducing the standard tax rate from 20 per cent to 18 per cent and all three have promised to index tax credits and tax bands to the rate of earnings inflation in the years ahead. Fianna Fáil has added a kicker by undertaking to reduce the top income tax rate from 41 per cent to 40 per cent.

The differentiating characteristic of the Fianna Fáil approach is its emphasis on reducing Pay-Related Social Insurance (PRSI) rates for employees. Its election manifesto states that "PRSI, as currently devised, is not a fair tax as it is not levied on incomes above €48,800".

It proposes not only to abolish the income ceiling for employees' PRSI contributions, but to cut the contribution rates from the present 4 per cent to 2 per cent over the lifetime of the next administration. It also promises to reduce the PRSI contribution rate for the self-employed from the existing rate of 3 per cent to 2 per cent.

The Fine Gael and Labour parties, in their joint manifesto, take a different tack. They are banking on making new friends among one-income families. To this end, they have promised to raise the home carers' tax credit from its current level of €770 to €1,760. They have also undertaken to widen the standard rate tax band applicable to one-income couples by €5,000 more than would be justified by indexation in the years to 2012. In essence, these tax moves indicate a partial rolling back of tax individualisation.

These disparate tax strategies have been adopted by the major political parties not only in the expectation of electoral advantage, but because they address weaknesses in the Irish tax system as it has evolved since 2002. Changes in the principal components of the income tax code since the current Government came to office five years ago are shown in Table 1. These changes have given rise to the following outcomes.

First, although the rise in personal tax credits has lagged behind both consumer price inflation and earnings inflation since 2002, the very sizeable addition to the Employee Tax Credit over the period has exempted many employees from income tax altogether.

The Government's biggest achievement on the income tax front has been to release increasing numbers of income earners from the income tax net.

Between 2002 and 2006, the number of income earners freed from liability to income tax increased by more than one-fifth, from 632,700 to 776,100. On the basis of the 2007 budget, the Minister for Finance has projected that the number of Irish income earners who will pay not a penny in income tax this year will rise to 845,900, or 38.2 per cent of all income earners. In 2002, 33.6 per cent of income earners were exempt from income tax, according to Minister for Finance Brian Cowen in answer to a Dáil question from Eamon Gilmore TD (Labour), on February 7th this year.

However, even where employees escape liability to income tax, they still pay direct taxes on their income. This paradox arises because private sector employees earning more than €17,628 must pay PRSI contributions at a flat rate of 4 per cent on their incomes up to the ceiling of €48,800 this year. In addition, they must pay a further 2 per cent health contribution on all earnings.

Thus, even relatively low-paid workers who are exempt from income tax can find their weekly pay packets lightened by deductions for PRSI and health contributions.

At the PRSI contribution ceiling of €48,800, private sector employees this year are paying €1,688 in PRSI and a further €976 in health contributions - a total of €2,664 - before they even begin to contemplate the calculation of their income tax liabilities. As a result, many employees earning average incomes are finding that they are paying half as much again in PRSI and health contributions as in income tax.

The Fianna Fáil proposals to halve PRSI contribution rates from 4 per cent to 2 per cent are thus designed to correct an anomaly where PRSI and health contributions are becoming an increasingly weighty part of the overall direct tax burden on employees.

The second major outcome of the budgetary tax changes since 2002 relates to the taxation of families. Over the past five years, budgets have consistently favoured two-income families over households dependent on a single earner. Changes in the income tax code since 2002 have benefited in two substantial ways married couples where both are working.

First, where both spouses are employees, they have collected the very sizeable €1,100 increase in the Employee Tax Credit on the double. As a result, their combined standard income tax credits have risen from €4,360 in 2002 to €7,040 in 2007, an increase of 61.5 per cent in total tax credits in the space of five years.

Second, they have seen the standard rate tax band for married working couples raised from €56,000 to €68,000, an increase of 21.4 per cent. This is ahead of the expected inflation rate of 18.0 per cent over the five years. Conversely, married couples where only one spouse is working in remunerated employment have been penalised, in relative terms, on three counts.

First, since only one is working in paid employment, they can claim only one Employee Tax Credit. As a result, they gain only half as much as married couples who are both working as employees.

Second, the home carers' tax credit - introduced by Charlie McCreevy in an effort to silence opposition to his tax individualisation proposals - has marked time at €770 since its inception.

As a result, the standard tax allowances available to a married couple with children and where one spouse is working outside the home have increased from €4,470 in 2002 to €6,050 in 2007, a rise of 35.3 per cent over the past five years, and well behind the increase of 61.5 per cent garnered by two-income couples.

Third, the standard rate tax band for one-income couples has been widened from €37,000 in 2002 to €43,000 in 2007, an increase of €6,000. Thus, as can be seen from Table 1, one-income married couples have only been awarded the same addition to the standard rate tax band as single people since 2002, whereas working married couples have enjoyed twice as large an increase, at €12,000.

Thus, budgetary developments since 2002 indicate not only that tax individualisation is alive and well, but that it has been reinforced. While the widening gap separating the tax treatment of one and two-income married couples may have arisen as much as the unintended consequence of other policies as by deliberate intent, it has nonetheless provided Fine Gael and Labour with a tempting target to attack. They have not passed up the opportunity.

The proposal to raise the home carers' tax credit of €770 to €1,760 would give households where one spouse remains at home to care for the children an additional €990 in tax credits by 2012. The commitment to increase the standard tax band for one-income married couples by €5,000 more than would be justified on grounds of indexation would act to restore a degree of balance to the tax treatment of all married couples without dispensing with tax individualisation. This is illustrated in Table 2.

As can be seen from Table 2, Fine Gael and Labour estimate that indexing the standard rate band to earnings growth in the years to 2012 would require widening the standard rate tax band by €6,000 for a single person and by €12,000 for a married couple. But they have sweetened the proposal for married couples depending on a single income by adding a further €5,000 to the breadth of their standard rate tax band, widening it in total by €17,000.

On the basis of the Fine Gael/Labour proposal, by 2012, single-income married couples could earn up to €60,000 without straying into the top tax rate.

The most salient social characteristic of the Irish economic boom has been the particularly rapid growth of the Irish middle class. No political party possessed of a will to power can afford to neglect its biggest potential market.

But precisely because this class has grown so rapidly, it is not a monolith possessed of a single economic interest. Instead it embraces an array of segments and strata, each with its own economic concerns, but all sheltering under the umbrella of the middle class.

These individual concerns have allowed the major political parties to maintain or even develop their identities by differentiating themselves from their opponents. In the present campaign, clear lines of battle have already been drawn on the economic front: Fianna Fáil is for the workers by hand and brain - "Our first priority remains low- and middle-income earners" its manifesto trumpets - while Fine Gael has pinned its colours to traditional family values, as epitomised by one-income married couples, with a slightly bemused Labour Party shuffling along in tow.

Series concluded