TAX reform is an enormously complicated subject, and there is a danger that because of its complexity some important issues may become clouded in the public mind. As a result, instead of a tax reform that tackles very real defects of the present system, we could get changes in the tax system that merely benefit a powerful pressure group of better off people.
Evidence of the influence of this interest group can be found in the income tax changes of the past eight years. The biggest percentage tax cuts in this period have been accorded to people whose incomes today are upwards of £27,500. Thus the percentage taken in tax and PRSI from an income of £27,500 today is one seventh lower than the proportion levied on the equivalent of this in 1988, viz. £20,000.
This reflects the impact of the reduction in the top tax rate from 58 to 48 per cent, combined with the fact that personal allowances have risen by less than the increase in incomes.
In the past couple of years there has, however, been a growing perception of the inequity of this process, and of both the injustice and disincentive impact of the very high marginal tax rate currently imposed on single workers earning less than the average industrial wage. That wage is now about £14,000 a year, but a single worker starts paying the 48 per cent tax rate before his income even reaches £13,000.
As a result, there has been a growing acceptance of the need to shift the emphasis of tax changes away from reductions in tax rates towards increases in personal allowances, and towards a widening of the 27 per cent band. Taken together, these two provisions of the tax code determine the income level at which single workers start paying a marginal tax rate of 48 per cent which, when PRSI is added, deprives such workers of 55.75p of every extra £1 they earn. The fact that by contrast, because of the way PRSI contribution rates operate, a person with a non PAYE income of £1 million a year faces a marginal tax rate of only 50.25 per cent highlights the glaring injustice of the present tax arrangements.
But in the last couple of weeks an attempt has been made to revive the idea of cutting tax rates further rather than increasing personal allowances and widening the 27 per cent band. It has been suggested that some politicians believe it would be easier to "sell" cuts in tax rates to an allegedly ill informed public. The public is supposed not to understand any other aspect of the tax code, and to be more impressed by lower rates of tax than by the actual extent to which its own after tax incomes are actually affected by Budget tax changes.
It may, therefore, be worthwhile to demonstrate before the Government starts to broach the issue of tax changes in the context of the next, pre election Budget, just how these alternative approaches to income tax would impact upon different income groups. For that purpose let us compare the respective outcome of two alternative tax relief schemes, each of which would cost about £330m in a full tax year although in the year 1997 the revenue loss would be an affordable £200m or less.
One of these schemes cuts the standard tax rate from 27 to 25 per cent and the high rate from 48 to 45 per cent. The other increases the personal allowance by 14 per cent - £375 for a single person and £750 for a married couple - while also widening the standard rate band by just over 15 per cent - from £9,400 to £10,825 for single persons and from £18,800 to £21,650 for married couples.
Table 1 shows the outcome of these two equally costly alternative approaches.
It will be clear from these tables why some interests are pushing the idea of further cuts in tax rates. For such cuts would not merely provide tax reductions - the amount and percentage of which rise indefinitely with the level of income - but these reductions in tax would rise indefinitely in percentage terms also.
Moreover, this perverse result would be achieved at the expense of the two groups of taxpayers who most need relief - single workers with incomes around the average industrial wage of £14,000, and families with incomes somewhat above £25,000, both of whom currently face a marginal tax/PRSI rate of 55.75 per cent.
For, as the table shows clearly, it is just at these points that the option of increased personal allowances plus a widening of the 27 per cent band would start to offer substantial relief, up to 80-90 per cent higher than people at these income levels would secure, if the option of reducing tax rates were followed.
Of course, because of the need to base any tax scheme on a arithmetic scale of some kind, there does not, and indeed cannot exist a modification of the present tax structure that will simultaneously meet every need and the one proposed here as an alternative to cuts in tax rates is no exception. The scheme involving cuts in tax rates would offer on average £50 more relief to single workers earning between £8,000 and £13,000 a year, and an average of £100 more relief to married people in the £17,000-£24,000 range. But this defect is overwhelmingly offset by the advantages cited above.
It may not seem credible that, as between these alternatives, any political party drawing its support from the general body of taxpayers rather than from the top earners would prefer to cut tax rates rather than to raise allowances and widen the standard tax band. But the fact is that this was precisely the policy pursued by the Fianna Fail/PD Government of 1989-1992 in successive Budgets. And last weekend, the Sunday Independent reported "a source close to Bertie Ahern" as saying that Fianna Fail's tax reform plan for the next election involved cutting both the standard and higher rates of tax.
More surprisingly, there have also been reports that individual Fine Gael Party and Labour TDs are also proposing such a policy, possibly without having studied its full implications, as set out above.