income tax & universal social charge - …€¦ · · 2017-07-31income tax & universal...

Tax Strategy Group | TSG XX/XX Title

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INCOME TAX & UNIVERSAL SOCIAL CHARGE

Incorporating an ex-ante equality impact assessment of possible changes to the income tax system

Tax Strategy Group – TSG 17/02 25 July 2017

Tax Strategy Group | TSG 17/02 Income Tax and USC

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INCOME TAX AND UNIVERSAL SOCIAL CHARGE

Contents 1. Introduction ................................................................................................................... 3

Summary of Tax Yields 2007 - 2016 .................................................................................. 3

Structure of Income Tax and USC ..................................................................................... 4

2. Distribution and Burden of Income Tax and USC .......................................................... 5

Income Tax 2017 Distribution of Income Earners ............................................................ 5

Universal Social Charge 2017 Distribution of Income Earners ......................................... 6

Estimated Cumulative Burden of Income Tax and USC for 2017 ..................................... 7

3. Recent Developments – Budgets 2015 to 2017 ............................................................ 8

4. Programme for a Partnership Government Commitments .......................................... 9

Equality Proofing ............................................................................................................. 10

Gender Proofing – Individualisation vs Joint Assessment .............................................. 11

5. International Comparisons .......................................................................................... 13

6. Tax Policy Considerations for Reform - USC................................................................ 14

Universal Social Charge ................................................................................................... 14

Potential to Merge USC with PRSI .................................................................................. 14

USC for over 70s and medical card holders .................................................................... 15

7. Tax Policy Considerations for Reform – Income Tax ................................................... 16

Earned Income Credit ..................................................................................................... 16

Tapered withdrawal of tax credits .................................................................................. 16

Mortgage Interest Relief ................................................................................................. 18

8. Further Potential Options for Consideration .............................................................. 20

Appendix A: Ready Reckoner – Potential Costs / Yields .................................................... 21

Appendix B: Distributional and Work Incentive Aspects of the Income Tax System ......... 23

Introduction .................................................................................................................... 23

Context ............................................................................................................................ 23

Approach and Key Concepts ........................................................................................... 24

Distributional Analysis .................................................................................................... 26

Financial Incentives to Work .......................................................................................... 33


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1. Introduction

1. In 2017, it is estimated that personal income taxes of c. €20.2 billion will be raised

for the Exchequer, representing about 40% of the total tax take. Of this, income tax

is expected to comprise c.€16.5 billion and USC is expected to comprise c.€3.7

billion. Income tax and USC therefore now comprise the single largest source of tax

revenue to the Exchequer, having surpassed the proportion contributed by VAT in

2009.

Summary of Tax Yields 2007 - 2016

Data source: Department of Finance

2. The total income tax yield for the last ten years is set out in table 1 below. Figures

for the years 2007 to 2016 represent actual yield and figures for the year 2017 are

projections.

Table 1: Income Tax (including USC) Yield

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

€bn 13.6 13.2 11.8 11.3 13.8 15.2 15.8 17.2 18.4 19.2 20.2

% Tax 28.7 32.3 35.8 35.5 40.5 41.4 41.7 41.6 40.3 40.1 40.0

28.7%40%

30.7%

25.9%

13.5%

15.4%12.4%

11.9%14.7%

6.7%

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

50,000,000

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

€ million Summary of Tax Yields 2007 - 2016

Income Tax VAT Corporation Tax Excise Duty Other Taxes


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Structure of Income Tax and USC

3. The 2017 rates and bands of income tax are as follows:

20% rate on income within standard rate band

40% on income in excess of standard rate band

Taxpayer Standard Rate Band

Single €33,800

Single Parent €37,800

Married – one earner €42,800

Married – two earners (max)* €67,600

*Where each spouse earns a minimum of €24,800 – the maximum rate-band transferability between jointly-assessed spouses is €9,000.

4. Spouses and civil partners may elect for joint assessment under the income tax

system, whereby the combined income of the couple is assessed in the name of the

higher earner, net of their combined reliefs and credits. This can allow for a

reduction in the couple’s overall tax liability as compared to separate assessment

due to the transferability of the married tax credit and a portion of the standard rate

band.

5. The Universal Social Charge is an individualised tax, meaning that a person’s liability

to the tax is determined on the basis of his/her own individual income and personal

circumstances. The USC was introduced in 2011 and replaced two existing levies –

the Income Levy and the Health Levy. The current rates and bands of USC are as

follows:

Incomes of €13,000 or less are exempt. Otherwise:

€0 to €12,012 @ 0.5%

€12,012 to €18,772 @ 2.5%

€18,772 to €70,044 @ 5%

€70,044 to €100,000 @8%

PAYE income > €100,000 @ 8%

Self-employed income > €100,000 @11%

Maximum rate of USC of 2.5% for individuals over 70, and for full medical

cardholders (under 70), whose aggregate income does not exceed €60,000.


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2. Distribution and Burden of Income Tax and USC

6. The years leading up to 2009 saw a progressive narrowing of the income tax base as

government policy with regard to income tax was to increase tax credits and bands

to the point where 40% of income earners were exempt from income tax and only

20% of earners were liable to the higher rate of tax. The subsequent falls in income

and rising unemployment resulted in over 45% of earners being exempt from income

tax in 2010 and just over 13% being liable to the higher rate of tax. A range of

measures have been taken since 2009 to correct this narrowing of the income tax

base, including reductions in tax credits and bands, the restriction or abolition of

many reliefs, and the introduction of the broad-based USC.

Income Tax 2017 Distribution of Income Earners

Data source: Revenue Commissioners

Table 2: Income Tax 2010 Distribution of earners

Income Tax Earners % of Earners

Higher Rate 277,086 13%

Standard Rate 864,726 42%

Exempt 946,631 45%

Total 2,088,443

Table 3: Income Tax 2017 Distribution of earners

Income Tax Earners % of Earners

Higher Rate 517,300 20.5%

Standard Rate 1,080,300 43%

Exempt 919,700 36.5%

Total 2,517,300

Higher Rate 13%

Standard Rate42%

Exempt 45%

Income Tax 2010 Distribution of Earners

Higher Rate

20.5%

Standard Rate 43%

Exempt 36.5%

Income Tax 2017Distribution of Earners


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Universal Social Charge 2017 Distribution of Income Earners

Data Source: Revenue Commissioners

Note: Distribution of 3% USC surcharge income earners in 2011 was less than 1%

Table 4: Universal Social Charge 2017 Distribution of Earners

USC (2017) Earners (2017) % of Earners (2017)

3% Surcharge 22,600 1%

8% 195,000 8%

5% 1,066,600 42%

2.5% 484,700 19%

Exempt 748,300 30%

Total 2,517,200

0%

5%

10%

15%

20%

USC Earners and Payments by Gross Income Range 2017

Number of Taxpayer Units % of Total Gross Income % of Total USC Paid

7% Rate64%

4% Rate24%

Exempt12%

Universal Social Charge 2011Distribution of Earners

3% sch'g1%

8% Rate8%

5% Rate42%

2.5% Rate19%

Exempt30%

Universal Social Charge 2017Distribution of Earners


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Estimated Cumulative Burden of Income Tax and USC for 2017

7. It is estimated that:

The top 1% of income earners (>€200,000) will pay 24% of total IT and USC



The remaining 74% of income earners will pay 17% of total IT and USC

Notes for tables 3, & 4:

1. Distributions for 2017 are estimates from the Revenue tax-forecasting model

using actual data for the year 2014, adjusted as necessary for income and

employment trends in the interim.

2. Figures are provisional and likely to be revised.

3. A jointly assessed married couple/civil partnership is treated as one tax unit.

4. Percentages are rounded to the nearest percentage point.


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3. Recent Developments – Budgets 2015 to 2017

8. The stabilisation of the economy has allowed for reductions in the personal tax

burden to be introduced in three successive Budgets, with Budgets 2016 and 2017

focussing primarily on reductions to the lower rates of Universal Social Charge. The

main cumulative effects of these three Budgets are as follows:

The three lower rates of USC have been reduced from 1.5%, 3.5% and 7% to 0.5%,

2.5% and 5% respectively.

The ceiling of the second USC rate band has increased by €1,196 to €18,772, in

conjunction with increases in the National Minimum Wage.

In Budget 2015 the income tax standard-rate band was increased by €1,000 from

€32,800 to €33,800 for single individuals and from €41,800 to €42,800 for

married one earner couples, and the higher rate of income tax was reduced from

41% to 40%.

A new 8% USC rate was introduced in Budget 2015 in conjunction with the

reduction of the higher rate of income tax. This USC rate-band has allowed the

benefits of the Budget 2015 to 2017 personal tax packages to apply on income up

to €70,044 only, thereby limiting benefits for higher earners.

A new Earned Income Credit for self-employed individuals who do not have

access to the PAYE tax credit was introduced in Budget 2016 at the rate of €550

per year, and was increased to €950 in Budget 2017.

The Home Carer Credit, which is available to families where one spouse or civil

partner works primarily in the home to care for children or dependents, was

increased over the last two budgets from €810 to €1,100. The limit on the

income which the home carer is allowed to earn and still qualify for the credit was

also increased from €5,800 to €7,200.

It was announced in Budget 2017 that, as part of an ongoing process to support

entrepreneurship and start-up companies generating employment, a new, SME-

focussed, share-based incentive scheme would be introduced in Budget 2018.

Work is ongoing on the design of the incentive and engagement with the

European Commission with a view to securing State Aid approval in advance of

Budget 2018 has commenced.


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4. Programme for a Partnership Government Commitments

9. The Programme for a Partnership Government (PPG) expresses a number of

commitments with regard to public finances and taxation. It recognises the need to

keep the tax and revenue base broad, while reducing the rate of tax on work and

some other activities in order to achieve specific social and economic objectives.

The PPG commits to meeting the required domestic and EU fiscal rules, and sets out

a planned 2:1 split of available resources between public spending and tax

reductions. Budget 2017 was announced with a split of over 3:1 in favour of public

spending.

10. The PPG also contains a number of specific undertakings with regard to personal

taxation, including the following:

To ask the Oireachtas to continue to phase out the USC as part of a medium-term

income tax reform plan.

To increase the Earned Income Credit from €550 to €1,650 to match the PAYE

credit by 2018, and to provide a supportive tax regime for entrepreneurs and the

self-employed.

To retain mortgage interest relief on a tapered basis beyond the current end date

of December 2017.

To support stay-at-home parents through an increase in the Home Carers’ Credit.

To explore mechanisms through which SMEs can reward key employees through

share-based remuneration.

Potential Offsetting Measures

11. The PPG states that the reductions in personal tax rates, such as the continued

phasing out of the USC, will be funded largely through:

Extra revenues from not indexing personal tax credits and bands.

The removal of the PAYE tax credit for high earners and other measures to ensure

the tax system remains fair and progressive.

Higher excise duties on cigarettes.

Increased enforcement and sanctions on fuel laundering and the illegal

importation and sale of cigarettes.

A new tax on sugar sweetened drinks.

Improvements in tax compliance.


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Equality Proofing

12. The PPG contains a commitment to task the Budget and Finance Committee with

looking at gender and equality proofing Budget submissions and proposals. In the

context of equality, it is important to note that it is the impact of the Budget as a

whole which should be assessed, and not the impact of the taxation or expenditure

measures in isolation.

13. Redistribution of income takes place through the taxation and social welfare

systems. Using OECD data, the extent to which each element contributes to the

redistribution of income, measured by the reduction in the initial market Gini

coefficient can be seen. The Gini coefficient is a measure of the distribution of

income where 0 represents a situation where all households have an equal income

and 1 indicates that one household has all national income. A reduction in the Gini

coefficient means that the distribution of income has become more equal.

14. The latest data from the OECD (for 2012), shows that Ireland had the largest

reduction in the Gini coefficient between market and disposable income for the

OECD countries for which data are available. The data show that, compared to other

countries, the Irish tax system is strongly progressive and that the tax and welfare

systems combined contribute substantially to the redistribution of income and to the

reduction of income inequality.

15. When looked at over a slightly longer time period and taking a more limited sample

of countries for which data are available, it is evident that Ireland’s tax system has

consistently reduced the Gini coefficient (i.e. increased the equality of income

distribution) to greater extent than is the case with tax systems in other OECD

countries. Of interest is the finding that – both for Ireland and the OECD as a whole -

the contribution of the tax system to reducing market income inequality has been

increasing since 2004.

16. The tax system does contain a number of provisions which discriminate in favour of

certain individuals, in view of additional challenges which they face. These include,

for example: the Age Credit and income tax exemption limits for individuals aged 66

and over; reduced USC liability for those aged 70 and over and medical card holders

whose income does not exceed €60,000; additional tax credit and standard rate

band for single parents; additional tax credits for parents of disabled children, for the

blind, for widows/widowers, and for carers of a dependant relative. While these

measures are deviations from the principle of horizontal equity, under which each

person with the same income should have the same tax liability, they have been

introduced into the tax code as a result of social policy decisions to provide

additional supports to individuals in these specific circumstances.


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Gender Proofing – Individualisation vs Joint Assessment

17. USC and PRSI are calculated and payable on an individualised basis, meaning that a

person’s liability to the tax / social insurance charge is determined on the basis of

their own individual income and personal circumstances. By contrast, income tax

allows for a system of joint assessment, whereby one spouse is assessed to the joint

income of both individuals and tax credits and bands may be (partially) transferred

between spouses.

18. With regard to each of the three charges on income, the system of tax rates, bands

and credits applies equally to both genders. Liability to tax and entitlement to

credits and reliefs is determined by factors such as the type and source of income

earned and the nature of deductible expenses incurred and is not influenced by the

gender of the individual taxpayer. For a married couple under joint assessment, the

assessable spouse is determined not by gender but by reference to the higher earner

of the couple.

19. Notwithstanding this non-gendered approach, earnings and workforce participation

data indicate that males are more likely to be the higher earners in households and

therefore the assessable spouse. Therefore policy measures targeted at the

secondary earner of a jointly assessed couple could be expected to have a more

significant impact on females.

20. Prior to 2000 income tax allowed for full joint assessment of married couples,

meaning that the earner in a single-income couple could use the combined tax

credits and standard rate band available to the couple – i.e. double the personal tax

credit and rate band available to a single earner. As a result, where the primary

earner of a couple had sufficient income to use the available reliefs in full, the

second earner faced the marginal rate of tax from the first pound of income earned,

and this could act as a disincentive to workforce participation for second earners.

21. A process of moving towards an individualised system of income taxation began in

the tax year 2000/2001 with the stated economic objectives of increasing labour

force participation and reducing the numbers of workers paying the higher rates of

income tax. Many European countries have made similar moves towards a partial or

fully individualised income taxation on the grounds that it improves equality and

economic independence for women.


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22. An individualised tax system is less favourable to single-income families whose

income is in excess of the married-one-earner standard rate tax band (currently

€42,800). The move towards individualisation was therefore opposed in particular

by single-income families with caring responsibilities in the home. The Home Carer

Credit (HCC) was introduced in tandem with the move towards individualisation in

order to benefit families where one spouse works primarily in the home to care for

children or other dependants. The HCC of €1,100 in Budget 2017 may be claimed in

full where the home carer’s income is below €7,200 per year, and on a reduced

tapered basis where the home carer earns up to €9,200 per year.

23. Other non-tax factors also have significant impacts on female workforce

participation, including in particular the cost of childcare. Studies of the

‘participation tax rate’ for families where women return to work (i.e. the amount of

the additional gross earned income which is loss through payments of tax, social

insurance, reductions in welfare entitlements), have found a participation rate of

below 20% for Ireland indicating a tax and welfare system that is supportive of the

second earner returning to work. However, in situations where the family has to pay

for childcare, the participation tax rate including childcare costs for women with two

children was 94% - the second highest in the EU (second only to the UK).1

24. The issue of tax individualisation was considered by the Commission on Taxation in

2009 and that body recommended no change should be made to the prevailing

income tax system. It concluded that the partially-individualised income tax system

represents a balance between, on the one hand, acknowledging the choices families

make in caring for children and, on the other, taking account of the need to

encourage labour market participation.

1 http://ec.europa.eu/justice/gender-equality/files/documents/150511_secondary_earners_en.pdf


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5. International Comparisons

25. A progressive income tax system means that those on higher incomes pay

proportionately higher rates of tax than those on lower incomes – this is in

accordance with the concept of vertical equity. Ireland has one of the most

progressive income tax systems in the developed world – the most progressive

within the EU members of the OECD, and the second most progressive within all

OECD countries. The tax revenues are used, among other purposes, to fund social

transfers such as welfare supports to those on lower incomes.

26. However high marginal rates of taxation as a result of progressive taxation can have

a negative impact on incentives to work for income earners, and lead to increased

labour costs for employers who may have to offer a certain level of net income in

order to attract employees in a competitive labour market. Marginal tax rates which

are high by comparison to competitor jurisdictions can therefore have a negative

impact on domestic businesses seeking to attract mobile highly-skilled workers.

They can also be a negative factor in the location choices of foreign direct

investment, a particularly important issue for the Irish economy.

27. The Tax Wedge is defined as the sum of personal income tax plus employee and

employer social security contributions together with any payroll taxes less cash

transfers, expressed as a percentage of labour costs. It is the difference between

what an employer has to pay in terms of gross wages plus taxes to hire an employee

and the net income received by that employee after deduction of all taxes on their

wages. High tax wedges particularly affect low skilled workers, second earners and

older cohorts whose labour force participation is more sensitive to taxation.

Reductions in the tax wedge on these groups can have significant impacts on

participation rates which can increase medium term economic growth rates through

the labour supply channel.

28. Reductions in the tax wedge can also increase the demand for labour from

employers. For these reasons, a competitive tax wedge is considered vital in

encouraging employment growth across all income categories and to incentivise

individuals to remain in or return to the labour market.

29. In terms of international comparisons, according to the OECD “Taxing Wages report

2017”, based on 2016 data, Ireland had the seventh lowest tax wedge (27.1) of the

34 members in the OECD for a single worker on average earnings and the lowest of

the 21 EU members of the OECD.


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6. Tax Policy Considerations for Reform - USC

Universal Social Charge

30. The USC was introduced with effect from 1 January 2011, and replaced two existing

levies, the Income Levy and the Health Levy. It was a measure intended to widen the

tax base, as previous increases in income tax credits and rate bands combined with

falls in incomes and employments in the recession had resulted in c.45% of income

earners being exempt from income tax in 2010.

31. The USC was also a revenue-raising measure intended to reduce the budget deficit.

However the projected net increase in revenue from replacing the two existing levies

with the USC was only €420 million per annum.

32. Further reductions to the three lowest rates of USC were introduced in Budget 2017,

such that the lowest rate of USC now stands at 0.5%. The USC, with its entry

threshold of €13,000, is the lowest point of entry to the income tax system for many

taxpayers. Continued reductions in the USC could, in isolation, result in a further

narrowing of the tax base.

33. The USC is a component factor in the top marginal tax rate, which stands at 52% for

all income over €70,044 and 55% for non-PAYE income over €100,000. High

marginal tax rates can be an impediment to international competitiveness, so

reductions in the highest rate of USC (currently 8% on income in excess of €70,044),

being one of the components of the top marginal rate, could improve Ireland’s

comparative competitive advantage.

Potential to Merge USC with PRSI

34. When the introduction of the USC was first proposed in Budget 2010 it was intended

that it would replace Employee PRSI in addition to the Income and Health Levies but

this has not as yet been accomplished for a number of reasons.

35. PRSI is a social insurance charge payable on employment, self-employment and most

investment income. There are two elements to the charge, a personal element

payable by the income-earner and a separate larger element payable by employers

in respect of the salaries of their employees. The PRSI charge is calculated based on

a series of 11 classes and 24 sub-classes, determined by the individual’s age and the

source and level of the income on which the PRSI charge is being applied.


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36. There are a number of theoretical advantages for simplifying from a three-charge to

a two-charge system by way of an amalgamation of USC with PRSI as opposed to an

amalgamation of USC with income tax, including:

Both USC and PRSI are individualised taxes, whereas income tax allows for joint

assessment of married couples / civil partners.

The tax bases for USC and PRSI are similar, including most forms of earned and

investment income and excluding social welfare income.

The Income Tax system incorporates a wide range of policy-driven tax credits,

reliefs and exemptions, whereas USC and PRSI have few reliefs or exemptions.

37. However notwithstanding the above, there are also challenges which would need to

be overcome in amalgamating USC and PRSI, including:

Individuals aged 66 and over are not liable to PRSI, but they are liable to USC.

PRSI operates on a week-one basis whereas the USC is a cumulative annual tax.

Whether the revenues of the new combined charge would accrue to the

Exchequer or the Social Insurance Fund.

Compatibility of the new combined charge with bi-lateral social security

agreements with other countries and with our network of tax treaties.

Whether to preserve the existing Employer PRSI charge in its current form.

USC for over 70s and medical card holders

38. The USC system currently contains a provision which limits the rate of USC payable

by full medical card holders and individuals aged 70 years and over whose aggregate

USC-liable income does not exceed €60,000 per annum. It allows income in excess

of €18,772 to be taxed at the second USC rate (currently 2.5%) in place of the third

rate (currently 5%).

39. The provision for medical card holders is due to expire at end-2017. In the absence

of any policy intervention, individuals aged under 70 who currently benefit from the

relief will see an increase in their USC liabilities from 1 January 2018. In this context

it should be noted that Social Welfare income, such as the State Pension, is not liable

to the USC.

40. Department of Health statistics show that over 1.6 million people had a full medical

card as at the end of April 2017.

41. Options open to the Government include allowing the relief for medical card holders

to expire as planned; a further extension of the current relief; or a modified

extension of the relief into a tapered phase-out period. The estimated cost of the

relief in its current form is in the region of €71 million per annum on a full-year basis.


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7. Tax Policy Considerations for Reform – Income Tax

42. Recent Budgets have focussed primarily on changes to the Universal Social Charge

rather than income tax. The last change to the income tax standard rate bands took

place in Budget 2015, when they were increased by €1,000. In addition to the

Earned Income Credit, set out in more detail below, the Home Carer tax credit (HCC)

was increased in both Budget 2016 and Budget 2017, and now stands at €1,100. The

HCC is available to jointly assessed couples where one partner works primarily in the

home to care for children or other dependant persons.

Earned Income Credit

43. A new Earned Income Credit was introduced in Budget 2016 and is available to self-

employed individuals who do not have access to the PAYE tax credit. It is estimated

that the credit will be available to approximately 147,500 cases in 2017. The PPG

committed to an increase in the value of the Earned Income Credit from €550 to

€1,650, to match the PAYE credit, by 2018, and the credit was increased by €400 to

€950 in Budget 2017.

44. Options for further increases to the credit in fulfilment of the PPG commitment

include:

An increase of €700 in Budget 2018 (Finance Bill 2017) to bring the credit up to

€1,650, at a cost of €58 million in the first year and €103 million in a full year.

This would equate to an additional benefit of over €13 per week for recipients.

A two-stage increase of €350 in each of Budget 2018 and Budget 2019 (Finance

Bill 2018), at a cost each year of €29 million in the first year and €52 million in a

full year. This would equate to an additional benefit of over €6.70 per week for

recipients in each of the two years.

Tapered withdrawal of tax credits

45. The PPG contains a commitment to consider the removal of the PAYE credit for high

earners as part of a medium-term income tax reform plan, and it is assumed that this

would also extend to removal of the Earned Income Credit on the same basis.

46. There are a number of technical issues and policy issues which would need to be

addressed in order to achieve such a withdrawal, particularly for PAYE employees,

and these were set out in some detail in the Income Tax Reform Plan published in

July 2016.2

2 http://www.finance.gov.ie/sites/default/files/Income%20Tax%20Reform%20Plan-FINAL_0.pdf


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47. The UK tax system incorporates a personal tax allowance which is subject to a

tapered withdrawal for individuals whose income is in excess of stg£100,000 per

annum. (In this context it is worth noting that a tax allowance allows relief at a

taxpayer’s marginal rate, whereas the PAYE and Earned Income Credits are standard-

rated tax credits.) The allowance is reduced by £1 for every £2 earned above this

limit, tapering out (in the 2017/2018 tax year) once income reaches £123,000. The

£100,000 threshold was chosen as all individuals with income above that level were

already obliged to file a tax return each year and this facilitated the operation of the

taper. By contrast, there is no similar liability to file a tax return based on income

level in Ireland.

48. Tapering the tax credits could affect the relative position of different categories of

taxpayer. For example, consideration would need to be given to how the taper

would work in the case of jointly-assessed individuals – such as whether the value of

a single personal tax credit or that of a married personal tax credit be subject to the

taper, and what income threshold would apply to a single-income couple.

49. The tapering out of a tax credit would also result in a higher marginal tax rate within

the taper zone than would apply at higher income levels. For example, were the

personal tax credit of €1,650 to be tapered out at a rate of 5% per €1,000 (i.e. a loss

of just over 8 cent per additional euro of income), the marginal rate within the taper

zone would be just over 60%. Once the taper period has expired, at income over

€120,000 in this example, the marginal rate would revert back to 52%.

50. The Income Tax Reform Plan, published in July 2016, contained estimated yields for

tapering the PAYE and Earned Income Credits over the income ranges €80,000 to

€100,000, and €100,000 to €120,000, in the region of €365 million and €212 million

respectively on a first-year basis. However, on review, it has emerged that these

yields were calculated on a “tax unit” basis rather than on an individualised basis.

This means that, in the case of a married-two-earner couple, the yield assumed the

credits were withdrawn where the couple’s joint income exceeded the relevant

threshold. As such it is expected that those estimated yields are significantly higher

than would arise if a taper were to be applied on a per-earner basis. Work is ongoing

to develop revised yield estimates on an individual-earner basis.


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Mortgage Interest Relief

51. The PPG contains a commitment to retain Mortgage Interest Relief (MIR) beyond the

current 2017 end date on a tapered basis. This intention was confirmed in the

Budget 2017 speech, which specified that the details of a tapered extension to 2020

would be set out in Budget 2018.

52. MIR is effectively a demand-side support to the residential housing market as it

facilitates the recipient in affording a higher mortgage repayment, and therefore

capital borrowing, than would otherwise be the case. The policy intention of MIR

was to support individuals in attaining home-ownership, particularly in the early

years of a mortgage when the interest portion of mortgage repayments is at its

highest. However where supply in a market is constrained the effect of a demand-

side tax incentive such as MIR is to drive up market price, effectively transferring the

benefit of MIR to the property vendor or developer, and to property-owners

generally as a result of the increased value of their asset.

53. For this reason the gradual phasing out of MIR has been under way since 2009. No

new mortgages taken out since January 2013 have qualified for MIR, and the relief

has expired for qualifying mortgages taken out prior to 2004. The cohort who

remain in receipt of the relief include those who purchased at the peak of the

property market and those who bought at the subsequent trough in the market.

54. An extension of the relief to current recipients may be unpopular with post-2012

purchasers who have not benefitted from MIR, particularly those who have

purchased more recently as house prices have risen again. Data from the Banking &

Payments Federation Ireland indicate that over 83,000 owner-occupier mortgages

have been drawn down between January 2013 and March 2017, of which over

49,000 were first-time buyer purchases.

55. The remaining recipients receive relief at a rate of between 15% and 30% of

qualifying interest paid – the highest rate of 30% applies to those who purchased

between 2004 and 2008 when house prices were at their peak. A ceiling on

qualifying interest applies of €10,000 per individual (€20,000 per couple) in the first

seven years of the mortgage, and €3,000 per individual (€6,000 per couple) in

subsequent years.

56. MIR for all remaining recipients is due to expire at the end of 2017. Existing MIR

recipients therefore face a ‘cliff’ in 2018 when their monthly mortgage payments

may increase when the tax relief at source is withdrawn (all other factors being

equal). The cost of MIR in 2016 was €187 million with 292,448 mortgage accounts,

equating to an average benefit per account of c.€639 per annum, or €53 per month.


| 19

57. The following options for extending MIR on a tapered basis could be considered:

Extend MIR into a phase-out period by reducing the rate of relief – this would

result in an equal proportionate reduction for all remaining MIR recipients over

the taper period. However this form of taper may be more difficult to implement

for the mortgage lenders who operate the relief at source and may therefore give

rise to confusion or the need to correct claims retrospectively.

Extend MIR into a phase-out period by reducing the ceilings for allowable

interest – a reduction in this manner would be more favourable to those with

lower outstanding borrowings whose annual interest is already below the current

ceilings. As a result it would also be more costly than a tapering of the rate of

relief over an equivalent period. It would however be significantly easier for

mortgage lenders to operate.

Extend MIR into a phase-out period for qualifying 2004-2008 buyers only – a

focused tapered extension of MIR for those individuals who were first-time

buyers during the peak of the property boom between 2004 and 2008 who are

already separately identified for the purposes of the higher 30% rate of MIR,

while allowing the relief to cease as scheduled at end-2017 for other non-first-

time buyers in those years and for borrowers who purchased when prices had

fallen. In 2016 approximately 148,000 mortgages were in receipt of relief at the

30% rate, with an estimated exchequer cost of €110m. (This equates to c.59% of

the total MIR cost for 2016 of €187m.)

58. The potential Exchequer costs of a range of options for the tapered extension of MIR

are as follows:

2018

(€ million) 2019

(€ million) 2020

(€ million)

Taper rate of relief evenly over 3 years 2018-2020

-123 -72 -32

Taper interest ceilings over 3 years 2018-2020

-138 -107 -61

Extend and taper over 3 years for 04-08 buyers only

-67 -39 -17


| 20

8. Further Potential Options for Consideration

59. The Ready Reckoner in Appendix A allows calculation of the cost/yield of

adjustments to the rates, bands and major credits in the income tax system.

60. Taking into account the PPG commitment to focus tax reductions on low and middle

income workers, the information on the distribution of income earners across the

various rates of income tax and USC contained in Section 2 will be of relevance to

the consideration of these options.

61. For example, the following could be extrapolated from the distribution projections in

Section 2:

Approximately 36.5% of income earners are exempt from income tax, and 30%

are exempt from USC. As such, these income earners would not be in a position

to benefit from reductions in income tax or USC rates, or from increases in tax

credits.

19% of income earners are liable to USC at a maximum of the 2.5% rate only, and

these income earners should fall within the exempt or standard rate bands for

income tax. A reduction in the 0.5% and/or 2.5% USC rates would therefore

target the income earners on the lowest taxable incomes. Individuals on higher

incomes would also benefit to the same extent, due to the USC band structure.

A reduction in the headline marginal rates of tax, targeted equally at employees

and the self-employed, could be achieved by reducing the 8% rate of USC

applying on income over €70,044. As illustrated in Section 2, projections indicate

that this would be of benefit to approximately 8% of income earners.

A reduction in the top rate of income tax or an increase in the income tax

standard-rate bands would be of benefit to approximately 20.5% of income

earners.

62. Members of the Tax Strategy Group may wish to consider these issues.


| 21

Appendix A: Ready Reckoner – Potential Costs / Yields

The below table has been updated to reflect the new pre-Budget 2018 Revenue Ready

Reckoner, published on 21 July 2017 subsequent to the circulation of TSG papers to

Group members.

(See notes on next page regarding costing methodology)

No. Options

First Year

Cost/Yield

€m

Full Year

Cost/Yield

€m

Tax Rate

1 Decrease 20% rate to 19% -523 -606

2 Decrease 40% rate to 39% -271 -330

3 Increase 20% rate to 21% +526 +609

4 Increase 40% rate to 41% +269 +328

Standard-Rate Bands

5 Increase standard rate cut off point by €1,000

(single, married one-earners and two earners) -175 -202

Tax Credits

6 Increase Earned Income Credit by €350 -30 -53

7 Increase Earned Income Credit by €700 -59 -106

8 Increase personal tax credits by €100 -201 -234

9 Increase Home Carer Credit by €100 -7 -8

Universal Social Charge

10 Increase USC entry point to €13,500 -2.3 -2.7

11 Increase USC entry point to €14,000 -4.7 -5.6

12 Increase €18,772 ceiling of second USC rate-

band to €19,772 -34 -39

13 Reduce 0.5% rate to 0.0% -111 -129

14 Reduce 2.5% rate to 1.5% -141 -164

15 Reduce 5% to 4% -336 -392

16 Reduce 8% to 7% -136 -177

17

Increase 8% rate to 9% on income over €70,044

(with consequential increase from 11% to 12%

in rate applying to non-PAYE income over

€100,000)

+136 +177


| 22

Points to note regarding costing methodology and assumptions:

Distributions for 2018 are estimates from the Revenue tax-forecasting model using

actual data for the year 2015, adjusted as necessary for income and employment

trends in the interim. The data are published in the new Revenue Ready Reckoner

which is available on the Revenue website.

Individual element cost estimates stand alone i.e. putting 2 elements together may not simply cost the aggregate of the 2 elements as there may be interaction between the elements.

Figures are provisional and likely to be revised.

A jointly assessed married couple/civil partnership is treated as one tax unit.

Percentages are rounded to the nearest percentage point.


| 23

Appendix B: Distributional and Work Incentive Aspects of the Income Tax System

Introduction

B1. This paper provides a short overview of the distributional and work incentive

impacts of a number of possible tax measures. Before presenting the results, the

context for the analysis and the approach and key concepts used are set out below.

Context

B2. The expected distributional impact of budgetary measures continues to be an

important consideration in the formulation of budget policy. A number of

Government departments (Finance, Public Expenditure & Reform, and Social

Protection) carry out distributional analyses in the period leading up to the Budget.

B3. The distributional analysis in this paper forms part of the Government’s undertaking

to facilitate earlier consideration of distributional issues in the budgetary process

and is in line with the Programme for Partnership Government (PPG) commitment to

“develop the process of budget and policy proofing as a means of advancing

equality”.

B4. Given that the details of the budget package are unknown, it is not possible to

directly examine its distributional or work incentive impacts at this stage. Neither is

it feasible to present all the possible individual tax measure permutations which

could be considered. As a result this paper presents the impacts of: (a) a number of

hypothetical individual tax measures; and (b) a hypothetical tax package, which can

be informative as to the general implications were similar measures undertaken.

B5. The differing goals of the budget – which include raising revenue, encouraging

economic efficiency and addressing distributional concerns – mean that trade-offs

are faced in balancing these different objectives. The main focus of this paper is on

distributional issues but consideration of financial incentives to work are also

discussed as they relate to considerations around economic efficiency and growth.

B6. Other issues which should be borne in mind when considering this paper include:

The importance of looking at Budgets and fiscal policy in the round, rather than at

the level of each individual measure;

This paper only addresses tax measures and does not incorporate expenditure

which performs the bulk of the redistributive function of the Irish tax and welfare

system (see Annex B of Budget 2017); and

The very strong progressivity already present in the Irish income tax system.


| 24

Approach and Key Concepts

B7. This paper makes use of the SWITCH (Simulating Welfare and Income Tax CHanges)

micro-simulation tax-benefit model developed and operated by the Economic and

Social Research Institute (ESRI). SWITCH uses household survey data on incomes and

other tax and welfare relevant characteristics to simulate how households are

affected by the rules of the current system and by proposed reforms. SWITCH has

limitations; for instance, it does not account for indirect taxes or expenditure on

public services (such as health care) and it does not incorporate behavioural

changes. The SWITCH model is updated regularly and the next release is due in

September 2017. The simulations in this paper were performed using the Post-

Budget 2017 SWITCH version.

B8. The SWITCH model presents the estimated distributional impact of a budget

measure or package by (i) income group and (ii) family type. The impact on different

income groups can be examined by decile of equivalised disposable income, by fixed

range of equivalised disposable income or by fixed range of gross income. The family

types in the analysis include lone parents and singles without children, both

employed and unemployed; single earner, dual earner and non-earning couples,

with and without children; and retired singles and couples.

B9. While the Government is committed to advancing an equality agenda in the budget

process, there are constraints around the available data to do so in tax policy

analysis. Currently, there are nine aspects covered by Ireland’s equality legislation.

These are gender, age, family status, civil status, sexual orientation, race, disability,

religion or membership of the Traveller Community. Although it is not currently part

of the legal framework around equality, socio-economic status is also an important

concern. Socio-economic status is not directly observable and income is often used

as a proxy for it.

B10. The SWITCH model can currently address two of these equality dimensions: socio-

economic status (via income) and family status. The ESRI have previously used the

underlying micro-data behind SWITCH to examine the distributional impact of

budgets by gender, although this is not a routine part of SWITCH outputs and was a

specially commissioned project for the Equality Authority.3 As SWITCH is based on

household survey data, and more than one person can live in a household, equality

dimensions which are unique to an individual are difficult to incorporate.

3 Keane, C., Callan, T., & Walsh, J. (2014). Gender Impact of Tax and Benefit Changes: A Microsimulation Approach. Economic and Social Research Institute (ESRI) and The Equality Authority.


| 25

B11. The impacts by income group in this paper are presented in terms of their impact

on deciles within the income distribution. Deciles are formed by ranking households

based on their disposable income and then dividing them into ten equally sized

groups.

B12. This ranking by decile is completed after households are ‘equivalised’.

Equivalisation involves adjusting household income on the basis of household size

and composition. The SWITCH model uses a scale of 1 for the first adult, 0.66 for

subsequent adults and 0.33 for children aged 14 or under. This means that the

income of all households is expressed in terms of a single adult household. For

instance, a single adult household with an actual income of 100 (100 ÷ 1 = 100) is

considered to have the same equivalised income as a two adult household with an

income of 166 (166 ÷ {1+0.66} =100).

B13. The distributional impact by family type is conducted on a ‘tax unit’ basis, i.e. an

individual or couple, grouped together with any dependent children. Young adults

(e.g. third-level students) are treated as independent tax units and are not grouped

into households.

B14. There are a number of possible alternative scenarios or counterfactuals against

which the budget or particular measures can be compared. Three alternatives which

can be used in particular when it comes to distributional analysis include a ‘no

change’ comparison as well as scenarios where the taxation system is assumed to

have been indexed to either price inflation or wage growth. The results presented in

the following sections are based on a ‘no change’ policy where all parameters and

policies are kept at Budget 2017 levels except those explicitly mentioned.


| 26

Distributional Analysis

B15. In the interests of transparency and ease of comparison, the SWITCH simulations

conducted here are on the basis of the modelled tax changes occurring in 2017

rather than 2018. This reflects the complication that SWITCH will be updated in

September 2017 and at that stage assumptions about 2018 parameters, which could

be made at present, will have changed. As such, the results do not account for wage

growth in 2018. Nonetheless the simulations can be considered to be highly

representative of the impact of measures were they to be introduced as part of

Budget 2018.

B16. The following table presents the results of simulations of five separate tax

measures each estimated using SWITCH to cost approximately €300 million as

follows:4

An increase in the Pay as You Earn (PAYE) tax credit from €1650 to €1760 and an

increase in the Earned Income Tax Credit (EITC) from €950 to €1760;

A reduction in the 20% rate of income tax to 19.5%;

A reduction in the 40% rate of income tax to 38.8%;

A reduction in the 5% rate of USC to 4.2%; and

A reduction in the 8% rate of USC to 5%.

B17. For the tax measures shown, the impacts can be considered symmetric such that

there would be a corresponding decrease in disposable income if tax rates rose

instead of falling e.g. increasing the standard rate of income tax from 20% to 20.5%

would reduce disposable income of the 1st and 10th deciles by 0.1 and 0.3 percent

respectively.

4 The circa €300 million cost associated with each of the measures is the cost estimate from SWITCH. These SWITCH cost estimates are used to ensure the comparability of the distributional impact. If the measures were costed to amount to €150 million, the percentage change in disposable income for each decile would halve. It should be noted that the Revenue Commissioners’ Ready Reckoner (RCRR) as of November 2016 indicates in some cases quite different cost estimates for the five separate tax measures. The RCRR estimates the full-year costs as follows: IT PAYE €1650-> €1760 and IT EITC €950-> €1760, €287 million; IT 20%-> 19.5%, €288 million; IT 40%-> 38.8%, €336 million; USC 5%-> 4.2%, €294 million; and USC 8%-> 5 %, €441 million. One possible reason for the difference is the different data sources and base years used. SWITCH uses Survey of Income and Living Conditions (SILC) 2013 and 2014 data uprated to 2017, while the RCRR is based on 2017 estimates from the Revenue tax forecasting model using latest actual taxpayer data for the year 2014, adjusted as necessary for income, self-employment and employment trends in the interim.


| 27

Table 1 Distributional Impact of Alternative Income Tax and USC Changes

TC €1650/€950

->

€1760

IT

20% ->

19.5%

IT

40% ->

38.8%

USC

5% ->

4.2%

USC

8% ->

5%

Decile Percentage Change in Disposable Income (%)

1 (<= 242.02) 0.0 0.1 0.0 0.0 0.0

2 (<= 292.61) 0.2 0.1 0.0 0.0 0.0

3 (<= 350.51) 0.2 0.2 0.0 0.1 0.0

4 (<= 409.8) 0.4 0.4 0.1 0.2 0.0

5 (<= 465.92) 0.5 0.4 0.1 0.2 0.0

6 (<= 527.39) 0.4 0.4 0.1 0.3 0.0

7 (<= 591.78) 0.4 0.5 0.2 0.3 0.1

8 (<= 679.33) 0.4 0.5 0.3 0.4 0.1

9 (<= 818.13) 0.4 0.4 0.5 0.5 0.3

10 (> 818.13) 0.3 0.3 1.0 0.5 1.4

All 0.33 0.36 0.36 0.33 0.35

Households

Gaining (%)

61% 79% 41% 58%

11%

Source: Results based on analysis by the Department of Finance using SWITCH, the ESRI tax-benefit model

(www.esri.ie/switch)

B18. The proportion of households benefitting under each measure is given in the

bottom row. This ranges from 11% of households for the reduction in the 8% rate of

USC to 79% of households for reductions in the 20% rate of income tax.

B19. In addition, while the average change in household disposable income (circa

+0.35%) is constant across the different tax measures, the impact on different

income deciles varies considerably. An increase in the EITC and PAYE tax credit or a

reduction in the 20% rate of income tax are relatively more beneficial to low income

deciles compared to the other modelled tax measures. This is because changes in the

40% rate of income tax or the 8% rate of USC do not affect households in these

deciles, as their incomes are below the respective thresholds for those tax rates.

B20. The distributional impact of the tax measures also varies by family status. Across

the range of measures, the family types with above-average income gains are dual

earning couples with and without children, and single earning couples without

children. The smallest gains are for non-earning lone parents and the unemployed.

Overall, families with children tend to benefit more from reductions in the higher

rate of USC than families without children. Families without children tend to benefit

more from reductions in the standard rate of income tax than families with children.

http://www.esri.ie/switch


| 28

Table 2 Impact of Alternative Income Tax and USC Changes by Family Status

% of

Families

TC

€1650/€9

50 ->

€1760

IT

20% ->

19.5%

IT

40% ->

38.8%

USC

5% ->

4.2%

USC

8% ->

5%

Percentage Change in Disposable Income (%)

Families with Children 25

Employed Lone Parent 5 0.3 0.2 0.3 0.3 0.3

Non-Earning Lone Parent 2 0.0 0.0 0.0 0.0 0.0

Single Earner Couple 8 0.3 0.2 0.3 0.3 0.5

Dual Earner Couple 9 0.5 0.4 0.5 0.4 0.7

Unemployed Couple 1 0.0 0.0 0.0 0.0 0.0

Families Without Children 65

Single Employed 32 0.4 0.4 0.4 0.4 0.2

Single Unemployed 3 0.0 0.0 0.0 0.0 0.0

Single Earner Couple 6 0.4 0.4 0.4 0.4 0.6

Dual Earner Couple 5 0.6 0.4 0.4 0.5 0.5

Unemployed Couple 0 0.0 0.0 0.0 0.0 0.0

Single Retired Tax Unit 10 0.0 0.3 0.3 0.1 0.1

Retired Couple 8 0.0 0.4 0.2 0.2 0.1

All Other Tax Units 10 0.0 0.3 0.0 0.0 0.0

All 100 0.33 0.36 0.36 0.33 0.35 Source: Results based on analysis by the Department of Finance using SWITCH, the ESRI tax-benefit model


B21. The PPG contains a commitment to remove the PAYE tax credit for high earners,

and in the following exercise it is assumed that this would also extend to removal of

the EITC on the same basis. There are a number of outstanding technical issues in

relation to implementing this policy. However, due to the developments in the

SWITCH model in the last year, it is now possible to model the impact on households

of the tapered withdrawal of tax credits.

B22. The following table presents the results of simulations of three separate taper

approaches each estimated using SWITCH:

Tapered withdrawal of the PAYE tax credit and EITC at incomes above €70,000;



In all cases, withdrawal is modelled as a 50% withdrawal rate i.e. for every one

euro increase in income, 50c of the tax credit is withdrawn.



| 29

Table 3 Impact of tapered withdrawal of EITC and PAYE tax credit

50% withdrawal

for incomes

>€70,000

50% withdrawal

for incomes

>€80,000

50% withdrawal

for incomes

>€100,000


1 (<= 242.02) 0.0 0.0 0.0

2 (<= 292.61) 0.0 0.0 0.0

3 (<= 350.51) 0.0 0.0 0.0

4 (<= 409.8) 0.0 0.0 0.0

5 (<= 465.92) -0.1 0.0 0.0

6 (<= 527.39) -0.2 -0.2 0.0

7 (<= 591.78) -0.2 -0.1 0.0

8 (<= 679.33) -0.3 -0.1 -0.1

9 (<= 818.13) -0.4 -0.3 -0.2

10 (> 818.13) -1.0 -0.8 -0.5

All -0.35 -0.25 -0.14

Households Affected (%) 11% 8% 5% Source: Results based on analysis by the Department of Finance using SWITCH, the ESRI tax-benefit model


B23. Withdrawal of credits for high-earners leaves the vast majority of households

unaffected. With an income threshold of €70,000, losses do not begin until the fifth

income decile, while an income threshold of €100,000 results in losses from the

eighth decile and upward.

B24. The PPG also contains a commitment to retain mortgage interest relief (MIR)

beyond the current 2017 end date on a tapered basis. The Department of Finance

Income Tax Reform Plan, published in July 2016, outlined a number of options for

MIR extension. Again, due to recent developments in the SWITCH model, it is now

possible to model the impact this would have across households.

B25. The following table presents the results of simulations of the options for MIR

extension which were outlined in the Income Tax Reform Plan each estimated using

SWITCH:5

Expiry of MIR at end-2017 as currently scheduled (as a baseline);

Reduce rate of relief to 75% of current level;

Reduce ceiling on allowable interest to 75% of current level;

Reduce rate of relief to 75% of current level for 2004-2008 first-time buyers (FTB)

only.

5 The impacts apply only to the first year of tapering and, as mentioned previously, the SWITCH simulations conducted here are on the basis of the modelled tax changes occurring in 2017 rather than 2018.



| 30

Table 4 Impact of tapered extension of Mortgage Interest Relief

MIR expiry

(baseline

scenario)

75% rate of

relief

75% ceiling 75% rate of

relief for

FTB only


1 (<= 242.02) -0.3 -0.1 -0.1 -0.1

2 (<= 292.61) -0.3 -0.1 -0.1 -0.1

3 (<= 350.51) -0.4 -0.1 -0.1 -0.2

4 (<= 409.8) -0.5 -0.1 -0.1 -0.2

5 (<= 465.92) -0.3 -0.1 -0.1 -0.2

6 (<= 527.39) -0.3 -0.1 -0.1 -0.2

7 (<= 591.78) -0.3 -0.1 -0.1 -0.2

8 (<= 679.33) -0.3 -0.1 -0.1 -0.2

9 (<= 818.13) -0.3 -0.1 -0.1 -0.2

10 (> 818.13) -0.2 0.0 0.0 -0.1

All -0.31 -0.08 -0.06 -0.16

Households Affected (%) 17% 16% 11% 17% Source: Results based on analysis by the Department of Finance using SWITCH, the ESRI tax-benefit model


B26. The three MIR extension options have a marginal negative impact on all income

deciles.6 However, the impact is distribution-neutral in the sense that all households

are impacted in a reasonably similar way. The options to reduce the rate of relief and

to reduce the ceiling on allowable interest result in similar impacts across deciles as

they target the entire existing cohort of MIR claimants (FTB and non-FTB). But the

smaller proportion of households affected under the tapered ceiling option indicates

that this extension would be less financially constraining for many households than a

tapered interest rate option (as certain households may not breach a lowered ceiling

due to a variety of factors including low interest rates or debt amortisation).

B27. The final MIR extension option only relates to FTBs in the 2004-2008 period, who

bought at the peak of the property boom. As a result of partial rather than full

extension of MIR, the average change in disposable income is greater under this

option than the previous two (0.16% reduction compared to 0.06-0.08% reduction).

B28. When MIR expires at end-2017, its recipients face a ‘cliff’ when their monthly

mortgage repayments may increase as the tax relief at source is withdrawn (holding

all else equal). The rationale for extension relates to protecting home ownership for

this specific cohort rather than to developments in the housing market more

6 A caveat exists with the analysis of FTBs in this paper in that it is evident that the SWITCH model over-estimates the number of FTB households who qualify for MIR. This implies that the figures in the first three columns are over-estimates of the losses experienced by households and that the figures in the final column are under-estimates of the losses.



| 31

generally. As such, it is of interest to compare the distributional impact of the MIR

extension options for the recipient population and for the population as a whole.

B29. Figure 1 shows that tapered MIR extension has a small and distribution-neutral

impact on the population as a whole. But for MIR recipients by themselves, MIR

expiry or extension has a much larger impact, particularly for recipient households in

lower income deciles. Progressivity and regressivity of a given tax measure are

appropriately judged with respect to the population as a whole, but it is nonetheless

interesting to observe that withdrawal of MIR results in regressive outcomes when

considering the sub-population of MIR recipients. This result likely relates to the

unusually high level of home ownership right across the income distribution in

Ireland.

Figure 1 Impact of MIR on population as a whole and on MIR recipients

B30. Having considered a number of individual tax measures in isolation, the following

section describes the impact of a hypothetical tax package. It is based on the

direction given by the PPG, which indicates that phasing out of USC could be

financed by, amongst other things, the removal of the PAYE income tax credit for

high earners.

B31. This hypothetical tax package is estimated to cost approximately €300 million in a

full year and is made up as follows:

Reduction in the 5% rate of USC to 4.2%;

Reduction in the 8% rate of USC to 5%; and

Tapered withdrawal of the €1650 PAYE tax credit at incomes above €70,000. This

withdrawal is modelled as a 50% withdrawal rate i.e. for every one euro increase

in income, 50c of the tax credit is withdrawn.

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

1 2 3 4 5 6 7 8 9 10

% c

han

ge d

isp

osa

ble

inco

me

Income decile

MIR expiry Tapered rate

Tapered ceiling Tapered rate for FTB-only

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

1 2 3 4 5 6 7 8 9 10

% c

han

ge d

isp

osa

ble

inco

me

Income decile

MIR expiry Tapered rate

Tapered ceiling Tapered rate for FTB-only


| 32

B32. Under this tax package, every household with an income above the USC threshold

of €18,772 would benefit (this is when the actual rate of 5% or the hypothetical rate

of 4.2% would apply). Other things equal, 58% of households would be estimated to

experience a rise in disposable income when we consider the USC changes in

isolation (see Table 1). Roughly four-fifths of these affected households experience

only one USC rate reduction (as their income is less than the €70,044 threshold

where the higher rate of USC applies) while one-fifth experience a double dividend in

the form of two reduced USC rates. However, in the hypothetical tax package, the

double dividend is simultaneously counter-acted by the withdrawal of the PAYE

income tax credit. As a result, 52% of all households are estimated to experience a

rise in disposable income when we consider this particular package as a whole.

B33. Figure 2 illustrates the distributional impact. Households in the highest income

deciles have the largest relative gains, as the majority of low income decile

households currently pay very little USC. However, this regressivity is moderated

somewhat by the withdrawal of the PAYE credit for incomes greater than €70,000.

Figure 2 Impact of a hypothetical tax package

B34. The tapered withdrawal of the PAYE income tax credit (or any other tax credit) is

generally progressive when it occurs above a particular high-income threshold, as

the percentage reduction in disposable income is greater for households above the

threshold than below it. As such, it is a tax measure that is consistent with the

concept of vertical equity i.e. that tax liabilities increase with higher incomes.

However, tapered withdrawal of tax credits also changes the Marginal Effective Tax

Rate (METR) on the last euro of income earned, and this can have important

implications for workers’ incentives to increase work, for example through taking up

over-time or seeking promotion. The next section will discuss this issue.

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

1 2 3 4 5 6 7 8 9 10 All

% c

han

ge d

isp

osa

ble

inco

me

Income decile

PAYE credit withdrawal USC rate reductions Overall package


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Financial Incentives to Work

B35. The Marginal Effective Tax Rate (METR) is relevant when considering the

incentive for various groups to supply labour. The METR captures the incentive for

someone already in work to increase their earnings (whether by working more hours

or switching to a better-paid job or seeking promotion). It measures what part of any

additional earnings are lost through the combined effect of increasing tax and

decreasing benefits. Low numbers for the METR imply stronger financial incentives

to work, while high numbers imply weaker incentives.

B36. The highest headline rate of marginal tax on the last euro earned is currently 52%

for employees (40% income tax, 4% PRSI and 8% USC) and 55% for the self-employed

((40% income tax, 4% PRSI, 8% USC and 3% USC surcharge for incomes above

€100,000). An METR above these values, therefore, is typically capturing an earnings

increase interacting with a benefit withdrawal, for example due to an earnings cap or

means-testing. As this paper only examines tax policy changes and holds expenditure

policy constant at Budget 2017 levels, the full impact of a Budget package on

financial incentives to work is not being captured here. On the other hand, the paper

is able to capture the METRs for those impacted by the hypothetical tax package

under discussion, and in particular the effect of tax credit withdrawal on the

incentive to increase earnings above particular levels.

B37. A tapered tax credit withdrawal operates in a similar fashion to a tapered benefit

withdrawal in that it can result in substantial changes in the METR for certain

individuals. As currently modelled in the hypothetical tax package, the METR for a

single employee with a gross income between €70,000 and €73,300 would be close

to 100%, which has serious implications for the incentive to increase work (headline

rate of 49% plus credit withdrawal rate of 50% in this income range). For incomes

above €73,300, the METR would revert to 49% (assuming no interaction with the

social welfare system).

B38. Table 5 divides the working population, as modelled by SWITCH, into two sub-

populations: those with a current METR below or equal to 50% and those with an

METR higher than 50%. It then indicates the share of these sub-populations who

experience changes in their incentive to work as a result of the hypothetical tax

package (holding all other factors constant). Many individuals would experience a

reduction in their METR due to the impact of USC rate reductions; almost half of the

population who currently have a METR higher than 50% would experience a notable

reduction in their METR (48.2% experience a fall of between 2 and 5 percentage

points, which corresponds to 177,000 people). This improves their incentive to work

as a result.


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B39. By contrast, there are individuals who experience extremely large increases in

their METR (2.8% of those with a current METR higher than 50% experience a

greater than 20 percentage point increase in their METR under the hypothetical tax

package). These extremely large changes are caused by the tapered withdrawal of

tax credits in particular income ranges (income between €70,000 and €73,300 in the

example of the single earner employee). Although these METR changes impact on a

minority of the population (2.8% corresponds to approximately 10,000 people), they

are concentrated among high earners who contribute the most in income tax

receipts.

B40. It is clear that there is a balance to be struck in maintaining an equitable income

tax system, protecting tax receipts and encouraging the incentive to work. One way

in which this balance could be met is through designing a low withdrawal rate if

tapered income tax credits are introduced for high earners. For example instead of a

50% withdrawal rate, there could be a 5% withdrawal rate as incomes increase. Any

policy decision in this area would also need to take into account administrative

complexity and other technical concerns.

Table 5 changes in METR due to hypothetical tax package

Share of people in population

Change in METR as a result

of hypothetical tax package

Sub-population:

Current METR <=50

(n = 1.65 million)

Sub-population:

Current METR>50

(n=0.37 million)

≤ -5 0.0% 0.0%

> -5, ≤ -2 0.7% 48.2%

> -2, ≤ -0.5 72.5% 7.2%

> -0.5, ≤ 0.5 22.9% 35.8%

> 0.5 ≤ 2 0.0% 0.0%

> 2, ≤ 5 0.0% 0.0%

> 5, ≤ 10 0.0% 0.0%

> 10, ≤ 20 0.5% 0.0%

> >20 1.0% 2.8%

Total 100.0% 100.0%

B41. Members of the Tax Strategy Group may wish to consider these issues.

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