Monday, December 16, 2013

Ireland’s Regressive Tax System

A recent study from the Nevin Economic Research Institute looked at the combined effective rate of direct and indirect taxes on Irish households along the income distribution.  The headline results are summarised in this chart.

Chart 7From the fourth decile up the results indicate that the Irish tax system is progressive.  The first three deciles run counter than this though with the first decile notable in particular because it has the second highest reported effective tax rate.

The lowest contributions are in the third and fourth deciles and we have previously looked at the composition of the households in those deciles (albeit using the SILC rather than HBS as used by the NERI study).

So what can we say about these estimated tax burdens.  The following table gives the estimated nominal amounts paid by each decile.

Table A12

The estimated average tax burden is €12,900 per household.  According to the Census taken in April 2011 there were 1.7 million households in the country.  Thus the total amount of tax included in the effective tax rates is €12,900 x 1.7 million = €21.9 billion (of which €12.5 billion is “direct” and €9.4 billion is “indirect”).  That is a lot of tax but it is around half of the total tax actually collected in 2010.  The 2010 tax take is summarised in this table.

2010 Tax Revenue

Of course, the incidence of taxation is incredibly difficult to determine.  Direct taxes are deducted from income but even that is not enough to isolate the economic incidence of the tax.  Do employers need to pay a higher wage to attract workers from a abroad in locations with high income taxes?  This is an issue in various soccer leagues.  Determining the exact incidence of indirect taxes is almost impossible.

If a household buys something for €123 that includes VAT at 23% then the amount of VAT in the price is obviously €23.  However, this doesn’t mean the purchaser paid the full amount of VAT.  It depends on what the price would be in the absence of the VAT.

If the VAT was eliminated the price might fall to, say, €110.  It is incorrect to say the household has paid €23 VAT when the price absent a VAT would be €110.  In this case the retailer, or some other element along the production chain, has absorbed part of the VAT.

The NERI report covers €5.7 billion of VAT (€3,360 x 1.7 million) as opposed to the €9.9 billion actually paid but it is not stated why this gap is present.  It could, in part, be because of VAT paid by businesses not fully passed on in the price.  Of course, this will be reflected in lower profits and dividends from the business so the burden of the taxation will ultimately be borne by households as is the case for all taxes.  Some of those households may be outside the country as with Corporation Tax with around 75% of the total paid by foreign-owned companies. 

There will be many small businesses who would regard the rates, excise duties and other taxes which they might not be able to pass on through prices as coming out of their income.  Of course, there will also be many cases where rates, duties and other taxes are put into the price but are not explicitly listed.  However, in the sense that these may affect all households equally it may not alter the overall results.  Then again they may not.

Returning to the household level it is worth looking at the income and expenditure figures for each decile.  The tax rates shown in the first chart above are as a percentage of gross income while the dominance of indirect taxes for the lower deciles means that the amount of tax paid is, in the main, a function of expenditure.  This table from the report summarises these.

Table 1

One of the notable features is that average expenditure of households in the lowest decile is almost two times greater than their disposable income.  This is also true for the second, third and fourth deciles though not to the same extent.This is not an unusual feature of household surveys and the following is noted by the CSO in their publication of the 2009/10 Household Budget Survey:

There are many reasons why expenditure may exceed income in lower income decile households and this is a common experience internationally in income and expenditure surveys. Households with recently unemployed household members may draw on savings to maintain their expenditures. Self-employed consumers may experience business losses that result in low incomes, but are able to maintain expenditure by borrowing or relying on savings.  Third level students may get by on loans or savings from summer employment, retirees may rely on savings and investments. In addition, across all deciles there may be an  under-reporting of certain categories of income (e.g. shadow economy employment income).

On the income measure in the HBS the CSO note that:

The HBS [.] calculates income on the basis of the “current income level” of the individual without adjustment for employment activity over the year in question.

The HSB is a weekly survey rather than an annual one with respondents reporting their income and expenditure over a two-week period.  Is it appropriate to calculate an effective tax rate using expenditure now when the income may have been earned previously? 

In the 2009 SILC the average disposable income of households in the lowest income decile (as measured over a year) was €11,000, around 12% higher than the equivalent figure in the HBS.  For the top decile the SILC has a figure of €118,300 versus €119,500 in the HBS, a difference of 1%.  The HBS may not the optimum instrument to measure income but it is good at what it is designed to measure: expenditure.  Here are the expenditures, estimated indirect tax burdens and effective tax burdens as a percentage of expenditure by decile.

Expenditure Ratios

Although VAT has some progressive features with most necessities zero rated it can be seen that the proportion of expenditure accounted for by indirect taxation is inversely related to expenditure.  The greater the level of expenditure the lower is the proportion taken in indirect taxes.  This is likely due to consumption patterns, particularly in relation to high excise duty goods, and also the disconnect between some indirect taxes and expenditure such as the television license, credit/debit card levies and annual motor tax to a certain extent.

Although there may be difficulties measuring it there can be little doubt that indirect taxation in Ireland is regressive.  Whether it is sufficiently regressive to offset the very high progressiveness in direct taxation is less clear cut.  Finally, the CSO also give a breakdown of the income by direct income and state transfers for each decile which can be used to infer that Ireland’s overall tax and transfer system is progressive.

Chart 12

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