Analysis: the Irish tax system is highly progressive and low earners pay zero or little income tax, but the rates rise very quickly

One topic in the news in advance of Budget 2023 is if there is a need for a third income tax rate. Reports indicate that the Government has considered a new "middle" tax rate of 30% inbetween the existing 20% and 40% rates. The current income tax regime means that workers earning over €36,800 face a direct tax rate of 48.5% on any income earned above this cut-off point. This is a high tax rate on a modest income so adding a third tax rate would increase the entry point to the top income tax rate.

Most income tax systems are progressive which means you pay a greater fraction or percentage of your income in tax as you earn more. Typically, people pay no income tax on the first slice of income, and then progressively higher rates on further slices of income. Countries with progressive income taxes have at least two income tax rates, and some countries have up to six or seven rates. Social insurance is often charged as well as income tax. The first income tax rate in most countries is typically somewhere between five to 20%, and the top income tax rate is often 40 to 50%.

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From RTÉ Six One News, entry point for top tax rate may move to €40,000 under Budget plans

The tax rate on any extra income is known as the marginal tax rate. As many people think at the margin when making decisions, this tax rate can affect people's decisions. Workers will consider the marginal tax rate when deciding to work more or less, do overtime, go for promotions etc. Stay-at-home-parents will include the marginal tax rate on wages when calculating whether returning to the labour force is worth it. Workers tend to be aware of the marginal tax rate they face on extra income.

However, they are less aware of the effective tax rate paid on all their income, which is lower than the marginal tax rate. In Ireland in 2022, most single workers do not pay any income tax on earnings up to €17,000. After that, the first income tax rate is 20%, until the so-called Standard Rate cut-off point of €36,800. Beyond that, any extra income is taxed at 40%. Social insurance is 4% on all wages, and the USC is 4.5% at that income level. The combined marginal tax rate is 48.5% from €36,800 upwards. The cut-off point for a one-earner married couple is €45,800.

The Irish system is highly progressive: low earners pay zero or very little income tax, but the rates rise very quickly. There is a further increase in the marginal rate to 52% at about €70,000, when the USC increases to 8%, but the focus of this article is the 48.5% rate facing many workers.

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From RTÉ Radio 1's Today with Claire Byrne, is the Government considering plans to introduce a new 30% rate of income tax? With Seán Fleming, Minister of State at the Department of Finance; Jack Horgan-Jones from the Irish Times and Prof Padraic Kenna from the University of Galway

The top rate is not the problem in Ireland as top marginal rates of 40% to 50% are common across many other countries. It is the very low entry point to the top rate that is the issue. Here are some top income tax rates and the associated entry points in 2021 : Austria charges 55% after €1m income; Finland charges 31.25% after €80,500; France charges 45% after €160,336; Germany charges 45% after €274,612; the Netherlands charges 49.5% after €68,507, and the United States charges 37% after $523,600. Our nearest neighbour, the UK, applies a 45% tax rate on income above £150,000. Most of these countries reserve the top tax rate for a small minority of high earners.

Ireland is unusual in that workers on average wages face the high 48.5% marginal tax rate. In 2021, mean annual earnings for full-time workers, including overtime and irregular earnings, was €52,088. Median annual earnings in 2020 were €40,579. If a graduate is lucky enough to get a full-time teaching role at the starting pay of €39,506, they face the 48.5% marginal rate the day they start teaching.

The entry point to the top tax rate has increased in recent years, but by modest amounts. In 2018, it was €34,550. It increased to €35,300 in 2019, and was the same during 2020 and 2021. The most recent increase was an extra €1,500 to €36,800 for 2022. Unless the entry point rises in line with earnings, more workers will find themselves facing the 48.5% rate. This has happened, with Revenue estimated that 23% of earners pay tax at the higher rate, up from 17% in 2011.

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From RTÉ Radio 1's Morning Ireland, Dr Barra Roantree, member of the Commission on Tax and Welfare, discusses the publication of the group's report on the tax system in Ireland.

The Tax Strategy Group of the Department of Finance considered a third rate of income tax. They noted that it would reduce the tax liability of workers with income above the cut-off points of €36,800/€45,800, and that low earners would not receive any direct benefit. They felt that other measures might be needed to compensate these groups. They agreed that increasing the entry point to the top rate would improve the competiveness of our income tax system.

I suggest that more income tax rates could maintain the highly progressive nature of our income tax system, while removing the penal near 50% marginal rate facing workers on median wages. Adjustments to tax credits, PRSI and USC could allow cuts to marginal tax rates on typical workers, while not reducing overall effective tax rates or income tax revenues. Four rates of 20%, 30%, 40% and 50% should be considered, with two key elements: workers on median wages of €40,000 should face a combined marginal rate of no more than about 35%, and nobody should face a combined marginal rate over 50%.


The views expressed here are those of the author and do not represent or reflect the views of RTÉ