The parallel tax system

While there will be intense competition to pick out the single worst feature of the budget, there’s a good argument that it’s the income levy.  To cut a long story short, it’s a display of Brian Lenihan‘s utter lack of confidence in the tax system.  Why?

Because it reveals a belief (which he confirmed yesterday) that he went for a levy because he did not trust the income tax system to fairly distribute the burden of higher taxes: upper income people would have used more deductions to dodge the higher rate.  Which is a startling admission: income tax is one of your primary revenue-raising tools, especially with indirect taxes like VAT and excise constrained by EU shopping.  But he chose not to use it.   It also doesn’t say much about the Department of Finance’s ability to project revenue.  Lenihan went into the budget needing to raise a certain amount of revenue.  But rather than trust a model of how much revenue could be raised through higher rates of personal income tax, which would have to take account of taxpayer response, he went for the much simpler calculation based on gross income (i.e. without regard to source or deductions) and applied a rate to that.  Easy to do on the back on an envelope.

But this simplicity is coming at enormous cost.  First and foremost, the incentive structure for low income workers has been severely damaged.  Now there is 1 euro per 100 coming right off the top of all income, except welfare payments.  That used to be a problem with PRSI but they ironed that out with concessions on when PRSI kicks in and tax credits.   1% of gross is big money for people living from paycheque to paycheque.   Second, it reinforces the quick fix mentality.  Why bother improving the tax system through getting rid of many deductions when you can simply impose a levy in a real revenue crunch?  Hopefully the voters won’t be silly enough to fall for the talking point that is being set up for future elections, that the government didn’t raise income taxes.  Last week’s ESRI Budget Perspectives conference had made clear that the tax burden was going to have to go up (see the papers by Lane and Honohan).  The government just chose a perverse way of doing it.