A progressive income tax would have been a much fairer option

19 October 2008  By Finola Kennedy

One of the basic insights of economics is that a euro is worth more to a poor person than to a rich person.

For one family, €1,000 covers the food bill for weeks; for another family, it might buy a Gucci handbag for a daughter’s 18th birthday - though it won’t buy a Herme's one.

I know a family where there are three young children and the father earns €55,000, including overtime. The mother stopped working when the third child was born.

Individualisation of the income tax system had been a spur for her to remain in the labour force. But the cost of childcare had neutralised her earnings and she wanted to be with her children.

The tax system did not welcome her home in any way. Necessity has made her a keen money manager. For 11months of the year, she puts €50 in the Post Office to save for all the Christmas expenses of the family.

As a result of the 1 per cent levy, her ‘Christmas fund’ will now go to the Minister for Finance.

The scenario that faced Brian Lenihan when he set about preparing his budget was - to borrow a phrase which he himself employed in a different context - ‘‘not a pretty picture’’.

What could the minister have done? My formula would have combined a progressive income tax with targeted expenditure.

A progressive income tax which increases with the size of income and takes account of the numbers who depend on that income is accepted as a fair tax. It meets the requirements both of vertical equity (that is, equity between rich and poor),and horizontal equity (that is, equity between those on the same income, but with a different number of mouths to feed).

A levy on gross income which disregards both the absolute size of income and the number depending on that income offends against both vertical and horizontal equity. As a result, it could become a trigger for social unrest.

If the door had been bolted on public sector pay and related pensions, then the way to proceed was via the reintroduction of a more progressive income tax. For example, a 50 per cent rate could be levied on those with income over €100,000, while allowing for the number of dependants. Furthermore, the ceiling on PRSI contributions could have been abolished.

In the 1980s, the response to high marginal tax rates was evasion - abetted by banks - via offshore accounts. Today, banks have a vested interest in good behaviour. In case objections are voiced on the grounds of disincentives to work, a study by a British economist, Cedric Sandford, showed that top lawyers did not stop working when their marginal tax rate was 65 per cent - they just worked harder. By contrast, levying the poorly-paid drives them onto welfare.

The government is right in principle regarding the targeting of benefits, but it must be done in a fair and well considered manner. No one would deny that there are some 70year-olds who do not need medical cards, some parents who don’t rely on child benefit and some people who can more than afford to pay university fees for their children.

Until 20 years ago, we had a progressive income tax system, combined with child tax allowances.

Child tax allowances were abolished in favour of universal child benefit, regardless of means. If the government wishes to support families with children, it could introduce tax credits for children of taxpayers and pay child benefit only to those who have insufficient income to pay tax.

Relative rates for credits and benefits would be determined on the basis of policy.

The manner in which the medical card change was introduced raises the question whether the younger generation of Fianna Fáil men and women have lost the vital sense of connection with the gnáth daoine, the ordinary people, which had been a matter of pride for the party.

I could not imagine Ber Cowen, Cathal Coughlan, Des Hanafin or Brian Lenihan Snr voting for some elements in Budget 2009.

One thing this budget has helped to do is to reduce expectations. This was neatly expressed to me in a pre-budget exchange with TK Whitaker, a man who helped produce several budgets. I remarked to him that it looked as though we were on a pathway back to de Valera’s ‘‘frugal comfort’’. His reply: ‘‘Just frugal."

Finola Kennedy is an economist and former member of the board of ACCBank. She also chaired a group on child benefit.