A tax suggestion for the recession

Ken writes:

Why do we have a tiered system of income tax in Ireland instead of a flat tax? Because it is felt that those who can afford to contribute more to the upkeep of society should contribute more. It is quite deliberately a form of redistribution of wealth. The rightness or wrongness of this aim is a large topic—too large for me—and I won’t discuss it here. But if we take for granted that redistribution and a tiered tax system are justified, I would suggest that we tie all tax-deductions (tax-deductible expenses) to the rate of the lowest tier.

A tax deduction might sound like it is an amount subtracted from how much tax you pay. In fact this is not what it is. It is an amount subtracted from your gross income before you pay tax. These deductions seem inconsistent with the redistributive aims of a tiered tax system, because higher rate tax payers benefit more than lower rate tax payers. They benefit more because the tax they avoid paying was more.

An example will show you what I mean. The Irish government is trying to create an incentive to cycle to work by offering a certain scheme the effect of which is to allow employees to buy a bicycle indirectly paying only what it would cost net of their taxes. So if the bike costs €100, a worker on the lower band (20% in Ireland) would pay €80. And a worker on the higher band (41% in Ireland) would pay €59. In fact the scheme is also net of the additional PRSI levies 6%. So, the worker on the lower rate of tax saves 26% and the higher rate worker saves 47%. (In case I’ve got the example wrong, there is a worked out example here showing what different workers pay for bikes costing €250, €500, €750 and €1000.)

This is an example of a tax-deduction because it treats the €100 as if it was spent on the bike before the individual paid tax. Given the individual pays tax at 20%, the Government says if you spend €80 on a bike, we’ll make it back up to the original €100. If you pay tax at 41%, the Government says if you spend €59 on a bike, it’ll make it up to €100.

Now, one thing this example makes clear is that other things being equal, under this sort of scheme, the more poorly aid worker ends up paying more for their bike. They have €80 deducted from their salary while the highly paid worker only has €59.

WTF???

Incidentally, one of the major uses of this sort of tax arrangement in Ireland is in private pensions arrangements. So this is not just a minor issue. The same principles will apply, which means that a low paid worker has to make contributions of €80,000 to build up a pension pot of €100,000, whereas a higher paid worker only needs to put up €59,000 for the same pot.

This does not seem consistent with the ideal of a redistribution, at least as it is normally understood.

I would suggest that all tax deductible relief be fixed to the rate of the lowest tier so that everybody pays at least as much as the lowest earners do.

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