The Psychology of Taxation

“Death, taxes and childbirth! There’s never a convenient time for them.” – Margaret Mitchell, Gone with the Wind, 1936

It is hardly controversial to suggest that rational people prefer to pay less tax rather than more, assuming all else is equal. If one follows the public debate in Ireland, however, it soon becomes clear that rationality is not universal on fiscal matters.

As the government struggles to bring the budget deficit under control, and as we are in a phase of increasing rather than stable or falling taxes, this is all the more pertinent. What is at issue, from the government’s perspective, is how to distribute and minimize citizens’ inevitable displeasure at rising taxes.

All taxes are not created equal, it would appear. What you pay tax on, and how you pay it, seems to matter a great deal,  perhaps even more so than the extent to which taxes hit our pockets.

An example from the 2012 budget is illustrative: the imposition of the €100 household charge was greeted with howls of derision, while the increase in the VAT rate from 21% to 23% raised hardly a murmor despite its impact being four times greater. They raised €160m and €670m respectively for the exchequer. Both were regressive measures in that their proportional impact was greater on those on lower incomes. This ‘irrational’ public response goes to the heart of the psychology of taxation in Ireland.

VAT is a discrete tax factored autmoatically into prices, and rarely clearly itemized for consumers. Moreover, the history of inflation conditions people to expect higher prices. They are also conditioned, of course, to higher incomes over time. This is one reason why income tax hikes, which reduce take-home pay in an environment of stagnant or falling wages, are much more strongly resisted than VAT hikes. Income tax changes are also spelled out in black and white on peoples’ pay slips.

The household charge – and its successor, the property tax – are both once-a-year taxes on something that people have not heretofore paid a recurring annual tax on. The Revenue Commissioners will spend a year explaining to people exactly how much the new tax is going to cost them, so it is fair to say that it will be far from ‘discrete’. People are not, and don’t want to get, used to the ‘new normal’.

As regards income tax, it would be politically easier to sell cuts in PAYE or personal tax credits rather than increases in tax rates. People intuitively associate higher rates with less income sooner than they do lower credits. This is somewhat surprising, given that changes to credits set out out explicitly the hit to your pocket without any need for further calculation.

In general, the Left gets fixated on increasing marginal rates for higher earners, perhaps because this is what is most intuitive. While this may well form part of a progressive fiscal equation, it is not the only variable. Removing gratuitous tax reliefs, enforcing the 30% minimum effective rate for high earners, and ensuring tax exiles pay a fair share should be early ports of call, in line with the programme for government (PfG). A properly designed wealth tax should also be considered.

Stepping outside the bounds of the PfG, the removal or reduction of PAYE and personal income tax credits for high earners would be a more economically efficient, fiscally beneficial and politically plausible approach than hiking marginal rates beyond 60%. This would bring in more money while avoiding disincentives to work or invest.

Those who have most should pay most, and those with the broadest shoulders  – those who benefitted most from the boom times – should bear the heaviest burden in balancing the books of the nation.

Since the onset of the crisis in 2008, the Irish people have paid a heavy price through tax hikes and spending cuts. Everyone has taken a hit. When taken together, the six budgets were broadly progressive in that they hit those on the highest incomes hardest. This is largely due to the nature of measures imposed in the 2009 and 2010 budgets.

By contrast, according to the ESRI, the 2012 and 2013 budgets were regressive, imposing a proportionally greater burden on those lower down the income distribution. This would suggest that inequality, which appears to have risen sharply in 2010 after a number of years of decline, will likely see further increases, wiping out the post-2006 progess during the ‘Inchydoney interlude’.

With the bulk of 2014 budget measures – at least those which have not been pre-announced – to be made up of current spending cuts (in the order of €1.9bn), which generally impact most on those on low incomes, the current fiscal consolidation trajectory would suggest the completion of a hat-trick of regressive budgets by the FG/Labour government later this year. Another approach is possible.

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