Taxing Questions, Taxing Answers
Posted on September 02, 2014 by Micheál Collins
Following the publication of the recent NERI working paper on total household tax contributions, there have been a number of issues raised by commentators and others on the paper, its data and its conclusions. Of course, given the topic, that comes as no surprise. Taxation is always a contentious issue and sadly one which, though discussed and speculated upon in great detail, is not often on the receiving end of detailed empirical research. The very fact that last week’s paper was the first to look at overall tax contributions since 1995 (a CSO report on 1987 data) underscores the gaps in our knowledge of the taxation system.
For the most part the issues raises are addressed in the paper. Below, I have pulled them together (in no particular order) and provide some brief comments and a reference to the relevant section/sections of the research paper.
As with all research (and as stated on the cover of the paper) comments, suggestions and feedback are welcome.
The full paper is available here.
Where did you get this data?
The analysis is based on the CSO’s most recent Household Budget Survey (HBS). The HBS is collected to establish data on the composition of the ‘typical basket of goods’ that consumers spend – the basis of the inflation data published each month. In that regard it offers a good insight into the expenditure pattern of households.
The data and the survey are discussed over pages 7-11 of the paper.
Is there a lot of VAT missing?
No. When you compare the estimated average VAT collected in the paper to the overall level collected from households they match quite well. To quote the paper (p11):
As a means of assessing the robustness of the modelled indirect taxation, table A13 of the appendix compares the calculated total VAT tax take (the average household level times the number of households) with the exchequer revenue from VAT. Overall the modelled VAT collected from households equals just over €5.5 billion representing between 54.5% and 56% of the exchequer VAT collected in 2009 and 2010. Estimates from the European Commission for the period 2000-2011 suggest Irish households contributed on average 49% of the total VAT tax take; with the remainder coming from investment (28%), industry (18%) and Government and non-profits (2%) (2013:60-61). The EC household VAT estimates for 2009 and 2010 were 51% and 53% respectively suggesting the modelled indirect taxation outlined above, and used in the remainder of this paper, offers a good representation of the indirect taxation experience of households.
See more on this on pages 11 and 38 of the paper.
A forthcoming paper (the subject of a NERI research seminar on Sep 10th - details here) also tests the modelled indirect tax estimates against Department of Finance estimates of additional revenue from indirect tax changes. Again, the modelled estimates are found to offer a good representation of the indirect taxation changes.
Why are there gaps between the levels of income and expenditure in the lower deciles?
As the paper shows (page 7 Table 2) there are households in the lower income deciles who spend more than they have in income. While there are small differences for deciles 3 and 4 – probably linked to the structure of the survey and its income sampling period – there are more notable differences for the bottom two deciles. In the Irish and international income distribution literature this is not unusual. To quote the paper (p8):
It also reveals that expenditure exceeds disposable income for the bottom four deciles, most notably for the bottom quintile, reflecting the composition of these households (for example pensioners who may also be living on past savings, the temporarily unemployed and students), their difficulties in making ends meet and the structure of the HBS which compiles its income and expenditure data on a current basis over the two weeks of a households participation in the survey.
A proposal made by a respondent to this paper at the recent International Institute of Public Finance conference raised the possibility of inferring income levels by modelling them using other household variables and characteristics. This might help in giving a better income picture for lower deciles, although it would be unlikely to radically change things.
Why not compare the levels of taxation with disposable income?
As the paper is looking at both direct and indirect tax contributions, a comparison with one income definition is required. Reflecting the way in which we consider income taxes (as a % of gross income) and given past examinations in the literature, the gross income measure is used. In fairness, this seems the correct baseline for making comparisons. However, for completeness, the paper does include tables with comparisons against both disposable income and expenditure – see tables 14a, 14b, 16a and 16b (pages 39-41). To quote the paper (p18 regarding data on table 7):
Tables A16a and A16b in the appendix present another set of comparisons benchmarked against equivalised disposable income and equivalised household expenditure. The disposable income results are broadly similar while those compared to expenditure mitigate some of the regressivity reported above.
How is the income and direct tax data you use calculated?
The CSO provide this data in their published HBS report and in the microdata file (from the Irish Social Science Data Archive) which was used in undertaking this research. There are more details on this on pages 11 and 12 of the paper.
The direct taxation estimates include income taxes and employee PRSI contributions. The estimates from the HBS line up well with those I established last year using the more detailed SILC data set (the principal Irish income data set). See tables 4 and A4 of that paper – the paper and the methods in the paper are all outlined here. That paper also compares the estimates with the published Revenue Commissioners data on effective tax rates and finds them to be a good fit.
Is the regressivity of the indirect tax system is driven by the bottom decile?
No. As table 7 (p18) of the paper shows, even ignoring the bottom decile the system is regressive.
Does the research imply a need for indirect tax cuts in the next Budget?
No. The research is just that – research on the shape of the tax contributions people make. The paper takes no policy positions. To quote the paper (p2 and p3):
In establishing these estimates, the paper aims to provide a more comprehensive understanding of the distribution and composition of household tax contributions. Understanding the overall shape of household tax contributions offers a firmer basis for considerations of policy options, or critiques of previous policy changes. Limitations in this understanding have been obvious in recent policy considerations…
Similarly, there has been limited consideration of who gains or loses from increases to excise duties, amendments to insurance levies or extensions of various indirect tax changes. While this paper does not address each of these issues, in establishing an up-to-date baseline understanding of the total tax contribution distribution, it provides a basis and context to begin to consider these issues. Such a framework should also assist in the inevitable future considerations of where tax reductions for individuals/households might best be targeted. Perspectives on such choices are likely to be different when judged across overall household tax contributions rather than solely on income taxation.
Should you not take differences in household composition into account?
Yes, and the paper looks at both the household level and the equivalised household level (adjusted for household size and composition). The latter are the figures highlighted (although the findings are similar for both) and used as the baseline for future policy examinations.
To quote the paper (p11):
Finally, the analysis considers taxation patterns first at the household level and then at the equivalised household level. The former provides an insight into the proportion of household income/expenditure that is consumed by indirect taxes. The latter adjusts the data (both expenditure and income) to account for differences in household size and composition. The analysis uses the national equivalence scale with values of 1 for the first adult, 0.66 for each additional adult (aged 14yrs+) and 0.33 to each child aged less than 14 years. Following equivalisation, households are ranked by gross income and divided into deciles. These equivalised household deciles are used for policy simulations later in the paper.
The unadjusted household figures are in table 6 (p18) and those adjusted to take account of the composition of households to give a per adult equivalent figure are in table 8 (p19).
Are you sure the Irish income tax system is progressive?
Yes. It is clearly a progressive tax system – as it should be as that is how it is designed (see table and chart on p 12). It is progressive as when income rises people pay more and vice versa. Being progressive does not mean it could over time become more or less progressive; that is a policy choice for years to come. One that I hope should be considered in the context of the broader taxation system and not just income taxes.
Are things likely to have changes since the HBS 2009/10 data?
Yes, since then both direct and indirect taxes have increased. There have been direct tax increases via the USC and PRSI thresholds and some small decreases via USC changes. There have been indirect increases via VAT rate increases, excise increases, insurance levies and new charges for property and water; there was also a VAT decrease for tourism related items. Indeed, we have closely watched the direct increases, but reflecting the starting point of this paper, the indirect ones have received limited consideration. It is fair to say that relative to 2009/10 people across the income distribution will be paying more in taxation.
Future work will address some of these issues. Most immediately will be two NERI working papers, the first on recent VAT changes and the second on the distributive impact of a suite of possible indirect tax changes. These papers will be released during September 2014.