On behalf of the Nevin Economic Research Institute, NERI, I thank the select committee for the opportunity to discuss these chapters of the Commission on Taxation and Welfare report. I am joined today by my NERI colleagues Ciarán Nugent and Chris Smart.
The report has rightly taken a high-level systems approach. It makes clear that Ireland’s fiscal position will deteriorate meaningfully over the next two decades and that the overall revenue yield will need to increase materially over the medium term to address the growing fiscal gap.
How well is our system of income supports and subsidised public services performing in its core job of protecting households from income inadequacy? The enforced deprivation rate is a useful proxy for income inadequacy and a measure of a society's failure or otherwise to adequately protect households. The proportion of people living in enforced deprivation increased from 13.8% in 2021 to 17.7% in 2022. Children have a one in five probability of deprivation, whereas it is closer to one in eight for retired people. Certain cohorts are particularly vulnerable. Persons living in one-adult households with children under 18 have almost a 44% probability of deprivation; persons unable to work due to a disability also have a 44% probability of deprivation; and renters have a 36% probability. The NERI anticipates that the surge in inflation in 2022 and 2023 and the decision not to index welfare rates in the budget will increase deprivation rates in 2023.
The report’s key recommendations on adequacy argue for regular evidence-based benchmarking exercises and multi-annual targets for working age payments; reform of working-age payments to ensure an integrated and co-ordinated system based on adequacy; and a new enhanced working-age payment and a second level of child income support, both of which should be tapered by income. The NERI welcomes each of these recommendations.
The new lower nominal rate of employee PRSI is likely to be one the most controversial recommendations. It is important that marginal effective tax rates remain low for low-wage households. In addition, there is a clear concern this recommendation will disproportionately impact low-income households. It should therefore only be implemented alongside the key adequacy recommendations already described.
The report recommends that all cliff edges in the tax and welfare system should be removed. Cliff edges create labour market distortions and can lead to perverse incentives for employees and employers. The recommendation is effectively saying that cash payments or access to other benefits should not be lost due to some arbitrary threshold such as employment status or the number of days worked. Instead, only income should determine whether someone qualifies. Step effects and discontinuities should also be avoided.
On horizontal equity, the NERI welcomes the key recommendation that PRSI on self-employment should be aligned over time with the employer’s rate of Class A.
This aligns with the report's core theme of horizontal equity and it aligns with the need to remove labour market distortions whereby similar activities are treated in different ways. Distinctions between legal forms should be eliminated for tax purposes.
The NERI supports the recommendation that the Government would undertake a regular benchmarking exercise in respect of all working-age income supports, including supports for the unemployed, people experiencing disabilities, and people parenting alone. Benchmarking would be a welcome reform as it would finally lead to income supports having some transparent basis in evidence. The Pensions Commission made a similarly welcome recommendation about the basic pension. A benchmarking process would need to consider a range of questions, only a few of which I will touch on. First, should there be a once-off process with benchmarks set for each of the different income supports or is an ongoing benchmarking commission necessary? The view of the NERI is that there should be a permanent advisory benchmarking commission that would adjust benchmarks over time based on emerging evidence and practical experience.
Second, what we should benchmark payments against? There are a number of plausible benchmarks. These include median wage, median income, price inflation, or potentially a derived indicator linked to an individual or household’s minimum essential standard of living, MESL. A composite benchmark based on a dashboard of indicators could also be considered. Benchmarking solely to price is unsuitable as income supports would fall increasingly behind average wages over time. As such, living standards for those dependent on working-age or old-age supports would increasingly fall behind the rest of society. Benchmarking to the median wage has a number of advantages. In particular, it ensures rates are set cognisant of potential employment impacts. The main argument for using a MESL metric as a benchmark is straightforward. It is the cost of living rather than wages that determines an adequate income and therefore the logic goes that only the cost of living is an appropriate benchmark for adequacy.
The NERI welcomes the recommendation of a new and tapered working-age assistance payment available to all households, including those without children. Moving to a system of working-age payments based on household income rather than employment status or any other arbitrary threshold, such as days worked, would help minimise employment disincentives. The tapered structure is crucial as it ensures marginal effective tax rates remain low. The recommendation that child benefit remains untaxed is welcome and is consistent with the findings of previous bodies set up to examine the issue. In addition, the current high rates of child poverty and associated long-term consequences indicate that Ireland’s current model of child income support is failing. We therefore strongly agree with the recommendation of an additional tier of income tapered child income support.
On pay-related benefits, the view of the NERI is that the case for income-related social insurance is actually stronger than that outlined in the report. Income-related social insurance provides a form of temporary security that enables better job matching. This reduces overqualification and ensures better utilisation of human capital. Reduced risk aversion also makes people more likely to start a new business or otherwise engage in entrepreneurial activity. Income-related social insurance also dampens the amplitude of recessions via consumption smoothing. Pay-related unemployment benefits help preserve aggregate demand and therefore protect other people’s jobs during a downturn.
We also note that Ireland is out of line with western European norms when it comes to aggregate tax, social contributions and benefits. Ireland raised just 37.4% of GNI* in Government revenue in 2019 compared with 40.1% of GDP for the EU. The explanation for the difference is that Irish employer social contributions are very low at 4.4% of GNI* compared with 8.2% of GDP in the EU.
I will also touch briefly on chapter 9 of the report which deals with enterprise. While the NERI supports many of the stated aims of chapter 9, there are also many aspects which we find problematic. The other 17 chapters make consistent acknowledgement of the need to minimise tax expenditures and differential tax treatment. This is intellectually consistent with the report's stated principles of efficiency and horizontal equity. The disadvantages of tax expenditures, namely, that they are non-transparent, related to uncertain cost, regressive, economically distortive in nature, and characterised by deadweight, are all set out repeatedly in the report, which concludes that they should only be used in very exceptional circumstances. In our view, this approach is correct. However, this approach is sidelined somewhat in chapter 9. Instead, there is a series of recommendations which implicitly or explicitly support a range of very generous tax expenditures, low tax rates for enterprises, high-earning individuals or both. While in some limited and special cases these types of reliefs may individually have an economic justification, collectively they somewhat undermine the approach taken in the rest of the report. I will give one example. The special assignee relief programme, SARP, makes a mockery of any notion of vertical equity. Such measures make it much more difficult to advocate for necessary tax reform in other areas. Let us recall the report's main recommendation that tax revenues will need to be meaningfully increased. However, why should people accept the need for their taxes to increase when they can see that the very rich are treated much more generously? The political economy of raising taxes over the next decade will be extremely challenging and the content of this chapter risks undermining much of the excellent work in the rest of the report. In our view, the overall balance between fairness and potential efficiency gains is not achieved in this chapter. The NERI therefore does not support this chapter while it broadly welcomes the rest of the report.
