ESRI: Removing tax cliff edges could improve work incentives
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Removing cliff edges from the tax and benefits system would improve work incentives during a time when Ireland’s labour market remains quite tight, a new report by the Economic and Social Research Institute (ESRI) has found.
Under the current taxing structure, both PRSI and USC have cliff edges where if a person earns under a certain amount they are exempt from paying the taxes.
However, once their pay goes above this amount, all of their income becomes liable for the charges, which leads to a drop in that person’s disposable income.
The ESRI’s research suggests people adjust their behaviour to keep their income below these points such as reducing work hours or misreporting income.
The report, published on Thursday, entitled 'Cliff edges in the Irish tax-benefit system' found the removal of these kinds of cliff edges would help “avoid possible economic distortions and improve work incentives”.
“The proposed reforms of the PRSI and USC systems highlight the fact that such distortions can be removed in a revenue-neutral manner while protecting those on lower incomes,” it said.
The ESRI said removing this cliff edge was possible by introducing a 0% tax band, with those above a certain amount only paying these charges on the income they earn above it, as is the case with the current tax system.
The report does acknowledge that for this proposal to be revenue-neutral it would mean either more low-income people would need to be brought into the USC/PRSI net or rates must increase.
Cliff edges also exist in other benefits such as the medical card system, whereby someone just over the cut-off is not usually eligible for the card, with the exception being if someone’s income is all from social welfare sources.
The ERSI said the GP-Visit card scheme, discretionary cards and the ability to retain cards when returning to work after long-term unemployment have helped soften this cliff edge.
In addition, the report points out the social welfare system largely avoids cliff edges through a gradual withdrawal of benefits as incomes increase — but there are still two areas where part-time and low income workers in particular face issues.
One of these is the 4-in-7 rule, where those working part-time can only receive a Jobseekers Allowance if unemployed for four days out of seven. The ESRI said this could be a disincentive to employment as it means a person working part-time, but whose hours are spread out over the week, will have no Jobseekers Allowance entitlement.
The other is for those on lower incomes who work at least 38 hours every two weeks, which means they are entitled to the Working Family Payment. However, those working just under 38 hours are not entitled to this payment at all.
Dr Claire Keane, an author of the report for the ESRI, said cliff edges can impact a person’s decision to take part in the labour force and removing them — as recommended by the Commission on Taxation and Welfare suggested — would “would help improve work incentives”.