Government proposal to taper the PAYE credit would create an effective marginal tax rate of 64.1 per cent on income of between €100,000 and €120,000, a UK independent research institute has warned. It is the first time that the Institute for Fiscal Studies (IFS), an independent micro-economic research institute similar to Ireland’s ESRI, has made its thoughts on the Irish budgetary process public.

Responding to the recent publication of the Department of Finance’s Tax Strategy Group papers, the IFS said it did so in the “hope that our comments can assist the department in improving the design of the tax system in Ireland”.

One of the proposals in the papers is to remove the PAYE and earned income tax credits from taxpayers with higher levels of income, as previously espoused in the Government’s Programme for Partnership Government published back in 2016.

The proposal is inspired perhaps by a similar decision in the UK to cut allowances on income of between £100,000 (€109,064) and £123,000.

However, researchers at the IFS have found that a tapering of the PAYE and earned income tax credits in Ireland would actually create an effective marginal tax rate of 64.1 per cent on employment income between €100,000 and €120,000.

This would be far in excess of the current top rate of tax of 52 per cent, and as such it could affect decisions as to whether or not to undertake paid work given the added tax burden. The IFS warns two-earner couples with income in this range may be discouraged from both of them working given the penal tax rate applied.

It is critical of an approach that would see tax rates rising further even for so-called higher earners. “Higher marginal rates reduce economic efficiency by weakening the incentive for individuals to increase their earnings,” it warned.

The IFS also has views on plans to introduce a minimum unit price (MUP) for alcohol in Ireland with a view to reducing the social costs of problem drinking.

It warns that the introduction of an MUP as suggested may in fact do a “poor job” of targeting these costs because “it does not systemically tax higher-strength alcohol products – which in the UK are disproportionately consumed by heavy drinkers – more than weaker-strength ones”.

The IFS says the Irish Government could target heavy drinkers more effectively by reforming taxes so that they increase in line with alcohol strength. This would mean, for example, that strong beers would attract a higher tax rate than mid-strength beers, which in turn would attract a higher tax rate than low-strength beers.

“Such a reform would also lead to an increase in tax revenues compared to a decrease associated with the introduction of a MUP,” the IFS says.

While it acknowledges the difficulties in such an approach due to restrictions arising from the European Council Alcohol Products Directive, it notes that the European Commission is currently preparing an impact assessment report on possible changes to this directive, “which may allow greater scope for targeting duties at higher-strength alcohol products”.

While business interests have been calling for an enhancement to Ireland’s current entrepreneur relief regime, which allows a reduced capital gains tax (CGT) rate of 10 per cent for entrepreneurs on the sale of their businesses, up to a lifetime limit of €1 million, the IFS questions this approach.

“The justification for applying lower tax rates to people who own their own business than to the rest of the population is far from clear,” the researchers write.

Typically, the difficulty and risk associated with entrepreneurship is offered as a justification for preferential tax treatment, but the IFS asserts that these “do not in themselves justify favourable tax treatment (the market usually rewards these activities)”.

As such the IFS argues that the benefits of scrapping the relief, including increased fairness, “would outweigh the cost of increasing the tax on the return to certain investments”.

While it says that the policy should also be scrapped in the UK, as long as it stands it may make sense to keep the regime in Ireland, as otherwise “it would provide an incentive for Irish business owners to dispose of assets in the UK rather than Ireland”.