New ESRI research examines the sensitivity of income tax and USC revenues to changes in income
Income tax (including USC) is the largest individual source of tax revenue in Ireland, accounting for over 35 per cent of the total. Thus, fluctuations in this source of revenue have a significant bearing on the total tax revenue.
The research finds that income tax revenue automatically increases by 2 per cent for every 1 per cent increase in taxable income. For the universal social charge (USC) revenue automatically increases by 1.2 per cent for every 1.0 per cent increase in taxable income. The results imply that income tax revenues are more sensitive to economic fluctuations than the revenue arising from USC.
The analysis also shows that income tax revenues are more progressive than universal social charge (USC) revenues.
The main explanation for the difference between the two types of taxes is the role of tax credits in the income tax system. When tax credits are exhausted, the automatic marginal increase in revenue for a small increase in income can be extremely high.
Tax credits increase progressivity because they result in low average tax rates at low income levels. The higher the level of tax credits, the higher the income required before a positive tax liability is generated.
The research also finds that mortgage interest relief, one of the most common income tax reliefs in the past, is notably progressive, with those at lower income levels benefiting proportionally more from it than those at higher income levels (although those at higher income levels benefit more in absolute terms).
The research also finds that discretionary tax policy was relatively revenue-reducing in the past. In other words, if the tax system had been left unchanged during the 2000s, more revenue would have been automatically generated than was actually the case.