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Analysis

Why a tiny tax increase no-one noticed could mean higher charges on the way for Irish workers

There was a tiny tax rise in the Budget which barely got any attention – but it should, writes Paul O’Donoghue.

NEVER MIND THOSE pesky experts at think tanks worrying about things like ‘sustainability’ – this was the Budget of tax cuts, baby.

With corporate taxes flowing in, various measures in last week’s Budget aimed to give everyone a few crumbs of the pie.

The Universal Social Charge was cut. Social welfare payments were raised. Essentially everyone was at least a little better off. All’s well that ends well.

Except there was actually a small tax rise included in the Budget. Because it was so small, it barely merited comment. But it should – it is potentially the first step in much higher taxes for workers down the line.

The charge in question was PRSI (Pay Related Social Insurance). This is used to fund the social insurance fund, which is primarily used for paying the state pension.

For PAYE workers, employers pay up to 11% PRSI. The employee themselves pays 4% of their gross salary.

The change in the Budget is this rate will rise for workers by 0.1%.

The increase is tiny. For someone earning €35,000, it equates to €35 per year. What is important though is it is a sign of intent. PRSI is likely going to continue to rise in the coming years.

This is because extra funds will be needed from somewhere to help pay the State’s pension bill, which will rise rapidly in the coming decades as the population ages.

The tax increases in future are set to be much larger – various estimates have put the PRSI increase needed to be between 3.5% and 8%. For that same worker earning €35,000, this could mean paying up to an extra €2,000 or so, every year, in tax.

The problem

First, some context. By 2040, the state’s social insurance fund is expected to record a deficit of €3 billion every year due to the increased cost of the State pension if the current system remained unchanged.

This would then keep rising year-on-year – the Irish Fiscal Advisory Council (IFAC) has warned the mounting pension bill will be “by far the largest challenge to the public finances in the coming years and decades”.

A key issue with the current state pension system is that PRSI contributions from workers are not invested – they are paid out immediately to current pensioners.

Fine when you have a large workforce of young people which can support a smaller older population. But when the size of each group moves in the ‘wrong’ direction, the system breaks down.

Potential solutions

There are several ways this problem could be tackled. One is by raising the age at which people qualify for the State pension. The government had planned to do this before, steadily increasing the qualifying age to 68.

However, unsurprisingly older people do not want to have to work more and the issue blew up during the 2020 general election. The government backed down and current political discourse is focused on keeping the State pension age at 66.

Raising PRSI is the other solution normally put forward. This could be increased both for employers or employees.

The 11% in social contributions Irish employers currently pay is low by European standards, where rates of around 20% are more common.

A fair solution would seem to be raising PRSI for both workers and employees. However, it isn’t clear how this will mesh with the government’s long-delayed plans to introduce auto-enrolment pensions, where companies would pay into their workers’ retirement funds.

If employers will already pay extra into an auto-enrolment pension, should they be liable for higher employee PRSI as well?

As the government continues to insist the state pension will be maintained alongside auto-enrolment, this would appear to be the case.

This will of course be fiercely resisted by business groups, which have already successfully lobbied for lower auto-enrolment contributions. Taoiseach Leo Varadkar has also indicated he is against further increasing employers’ PRSI.

Alongside employers, workers will also face increased PRSI. This 0.1% rise will likely be peanuts compared to what could be in store.

Higher taxes

Again, no one wants to pay more taxes. But if the government is planning to do it, IFAC argues the worst way possible would be itty-bitty annual increases, like the 0.1% raise.

The reason is, soon, the working age population will start to fall. Less people to tax means the ones left working will have to pay more to raise the same amount of money.

This is why the organisation recommended raising PRSI by 3.5% over the next two years. This would be an extra €1,200 or so for someone earning €35,000. But it warned doing it more slowly means the rate would eventually have to go up by 8% – over €2,000 a year extra for that same worker on €35,000.

IFAC’s argument makes sense. It doesn’t take an economic expert to recognise the extreme difficulty paying an extra €2,000 a year in tax would have on many earning a wage as relatively modest as €35,000 in a country as expensive as Ireland.

But €1,200 would likely cause plenty of issues too. However, with no plans to raise the state pension age, it is hard to see where else the extra money will come from. Higher PRSI for the working population looks the most likely move future governments will make.

There is no easy fix. With corporate tax windfalls unlikely to last forever, tackling the state pension issue means more money will have to come from somewhere. The question is how fairly the burden can be spread around.

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