Paul O'Donoghue

WITH CHRISTMAS A-COMING, ’tis the season to get into the giving spirit.

Unless you’re the Irish government, in which case, you already dished out your festive goodies in October.

A tenner for the job seekers! An extra €12 for the pensioners! More cash for all – oh, how grand!

Except – Ireland’s much-heralded budget ‘giveaways’ often don’t leave people better off financially.

That’s where we come to two topics sure to bring the season’s cheer – ‘indexation’ and ‘stealth taxes’. Fun for all the family!

The ESRI said this month that changes to tax and social welfare payments over the past five years means a typical household is slightly worse off than they would be if these payments were linked to an index such as wage growth.

The difference wasn’t big at only 0.3%. But it’s notable that, despite all the talk of massive ‘giveaway’ budgets in recent years, the net effect for households is that they’re basically no better or worse off.

How can this be, when we’ve heard endless reports about ‘giveaway packages’ worth billions of euros and bumps in welfare payments?

This is where ‘stealth taxes’ come in. This refers to when people end up paying more tax because tax bands don’t rise in line with inflation.

For example, say a typical salary is €50,000, and people pay the top rate of income tax on earnings above €40,000.

Keeping things simple, let’s say general inflation is 5% in a year. Then, wages generally also rise by 5% a year. So now a typical salary is €50,000, plus 5% (€2,500), which gives €52,500.

Even though your wage goes up, your buying power stays the same – the €52,500 typical salary now only buys as much stuff as the €50,000 did the year before.

But wait! What about taxes? See, to keep your after-tax income the same, tax bands should rise in line with inflation.

So if you started paying the top rate of income tax at €40,000 when a €50,000 salary was normal – when everything else goes up by 5%, so should the tax band, from €40,000 to €42,000. This would make sure your after-tax income remained the same.

But if the band stays at €40,000 you effectively end up paying more of your income in tax.

This, right here, would be an example of a stealth tax.

People don’t tend to get too wound up about them, because it’s something which is easy to ignore.

Many people only see that their salary is €2,500 higher this year compared to last. But in real terms, they’re actually worse off.

Stealth taxes are common in Ireland in all sorts of areas.

In many European countries, there is ‘indexation’. This is where things like social welfare payments are linked to an index, such as consumer inflation or wage growth.

So if wage growth is 3% in a year, all welfare payments automatically rise by the same percentage.

In Ireland though, any changes to tax bands and welfare payments are decided by politicians.

This has a few drawbacks. It makes welfare payments and tax bands unpredictable. In countries where there is indexation, people know that if wages go up by 3%, their welfare payments will go up by 3% as well.

This also applies to tax bands. For example, Germany adjusts its income tax brackets every two years in response to an inflation report. This helps keep real incomes stable.
But in Ireland, if inflation rises by 3%, there’s no guarantee there’ll be a change in tax bands or welfare payments.

Then, when there is a change, adjustments can be arbitrary. Politicians tend to like round numbers – think of how often we’ve heard of an extra ‘fiver a week’ being talked about for pensioners as part of the budget process.

But say inflation means that pension payments should actually go up by €6.23 a week to keep up with inflation? Well, if the politician picks €5, your real income goes down.

As previously outlined, 18 out of 19 euro area countries currently have some form of indexation for their pension payments, using various different systems. This means stealth taxes aren’t as big of an issue.

There’s been a push for years to introduce indexation in Ireland to ensure people aren’t hit with these ‘stealth taxes’. But these proposals have mostly just been talked about, without any major change happening.

One factor which is worth mentioning, and which may feature in Irish politicians’ reluctance to introduce indexation, is the ‘narrowness’ of Ireland’s tax base.

This basically means that the Irish state gets most of its tax take from a relatively small number of sources.

This is risky for the state, because if something happens to one of these sources and they start paying less tax, it risks blowing a hole in the country’s finances.

It’s well recognised that Ireland’s tax base is currently quite narrow, and the problem has gotten worse in recent years. Despite endless warnings not to, the country is becoming reliant on big corporate tax windalls to help balance the books. The Irish Fiscal Advisory Council noted this year that in 2022, 0.02% of companies accounted for 80% of corporation tax receipts.

The country is also very reliant on high-earning PAYE workers, with 20% of taxpayers paying 80% of taxes.

When looked at with this problem in mind, perhaps Ireland’s ‘stealth taxes’ actually serve a purpose.

They are basically a way for the government to raise more money from people, without having to actually announce any new tax measures or increases.

The extra amount that the state is actually taking in from these ‘stealth taxes’ is hard to quantify, as they don’t tend to be properly tracked. But they would have more of an effect on higher earners, helping to prop up the tax system.

But ‘stealth taxes’ can serve another purpose too. As they’re often ignored by the general population, the government of the day can talk year after year about ‘budget giveaways’ and how much more money the average household is getting. The government gets to seem like it’s giving people lots of money, even if the reality is that their living standards largely don’t change.

Irish politicians like talk of giveaways. Although it’s debatable whether this actually cuts through with the public – polls tend to show that hoped-for ‘budget bounces’ after ‘giveaways’ didn’t materialise this year or last.

But compared with budgets, indexation isn’t exciting. And despite their cool name, neither are ‘stealth taxes’. And given the lack of political will to change the system, perhaps we’ll have to settle for both topics remaining no more than Christmas talking points.