Inheritance Tax in Ireland: An Unjustified Burden?

Inheritance tax, officially known as Capital Acquisitions Tax (CAT) in Ireland, is a levy on gifts and inheritances. The standard rate for this tax is currently 33%. While the tax is designed to generate revenue for the state, it has been a subject of debate, with many arguing that it is an unjustified burden on beneficiaries.

How Inheritance Tax Works

Inheritance tax applies to the transfer of assets upon the death of an individual. The amount of tax payable depends on the value of the inherited property and the relationship between the benefactor and the beneficiary. There are three categories of relationships, each with different tax-free thresholds2:

• Group A: Children (including adopted and stepchildren) can inherit up to €335,000 tax-free.
• Group B: Siblings, nieces, nephews, and other close relatives can inherit up to €32,500 tax-free.
• Group C: All other relationships can inherit up to €16,250 tax-free.

Any amount above these thresholds is taxed at the standard rate of 33%.

The Argument Against Inheritance Tax

Critics of inheritance tax argue that it is fundamentally unjust for several reasons:

• Double Taxation: The assets being inherited were often acquired using income that was already subject to income tax. This means that the same wealth is being taxed twice—once when it is earned and again when it is transferred to heirs.
• Penalising Savings and Investment: Inheritance tax can be seen as a penalty on those who have saved and invested their money wisely. It discourages long-term financial planning and can lead to the forced sale of family homes or businesses to pay the tax bill.
• Economic Impact: High inheritance taxes can have a negative impact on the economy by reducing the capital available for investment. This can stifle entrepreneurship and economic growth, as potential business owners may be less inclined to invest in new ventures if they know a significant portion of their estate will be taxed upon their death.
• Fairness and Equity: The tax is often viewed as unfair because it disproportionately affects middle-class families who may not have the resources to employ sophisticated tax planning strategies. Wealthier individuals can often find ways to minimise their tax liability through trusts and other legal mechanisms.

Conclusion

While inheritance tax is intended to redistribute wealth and generate revenue for public services, its implementation raises significant concerns about fairness and economic impact. The argument that it constitutes double taxation is particularly compelling, as it highlights the inherent injustice of taxing the same assets multiple times. As such, many believe that inheritance tax in its current form is an unjustified burden on beneficiaries and should be reformed to better align with principles of fairness and economic efficiency.

In a system of both direct and indirect taxation, just how much tax will I pay?

The Republic of Ireland has a progressive income tax system and a VAT system for spending tax. The income tax system has two tax rates (writing in November of 2023): 20% and 40%. The first part of the income, up to a certain amount, is taxed at 20%. This is known as the standard rate of tax and the amount that it applies to is known as the standard rate tax band. The rest of the income is taxed at 40%. The amount that one can earn before paying the higher rate of tax is known as the standard rate cut-off point. The standard rate tax band and the standard rate cut-off point vary depending on one’s personal circumstances, such as marital status, number of children, or age. The VAT system (again writing in 2023) has three tax rates: 23%, 13.5%, and 9%. The standard rate of 23% applies to most goods and services, while the reduced rate of 13.5% applies to certain goods and services, such as fuel, electricity, or construction. The second reduced rate of 9% applies to certain goods and services, such as tourism, hospitality, or entertainment.

To illustrate how income tax and spending tax work in the Irish context, let us consider an example of a single person earning €50,000 per year and spending €30,000 per year on goods and services subject to the standard VAT rate of 23%. The income tax calculation for this person is as follows:

• The standard rate tax band for a single person in 2023 is €40,000, so the first €40,000 of income is taxed at 20%, resulting in a tax liability of €8,000.
• The remaining €10,000 of income is taxed at 40%, resulting in a tax liability of €4,000.
• The total income tax liability is €12,000, which is 24% of the gross income of €50,000.

The spending tax calculation for this person is as follows:

• The gross spending of €30,000 includes the VAT of 23%, so the net spending (excluding VAT) is €24,390.
• The VAT paid on the gross spending is €5,610, which is 23% of the net spending of €24,390.

The total tax liability for this person is €17,610, which is the sum of the income tax liability of €12,000 and the spending tax liability of €5,610. This is 35.2% of the gross income of €50,000, or 58.7% of the net income of €30,000 (after deducting income tax).

This example shows that taxation can have a significant impact on one’s income and spending, and that the effective tax rate depends on various factors, such as the level and source of income, the type and amount of spending, and the applicable tax rates and bands. 

Therefore, it is important to remember that all money earned in Ireland has already been subject to taxation, and is then taxed again when spent on goods and services. At this point it might be worth reminding ourselves of the Canons of Taxation.

The Canons of Taxation

Adam Smith, a prominent economist of the 18th century, proposed five canons of taxation to guide policymakers in designing an efficient and equitable tax system. These canons serve as fundamental principles to ensure a well-functioning tax system. In this set of notes, we will explore each of Adam Smith's canons and provide examples of their relevance within an Irish context.

1. Equity

Emphasises fairness in taxation. Individuals and businesses should contribute to the tax burden based on their ability to pay. Progressive taxation is often employed to achieve equity.

Example: Income Tax

The income tax system in Ireland follows a progressive structure with various tax bands and rates. Higher-income individuals are subject to higher tax rates, ensuring a fair distribution of the tax burden. The principle of equity is implemented by taxing individuals with higher incomes more than those with lower incomes.

2. Certainty

Highlights the importance of predictability and certainty in tax regulations. Taxpayers should be able to anticipate and plan for their tax liabilities.

Example: Annual Budget Announcement

The Irish government announces changes to tax rates, allowances, and exemptions during the annual budget. By providing prior notice and announcing tax changes well in advance, taxpayers have certainty about the upcoming tax year. This allows individuals and businesses to make informed financial decisions based on the anticipated tax regime.

3. Convenience

Advocates for taxes to be collected in a manner convenient for both taxpayers and the government. Taxes should be levied in a way that minimizes administrative burdens and maximizes compliance.

Example: Value Added Tax (VAT)

VAT is a consumption tax levied on the sale of goods and services. The tax is collected by businesses at the point of sale, making it convenient for both the government and taxpayers. VAT is administered and collected by Revenue, minimizing the administrative burden for individual taxpayers.

4. Economy

Promotes efficiency in taxation by minimising administrative costs and economic distortions. Taxes should be structured to minimise deadweight losses and avoid discouraging productive activities.

Example: Capital Gains Tax (CGT)

CGT is applied to the profit realized from the sale of assets, such as property, stocks, and businesses. The tax aims to ensure fairness and capture gains from asset sales. However, an excessively high CGT rate could discourage investment and entrepreneurial activity, impacting economic growth. Setting an appropriate CGT rate is crucial for maintaining economic efficiency.

Productivity

Highlights the need for taxes to generate adequate revenue to fund public goods and services. Tax policies should be designed to ensure a sufficient and stable source of income for the government.

Example: Corporation Tax

Corporation tax is levied on the profits of companies operating in Ireland. Ireland has a low corporation tax rate (12.5% at time of writing, check here for latest figure), attracting multinational companies to establish their European headquarters in the country. This strategy has led to increased foreign direct investment, job creation, and economic growth, resulting in a productive source of tax revenue for the Irish government.

Adam Smith's canons of taxation provide a framework for designing an efficient and equitable tax system. In an Irish context, examples such as income tax, annual budget announcements, VAT, capital gains tax, and corporation tax demonstrate the application of these canons. By adhering to these principles, policymakers can strike a balance between revenue generation, fairness, simplicity, and economic efficiency, ensuring a robust tax system that supports Ireland's socio-economic development.

Progressive and Regressive Taxation

Taxation is the process of levying and collecting funds by the government to finance public expenditures. Progressive taxation is a tax system where the average tax rate increases as income or wealth increases.While regressive taxation is a tax system where the average tax rate decreases as income or wealth increases.

Progressive Taxation

Characteristics:

• Higher-income individuals pay a higher percentage of their income in taxes.
• Intended to reduce income inequality and promote social welfare.

Examples:

• Income Tax: Ireland's income tax system consists of multiple tax bands with increasing rates as income rises. For example, higher-income earners are subject to a higher marginal tax rate.
• Capital Gains Tax: The tax rate on capital gains in Ireland is generally lower for individuals with lower incomes and increases for those with higher incomes.

Regressive Taxation

Characteristics:

• Lower-income individuals pay a higher percentage of their income in taxes.
• Can exacerbate income inequality and be considered less equitable.

Examples:

• Value Added Tax (VAT): VAT is a consumption tax in Ireland that applies to various goods and services. Since it is a fixed percentage, lower-income individuals may spend a larger portion of their income on taxable goods, making it regressive in nature.
• Excise Duties: Taxes on certain products like tobacco and alcohol are regressive as lower-income individuals tend to spend a higher proportion of their income on these items.

Advantages and Disadvantages

Progressive Taxation:

Advantages:

• Equity: It reduces income inequality and provides a more equitable distribution of the tax burden.
• Social welfare: Progressive taxation can help fund social programs, public services, and infrastructure that benefit society as a whole.

Disadvantages:

• Discouragement of productivity: Higher tax rates on higher incomes may discourage individuals from pursuing higher-paying jobs or engaging in additional work.
• Tax avoidance: Individuals may employ various strategies to minimise their tax liabilities, reducing the intended progressivity.

Regressive Taxation:

Advantages:

• Simplicity: Regressive taxes are often easier to administer and collect.
• Stability: Regressive taxes can provide a more stable source of revenue as they are less dependent on economic fluctuations.

Disadvantages:

• Inequity: Regressive taxes tend to place a heavier burden on lower-income individuals, potentially exacerbating income inequality.
• Social impact: They can disproportionately affect vulnerable populations who have limited financial resources.

Progressive and regressive taxation represent different approaches to distributing the tax burden.

Understanding their advantages and disadvantages helps policymakers design tax systems that balance fairness, revenue generation, and economic incentives.