OVER THE WEEKEND, Ryanair boss Michael O’Leary took a stand on income taxes. He had two main points. Firstly, he said that high marginal rates (above 60 per cent) encourage people like him to become tax exiles and so hurt, rather than help, the Exchequer. Secondly, he said that the income tax system should be simple.

On the latter, he gave some more specifics. According to the Irish Independent, O’Leary said: “Anybody earning under €50,000 should pay 10 per cent tax. If you’re earning under €100,000, you pay 25 per cent and anybody earning over €100,000 pays 50 per cent. I’m one of the largest taxpayers in the country and I have no problem paying 50 per cent of my income in tax.” So how do his suggestions stack up?

Keep it Simple, Stupid

What’s not clear from that is whether he means a flat rate (i.e. someone earning €250,000 would pay 50 per cent on all their income) or three marginal rates (i.e. that person would only pay 50 per cent on income over €100,000). I’m going to assume he meant the latter, otherwise you would have the odd situation where workers earning €48,000 a year dread overtime or even worse a promotion as their tax bill would rise from €5,000 to €12,500 a year.

A Twitter connection of mine pondered out loud about what sort of impact such a system would have on the Government coffers. I’ll do my best to answer, using the Revenue Commissioners figures for 2008 on who earned what and how much income tax they paid. (As before, PRSI may look like a tax, but it’s actually an insurance premium you pay, so the Revenue does not include these figures in their totals. Health and income levies were not included but now – as the revamped Universal Social Charge – are part of the income tax system so I’ve included them below.)

One thing that is worth noting in passing is that even though we rightly think of housing bubble having come to an end in 2007 (or even late 2006), there is scant evidence of any hit in incomes as of 2008. There were 757,000 people earning €40,000 or more in 2008, compared to 640,000 in 2006 – indeed, the number earning more than €100,000 rose by 25% in the same period. It’s difficult, in that context, to be certain about what an income tax in 2011 (or realistically 2012) would raise, as we don’t know yet who’s been hit and by how much.

Given all that, let’s compare instead the income tax system we had in 2008 with what Michael O’Leary’s three-band taxation system would have raised in 2008. First things first, the biggest change to the tax system is the abolition of tax credits. Anyone earning under €50,000 would pay 10% of their income over in tax – including, one would assume, those earning less than €15,000 who are currently paying only the Universal Social Charge.

Winners & Losers

This would be a big culture shock for the vast majority of earners. Two years ago, I wrote about how the median earner in the country in 2006, earning €25,000, paid just four per cent in income tax, compared to 20 per cent in most other developed countries. By 2008, the median earner was taking home about €27,500 and still paying just four per cent in income tax (this excludes PRSI, remember, which is insurance not tax).

Even taking account of the health levy or, to make it more relevant to today’s earners, the Universal Social Charge, as is shown in the graph below, the average tax rates enjoyed by Irish earners up to about €50,000 are still well below the international benchmark of about 20 per cent.

Average tax rates by 2008 income bands, according to various schemes

What about Michael O’Leary’s system? That’s shown in red in the graph above. There are effectively three significant changes under such a system. Firstly, all those earning €30,000 or less would pay a flat 10 per cent of their income over in tax, compared to five per cent or less under the 2008 system and anything from zero to ten per cent under the current system. Secondly, those earning more than €200,000 would see their average tax rate increase from about 34 per cent now (including the USC) to 43-51 per cent. Lastly, those earning from €40,000 to about €150,000 would see relatively significant falls in their average tax rate. For example, the average amount of tax paid by those earning €60k-€75k is currently 22 per cent (including USC) but this would fall to 14 per cent under the O’Leary system.

Will the Government bite?

But would the Government be interested in such a scheme? It’s safe to say that the Government would only be interested if it resulted in more income tax coming in to the coffers. The 2008 system of income tax (and health levies) brought in about €13.9billion. Applying the 2011 system to the incomes earned in 2008 would have brought in €18.4billion, which is the benchmark for any new suggestions to beat.

The straightforward “three marginal rates” system (with no USC) would have brought in €15.6billion in 2008. So it’s safe to say, for all its simplicity (and the unknown impact of that in creating new jobs), it’s not a runner. The reason so much tax revenue is lost is because of what happens to the €40,000 to €100,000. Suppose O’Leary’s proposal was adjusted so that people paid 25 per cent on everything earned between €25,000 and €100,000 (and 50 per cent above that). Such a system would have brought in €18.6billion, based on what was earned then.

I’ll suggest one more tweak. This would be to include all social welfare as taxable income – they are the people marked “LR” (Live Register) in the graph above. The primary aim of this measure is reduce the barriers to returning to work. Like every other developed country in the world, in Ireland someone who earns €10,000 should make some direct contribution in income tax. However, it’s simply not fair that someone earning €10,000 working has to pay tax while someone who receives €10,000 for not working doesn’t. And that lack of fairness affects people’s decisions.

Such a revised system of income tax would face stiff political resistance, as although high earners would pay significantly more in tax, so would those who earn less than €25,000. Nonetheless, there are three principal benefits. Firstly, it would increase revenue to the Government. Secondly, it would create a simple and fair tax system, where everyone contributes and those who earn most contribute proportionately more. Lastly, it would demolish the artificial boundaries between money earned through various sources including social welfare.

Ronan Lyons is an Irish economist based at Oxford University, and runs the Economic Research unit at Daft.ie. You can read more articles on his blog, where this originally appeared.