Why do the self-employed pay higher taxes?

[Duke of Marmalade]

If the self-employed were being unfairly burdened then logic dictates that Revenue’s figures of income tax paid should back up this assertion.

One would expect self-employed with incomes in excess of €100,000 to have higher effective rates than employees.

However, the reverse is true.

This can only be because the self-employed, despite the unavailability of the PAYE credit, have received more tax relief than employees.

One presumes that the Revenue stats refer to the Net Reckonable Earnings of the S/E i.e. after deducting allowable business expenses. The tax relief on NRE is very limited, the main one being pension contributions. And here we see that the stats are not comparing like for like. Many employees in that bracket will have their pensions funded to a large degree by their employers. To compare like with like the effective employer pension support would need to be added to the employee's income and this would bring down the effective rate of tax.

The fact is that at the Net level S/E pay 3% USC surcharge and get no PAYE credit - End Of, and at this net level are clearly facing a higher tax burden. The issue is do they have enough flexibility between Gross and Net to compensate for this - manicures, dog kennels etc.

 

[Sarenco]

You must have missed my post in reply to BB’sThe State does incur a greater liability for employees compared to the self-employed but it is 40% to 50% greater – not the multiples that would warrant total PRSI of 14.75% vs. 4%.

The self-employed (particularly the lower paid) get an absolutely fantastic deal for their PRSI (that dwarfs whatever extra taxes they have to pay). The contributory pension is by far the most expensive benefit provided by PRSI contributions – yet all you ever hear is moans of ‘but we don’t get JSB if our business goes belly-up…’. JSB costs less than 7% of the cost of benefits provided under PRSI.

If you look at the economics of the contributory pension:
You can earn a full 12K contributory pension with 30 years of PRSI contributions.
So for each year of PRSI contributions, a pension of €400 pa in retirement is accrued. The usual valuation factor for pensions is at least 20 and probably closer to 30/35. So that €400 pa pension is valued at somewhere between €8,000 and €14,000. Even allowing for a fully contributing 50 year career, each year of PRSI contributions accrues €5,000 + of pension value.
Just think about that for a minute (although not for too long or you will realise how unsustainable it is…) – for every year a person works and pays PRSI, whether they earn 20K or 200K, they accrue a benefit with a value of 5K to 14K…

And for this the self-employed pay 4% of income (so, e.g. €800 on a 20K income). Between employers and employees PRSI, the state receives just under €3,000 in respect of an employee on 20K. Still not enough (but that’s the joy of a hugely progressive tax system) but getting close in orders of magnitude.
Even a self-employed person on 100K only pays 4K in PRSI – still not anywhere near enough to fund their contributory pension. For an employee on 100K, the state receives just under 15K – just about enough.

So, overall, IMHO, the self-employed get a fantastically brilliant deal from their PRSI and they are generally very unaware of it preferring to focus on cheaper benefits that they don’t get.

orka

In the quoted post I was simply trying to make the point that it was appropriate in principle that greater PRSI contributions would be made by or in respect of an employee to reflect the additional benefits accruing. However, in a subsequent post I agreed with Duke that the level of employers' PRSI contributions is not proportionate to the value of the benefits accruing to their employees, over and above the entitlement to a contributory pension. In other words, I think we are in violent agreement on this point!

As such, I would agree that the ratio of contributions should be changed such that the rate of employers' PRSI contributions is lowered (to more accurately reflect the lower value of the non-pension benefits) and/or the rate of employee and self-employed PRSI contributions should be increased (to more accurately reflect the higher value of the pension benefit).

However, it is not valid, in my opinion, to try to achieve this rebalancing by retaining the employee tax credit and/or imposing a surcharge on non-PAYE income in excess of €100k. Do you disagree?

 

[Sarenco]

One presumes that the Revenue stats refer to the Net Reckonable Earnings of the S/E i.e. after deducting allowable business expenses. The tax relief on NRE is very limited, the main one being pension contributions. And here we see that the stats are not comparing like for like. Many employees in that bracket will have their pensions funded to a large degree by their employers. To compare like with like the effective employer pension support would need to be added to the employee's income and this would bring down the effective rate of tax.

The fact is that at the Net level S/E pay 3% USC surcharge and get no PAYE credit - End Of, and at this net level are clearly facing a higher tax burden. The issue is do they have enough flexibility between Gross and Net to compensate for this - manicures, dog kennels etc.

Agreed Duke but I don't think it is fair to penalise an entire category of tax payers (the self-employed) on the basis that some individuals within that group are undoubtedly deducting inappropriate expenses in determining their NRE.

 

[Sarenco]

This can only be because the self-employed, despite the unavailability of the PAYE credit, have received more tax relief than employees.

Sophrosyne

Can you clarify what tax relief is available to the self-employed that is not also available to employees? I'm starting to wonder if I'm missing a trick...

 

[Sarenco]

One additional aspect of the 3% USC surcharge on the self-employed that seems particularly inequitable relates to the erosion of the benefit of making personal pension contributions. At income levels in excess of €100k, a self-employed person will in effect pay tax (USC and PRSI) at a rate of 15% on any amount contributed to a personal pension whereas an employee with an equivalent level of income would [only!] pay tax at a rate of 12% on any such contribution. The additional 3% surcharge levied on non-PAYE income above €100k is the equivalent of an additional commission or front-end load on this investment, which could become very significant over time. In other words, an employee in similar circumstances can contribute an additional 3% tax free to his pension pot which could become very significant when the income and gains on this investment are compounded over time.