Poorest households hit hardest with incomes suffering a 2% reduction

ANALYSIS:An examination of the impact of cuts and taxes shows better-off take the smallest hit

WHO WILL lose most from Budget 2012? And what has been the overall impact of the austerity budgets of the past four years? Analysis based on a few household examples cannot provide accurate answers to these questions – the results would depend too much on the particular cases chosen. To get the true picture, we must calculate the impact of tax and welfare policy changes on large numbers of real households in a nationally representative sample.

The Economic and Social Research Institute (ESRI) tax-benefit model (Switch) allows us to do this: it estimates the impact of direct tax and welfare changes using anonymised data from the Central Statistics Office’s Survey on Income and Living Conditions.

Given the importance of indirect tax measures in Budget 2012, we combine this analysis with results on the impact of the increases in VAT and carbon tax produced by our colleagues, Seán Lyons and Anne Pentecost. Again, these are firmly based on national survey data – in this case, the CSO’s Household Budget Survey.

The welfare measures in Budget 2012 are unusual in a number of respects. They include large-scale items which are not part of the core income supports provided by the welfare system – for example, the reduction in the refunds of redundancy payments to employers.

It is unclear where the burden from this change will ultimately fall. For those made redundant, there is still a guarantee of statutory entitlements, but there could be implications in terms of redundancy terms above this minimum. Given the uncertainty as to where the burden may fall, this measure cannot be included in our analysis.

We estimate that, of the total reduction in welfare spending of €475 million, about €300 million is in the form of reductions in income supports, with the rest made up of a variety of savings in expenditures not directly contributing to income supports.

The welfare measures that are directly included in our analysis are:

* reductions in child benefit payable to families with three or more children;

* reductions in the amounts payable under the rent supplement scheme;

* restriction of the fuel allowance to 26 weeks;

* reduction in the amount of earnings which is “disregarded” in the means test for one-parent family benefit;

* reductions in the amounts payable under the back-to-school scheme.

Taken together, these changes account for about 70 per cent of the total reductions in income support. We make allowance for the remaining 30 per cent by assuming that the impact of other cutbacks is distributed across income groups in the same way as the set of items listed above.

On the tax side, we allow for the impact of the increases in VAT and carbon tax, and for the introduction of a household charge; but increases in motor tax are not covered.

We also take into account the increase in the exemption limit for the universal social charge.

As in past years, we assess the impact of policy against a neutral baseline – that is, one in which all incomes rise or fall by the same percentage. This is achieved by indexing the policy for the baseline year in line with the expected rise or fall in wages. For 2012, average wages are expected to be unchanged from 2011. Over the period 2008-2012, estimates suggest a fall in average wages of 4.2 per cent.

Looking at the impact of the 2012 budget (see chart), it is clear that the greatest reduction in income is for those on the lowest incomes – a fall of between 2 and 2.5 per cent for the poorest 40 per cent of households.

This compares with a fall of close to 1 per cent for the next 40 per cent of households, and of 0.8 per cent for the top 20 per cent.

These results reflect the fact that increases in indirect taxes are known to be regressive and that cuts in welfare tend to have a greater impact on low income groups.

How do the measures in Budget 2012 affect the overall impact of policy changes from October 2008 up to and including the present budget? These results over this four-year period show a strongly progressive pattern, with the lowest income group losing by about 2 per cent and the highest losing by 11 per cent.

The scale of the progressive impact of earlier budgets, which raised income tax, abolished the ceiling on PRSI payments, and introduced the universal social charge is much greater than the regressive impact of Budget 2012. The net effect over the whole period is therefore strongly progressive.

Some recent studies have examined the distributional impact of austerity measures in six EU countries – the UK, Spain, Portugal, Greece, Estonia and Ireland. Two key features stand out from an Irish perspective. First, the size of the adjustment undertaken by Ireland dwarfs that of all the other countries. Second, the distributional impact of the policy changes in Ireland is among the most progressive – with one important caveat.

The lowest income losses are not at the very bottom of the distribution, but for those with somewhat higher incomes. This arises because of the special treatment afforded to the elderly, with a rise in the State pension in 2009, and no subsequent downward adjustment, unlike other welfare payments over that period.

Under the Government’s programme, and the agreement with the troika, the regressive flat-rate household charge is to be replaced by a tax on property values. The design and implementation of such a tax can help to offset some of the regressive features of Budget 2012. This is a topic which we will be exploring in the near future.

Tim Callan, Claire Keane and John Walsh are researchers at the ESRI