Budget buffers against inflation trickier to manage than budget giveaways

The budget for 2023 will see the Government spending billions extra, but without the prospect of leaving people better off.

The culprit is a massive jump in the rate of inflation sparking a cost-of-living crisis which could yet worsen over the winter months. The Tax Strategy Group papers, published on Wednesday, examine the options for Ministers who will have to spend probably well over €1.5 billion on welfare increases for 2023 and more than €1 billion on tax measures. And this is just to try to cushion the blow from an inflation rate now heading towards double figures.

Inevitably extra cost will be incurred this year too on the back of emergency measures introduced in 2022 and the likelihood of some budget welfare and tax measures being implemented sooner.

Luckily tax revenues are way ahead of target, so there is scope for this. Inflation could average 7 to 8 per cent this year, a huge hit on people’s pockets. The outlook for inflation next year remains really uncertain.

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At best significant welfare increases and adjustments to tax bands and credits will try to protect those on welfare from the worst of the hit and provide some additional cash for taxpayers. But higher energy prices in particular are a cost to Ireland and the Government cannot insulate people completely. And with mortgage costs rising and the threat of yet further rises in energy bills, particularly if Russian gas to the EU is shut off, the Government could yet find itself running hard to stand still.

What is at issue are not budget giveaways in the sense that they leave people better off – they might instead be called budget buffers to try to fend off some of the hit.

The Tax Strategy Papers are, of course, just a menu for the Government. And typically politicians dine a la carte. But there are clear indications in the papers of the way this is going. The paper on social protection looks at a variety of options, many including a €15 increase in basic welfare rates. Depending on the mix of basic rate increases, pensions rises and targeted measures such as higher fuel allowances, dependent children payments and living alone allowances, the cost in 2023 could be between €1 billion and €1.7 billion. There will be some trade off here between general increases and targeted measures.

For taxpayers adjustments to take account of inflation are similarly expensive. A range of options are given for the indexation of tax credits and bands, which would ensure fewer people enter the tax net – or get hit by the higher 40 per cent rate – as earnings rise in response to inflation.

Those who do not see wages rising will also gain, of course. Again this is expensive; a 4 per cent indexation of all tax bands and credits would cost a hefty €845 million.

The Government does get some extra tax revenue as inflation boosts earnings and indirect tax revenues but indexation still costs a lot.

And the Government cannot afford indexation as well as introducing a new 30 per cent income tax rate. It is one or the other and Minister for Finance Paschal Donohoe appears to favour the indexation route, which would potentially spread the benefits more widely.

The political difficulty is that protecting people from the cost-of-living crisis is potentially a lot more difficult and divisive than giving out budgetary largesse in times when it leaves people better off. Inflation, particularly at current levels, changes everything. The risk of the cost-of-living crisis intensifying, at least for a period, makes this even trickier politically.

If the Government was sure that inflation would ease sharply next year it could be confident that it is looking at a costly but manageable, once-off adjustment to a higher price level. But, of course, nobody knows what the rest of this year will bring, never mind 2023.