Wages and salaries are expected to rise by about 3 per cent in 2018. A neutral budget – increasing tax credits, tax bands and welfare payments in line with expected wage growth – would translate into 3 per cent income growth for all households.
Measured against this neutral benchmark, initial analysis shows that Budget 2018 leads to small losses in income at all income levels.
The usual budget narrative is about gains from tax cuts and welfare increases. This is because the “opening budget” is one in which tax credits, bands and welfare rates are all frozen in nominal terms. Under this opening budget, average effective tax rates would tend to rise as incomes grow, as more people are drawn into the tax net and more tax is paid at the higher rate of tax – a phenomenon known as “fiscal drag”.
Many countries have adopted budgetary rules which raise tax bands and credits in line with inflation in order to ensure that increases in taxation must be explicit. While there have been a number of improvements in the transparency of Ireland’s fiscal policy over recent years, the opening budget still operates on the basis of unchanged credits and bands in nominal terms.
There are parallel issues in terms of welfare payment rates. A freeze on welfare payment rates in nominal terms – implicit in the opening budget – would mean a decline in real terms, and relative to other incomes in society. This is inconsistent with the poverty reduction goals of the national action plan for social inclusion.
Our analysis is based on a neutral benchmark, indexing tax bands and credits, along with welfare payment rates, in line with wage growth. Key differences between Budget 2018 and simple indexation include the following. Personal tax credits were left unchanged in Budget 2018, but would have risen by €50 under indexation. While the tax band was increased by €750, indexation would have implied a rise of €1,050. Welfare payments rose by €5, while indexation would have required an increase of €6, or for pensioners, €7.
It is these gaps between the changes required by indexation and the actual budget changes which generate the losses observed in the chart. We do not argue that indexation is necessarily the best policy. It does, however, provide a more informative benchmark against which to measure the distributional impact of actual policy than the unindexed policy.
We estimate the impact of Budget 2018 on a nationally representative sample of almost 8,000 households in the CSO’s survey on income and living conditions – a key resource for the analysis of public policy. For each of these households, Switch, the ESRI tax-benefit model, calculates the tax liabilities and welfare entitlements under the benchmark policy and Budget 2018 policy.
Our estimates suggest that indexation of tax bands, credits and welfare payments would cost in the region of €1,100 million. The resources used in Budget 2018 for personal taxes and welfare payments were some €400 million lower than that figure, reflecting the particular squeeze on resources during this budgetary year.
Our analysis takes into account most of the major personal tax and welfare initiatives in Budget 2018 including the widening of the tax band, reductions in USC, increases in the self-employed and home carer tax credits, and reduction of mortgage relief to 75 per cent of its 2017 levels.
On the welfare side, we take account of the €5 per week increase in personal payment rates for all welfare schemes, the measures to support low income families in and out of work, the increase in the earnings disregard for lone parents and the new phone allowance.
While work is ongoing in the areas of Housing Assistance Payment and Affordable Childcare Subsidy, they are not included in the current analysis. Similarly, the impact of indirect tax changes cannot be included at present, though a new joint project with the Department of Finance will improve analytical capacity in this area. The impact of the rise in the minimum wage is not included, but is relatively small.
Our analysis, like similar models internationally, looks at the immediate distributive impact of direct taxes and cash benefits before any responses in labour market or other behaviour. We rank households by their income, adjusted for numbers of adults and children in the household. We then divide the households into five equal-sized groups or “quintiles”, from lowest income to highest income.
The chart shows the percentage gain or loss for each of these quintiles for Budget 2018 compared with a neutral, wage-indexed budget. The average income loss is close to 0.4 per cent, with somewhat greater losses for the lowest two income groups (close to 0.6 per cent) and lower losses for the 20 per cent of the population with highest incomes (losses of about 0.2 per cent). These changes are small compared to the losses imposed by austerity budgets, and the gains from budgets during the boom years.
Two issues in the welfare area deserve attention. First, as we recommended in a paper to the ESRI’s Budget Perspectives conference, the introduction of major reforms to the structure of income supports for low-income families has been deferred, and existing mechanisms used to increase support.
Our argument is that new developments in tax administration are likely to provide information which will help with both the design and the implementation of reform.
The dangers of attempting reform without an adequate development of the administrative system are well illustrated by the problems currently plaguing the introduction of universal credit in the UK.
Second, the increases in earnings disregards for lone parents are welcome. Economic analysis indicates that taxes are raised more efficiently if they are lower on individuals whose economic behaviour is likely to respond more to the tax.
It is known that lone parents’ decisions regarding employment are more responsive than others to the economic incentives they face. This makes a case for a tax/transfer regime which is more supportive of lone-parent employment, and the rise in the earnings disregard contributes to this.
Tim Callan is a research professor at the ESRI