ESRI: Inflation-proofing budget would cost up to €1.2bn

Inflation-proofing tax and welfare changes in the budget would cost the Government an additional €1.2 billion, a new study has indicated.

The research by the Economic and Social Research Institute (ESRI) examined the cost of increasing tax bands, credits and welfare payments in line with inflation, a process known as indexation.

It has been a perennial bugbear of workers here that tax cuts announced in the budget are often eroded by the Government’s decision to keep tax bands and credits unchanged from the previous year.

If tax credits and bands are kept frozen, workers face higher tax bills as their earnings rise in a kind of inflationary stealth tax, potentially weakening the financial incentives to work.

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Similarly if welfare rates are not increased in line with price growth, the purchasing power of welfare recipients can fall, increasing poverty rates and inequality.

The ESRI’s study indicated that indexation of the Irish tax-benefit system would cost €460 million in Budget 2020 if the indexation is tied to price inflation and €1.2 billion if it is tied to wage inflation.

This is based on expectations that price inflation will be in the region of 1.4 per cent next year while wages will rise by 3.5 per cent.

"If you don't automatically increase in line with inflation then you will get people paying more taxes and you'll get social welfare recipients falling behind," said the report's author Claire Keane.

"We carried out this research in light of increased discussion amongst policymakers in Ireland about linking pensions and social welfare benefits to inflation," she said. "This would be a positive move in terms of inequality and poverty. However, the cost of doing so in line with price inflation would be €460 million or €1.2 billion, if increased in line with wage inflation."

Minister for Social Protection Regina Doherty signalled earlier this year that she favoured ending the blanket €5 increases in social welfare payments with plans for a new index-linked welfare system.

Less USC but more tax?

Some countries have “default” budgets that take account of price or wage inflation. The UK, for example, has indexation for state pensions. No such default policy applies in Republic – instead changes to tax credits, tax bands and welfare payments are announced in an ad hoc fashion on budget day.

While budget 2019 introduced cuts in Universal Social Charge and a widening of income tax bands, these gains are expected to be completely eroded by the Government's decision to freeze personal and employee tax credits, resulting in a 0.7 per cen reduction in average household income.

So an employee with earnings of €30,000 per year who could have expected to pay €2,600 in income tax next year had tax credits increased in line with forecast wage growth. However, because of the decision to freeze these credits in cash terms, they will instead pay €2,700.

The ESRI has previously stated Government’s decision to hold both personal and employee tax credits fixed while wages and prices are rising “amounted to an effective tax increase for many workers”.