Adjusting the tax-benefit system in line with inflation would cost between €460 million and €1.2 billion in Budget 2020

New ESRI research calculates the cost to the Exchequer of increasing tax bands, credits and welfare payments in line with price or earnings inflation, a process known as indexation.

It finds that while indexation of the tax-benefit system has a cost to the Exchequer, this is partly offset by indexation of those indirect taxes that are fixed at a money amount per commodity unit (e.g., tobacco, alcohol and the carbon tax). Between 3-8% of the cost of indexing the direct tax-benefit system would be offset in this manner.

The research also looks at the distributional impact of indexation. If social welfare rates are not increased in line with price inflation, the purchasing power of social welfare recipients falls and poverty and inequality rise. If they are not increased in line with wage growth, which is generally higher than price inflation, purchasing power may be maintained but poverty rates and inequality still increase as the incomes of workers rise faster than those of benefit recipients. Likewise, if tax credits and bands are kept frozen, workers face higher tax bills as their earnings rise. This also weakens financial incentives to work.

Some countries have “default” budgets that take account of price or wage inflation. No such default policy applies in Ireland - instead changes to tax credits, tax bands and welfare payments are announced in an ad hoc fashion on Budget day.

Claire Keane, ESRI Senior Research Officer and an author of the report, commented “We carried out this research in light of increased discussion amongst policymakers in Ireland about linking pensions and social welfare benefits to inflation. 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.”