In this blog, NERI Co-director Dr. Tom McDonnell discusses the outcomes of Budget 2023.
While almost everyone will benefit in cash terms from this budget it won’t be enough to compensate for the projected cumulative inflation of 16% over 2022 and 2023. In particular, the lump sums and once-off double payments that are being used to prop up the welfare system won’t be of any help to those households by this time next year. Households on fixed incomes will be worse off and more likely to be experiencing poverty and/or deprivation.
A far superior approach would have been to index the welfare system, both in terms of rates and thresholds, against inflation. Its striking that the standard rate cut-off point for income tax was increased by 8.7% and effectively indexed, whereas welfare rates were generally set at lower levels. The tax cuts will add to inflation and disproportionately benefit middle and higher earners.
The decision not to protect low paid workers from inflation is regrettable with the limited gains from tax cuts and the national minimum wage increase (2022 and 2023 increases) falling far short of inflation over these years. The lump-sum increase in the working family payment is welcome but won’t help in 2023. Part-time and low paid workers seem to be the big losers from this budget.
The ad hoc treatment of welfare rates and thresholds shows us once again the need for benchmarking of the welfare system. Benchmarking was recently recommended by the Commission on Tax and Welfare (COTW), and also earlier this year by the Oireachtas Committee on Budgetary Oversight. A ‘benchmarking of welfare’ commission should be established as a priority in order to bring a proper evidence base, adequacy and certainty to the system. Its recommendations need not tie the hands of policymakers, and could be based (in modified form) on the advisory model exemplified by the Low Pay Commission and the Irish Fiscal Advisory Council.
The reduction in the cost of childcare is an extremely welcome first step. This measure will help increase labour supply over the long-run and could ultimately pay for itself. The other announced measures that will reduce the cost of using public services such as free school books and the extension of free GP care are similarly welcome. These types of intervention will help reduce inflationary pressure and the cost of living.
On the other hand, it was disappointing that the capital budget was not increased to reflect the recent inflationary environment. We remain very far from meeting our housing targets and the overall strategy for housing will need to be reassessed. The ongoing failures in housing supply are home-grown in nature and cannot be blamed on external factors, notwithstanding the increase in commodity prices. The new levy on concrete seems unwise in this context as it will simply push up the cost of construction.
In addition, a lot of fiscal firepower (tax cuts, universal credits) was wasted on households that simply don’t need protection against cost of living increases. Household savings have grown substantially in recent years with the savings rate elevated over historical levels. The better off cohorts that have been accumulating these savings could have managed this period of high inflation without a qualitative decline in living standards by reducing their savings. The universal ‘energy’ credits should be seen as wasteful in this context. Better targeting could have been achieved, as I noted above, by simply utilising the existing tax and welfare systems – i.e. partial indexation of taxation and full indexation of welfare. The ‘energy’ credits do at least have the advantage of not disincentivising energy cuts. On the other hand, the excise tax and VAT cuts are poorly targeted and unhelpful in terms of our climate targets.
The COTW has pointed out the need to meaningfully increase government revenue (taxes and social contributions) as a percentage of national income. In this context, the narrowing of the tax base through the retention of the regressive and distortionary ‘help to buy scheme’ was unfortunate, although the decision to end the reduced 9% VAT on hospitality is an important step in the right direction. Future budgets will need to much more meaningfully tackle the system of tax expenditures and increase taxation on capital.
The energy shock represents a substantial loss of income for Ireland and for other energy importers. It is also a shock to world demand because the benefiting countries (energy exporters) are unlikely to fully compensate for the income shock to energy importers, non-energy sector businesses and households, in terms of exporter’s own additional demand. We may be facing into a number of years of high energy and gas prices, with it potentially taking a number of years for Europe to increase its own energy production capacity. The ‘cost of living’ crisis may therefore extend well beyond 2023.
The business supports were understandable given the desire to preserve productive capacity and employment in the face of the energy price shock. However, if energy prices remain elevated into Spring of 2023, then the government will need to be cautious about prolonging these supports for those businesses that are unable to adjust. Such supports cannot be ongoing and will eventually need to be wound down.
The economic outlook is darkening. Real incomes are falling, interest rates are rising and our main trading partners are likely to stagnate or fall into recession. The government is projecting GNI* will grow by just 0.4% in 2023 and that Modified Domestic Demand will increase by 1.2%. They also project inflation of around 7%. Any further shocks – such as contagion from the current self-induced crisis in the UK – could push the economy fully into stagflation. We are at least facing into this storm from a position of close to full employment.
The budget gives the economy a fighting chance of falling into recession next year and does so without endangering the public finances. We are fortunate in so far as the bloated and potentially unreliable corporation tax receipts are allowing the government to stimulate the economy without endangering the finances. Even so, it was a mistake to try and insulate all households over the next six months. Better targeting would have made for a better budget.
Budget 2023: NERI Post-Budget analysis takes place next Wednesday, 5 October in the Fórsa offices, full details and registration here