In this NERI blog, NERI Co-director, Dr. Tom McDonnell discusses the government's 'cost of living' intervention.
The government's 'cost of living' intervention was somewhat difficult to understand from this humble economist’s perspective. In particular, the decision to retain the privileged 9% VAT rate for restaurants and hotels at a cost of around €300 million is difficult to justify if not bizarre at a time of record employment, tight labour market and strong economic growth. The Labour Force Survey shows that employment is up by 217,000 over the last three years (9.2%) and that weekly hours worked is at a record level. The female employment rate is at its 2nd highest ever level, while the male employment rate is at a 15-year high.
There is simply no need for a stimulus at this point, notwithstanding that the 2022 outlook is admittedly mixed, with concerns about rising interest rates, weak trading partner performance and declining real incomes. The household savings rate is well above its historical average while net household wealth is at record levels. This implies that the better off cohorts could easily absorb the increase in their cost of living simply by reducing their rate of savings, and are in no danger of any qualitative decline in living standards. There is certainly no shortage of resources available to the demographics that tend to avail of expensive restaurants and hotels. In addition, the more successful a business is the more VAT receipts it will generate. Thus, the VAT cut will disproportionately benefit the businesses that need the least support. Finally, I might also note that 'accommodation and food services' sector is by far the worst paying of the 14 main economic sectors. All in all, it really isn’t clear why the sector deserves special treatment, particularly at this point in the economic cycle.
Recommendation 6.11 of the Commission on Tax and Welfare (COTW) report states that ‘the Commission does not support the use of VAT reductions as a short-term stimulus measure’. I find it extremely unlikely that the Department of Finance was advocating for retention of the 9%, so we can most likely attribute the decision to the political lobbying power of the special interest group. It shows us once again the danger of ‘temporary’ tax expenditures. They create motivated lobby groups that work to retain and ‘normalise’ their special privilege at the cost of the taxpayer. This was ultimately a political economy decision rather than an economic decision.
That is not to say that there isn’t a cost of living crisis. The latest CSO SILC data makes clear that there is indeed a crisis. Cumulative inflation over 2022 and 2023 may run close to 14% and real incomes will decline for most households over this period. Analysis from the CSO shows that lower income households were experiencing higher inflation rates in 2022 due to their higher share of spending on essentials like energy and food. These households tend to have fewer savings, if any, and are much less able to absorb the rise in the cost of living.
The deprivation rate increased from 13.8% in 2021 to 17.7% in 2022. Of particular concern is that children have a one in five probability of living in deprivation. Child poverty has life-long implications for people’s outcomes. Also, of grave concern, is that the deprivation rate stands at 44.3% for persons with disability, 43.5% for lone parents, 48.6% for the unemployed and 35.6% for renters. This is a failure of incomes policy.
The cost of living package did include a set of ‘once off’ bonuses for certain groups (pensioners, lone parents, people with disabilities) as well as a once-off child benefit top-up. This follows on from the range of once-off supports announced as part of Budget 2023. Yet once-off payments are not the best way to address cumulative increases in the cost of living. Once-off payments only make sense as a response to once-off costs. That is not what is happening. We are experiencing a structural increase in the cost of living. Average annual growth in price inflation will be lower in 2023, and then again in 2024, but the rate will not decline. Lump sums and double payments won’t help poorer households manage the structural increase in their cost of living this year, and therefore households on fixed incomes will be worse off and more likely to be experiencing poverty and/or deprivation.
A far superior approach and one that will hopefully be in place for Budget 2024 would be a commitment to index the welfare system and also to commit to introducing an evidence-based system of cost of living benchmarked supports. Recommendation 12.1 of the COTW report proposes that ‘Government undertakes a regular benchmarking exercise in respect of all working-age income supports including supports for people who are unemployed, people with disabilities and people parenting alone’. Pensioner supports should also be benchmarked, while the high level of child poverty implies the need for a second tier of enhanced child income support.
It’s time to move to an evidence-based approach to welfare policy with a core focus on income adequacy and on reducing the cost of universal basic services.