Mr. Joe Cullen:

On behalf of the Department of Finance, I thank the Chairperson for the invitation to appear before the committee. We are happy to provide the Department’s expertise to support the committee in examining the question of indexation of the tax and welfare system and, in particular, the rationale for and against indexation of the tax system; the approach that might be taken, including how it might operate; and how automatic indexation might affect budgetary sustainability.

We have followed very closely earlier discussions which the committee has had with other contributors over recent weeks. Those discussions have covered in some detail the rationale behind indexation of the tax and welfare system and we are happy to make available our analysis to further inform the discussion today.

The Department of Finance’s responsibility, and hence expertise, in this area largely relates to tax policy. However, the Department also has responsibility for overall fiscal sustainability. In that regard, as part of our contribution, we can outline the extent to which the EU fiscal rules impact on budgetary flexibility and, in particular, how the rules would account for a system of automatic indexation, as compared with the present approach.

In terms of the underlying rationale, when welfare support payments or personal income tax credits and bands are increased in a particular year while earnings and prices are rising, such an approach seeks to ensure that the purchasing power of welfare supports is maintained and the value of take-home pay for those at work is preserved. Our ESRI colleagues indicated during their appearance earlier this month that indexation of tax and welfare changes in line with wages growth as opposed to prices growth is the only way to ensure that welfare recipients and workers see their income grow at the same rate. We also note in this regard that the current programme for Government contains a commitment that from budget 2022 onwards, "in the event that incomes are again rising as the economy recovers, credits and bands will be indexed linked to earnings." The question of whether the base reference for the index used should be prospective or retrospective is also a point for consideration and it is brought into particular focus at the moment by current price and wage movements.

A further key point made by our ESRI colleagues, one which we would underline, is that, historically, changes to tax and welfare parameters have, on average, kept pace with earnings. This aligns with the Department’s own analysis when we look at the effect of budget changes over time on the personal income tax system. The picture as it applies internationally was addressed in detail by the ESRI in its presentation to the committee. In our view, it would be important to explore this aspect and reflect carefully on any learnings, while remaining cognisant of the fundamental differences in approach to taxation and welfare that exist across countries.

In relation to the steps that might be required to create an indexation system, these would initially be likely to require policy decisions regarding the scope of the change. Questions in this regard include whether it would involve both the tax and welfare systems; whether it would apply to all elements and supports or just a key subset; and whether the same degree of indexation would apply to both systems in any year. Other questions include whether indexation should take place by reference to increases in wages or prices; whether the index used would be retrospective or prospective; whether, and to what extent, a facility for discretion to suspend or modify the system in any particular year would be built into the arrangements; and whether the system would be placed on a statutory footing or something less binding, for example, a set of non-statutory guidelines.

Were such a system to encompass both tax and welfare, it would be likely to require in advance of the annual budget close co-ordination and co-operation at the political and official levels across a number of Government Departments in order to discuss and agree matters such as the degree of any deviation from the expected extent of indexation, if the system allowed for this and, of course, the percentage index to be used.

Returning to the issue of the rationale for having a system of automatic indexation, a key attraction of such an approach is that it might be expected to give more certainty to beneficiaries on both the tax and welfare sides, both individuals and families, from year to year about the value of their income or take-home pay and entitlement to supports. At the same time, as has been pointed out by contributors previously, the main drawback is that, to the extent that automatic indexation might apply, it would limit or curtail Government flexibility around the discretionary allocation or non-allocation of resources in any particular year. This would be likely to have practical implications not only within the tax and welfare systems but also for the allocation of resources for support and incentive schemes across a wide range of other areas of government.

As noted earlier, the approach of successive Governments over the years has been one where automatic indexation has not applied each year and where budgetary flexibility has been retained in large measure from year to year. However, as has also been noted, this approach has delivered results which are broadly similar to what would have been achieved if indexation to earnings growth had been in place. Ultimately, the question of annual automatic indexation is one of political choice and preference.

I thank the Chair and members of the committee for their attention. We are happy to provide further information or clarification on any point.