Dr. Tom McDonnell:

Mr. Nugent and I thank the Chair, the select committee and its staff for the opportunity to appear today to discuss the recommendations contained in the committee’s report on indexation of the taxation and social protection system. We will comment upon the report and discuss recommendations, updates, and developments in the intervening period. The committee’s report was broadly supportive of the principle of indexation. NERI’s view is that indexing all social assistance payments to various appropriate benchmarks, including child, working age and pension payments and the income thresholds for benefits is the most efficient way to design the welfare system if we are genuinely serious about ensuring adequacy and eliminating deprivation, and doing so in a manner consistent with fiscal sustainability.

Indexation should apply to all benefits and thresholds if it is to apply to any benefits and thresholds. However, price indexation is generally insufficient because it will only keep living standards at their current level; it will never improve them. For this reason, indexation to wages or to economic growth is preferable, and even then, it is only sufficient if the relevant rate - the pension rate, for example - is already at or above its adequacy threshold. Indexing to price inflation will also see inequality increase over time as welfare benefits will fail to keep pace with labour income and capital income in most years. On the other hand, wage indexation to something like a percentage of median weekly earnings would anchor welfare rates to developments in the labour market thereby minimising the risk of unintended distortions. Growth in wages, in addition, means

higher tax receipts from labour and consumption taxes. Linking social assistance rate increases to increasing wage rates thus means de facto linking them to increasing fiscal capacity and to developments in the wider economy. Any benchmarks for sufficiency will ultimately have to be based on the cost of living for various cohorts.

Once an appropriate set of benchmarks is established for each of the welfare rates there would need to be a two-stage process. The first stage would see welfare rates converging on the benchmark, as is currently the case with the new national minimum wage which will be benchmarked to 60% of the median wage. Once the benchmark is achieved, the second stage begins and annual growth in the rate is then indexed to growth in the selected benchmark. Income smoothing over a two- to three-year period can be used to ensure real welfare rates do not deteriorate if real wages fall, but also that the rates do not become decoupled from the benchmark over time. There are a range of ways to approach income smoothing and various arguments for and against forward and backward looking approaches to indexation. We are happy to discuss further.

The case for indexing the tax system is more contentious.

Non-indexing the tax system will, of course, marginally increase the effective rate of tax on labour income over time for those middle- and higher-earning individuals earning enough to be captured by higher rates. On the other hand, non-indexation or bracket creep will add to Government revenues over time and will do so in a way that is less politically fraught than increasing tax rates on things like carbon or VAT or introducing new sources of revenue, such as a site value tax or water charges. This fact is particularly pressing given the key finding of the report of the Commission on Taxation and Welfare that the overall level of revenues from tax and PRSI as a share of national income must increase materially to meet future challenges to fiscal sustainability. The mixed political reaction to that report shows just how difficult it will be to achieve this. A final point on this is that non-indexing of the tax system does not pose the same existential adequacy issues for households that is posed by non-indexation of the welfare system.

Since the committee's report, the IMF has put together a new 2023 data set on indexation in public finances around the world. It found that 115 out of 192 countries have at least one form of fiscal indexation. It found that pension indexation is most common in Europe. Globally, from 93 countries in total, 40 countries index to prices, 15 countries index only to private wages and 38 countries have some form of mixed indexation. Other social assistance indexation, namely, non-pensions, is most common in advanced economies. Some 31 countries have some indexation to price and 15 have some indexation to other variables. Indexation of personal income tax thresholds is less common. Some 18 economies automatically adjust thresholds and another 16 do so regularly. Finally, public wages are the least likely to be indexed, with very few countries doing so. Some of these countries index public wages to prices, while others index to variables such as growth.

The Commission on Taxation and Welfare was clear in its analysis in its 2022 report that it saw benchmarking of social assistance payments and thresholds as the key necessary reform to the welfare system. Specifically, it recommended that the Government undertake a regular benchmarking exercise of all working age income supports, including supports for people who are unemployed, people with disabilities, people parenting alone and so on, following which multi-annual targets should be set for social welfare rates which provide for regular incremental progress. As noted in the report, annual increases in social welfare rates should be based on a transparent and evidence-led process. Its view was that the adequacy of social welfare rates is central to poverty reduction. This implies different rates to reflect, for example, the cost of disability for various cohorts. Crucially, the commission also argued that secondary benefits for people of working age should be designed on a cross-departmental basis to ensure policy coherence and assess the cumulative impact of all benefits, thresholds and cliff edges. Any independent indexation body that was set up would ideally liaise on an ongoing basis with such a cross-departmental group. The process of reforming existing structures and benefits and adopting the commission’s various reforms would ideally precede the multi-annual two-stage indexation process. Good quality data on household income and household spending will be crucial.

Unfortunately, the Government’s response to the cost-of-living crisis and the subsequent rise in the deprivation rate over the last two years has shown clearly the inadequacy of the tools being used by the Government to protect against poverty and deprivation. Despite being advised by a range of NGOs and national and international institutions to adopt a targeted approach to the cost-of-living crisis, the Government persisted with a slew of untargeted once-off measures and inflationary tax cuts, including to households that were in no danger of poverty or deprivation and at a time of record net household wealth. Once-off measures were an entirely inappropriate response to a cost-of-living shock. The reality that the increase in the cost of living was structural, cumulative and permanent was either not acknowledged or, when it was acknowledged, it was stated that we did not have the State capacity to make appropriate targeted interventions. Policy failed because it did not have a benchmarking and indexation process in place. We need to be able to do better next time.

Of course, indexation has now entered the policy tool kit with regard to the national minimum wage. This reform was perhaps prompted by the need for the Government to come into line with the EU’s adequate minimum wage directive, which sets a target of 60% of the median wage. The indexation of the minimum wage makes it easier to index social welfare rates as they can be calibrated multi-annually to ensure there are no labour market disincentives inadvertently created.

In conclusion, benchmarking and indexation are important policy tools that can improve well-being and reduce inequality, poverty and deprivation. Properly designed and coupled with other policies, these tools are consistent with fiscal sustainability and, indeed, with wider labour market goals. In practice, an independent ongoing body including civil servants, NGOs and academics should be established to determine appropriate benchmarks for the various rates and to recommend to the Government as part of the budgetary process. A clear process of indexation will enhance budgetary transparency and improve the quality of the national debate about poverty, distribution and fiscal impacts but, at the same time, the recommendations should be treated as such and need not tie the hands of elected representatives. However, even with this discretion, automatic indexation would become a de facto baseline against which policy is assessed, rather than the current no-change baseline we use at present.