The recent report published by the Irish Fiscal Advisory Council (IFAC) has suggested that the government’s budget policy could be driving up the cost of living. The IFAC posits that the government’s increase in economic demand has elevated prices, costing an average household an additional €1,000 annually. The government has rejected this claim, highlighting that inflation rates have simultaneously decreased with other EU nations.
The IFAC’s argument is centred around the idea that the government’s strategy of increasing demand via tax cuts and accelerating spending where the economy is already at full potential is causing a surge in prices. Despite a decline in general inflation, a significant factor being the large decrease in energy costs, IFAC has noted persistent price increases in specific service sectors like eateries, accommodations, renting, and healthcare services, including doctors and dentists. The council proposes that these inflation rates are a direct result of booming local economic activity, influenced in part by the government’s budget strategy.
IFAC’s case is reinforced by a research study by the Central Bank released earlier this year. Like the council, the researchers from the Central Bank assert that the economy has been exceeding its maximum potential since the upswing after the Covid pandemic. They have predicted that the government’s violation of its own fiscal rule of maintaining an annual growth rate in permanent spending at 5% is contributing approximately 0.5% to the annual inflation rate. They further calculate that this would cause prices to be 1.9% higher by 2025 than they would have been, leading to IFAC’s €1,000 figure based on yearly household expenditure of €52,000.
While it’s no mean feat to accurately nail down cause and effect in this situation, both the IFAC and the Central Bank agree that prevailing wage growth is a by-product of strong growth. Likewise, in line with IFAC, the Central Bank also anticipates continued inflation in the service economy, predicting that it will maintain a rate of 3% till the year 2026.
The escalating cost of living in Ireland is deteriorating, leading to questions as to whether or not the Government is responsible for an additional €1,000 in household bills. With a burgeoning population, is the state in a position to manage it adequately?
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The phenomenon of inflated Irish prices seems to be intensifying compared to the situation in the rest of Europe. The latest data from Eurostat reveals that only Denmark surpasses Ireland as the most costly EU country, with prices exceeding the average by 42 per cent. Four years ago, in 2016, Ireland held the same rank, but the expenditure was only 25 per cent above the norm. By 2019, preceding the onslaught of the pandemic, the figure had escalated to 34 per cent. The steady increase in Ireland’s cost compared to other nations impacts not only its residents but also has a notable effect on its competitiveness.
A glance back to the mid-2000s shows a concerning trend: the cost growth of services has significant outpaced that of goods. An index mapping goods, services and total consumer prices uncovers that goods’ prices have marginally increased by slightly over 8 per cent since 2016. In contrast, the cost of services has surged by 34 per cent.
This pattern of divergence is part of a broader international circumstance, even though the Irish scenario seems incredibly stark. ECB research accentuates that this price chasm, tangible throughout the eurozone since its inception, presents how complex inflation and its correlation with customer purchasing power are.
It is specially noted that in a completely open economy like Ireland, intensified demand typically catalyses marked price hikes for services like the domestic ones we utilise daily, in contrast with globally traded goods. In-depth analysis indicates that due to high employment rates and advanced earnings, Ireland’s strong local demand will likely reflect most heavily in the service prices where the supply struggles to keep pace with enhanced spending capacity. Simultaneously, many imported goods remain less affected.
With the costs of wages making up a significant percentage of the total costs for domestic services, the highly competitive labour market may also influence prices for consumers, as companies might pass on higher wage costs in their pricing.
According to the analysis, the rising services inflation is set to persist within the Irish economy, particularly in sectors where there’s a supply shortage such as medical professionals, childcare and rental properties. The government is essentially maintaining the status quo, and the surges in the economy demand leading to inflation and wage increases consequently pressurises the coalition to adjust household incomes and income taxes to prevent inflation from heavily impacting. The Central Bank’s study notes that even with modifications to bands and credits, the income tax derived from wages is increasing, partially due to heightened wages pushing more individuals into the higher 40% tax bracket, thus reducing the actual value of tax credits.
Even though tax rates remained the same, the paper indicated that the effective income tax rate — calculated by dividing the total income tax receipts by the overall employee remuneration — surged from 24% in 2021 to nearly 25% in 2023. This indicates a rise in the portion of compensation taxed at the higher rate, leading to a covert tax on those employed, that equates to approximately €1.2bn. More people working in high-paying jobs could also influence this, but the slightly increased tax on numerous earners was primarily contributing factor.
To prevent this recurrence in 2025, Finance Minister, Jack Chambers, would need to allocate between €1.1bn-€1.2bn to fully modify tax credits and the standard band to match expected wage inflation. This would utilise most of the €1.4bn set aside for tax cuts (though these figures could slightly rise due to extra tax revenue).
Despite the talk of budget “giveaways”, it is prudent to question the actual affect following inflation adjustment. A substantial amount will be necessary for the adaptation of the income tax system to inflation. If predictions from Ifac and the Central Bank prove correct about the government’s budget policy influencing inflation, it will further cost households and diminish the real value of measures announced on budget day.