Fine Gael throwing a €1,000 tax cut into the mix started a row ... but it may not be far off what happens

Quite the Coalition row has been kicked off after an article by Fine Gael junior ministers Jennifer Carroll MacNeill, Martin Heydon and Peter Burke was published in the Irish Independent on Monday, in which, among other things, they called for a tax package in the budget which would be worth €1,000 to a middle income earner on about €52,000. Tánaiste Micheál Martin has accused the three of undermining the budgetary process. Enterprise minister Simon Coveney has countered that the three were merely outlining Fine Gael policy and had a right to do so.

This spat will pass, but it sets the scene for fraught budget negotiations in the months to come.

1. The background

There is money to spend in the 2024 budget, to be presented in October. We won’t find out exactly how much the Government actually plans to dish out in extra spending and tax cuts until it publishes the key pre-budget document, the Summer Economic Statement, in July. That will be preceded by what is called the National Economic Dialogue, a gathering where interest groups and lobbyists for various sectors lay out their budgetary asks. Subsequently the Coalition is due to get into detailed negotiated.

Fianna Fáil is irked because it presumably feels Fine Gael is pre-empting things, probably in part in a bid to claim credit for what may happen anyway. Taoiseach Leo Vardakar did not help the Fianna Fáil mood by promising a hike for pensioners.

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It remains to be seen whether this develops into a full-scale row about the share-out of budget resources, with Fine Gael pushing for more on tax than the other two parties want. It might, as the Coalition parties seek to carve out clear water in advance of the next election.

[ Coalition row: ‘No intention to upset anyone’, says Coveney after FG tax cut article ]

[ Fourth budget sees a chasm open between formerly united Coalition partners ]

2. The tax cuts argument

There was little particularly surprising about the article from the three junior ministers. Had it not included the phrase about the €1,000 less in tax for middle earners, it might have passed without much commentary. But it did.

The vast bulk of spare budgetary resources in recent years has gone on increasing spending, rather than lowering taxation. A lot of spending increases are baked in to maintain existing service levels before the budget share-out gets under way each year. And even then, pressures to increase spending in areas like health and education, as well as on entitlements for those on welfare and pensions, has meant the bulk of budget day resources has gone in this direction.

Last year’s tax package was a bit bigger, worth €1.1 billion. But this was out of permanent budget changes of €6.9 billion.

A further €4.1 billion was spent on temporary spending measures to support people through the cost-of-living crisis.

How much the tax package will be this year will depend on a few key decisions. First, with a forecast budget surplus of €16 billion next year, what will the total budget package be? Department of Finance officials warn that three-quarters of this surplus (€12 billion) is due to what it classifies as windfall corporation tax receipts – and say it would be unwise to rely on this money to fund ongoing new tax and spending commitments.

As one move to combat this, Minister for Finance, Michael McGrath, wants to put money aside in a new national investment fund but, given this won’t be up and running until next year, it is not clear how this will be dealt with in the budget.

Once the total amount of money available for tax and spending measure is decided, the next issue is the breakdown between the two – and then the precise measures to be introduced. Each stop of this process looks set to be controversial.

3. The vital role of inflation

The return of inflation has changed a lot of the budget parameters. Most obviously, it puts pressure on spending as more money is needed to provide the same level of service to the public.

But inflation also has an impact on taxpayers. If tax credits and bands are not increased in line with earnings, then taxpayers end up paying a bit more in tax each year, as the real value of credits declines and people are gradually pushed into higher bands in the income tax and USC systems. Economists can this “fiscal drag” and, over a period of years, it can have a significant impact.

In some countries elements of the welfare and tax systems – particularly pensions – are indexed for inflation. Ireland has traditionally not had indexation, preferring to leave the announcement to the Minister for Finance of the day, who typically presents inflation adjustments as a giveaway. As well as this political advantage, Department of Finance officials also prefer to keep flexibility from year to year, presumably to give more room for manoeuvre if the budget sums get tight.

Full indexation of the tax and welfare systems for inflation would be costly, though the exchequer does gain, too, from higher inflation as it also leads to more taxes in areas like VAT, as prices rise. Indexing the income tax system to fully take account of rising earnings would be likely to cost around €1.5 billion next year, depending on estimates of income rises. An issue here is that average incomes are being pulled up by high earnings growth in the top earnings sector, with increases more modest elsewhere.

The Government committed in principle to indexing the tax system each year from 2022 on and how this might work for personal taxes is part of a wider consultation on income taxes which has been kicked off by the Department of Finance. Indexing taxes would also inevitably meant the same being done for welfare and pensions.

4. What about the €1,000 for 2024?

A single middle income taxpayer on €50,000-plus benefited to the tune of around €830 from the income tax measures in this year’s budget, mainly due to an increase of the income level – from €36,800 to €40,000 – at which they become liable to pay tax at the higher rate. For a married couple with one earner, it increased from €45,800 to €49,000. There were also changes to tax credits and some USC relief.

A lot of these increases were needed to keep pace with inflation and so protected the spending power of households, rather than adding to it. There was also an element of catching up to do after inflation took off in 2022, averaging 8 per cent.

The increase in the standard rate tax band last year – the income level at which people enter the higher rate – of 8.6 per cent was in advance of inflation, which the department forecasts will average 4.2 per cent this year.

So the key political question, with inflation due to fall to 2.5 per cent next year on the department’s forecasts, is what size of income tax package is appropriate? Clearly the Government will want to ensure that inflation and higher wages do not lead to people paying more tax – in other words they will at least index large parts of the system. But the case put forward by the three junior ministers is that the budget should go further and involve real gains for middle income tax payers.

If the standard rate tax band is adjusted again - Fine Gael wants a €4,000 increase for single earners to €44,000 - then inevitably tax credits will be adjusted too. Fine Gael wants a €100 rise in personal credits. This is to ensure that lower earners, who do not earn enough to benefit from the extension of the standard rate band, benefit too. But the biggest cash gains would still go to middle to higher income earners. This is not just about how much taxpayers get - it is also about which income levels do best.

And if taxpayers are getting a boost in advance of inflation, then welfare recipients and pensioners can presumably expect similar treatment.

As well as trying to make ground in contentious areas like health and housing, this will be the real meat of the budget debate to come. By throwing the €1,000 figure into the mix, the three junior ministers have kicked it all off. It is hard to see a tax package less than last year’s level and it could be higher. The €1,000 forecast may yet not be too far off.