Assessing the distributional impact of budgetary policy: the role of benchmarks and indexation

This paper examines the potential role for increasing social welfare rates, along with tax credits and bands, in line with price or wage inflation – a process known as indexation. Ireland currently has a default policy of no increases in line with inflation, with ad hoc changes instead announced on Budget day. The recent ‘Pensions Roadmap’ commits to ‘a process whereby future changes in pension rates of payment are explicitly linked to changes in the consumer price index and average wages’, and the Minister for Employment Affairs and Social Protection has also announced the intention to examine an index-linked system for the wider welfare system. In light of these discussions, the paper examines how Ireland compares to other countries with regard to indexation. It also examines the impact that different indexation options have on income inequality and poverty over time. Both nominal freezes in taxes and social welfare rates and increases in line with price inflation result in an increase in poverty and income inequality in the longer run. Indexation in line with wage inflation, however, helps keep poverty rates and income inequality more constant in the longer run. Indexation would, of course, represent a cost to the Exchequer – for Budget 2020 we estimate that indexation of the tax-benefit system would cost in the region of €462 million, while indexation in line with average wage increases would cost in excess of €1.2 billion.