Tax hikes and spending cuts needed to offset rising cost of living, state budget watchdog warns

Tax hikes and spending cuts will be needed to fully offset the rising cost of living next year, the state budget watchdog has warned.

he government faces a €2 billion bill if it wants to fully link or ‘index’ wages and social protection to inflation this year, which it can afford to do if it taps into a contingency fund created in the budget.

But the Tax Council said ministers would face “tough choices” from 2023 as prices for energy, food and other goods are expected to outpace pay rises.

“We’re not saying the government should necessarily index,” said Sebastian Barnes, chairman of the Tax Council. “He may not choose to do so as well.”

Linking public sector wages, social protection and pensions to inflation – known as indexation – is popular in some European countries.

Public and private wage increases in line with prices in Belgium, which experienced near double-digit inflation in April (9.3 pc), are among the highest in the euro zone.

But Belgium excludes the price of alcohol, tobacco and gasoline from its calculations, which are based on past inflation rates.

Spain, France, Cyprus, Luxembourg, Malta and Slovenia have automatic indexation of private sector wages, although their calculations differ.

Some adjust wages upward when inflation hits a certain rate, while others target only those earning the minimum wage.

Most of the seven countries – with the exception of Spain and France – also index public sector wages.

But full compensation for higher prices could lead to higher inflation, as people have more to spend.

“Large-scale and sustained spending would increase the risk of contributing to higher second-round increases in prices and wages, potentially destabilizing the economy and public finances,” the council said in its latest budget assessment report. , published today.

Protecting low-income households from rising costs should be the priority, he said.

The Ministry of Finance expects inflation to average 6.2% this year, although it could peak at nearly 9% this summer, according to other forecasts.

There is €2.5 billion left in the government’s €7 billion provident fund this year, which the council says could be spent on supporting Ukrainian refugees or on cost-of-living measures for more vulnerable.

“Fiscal policy cannot permanently protect the economy from falling real incomes,” the report says.

He also warned of splits in the economy as poorer households cut spending to cope with rising prices, while well-paid IT and pharmacy workers continue to earn and to spend.

A decline in overall demand for recreational activities, restaurants and non-essential retail could put additional pressure on sectors already impacted by Covid.

“It is unclear to what extent workers in still-depressed sectors might see demand in these areas pick up, or whether they will need to move to other areas where demand is greater,” the report said.

“In some cases, the same sectors that have seen reduced demand due to containment measures during the pandemic are also likely to face weaker demand due to price pressures during the war in Ukraine.”

At the start of this year, hours worked in administration, support services, accommodation and food were still down 16% from the end of 2019.