Budget season kicks off earlier these days and the holding of the National Economic Dialogue (NED) this week – where interest groups put their case - has sounded the starting gun ahead of October’s package.
Over recent years governments have favoured using scarce resources for extra spending over lower taxes. And this is set to continue.
This means less wherewithal for tax cuts – and here the promised return of the VAT rate for the hospitality sector to 9 per cent looms large.
Costing over €750 million a year, it would eat up most of the spare cash for tax reductions. And this will be a big political issue. Because the trade off for this is likely to be much less by way of an income tax package for households.
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The VAT move would leave less cash for what are referred to as income tax “cuts” – but are really adjustments to the income tax system to take account of inflation.
If income tax bands and credits are not adjusted for inflation each year, then taxpayers end up seeing a bit more of their income taken in tax – for example due to a higher proportion of their income being payable at the higher 40 per cent rate.
It is what is called “fiscal drag” in the jargon and is one of the most powerful hidden tax increases available to any government. Just by doing nothing, the tax burden creeps higher.
Central Bank researchers found that the average income tax rate on all incomes increased from 24 per cent in 2021 to 24.9 per cent last year in 2023.
Much of this is due to more people having higher paid jobs but, according to the bank, fiscal drag – the lack of full indexation of the income tax system for inflation – is also factor. Some tax relief has been given in recent budgets, but not always enough to take account of wage inflation.
And, as things stand, this may continue into 2026. The mood music is interesting. At the NED, Tánaiste Simon Harris spoke of the " solemn commitment” the coalition has given to reduce the hospitality rate back to 9 per cent. The lower rate had applied from 2011 to 2019, when it was increased back to 13.5 per cent.
The rate was then cut for all hospitality business on November 1st, 2020 in response to the challenges faced by these sectors during the Covid-19 pandemic.
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The expiry date was extended a few times, but the rate finally returned to 13.5 per cent on September 1st, 2023. Department of Finance officials finally thought they had won the battle – but then the general election came along and a big lobbying campaign from the sector.
The subsequent Programme for Government said: “The Government will bring forward measures to support SMEs (small and medium enterprises), in particular the retail and hospitality sectors, acknowledging the increased cost pressures on these sectors and this will entail changes to VAT, PRSI and other measures.”
While the return to 9 per cent was not mentioned specifically, we were told that the two big parties had agreed that the rate would be returned to this level for “food-based hospitality”.
This means that cafes and restaurants would get the lower rate, but hotels would not – at least in relation to their accommodation services.
Splitting in this way may not be easy – Revenue, according to previous Dáil debates, cautioned about “administrative and operational difficulties”. What happens, for example, to a small Bed & Breakfast which charges one amount for an overnight stay and “the full Irish?” How is the VAT rate apportioned?
Nonetheless, according to Harris, the die is cast. The problem is that even restricting the cut to food-based hospitality will be costly and take up the vast bulk of any likely tax package.
Department of Finance officials estimated last year that the annual cost of cutting the 13.5 per cent rate to 9 per cent was €764 million, while restricting the cost to food-based items would be €545 million.
The Department, wanting to stop the return, warned against it in last year’s pre-budget advisory papers, saying it would represent an “enormous fiscal transfer of taxpayer’s money to the sector which the evidence available at present does not support.”
Apart from the cost, the Department said that recovery in consumer spending should benefit the sector, where employment had already returned to above pre-pandemic levels. Ireland’s VAT rate was not out of line, they argued, as “14 EU countries have a VAT rate of 12 per cent or higher on food services”.
The sector’s case is also well known – its representatives point to a large number of closures and the financial pressure on SMEs from official measures including a rising minimum wage, and – from next year – pensions auto enrolment, though some extra impositions have been delayed.
But the political choices for the Government are stark enough. The total package for reducing tax in the budget may not exceed €1 billion by much, if at all. The VAT package would thus consume a significant amount of this.
Other SMEs may wonder why they are being left out. And households may see a very restrained income tax package, which is unlikely to keep pace with wage inflation.
As Minister for Finance Pachal Donohoe said somewhat delphically at the NED: “If we decide that we are going to make a particular set of decisions and investments, that means there are other things that we will not do.”
With uncertainties rising, Donohoe and Minister for Public Expenditure Jack Chambers have both underlined the need for caution.
They are likely to spell out to colleagues the trade-offs from the VAT cut, particularly in terms of scope for income tax measures. Trade-offs do not imply that a particular policy is " right or wrong” but focus on what is called the opportunity cost – the price of not being able to use the money elsewhere.
The VAT cut is unlikely to provide much to consumers, bar perhaps holding down the rate of inflation they face while eating and drinking out.
On the flip side, it will limit the cash for adjustments in income tax bands and credits at a time when many budgets of lower and middle income households are tight.
Fiscal drag will take its toll. And households will also feel the pinch from the ending of the once-off universal supports in energy credits and double child benefit - assuming that the Government holds to its indications that these will not be repeated.
It is impossible to know how the world will look when the budget is presented in October. But whatever happens the first budget of the new administration, coming after last year’s pre-budget giveaway, is going to be far from easy to agree on. Prepare for summer sparks in the Cabinet.
