Income tax cuts might sound good, but how do they affect the economy?

Opinion: income tax cuts would increase spending, prices and inflation yet some Government members are proposing them for political reasons

There have been a plethora of signals recently which indicate that the powers-that-be are trying to slow the economy down. The ECB has increased interest rates and the Irish Government appear reluctant to spend the billions they have saved up. These strategies make sense given that inflation has been increasing in the last year and that rising prices aren't helping the cost of living crisis.

Slowing the economy down would mitigate against issues like inflation and slow the rise of prices. The current government policy of saving rather than spending seems to indicate they are committed to tackling rising prices.

So why then have some Government junior ministers recently proposed a cut to income tax? This is a completely counter intuitive strategy if you want to decrease inflation. A cut in income tax would increase people’s disposable income, encourage spending and further increase prices through inflation.

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From RTÉ Radio 1's Today With Claire Byrne, row over Government ministers calling for tax cuts

So, why is an income tax cut being proposed? Simple answer, politicians need votes.

Ideally, politicians would have incentives which are exactly in line with what is best for society, and broadly speaking, they do. A politician has the incentive to be elected and re-elected by the voters of their constituency. Assuming that citizens will vote for candidates who do a good job, this means one would think politicians have an incentive to do their job well. But more specifically, it means politicians have an incentive to please voters. I don’t think it should be seen as a coincidence that Fine Gael are talking about a cut to income tax amid rumours that a general election may be called in October.

The economic purpose of a strategy like this would be to increase people’s spending and stimulate short-run economic growth. A Keynesian economist would generally advise that this be used during a recession to help the economy recover via an increase in consumption. The trade off with this strategy is that prices will go up when money starts circulating the economy again. During a recession however, this won’t be too much of an issue because spending and prices should be lower. Currently, this is not the case in Ireland.

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From RTÉ Radio 1's Today With Claire Byrne, are tax cuts a good idea?

Inflation is an issue for Ireland right now as prices have risen by over 8% from February 2022 to February 2023. An increase in consumption now may further increase inflation and worsen the cost of living crisis with even higher prices. What’s particularly frustrating is that the government knows all of this.

I would wager it is the exact reason they have been eager to save rather than spend the billions of euro they now have in their National Reserve Fund. My sense is that they are aware that any further increases in expenditure while the economy is near capacity would further exacerbate inflation. This is the same reason the ECB are finally increasing interest rates to make it more expensive to borrow money.

This raises an important question about the sincerity of the government’s concerns for 'middle Ireland’. If the Government are actually as worried about middle Ireland as they say they are, why aren’t they putting the billions of euro they already have towards this effort? Why are they opting for a tax cut instead? Both strategies could achieve the same goal, putting more money in the hands of middle Ireland.

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From RTÉ Radio 1's Morning Ireland, why are food prices still high if inflation is falling?

It’s because they would induce inflation by spending money. They also know they would be held responsible when inflation led to people’s income and savings being eroded over the next few years. On the other hand, taxing people less makes the people themselves do the damage. If the Government cut taxes, it’s not completely their fault if citizens spend their extra disposable income– that’s the consumer’s fault, not ours!

Providing people with a tax cut during a time where we have already experienced high inflation places the blame for inflation on the taxpayer while making it look like you did them a favour in the process. This is a particularly handy strategy to pursue if you also happen to need their votes in a few months.

Good politics, then, is rarely good economics. The reason Irish politicians may be opting for a tax cut when they’re supposed to be curbing inflation is the same reason people opt for a take away when they’re trying to lose weight. The tax cut tastes better.

The views expressed here are those of the author and do not represent or reflect the views of RTÉ