Increasing income tax credits and bands to stop people paying more tax as they earn more and hiking pensions will cost the Exchequer up to €1.2bn.
Raising pensions and other welfare rates to counteract rising prices will add hugely to the Budget costs, the Economic and Social Research Institute (ESRI) says. But the changes are necessary to stop people slipping into poverty and to avoid income inequality.
The ESRI study comes after the Government committed last year to moving to a system of increasing pension rates in line with inflation and average wages.
The study states it is necessary to index - or increase - the credits people who pay tax through PAYE receive to stop them paying more tax as incomes rise. A tax credit is the amount of income earned before paying tax.
There is also a need to adjust the bands to stop people ending up on the higher tax rate. This refers to the amount earned on the lower tax rate before your income is taxed at the higher 40pc rate.
Failing to index, or increase, tax credits and bands and welfare rates to take account of higher wages and prices will lead to greater income inequality, the ESRI pointed out.
The ESRI paper comes as wage growth in the economy has accelerated to over 3pc last year, the fastest rate recorded since the recession.
Indexing tax and welfare rates to wages will see real incomes rise at the same rate across all earning levels.
But indexing in line with price rises will mean the greatest gains for high earners, as price rises then to be lower than wage increases.
Both price and non-indexation will result in increased income inequality and poverty rates.
The ESRI favours indexing income tax changes and welfare rates to wage rises.
Adjusting income tax credits and bands and linking State pension rates to wage rises will cost €1.2bn.
Linking changes prices will be cheaper at €460m.
However, economists said Finance Minister Paschal Donohoe only has €600m for tax and welfare adjustments after he meets prior commitments on pay rises and other spending.
There may also be a need to increase indirect taxes such as excise duty and carbon tax. This is to avoid the returns from these falling over time.
Means tests for the likes of GP visitor cards, childcare and housing benefits will also not be adjusted to account for higher incomes.
ESRI senior research officer and an author of the report Claire Keane said linking pensions and social welfare benefits to inflation would be a positive move in terms of inequality and poverty.
"However, the cost of doing so in line with price inflation would be €460m, or €1.2bn if increased in line with wage inflation."