This “Flash Release” gives a preliminary analysis of Budget 2023 and some of the key areas that the Council will explore in its next Fiscal Assessment Report (due out in November).
Economic growth is projected to slow in the coming months before recovering in 2023
While the economy has continued to grow this year, underlying demand is expected to remain subdued in the coming quarters due to higher energy prices and lower international demand.
The Department forecasts modified domestic demand growth of around 7.5% this year, before slowing sharply to just over 1% in 2023, and reverting to about 3% in later years.
Ireland will continue to benefit from developments in the digital and pharmaceutical sectors. Unemployment is expected to remain low by historical standards.
The macroeconomic forecasts were assessed by the Council as being in an endorsable range. However, the forecasts only cover three years ahead — shorter than the five-year-ahead forecast horizon adopted by the Department in past years. In order to inform policy decisions with a medium-term orientation and to ensure the consistency of short-term forecasts, it would be preferable to use a longer, five-year-ahead forecast horizon for all forecast exercises. This would be in line with past commitments.
Prices are set to rise more than previously expected
Inflation is projected to average 8.5% this year, remaining high at 7.1% in 2023, before falling back towards 2% in 2024 and 2025.
This upward revision to inflation forecasts for 2023 primarily reflects higher gas prices related to disruptions in supply to Europe from Russia.
Price pressures have become more broadly based as higher food and energy prices have fed through the economy. Labour shortages, rising rents, and ongoing supply disruptions internationally have added to price pressures.
Expectations that inflation will fall in later years rest on the assumed decline from recent peaks in oil and gas prices. However, there remains substantial uncertainty around how these will evolve.
Downside risks to the economy have intensified in recent months
Risks from the shut off of gas supplies this winter have risen. There is also substantial uncertainty around price pressures, while financial conditions could continue to tighten significantly.
Domestic risks could also derail growth, including competitiveness issues and capacity constraints arising from labour shortages, rising wages, and housing costs.
Other risks from Covid-19 and Brexit-related uncertainties continue.
Excluding excess Corporation tax, the budget balance remains in deficit
When excluding the corporation tax receipts that are estimated by the Department to be potentially ‘windfall’ in nature, the government’s budget balance is set to register a deficit of €8 billion in 2022 and €3.8 billion in 2023.
Given the unpredictable nature of corporation tax receipts and the reliance on a small number of multinationals, it makes sense to “look through” some of these receipts: the Department estimates some €9-10 billion are ‘windfall’ in nature, similar to the Council’s own estimates.
The overreliance on corporation tax has grown substantially in recent years
Corporation tax receipts are expected to account for more than one-in-every-four euro collected in Exchequer taxes.
Corporation tax will this year surpass VAT for the first time as the State’s second largest tax source.
The core budget package itself is broadly in line with the Summer Economic Statement plans and stands alongside a large package of temporary measures.
The €6.9 billion overall core package is made up of core current spending increases of €0.7 billion in 2022 and a further €4.3 billion in 2023; along with core capital increases of €0.8 billion in 2023; plus a package of €1.1 billion of permanent tax measures, primarily to update tax bands.
There are temporary measures equivalent to €4.4 billion for cost-of-living supports and supports to businesses, primarily during the winter months.
This makes the overall package exceptionally large compared to pre-pandemic norms.
Separately, there are unallocated contingencies of €2 billion for humanitarian assistance for refugees from Ukraine and €0.5 billion for Covid-related costs in 2023.
The temporary cost-of-living support measures are more targeted than previous supports
More than half of the temporary €4.4 billion cost-of-living package announced by the Government appears to be in the form of targeted supports.
However, some of the measures are still relatively untargeted, including the electricity credits, the double child benefit payment, and the extension of the VAT and Excise reductions on fuels, gas and electricity.
Overall, by broadly following the 5% Spending Rule, Budget 2023 strikes a balance between providing support and avoiding adding excessively to higher inflation
Increases in pay, welfare spending and pensions, together with temporary cost-of-living measures, will help to protect people from higher energy prices and wider inflation.
However, not all households can be fully compensated for the impact of higher inflation.
By largely following its 5% Spending Rule, the Government has been able to strike a balance between providing support and avoiding adding to inflationary pressures. The temporary deviation from the rule for 2023 is sensible in view of the very high rates of inflation.
It is welcome that the Government has signaled its intention to return to normal application for the spending rule from next year.
The Government should stand ready to take additional measures if needed if there are significant disruptions to energy supply this winter.
The core current spending increases are broadly in line with plans set out in summer
In summer, the Government set out plans to increase core current spending by 6.5% or €4.5 billion in 2023. The Budget 2023 plans imply a modest increase over and above this. Relative to the original level of spending planned for 2022, as set out in the Summer Economic Statement, core current spending is now set to rise by 6.7% or €4.7bn in 2023.
The increase in core current spending comprises €1.9 billion for measures to maintain the existing level of service, including demographics and price pressures; €1.4 billion allocated for public sector pay under the proposed extension of Building Momentum Public Sector pay agreement; with the remaining €1.4 billion going towards new measures.
The core capital spending increases next year are also consistent with previous plans
The core capital spending increase is also in line with previous plans for a €0.8 billion increase in 2023.
However, the fact that prices have increased and capital allocations remain unchanged raises questions. This means public investment is now set to be lower as a share of the economy.
It is unclear whether the volume of output delivered will be a lot less than originally envisaged or whether spending will ultimately be revised up to accommodate higher costs. Projects may also be deferred.
The Government is allocating €2 billion to a Reserve Fund
The Government plans to allocate €2 billion to a “National Reserve Fund”, which is intended to ‘bank’ a large share of the additional corporate tax revenues received, ensure these do not fund permanent expenditure, and give the Exchequer additional firepower to respond to challenges over the coming years. A further €4 billion is planned to be allocated in 2023.
The use of the Reserve Fund is welcome. It is in line with the Council’s advice to unwind the State’s overreliance on excess corporation tax receipts gradually over time and build up a buffer that can be used in future downturns.
The Government debt ratio is forecast to fall in the coming years.
As a share of modified gross national income (nominal GNI*), gross debt is set to fall to 86.3% of GNI* at the end of this year. This is still high by international standards, particularly for a small open economy. It is forecast to fall to 73.2% in 2025. This is due to fast growth and planned surpluses. Higher interest rates are unlikely to put upward pressure on the debt ratio in the short term.
Net debt, which excludes cash and other liquid assets, is forecast to fall to 72.9 % of GNI* at the end of 2022, and is projected to fall by an average of 5 percentage points per annum between 2023 and 2025, leaving it at 57.8% GNI* in 2025.
Ireland’s ageing population and climate goals will put pressure on spending.
The Irish population is rapidly ageing. This will put pressure on pension and healthcare spending at the same time that growth is likely to slow. The Government has said it will not raise the pension age, but is instead likely to put more of the burden on the tax system to meet the expected funding shortfalls.
The Government has not spelled out the fiscal costs of achieving its required 51% reduction in greenhouse-gas emissions by 2030. These could be sizeable. Revenues at risk could amount to as much as 2.7% of GNI*, while the additional public investment required could be between 1.7 and 2.3% of GNI* over the coming years (FitzGerald, 2021).