Key Messages
The Government should stick to its existing budget plans for 2019 of a budget-day package of €0.8 billion. This would increase government expenditure (net of tax measures) in line with the sustainable long-term growth rate of the economy. Various estimates would put this at approximately 3¼ per cent per annum. This combined with inflation would imply an approximate limit of up to €3½ billion for spending increases or tax cuts for 2019. There is no case for additional stimulus in 2019 beyond this.
The cost of previously announced measures, including sharp increases in public investment spending, means that the scope for new initiatives – over and above previous commitments – in Budget 2019 is limited. If additional spending measures are to be addressed in 2019 beyond the quantity in the Summer Economic Statement 2018, these should be funded by additional tax increases or through re-allocations of existing spending.
An earlier move to a small budget surplus than planned would be warranted if cyclical growth and corporation tax receipts continue to exceed expectations. Any unexpected increases in tax revenues or lower interest costs that arise this year or in 2019 should not be used to fund budgetary measures beyond those currently planned. The risks of overheating and the narrowing window of opportunity provided by a favourable external environment would suggest that improving the budget balance by more than currently planned would be desirable. This would be especially warranted if revenues were to outperform expectations for factors that may be temporary. This includes higher corporation tax receipts or stronger-than-expected growth in the domestic economy. The Government should instead use these receipts to build buffers either through additional contributions to the Rainy Day Fund or through a budget surplus and faster debt reduction. Moreover, expenditure ceilings should not be allowed to continue to drift up as unexpected – and likely cyclical or transitory revenues – arise.
The economy looks set to continue to grow at a rapid pace. A number of indicators show that the Irish economy is still growing rapidly. Forecasts assume that this pace of expansion in the domestic economy will only gradually moderate and the current outlook for Ireland’s main trading partners remains reasonably strong.
Most plausible estimates suggest that the domestic economy has been growing faster than its potential growth rate since 2014 and is now, in 2018, close to its potential. Central forecasts suggest that it will move beyond potential from 2019 onwards, with overheating emerging in later years.
It is inevitable that adverse shocks will occur in coming years. Further ahead, three major sources of potential downside risks to Ireland are apparent: Brexit, rising protectionism, and the international tax environment. The size and nature of potential impacts from various Brexit scenarios are highly uncertain. Standard models may not fully capture the extent of Ireland and the UK’s closely integrated supply-chain networks, and other key channels may be more important than is assumed. In terms of the international tax environment, the highly concentrated nature of Irish corporation tax receipts means that substantial reductions in government revenue could arise if even one large firm were to relocate its operations to elsewhere.
Efforts to stabilise the public finances since the crisis have proven successful, but improvements on the budgetary front have stalled since 2015. This comes despite a strong recovery in the economic cycle – both domestically and internationally – in addition to a supportive monetary policy environment. Non-interest spending has risen at essentially the same pace as tax revenue since 2015 so that the strong cyclical recovery and favourable external environment have not led to any notable improvement in the underlying budgetary position (excluding interest savings). It is clear that recent revenue growth has been supported by short-term cyclical developments and a possibly transient surge in corporation tax receipts. Looking through these effects, the underlying structural position would appear to have deteriorated since 2015.
Ireland’s debt burden is still among the highest in the OECD. When set against a more appropriate measure of national income like GNI*, Ireland’s net debt burden for 2017 is equivalent to 96 per cent, the fourth highest in the OECD behind only Portugal, Italy and Japan.
The Government should reinforce its medium-term plans to ensure that these are credible. Focusing on the right budgetary stance and being prepared to be more cautious than the fiscal rules allow is the correct approach for the Government to follow over the medium term. This is particularly true, given that the strict legal application of the current fiscal rules using the EU’s Commonly Agreed Methodology for potential output estimation will not necessarily prevent a repeat of procyclical fiscal policy mistakes made in the past. In particular, the Rainy Day Fund – though potentially useful – is currently only half-formed and needs more development if it is to be effective. A better goal for the Fund would be to counteract some of the procyclical bias currently present in the fiscal rules and evident in policy in the lead-up to the last crisis. As it stands, the Rainy Day Fund is not countercyclical and is only envisaged as a fund that would deal with unexpected shocks or events.