Despite warnings of overheating, the Coalition signals bigger budget package and again parks spending rule

Three months ago, the Government — in its Stability Programme Update — signalled that it planned to increase spending in the budget by approximately €4.3 billion and to adhere to the recently adopted 5 per cent spending rule. The rule seeks to anchor public spending increases to what the Department of Finance calls “trend growth” in the economy, 5 per cent in Ireland’s case.

The Summer Economic Statement, published yesterday, reveals that both pledges have now been dropped in favour of a bigger €6.4 billion budgetary package, involving an additional €5.2 billion in additional spending, which corresponds to a 6.1 per cent increase in core spending, and a €1.1 billion tax package.

The reason for this budgetary recalibration is most likely a combination of political pressure to relieve cost-of-living pressures on households and surging tax receipts. The latest exchequer returns for June indicate the Government collected a record €41 billion in taxes during the first six months of 2023, €4 billion more than the same period last year.

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Either way, the move is likely to elicit criticism from the Irish Fiscal Advisory Council (Ifac) and the Central Bank, which have been warning about overheating pressures in the economy and the dangers of exceeding the spending rule at a time of full employment and with consumer spending still growing strongly.

The Central Bank estimates that a 6.5 per cent increase in spending in the budget would add 0.3 per cent to inflation in 2024 and between 0.3-0.4 per cent to inflation in both 2025 and 2026, over and above where it would otherwise have been.

Economists typically want governments to use fiscal policy to pull against the prevailing wind, in other words to spend in a downturn and to cut back when the economy is running hot or close to full capacity thereby smoothing the economic cycle.

In reality, that’s a difficult political sell, particularly in the context of the domestic housing crisis and a slide in living standards driven by inflation and higher mortgage costs.

Minister for Finance Michael McGrath insisted the strategy seeks to strike a balance “between investing to deliver improvements in public services, while minimising the impact of fiscal policy on inflation and maintaining the public finances on a sustainable trajectory over the medium term”.

Justifying breach

He and Minister for Public Expenditure Paschal Donohoe, perhaps in anticipation of criticism from Ifac and others, spent a considerable amount of time at the economic statement press conference justifying their non-adherence to the spending rule.

They insisted that “the parameters” of the rule had been “temporarily” suspended to reflect the “highly elevated inflationary environment”. Since it was adopted in 2021, the rule has been adhered to once and is now about to be broken for the second year in a row.

The other side of the Government’s budgetary package — the €1.1 billion in tax measures — would primarily be directed at relieving the income tax burden on workers, said Mr McGrath.

In many ways, this is a free play for the Government as it will gain an estimated €1.3 billion in income tax receipts next year from workers in receipt of higher wages slipping into higher tax brackets, a concept known as fiscal drag. In net terms, the budget will actually lift taxes.