Corporation tax windfall allows Government to spend big and save at the same time

If the main focus of Budget 2023 is cost of living, the main enabler is corporate tax. The continuing business tax windfall is allowing Minister for Finance Paschal Donohoe to effectively face two ways at once.

He can lay claim to be spending significantly on the cost-of-living crisis while being prudent in setting aside €2 billion for the national reserve fund (the State’s rainy day fund).

The €11 billion overall package, split between €6.9 billion in permanent tax and spending measures that go into the base from 2023 onward and €4.1 billion in temporary measures, is one of the biggest budget spends on record outside of the Covid era.

It wouldn’t have been possible without corporation tax or would have required significant additional public borrowing. And you can see how well that’s going across the water in the United Kingdom.

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The Government’s pre-budget White Paper, published last week, illustrates the bulge in the public finances from corporate tax. It noted that if the windfall element were removed, the Government’s expected budget surplus this year of €4.4 billion would morph into a deficit of €4.5 billion.

Despite repeated warnings about the concentration risk of having just 10 firms accounting for more than half the receipts, the windfall keeps getting bigger. The tax is expected to net the exchequer €21 billion this year and nearly €23 billion next year, double the take of just a few years ago.

This largesse is providing us with a financial backstop right in the middle of a cost-of-living crisis.

Announcing that he would place €2 billion of corporate tax revenue into the national reserve fund this year and €4 billion in 2023, Donohoe said: “These contributions effectively mean that we will have: banked a large share of the additional corporate tax revenues; ensured that they do not fund permanent expenditure; and supplied the exchequer with additional firepower to respond to challenges over the coming years.”

[ Budget 2023 main points: Vacant homes tax introduced, excise reductions on fuel extended, tax credits for renters ]

[ Putting money back in people’s pockets will not offset effects of ongoing inflation ]

[ Do you have a query on how this year’s budget affects you? ]

[ Standard rate income tax threshold rises €3,200 to €40,000 ]

One insider said the strength of corporation tax probably caught the Government off guard (and not for the first time), facilitating the bigger-than-expected contribution to the fund.

The darkening economic cloud in advance of us was, however, reflected in Donohoe’s revised forecasts for the economy. He projected modified domestic demand – the indicator that best reflects conditions on the ground here – would rise by a mere 1.25 per cent next year. Headline inflation is expected to average 8.5 per cent this year and just more than 7 per cent for 2023. These are big revisions.

As real income contracts, this is going to feel like a recession for many households.

Because there are so many moving parts, budgets are difficult to assess. But you could do no worse than ask three basic questions of Budget 2023: does it keep the public finances on a sustainable path? Is it a wise use of public resources? And in the current circumstances, will it add to inflation?

While the increase in permanent spending breaches the Government’s 5 per cent spending rule, core expenditure remains – more or less – in line with the long-run growth potential of the Irish economy (which is usually put at about 3 per cent) and when taking into account the impact of higher prices. Hence you could say it fulfils the sustainability criteria.

Broad measures like energy credits are costly and while they help poorer households, they also go to well-off households that perhaps don’t need them.

The Government will say that there are many middle-income families that earn too much to qualify for supports but that are still heavily affected by rising prices and designing a more means-tested system would be too onerous and too slow.

That means a lot of public money will end up in the wrong place.

And then there is the question of whether Budget 2023 will be inflationary. Placing more money in people’s pockets when the economy is running at close to full capacity – we’re close to full employment – isn’t a good idea as it creates additional demand when supply is limited, placing further upward pressure on prices.

The Government will claim that permanent expenditure is not rising significantly and that much of cost-of-living measures are temporary and therefore their impact on inflation will be limited. Temporary budget measures have in the past become permanent and that’s when the inflation impact could be more problematic.