Three months out from the budget and we’ve already had a big widening of parameters

The Government would be running a budget deficit for the 17th consecutive year if it was not for the windfall component of our corporate tax receipts. That would be a sequence stretching all the way back to the financial crisis and to a time when the public finances here were keeping not just Irish policymakers up at night but EU ones, too.

That’s not to say the Government’s current budgetary position is built on sand – income tax and VAT receipts that reflect a strong labour market and consumers who are still spending despite the inflationary squeeze are also supporting it – just that it flatters to deceive. If corporate tax receipts fell back in line with the underlying performance of Irish economy, the €10 billion budget surplus projected for this year would morph into a deficit of €1.8 billion by the Department of Finance’s own calculation.

In such a scenario, the budgetary parameters would be a lot narrower, the capital spend on things like housing and health more constrained and the room for tax cuts or one-off cost-of-living measures practically almost non-existent.

As Minister for Finance Michael McGrath said recently, the Government is in a “sweet spot” financially.

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Put it this way, there are few governments in the world in a position to simultaneously announce a bigger-than-expected budgetary spend and signal a record end-of-year €10 billion budget surplus, the largest in the euro zone on a per capita basis while promising to stash away a significant amount of cash in a new sovereign wealth fund.

Most of Ireland’s economic peers are still trying to repair their balance sheets after big financial outlays during Covid-19.

Speaking on The Irish Times’ Inside Business podcast this week, Davy chief economist Conall MacCoille argued that there had been “too much catastrophising” about corporate tax and that the department’s base case is that revenue from the business tax will be stable and continue to grow gradually over the next four to five years.

“It’s a slightly difficult, nervous place to be when you’re so reliant on these corporate taxes so we should be prudent but at the same time we shouldn’t expect them to collapse either,” he said, noting the economy had strong multinational-dominated sectors that were forecast to continue to do well.

In the summer economic statement, Minister McGrath signalled a revised €6.4 billion budgetary package for 2024, almost on a par with the previous one, comprising additional spending worth €5.2 billion and tax measures worth €1.1 billion.

The budgetary recalibration is likely to have been driven by political pressure

This excludes the once-off measures to address the cost-of-living challenges, the so-called budget within the budget, which came to €4 billion last year and which is expected to be of a similar quantum this year, a worrying throwback to the days when finance ministers could spring budget day surprises. Responsible budgeting should hold no surprises.

The Coalition’s proposed spending package is €1 billion greater than the trajectory set out in April’s stability programme update (SPU), meaning the Government will breach its 5 per cent spending rule again next year. The rule, which aims to align annual spending increases with “trend growth” in the economy – in Ireland’s case 5 per cent – has been broken every year since its adoption in 2021.

That prompted one pesky journalist at the press conference releasing the statement to ask “how many times does a rule have to be ignored for it not to be a rule any more?” .

The budgetary recalibration is likely to have been driven by political pressure, as all budgetary calculations must be on some level. Despite presiding over full employment and strong economic growth, the Coalition’s failure to come to grips with the housing crisis in any meaningful way combined with a conspicuous slide in living standards on foot of rising prices has kept it on the back foot politically.

Either way, the additional spend is being facilitated via stronger-than-expected tax numbers.

Exchequer returns for June, published this week, indicate the Government collected €41 billion in taxes during the first six months of 2023, €4 billion more than the same period last year. Corporation tax generated a record €10.5 billion for the six-month period, €1.8 billion or 20 per cent more than this time last year.

The half-year total for corporation tax signals it will probably again overshoot the department’s €24 billion forecast for the year.

Criticism

The Government’s shifting budgetary stance drew sharp criticism from the Irish Fiscal Advisory Council (Ifac) on Thursday. It said the plan repeated a pattern and “undermines the credibility” of the Coalition. It also said the additional spending and tax measures risked “making high prices more persistent as a result”.

The council noted the revised spending plans “come at a time when unemployment is at record lows, and inflation remains high” and with “capacity constraints already apparent”. It said the “additional stimulus” to the economy would likely add 0.1-0.2 per cent to the annual rate of inflation in the short term.

It’s highly probable the public has become desensitised to warnings about an overheating economy

All told, coming just a day after its chairman, Sebastian Barry stepped down early, it was the sharpest criticism levelled at the Government by its financial watchdog for several years.

Back in 2019, Ifac rebuked the Department of Finance for “repeatedly” breaching its own targets; allowing public spending to advance at an unsustainable rate; and presenting unrealistic spending targets into the future. The council’s then chairman, Seamus Coffey, said there were “worrying echoes” of the 2000s when a cyclical expansion in tax revenues had funded a significant increase in public spending, a point that was said to infuriate the then minister for finance Paschal Donohoe.

Minister McGrath said 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”. On breaching of the spending rule, he said “the parameters” of the rule had been “temporarily” suspended to reflect the “highly elevated inflationary environment”.

It’s highly probable the public has become desensitised to warnings about an overheating economy. They seem to come and go – we were getting them in 2019 but the pandemic made them redundant – and are something of an abstraction for individual households struggling to make ends meet.

Similarly fussing about the Government spending rule might seem like much ado about nothing when rising mortgage repayments and higher food bills are placing such a squeeze on domestic budgets.

Nonetheless, capacity constraints, overheating risks, the future trajectory of inflation and the possibility that interest rates will remain higher for longer, frame the economic outlook here. They are also interrelated. The more we run up against capacity constraints, the more we bid up domestic inflation and the longer households remain squeezed by higher prices.

In his annual pre-budget letter to the Minister for Finance, Central Bank governor Gabriel Makhlouf said there were now “binding capacity constraints” in the wider economy and labour market that were contributing “to more robust domestically-driven price inflation”. The Economic and Social Research Institute (ESRI) has also warned the Government there is “no rationale” for tax cuts in the budget.

While the initial surge in inflation across Europe was driven by supply-side issues, most obviously energy prices and supply chain bottlenecks, domestically-driven pressures, such as wage growth, are now bubbling to the surface.

Many will assert Ireland is already a place of high prices. Events like the hotel price hikes associated with the recently-announced Taylor Swift concerts in Dublin next year will do little to puncture the argument that consumers here are being gouged at every corner.

Placing a significant chunk of our excess corporate tax receipts in a wealth fund or a savings vehicle, which could be used to generate returns for the State, could break the boom and bust element within Ireland’s capital spend

The sentiment coming out of central banks is decidedly more cautious, if not negative, as a result. According to the minutes of its June meeting, Federal Reserve officials signalled they intend to resume interest rate increases amid a growing consensus that more monetary tightening is needed to stamp out high inflation in the US.

European Central Bank president Christine Lagarde warned last week that euro zone inflation had entered a new phase which could linger for some time and that policymakers could be embroiled in a lengthy fight against price growth that will inevitably dampen demand. Already a downturn in global demand has triggered a slowdown in Ireland’s seemingly evergreen pharma exports, the first in nearly a decade, and a downgrade in headline growth as a result.

Economists are now warning that recession might be the price of achieving shared 2 per cent inflation goals as central banks globally enter a new phase in their battle with rising prices.

Pro-cyclical

Historically, Irish governments have been bad at managing the economic cycle, pushing money into the economy when it’s hot only to find themselves having to cut back when a recession hits. Ifac’s assertion that the Government’s latest plans for Budget 2024 amount to a “clear case” of this pro-cyclical fiscal policy is possibly the most pointed element in its reaction to the summer economic statement and a clear warning that trouble could lie ahead if such a policy is pursued.

It might sound abstract but the first thing that tends to get cut when the public finances are under pressure is the capital budget. It’s easier politically to take knife to infrastructural investment than to announce cuts in welfare or pension rates. But that is the main reason why we find ourselves with such glaring infrastructural deficits.

Placing a significant chunk of our excess corporate tax receipts in a wealth fund or a savings vehicle, which could be used to generate returns for the State, could break the boom and bust element within Ireland’s capital spend. The Government has been slow to move on this and putting €4 billion aside – as the Government did this year – is small beer in the context of corporate tax receipts that are expected to eclipse €24 billion this year.

“The proposed sovereign wealth fund could be used to smooth out often volatile capital spending over the coming years,” Goodbody economist Dermot O’Leary says.

While playing down the Government’s planned breach of its spending rule, he argues that “with no spare capacity remaining in the Irish economy, it can certainly be argued that the Irish Government should be aiming to have a dampening effect through fiscal policy”.

Minister McGrath will argue that he has resisted political pressure for big tax cuts, and the €1.1 billion package signalled doesn’t keep pace with inflation. Many workers will end up paying more in tax as their incomes rise and they slip into higher tax brackets.

He will also argue that his proposed budgetary package is split five to one in favour of spending increases over tax cuts, a reflection of the need to invest in services. However, we’re still three months out from the budget and already we’ve had a big widening of the budgetary parameters.