Brexit has potential to wipe out Government’s fiscal space

A British exit from the EU could reduce Ireland’s economic growth by 1.2 per cent over two years, potentially wiping out much of the Government’s “fiscal space”.

The likely drag on Irish gross domestic product (GDP) from Brexit was contained in the Government’s summer economic statement.

The forecast, which does not factor in a major depreciation in sterling, equates to about €2.5 billion on current GDP metrics, which is more than the Government’s planned budgetary adjustment for 2017and 2018.

Minister for Finance Michael Noonan acknowledged the potential impact on Ireland of the UK voting to leave but insisted the fall-off in Irish GDP would be "containable" within the Government's fiscal plans.

Publishing the statement, he said the Government expected to have roughly €1 billion for spending increases and tax cuts in October’s budget.

This is nearly €500 million more than projected at the start of the year and €100 million above the figure signalled in April, and reflects the current strength of the economy and the associated tax dividend for the exchequer.

Based on current macroeconomic projections, Mr Noonan said the available “fiscal space” for the next five years would be €11.3 billion.

This is the amount that remains after providing for pre-committed policies such as demographics, the Lansdowne Road agreement and capital plans, he said.

He said a particular focus of tax reduction in the coming budget would be the continued phasing out of the Universal Social Charge (USC) with an emphasis on low and middle income earners.

“This will help us to incentivise work while maintaining a broad tax base,” he said.

The Government has pledged to abolish the USC gradually over the next five budgets.

The scope for new measures in the upcoming budget is below the €1.5 billion announced in the 2016 package, which was also augmented by a series of supplementary estimates.

With new EU rules restricting supplementary budgets, Mr Noonan said the health and justice departments would have to live within their allocations.

Minister for Public Expenditure and Reform Pascal Donohoe also announced an additional €1 billion for capital investment over and above the €4 billion already signalled in the programme for government.

This will bring total capital spending over the next five years to €5 billion.Mr Donohue said the breakdown and profile of the €5 billion has yet to be finally decided, but €200 million has already been committed and announced for the new Local Infrastructure Fund.

“We are making this announcement today in order to further fast track the delivery of important infrastructural projects, including those that address social problems in the areas of health and housing that I have already spoken about, but also to reduce the number of infrastructural bottlenecks that could hold our economy back in the future,” he said.

Mr Noonan also announced plans for the establishment of a so-called rainy day fund, with €1 billion assigned per year from 2019 onwards.

“It is appropriate to set aside a certain amount each year which can be used to support activity and employment should it be necessary,” he said.

In its most recent report, the Irish Fiscal Advisory Council strongly advocated removing money from the economy through such a fund as a way to prevent overheating and a return to the boom and bust cycle of previous eras.

The Fine Gael Government’s has already signalled it plans to spend two thirds of additional resources on expenditure programmes, and one third on tax cuts over the next two budgets.

From 2019 onwards, the ratios would change, with 46 per cent going on expenditure programmes, 20 per cent on tax cuts and 34 per cent on the rainy day fund.