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The trouble ahead after Budget 2022

Surge in tax revenue transforms outlook for public finances – but big questions lie ahead

The job of the two budget ministers in the run-up to the big day each year is twofold. They have to persuade the public that the economy is going swimmingly – and get their ministerial colleagues to accept that there is very little additional money to spend.

After this package, a few Ministers will be going back to Minister for Finance Paschal Donohoe and Minister for Public Expenditure and Reform Michael McGrath and saying: "but you never told us . . ."

The turnaround in the exchequer financial forecasts has been extraordinary. But the Government's updated forecasts were only published over the weekend, by which time the bulk of the work on Budget 2022 was done.

Gap

Over the summer, the Department of Finance predicted the Government would need to borrow more than €14 billion this year to bridge the gap between revenue and spending.

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However, the target set in the budget was €8.2 billion, a really significant reduction. In total, the amount borrowed this year and next year will be 40 per cent less than anticipated, meaning the national debt will remain under €240 billion next year, rather than previous estimates of over €250 billion.

The reason for this is that the economy has taken off much more rapidly than expected. Tax revenues this year are more than €4 billion higher than anticipated in last summer’s forecasts, and predictions for next year have been upped by a similar amount.

With spending and debt servicing estimates also coming down slightly, the outlook for the public finances has improved sharply. This is how the Government managed to increase spending on budget day and still cut borrowing. Staying withing the existing set spending limits meant most of the impact of stronger than expected growth went to a lower deficit. Last night the Irish Fiscal Advisory Council, the budget watchdog, said this had put the public finances on a more prudent path.

Can this continue? It all depends on economic growth remaining strong, of course. In the short term, there is no reason to think this won’t happen. The recovery is broadly based and the economy is being driven by a much higher than expected pick-up in consumer spending and a continued growth in exports.

But beyond that there are questions looming – some of them old and some more recent. One is the return of inflation and how we will deal with it. A range of welfare and fuel allowance increases will help households, but many are already facing a €400-plus rise in fuel bills.

Rise

Together with clogged-up supply chains and job shortages in many sectors, the energy crisis may start to have a more noticeable economic impact next year, both here and internationally. And it means that the era of super-low interest rates may draw to an end sooner than we might have hoped. There is still great uncertainty about how the world economy emerges from all this but this will really matter.

Other spending pressures loom. The debate over the carbon tax is just the foothills of a massive national discussion which is necessary sooner rather than later on the climate change agenda

The ageing population is another key spending pressure – focused around the pension debate.

And beyond this the trend is now firmly towards a bigger State, with no support in Leinster House either on Government or Opposition benches for a smaller State/lower tax model. In fact, a large amount of the reaction to the budget from Opposition and interest groups was asking for yet more. You could call it the Oliver Syndrome.

Spending

The Government has spent billions during the pandemic, and underlying spending is due to rise 5.5 per cent next year and by 5 per cent in subsequent years. The real political issue for it is to show that this can now deliver better public services – more housing, better healthcare and childcare and so on.

For now, considerable extra spending – and some very modest tax reductions – are being paid for by soaring tax revenues and by borrowing, albeit at a lower level and now to fund capital spending. But Ireland’s national debt remains high and the exchequer finances are vulnerable to any slowdown over the next few years, notably from the massive reforms in corporation tax, the impact of which is very hard to predict.

So some way has to be found to pay for the bigger State and the ageing population. Donohoe has asked a commission on tax and welfare to examine all this and its reporting date of next summer suggests these issues will start to come into focus for next year’s budget.This budget was not the one to increase taxes – not coming out of a pandemic. But sooner or later higher PRSI and other revenues will be needed.

Cash

The politics of this will be difficult. Everyone wants a bigger State – but believes someone else should pay for it. Restoring the link between what you pay and what you get is a key political challenge.

For now, the rapid economic bounceback has allowed the day of reckoning to be put off. It is a much smoother exit from the pandemic than might have been expected. But with spending firmly on the rise, how we might pay for it is a question still unanswered.