Budget 2027 – Planning for the storms to come

In this blog, NERI Co-director, Dr. Tom McDonnell gives his opinions on Budget 2027.  This is the second of a three part pre-budget blog series.

In my budget blog last week, I expressed concern we were echoing the budgetary mistakes of the past. 

Exactly what is our plan? How does Budget 2027 link to future well-being?

First, will the decisions to be made in Budget 2027, both on spending and tax, actually make people better off in the here and now? What are these policies trying to achieve and to what extent are the spending and taxation decisions helping to meet those goals? Will these policies provide access to affordable and high-quality public services such as healthcare and housing? Are these policies and decisions helping reduce poverty and deprivation? In terms of taxes, do people who are able to pay more actually pay more, and does our tax system properly account for affordability concerns? Do we tax all forms of income and wealth fairly? Finally, are our existing budgetary policies the most effective way of achieving both these and other well-being goals.  

Second, will our policies deliver longer-term prosperity. This forces us to think about how much public spending we need not only now, but in the future. It forces us to think about how much we spend on welfare and pensions and on different public services like health and education as well as on infrastructure and R&D. It forces us to think about how well that money is being spent. Finally, it forces us to consider how growth-friendly and progressive our tax system is, both in specific areas and overall. 

Third, we need to ensure that our budgetary policy is sustainable. This means we need a tax system that is capable of generating enough revenue to fund our public spending priorities and commitments. We need a political system that treats the long-term and intergenerational fairness seriously – climate justice is a particular concern here but also fiscal sustainability. There is a tendency for politicians to make short-term populist decisions around budget time particularly when close to elections and during economic good times. The consequences of this short-term focus often fall on the next government or, in some cases, the next generation. The time inconsistency between short-term benefits and long-term consequences makes us much more vulnerable to economic shocks and also hampers our ability to recover from them. 

The budgetary decisions that we make, therefore, need to fulfil three goals, they need to meaningfully improve the well-being of society in the short-term, they need to promote longer term prosperity, and they need to be sustainable both now and into the future. There will often be tensions between the three goals. Short-run well-being gains from tax cuts or cash supports may undermine longer-term prosperity and sustainability goals particularly when they are not temporary. Tax breaks for politically powerful groups may serve a short-term interest, but ultimately it will fall to the rest of us to cover the cost. 

What do we need to do?

We need to embed and hardwire sustainable budgetary policy into our economic model. 

To be economically radical we need to be fiscally conservative. 

To consistently and sustainably improve living standards we need to be resilient. In other words, we need to be capable of thriving and flourishing even under conditions of external or internal stress. We need to be able to respond with agility to recessions as well as to other shocks whether they be pandemics, trade wars, supply chain disruption, banking crises, or the inevitable plethora of technological and geo-economic transformations that await us. 

A good example of success in action was our ability to robustly support the economy and our workers and businesses during the Covid pandemic. In contrast, we must ensure we never again have to go through the deeply damaging austerity of the 1980s and the 2008-2012 period. That is what policy failure looks like.

If we are to respond robustly and successfully to future shocks and transformations, then we must not undermine the public finances when times are good. Yet great care is needed so that other critical goals such as people’s well-being and long-run economic growth are not sacrificed to budgetary rules.

More goals inevitably mean more complex rules. How should our fiscal rules interact with major economic transition costs? What are the appropriate protocols around the use of ‘once-off’ supports, and what should trigger such supports? How should we treat tax windfalls? 

Ultimately, we want to ensure that our fiscal policy is sustainable but, equally, that our fiscal policy does not impede needed investments in the long-term health of the economy. Common sense guidelines might include: 

1. Always be countercyclical – This means running meaningful current spending surpluses in the good times and even in the normal times. 
   1. Acting counter-cyclically and being fiscally conservative in the good times is what enables us to properly defend the economy and households during a recession. Over the medium-term, a government’s day-to day or current spending should be completely financed through taxation and not through debt;
   2. By building up a reserve of fiscal space during the good times policymakers can insulate the economy from international bond markets. The UK provides an example here where budget decisions can often be determined not by how they will improve well-being, but rather how financial market will react. Running a budgetary policy that leaves you at the mercy of bond markets is gambling on a future that is becoming more and more uncertain.  
2. Apply a medium-term target that protects investment spending - This is to ensure sufficient and stable resources for investment spending are protected across the economic cycle. 
   1. The amount we borrow to invest should (1) account for the state of the infrastructure we already have; (2) population growth and the medium-to-long-term needs and potential growth of the economy; (3) whether we have the resources to deliver that investment (i.e. do we have enough construction workers in the short-run to match our ambition); (4) whether making such an investment might overheat the economy, and what state the overall economy is in;
   2. Borrowing to fund investment is sustainable to the extent that the investments increase the economy’s productive capacity. If spending on infrastructure now will make us more efficient in the future then it will boost our long-run fiscal capacity and help to pay for itself;
   3. Additional capital spending may be desirable but, if pursued, should be sourced from running surpluses of government revenue in excess of current or day-to-day spending. 
3. Quarantine potentially transitory revenues – Windfalls and transitory or cyclical revenues should not be made available for use either to fund day-to-day spending or to finance tax cuts. 
   1. All potentially transitory revenues, for example the ‘excess’ corporation tax receipts, should be fully removed from the budget - either allocated to long-term savings funds, or to funding vehicles that support countercyclical investments in infrastructure when the economy experiences a downturn. We can see the example in the UK during the 1980s where a windfall from North Sea oil was used for day-to-day expenditure. This disguised the fiscal impact of tax cuts that took place over the same time period. Ultimately the UK’s precarious fiscal position today owes a lot to that mistake; 
   2. Other revenue sources may also prove transitory. For example, carbon taxes and other green taxes will decline over time to the extent governments actually succeed in reducing greenhouse gas emissions. Time-bound receipts of this nature should not be used to finance ongoing current expenditure or tax cuts elsewhere, but rather should be allocated to finance temporary green transition costs such as building out green infrastructure, subsidies for retrofitting and electric vehicles, and climate adaptation measures such as flood defences.
4. And start a mature debate – This debate should encompass expenditure needs, fiscal sustainability, intergenerational equity, and revenue composition and sufficiency. 
   1. Multi-annual and transparent fiscal planning needs to become a priority. Government fiscal projections should be shown at least 10 years in advance. With this in mind, the Republic of Ireland’s 2022 Commission on Taxation and Welfare (COTW) made 116 policy recommendations around reforms to tax and fiscal policy. If individual political parties disagree with he Commission then perhaps they might produce their own alternative medium-term plans.

Fundamentally we need to embed and hardwire sustainable budgetary policy into our economic model. If we can achieve this we will strengthen our economic resilience and protect ourselves from devastating and periodic bouts of boom and bust that culminate in inevitable and painful austerity.

The world is a volatile uncertain place. We should at least ensure we have our own house in order so we can withstand the storms to come.