In this blog, NERI Co-director, Dr. Tom McDonnell gives his opinions on Budget 2027. This is the first of a three part pre-budget blog series.
Budget 2027 is just a few weeks away. The Irish Fiscal Advisory Council has already issued its annual pre-budget warning about the government’s unsustainable fiscal policy. As always, it will, in practice, be broadly ignored by the government. This is unfortunate. We need to embed and hardwire sustainable budgetary policy into our economic model.
To be economically radical and protect our budgetary sovereignty we will need to be fiscally conservative.
Most of the big budgetary decisions are already made. The Summer Economic Statement provides for a fiscal package of €8.5 billion in new measures. This will be made up of €5.9 billion in extra current (day-to-day) spending, €1.1 billion in extra capital spending and there will be tax cuts amounting to €1.5 billion. Much of the nominal increase in additional day-to-day spending will be absorbed by inflation, population growth and the demand cost pressures of an ageing population. A deal on public pay that adequately compensates workers will also need to be accommodated. The mooted indexation of the income tax system will absorb most if not all of the space for tax cuts. In practice there will be very little in new policy measures (e.g. 2nd tier child benefit, roll-out of a public childcare model, better supports for the green transition) and without tax increases there will remain limited space for major spending initiatives in the future.
The economy continues to grow strongly with the employment close to a record high. This is not an economy that needs fiscal support. Such support would be procyclical and inflationary. A more prudent approach would be a package marginally smaller than the economy’s potential growth rate. Times of economic strength are when we should be increasing taxes and preparing for the future with a degree of strategic foresight. This doesn’t preclude us from protecting people from cost of living pressures but it does mean we have to choose who to support and how best to do it.
Ostensibly the public finances look in good shape in the short-term with a fiscal surplus of close to €9 billion expected this year and a net debt ratio of around 42% in GNI* terms. Yet the headline figures mask severe vulnerabilities and concentration risks. Thus far, the surplus means that Ireland has at least been spared the recent bond market pressure faced by the United States, the United Kingdom, France and other advanced economies.
We desperately need mature and honest debates about how we manage the public finances, about how we raise revenue, and about how we allocate our precious fiscal resources.
The Republic of Ireland and the UK (and as a consequence Northern Ireland) have been consistently plagued by unsustainable boom-bust fiscal policies that have arguably been the greatest source of economic volatility over the last half century.
Perhaps most dramatically, the Great Financial Crash at the end of the 2000s caused severe and partially self-inflicted recessions which were then made worse by governments withdrawing money from the economy via tax increases and public spending cuts as part of a policy that came to be known as ‘austerity’. While the austerity measures undoubtedly deepened the downturns, it was actually the budgetary and other policy decisions made during the ‘boom times’ that left so little room to manoeuvre when things went badly.
The fiscal mismanagement and eventual debt crisis became so severe in Ireland that economic sovereignty was de-facto and infamously ceded to the Troika of international institutional lenders in 2010. What had gone wrong? Prior to the crash, the government of the day, via a slew of generous and unnecessary tax breaks, had unwisely fuelled an already unsustainable boom based heavily on house building, property transactions and growing asset values. During this boom the government used cyclical and, therefore, temporary receipts to persistently narrow and undermine the tax base and make unfunded spending commitments. The underlying fiscal damage was exposed when the construction boom collapsed and was then made far worse by a costly series of bank bailouts. While the scale of the crisis was not the same in the UK, we can see a similar pattern in how revenues that flowed from financial services in the City of London created an illusion of sound public finances that was blown away when the crash came.
During the recession that followed, the Irish government – due to spiralling borrowing costs – decided it had no choice but to withdraw money from the productive economy via current and especially capital spending cuts and via tax increases, all of which further shrunk demand and deepened the downturn. The UK government also chose to follow this path, even though it did not face the same constraints as Ireland. Many scars remain to this day, not least via the collapse in construction activity and employment and chronic housing and infrastructure deficits. The UK and Ireland were far from unique in this experience and in other European countries austerity policies helped catalyse the rise of far-right populism.
More recently, the UK’s experience under former Prime Minister Liz Truss shows that fiscal policy continues to have real constraints, and not just for small countries. The UK’s public finances remain fragile and UK governments have in recent years been talking about cutting back public expenditure and increasing taxes at a time when the economy needs a boost, particularly for investment spending which has fallen back so much over the last 15 years.
Headline surpluses can be illusory. There are legitimate concerns that current budgetary policy in Ireland is insufficiently prudent. Fragile and heavily concentrated ‘windfall’ corporation tax receipts whose sustainability is uncertain are being used to balance the books and ignore longer-term problems.
Looking at the official data, Ireland’s public finances look like they’re in great shape. However, these statistics give a false sense of security and the real position is far more precarious. This is because, for a number of years now, money raised from corporation tax has vastly exceeded what had been expected given the size of the economy and its composition. This surge in receipts is being driven by a tiny number of companies, meaning that if just one of these companies were to go under, lose market share, or even perhaps move intellectual property assets out of the country, then Ireland’s budget position would experience a significant shock. Relying on these receipts is, therefore, neither sensible nor sustainable. While this surge of receipts is still in train, we don’t know when it might stop and how bad the fiscal fall out might be.
In effect, the Irish government is cutting taxes, increasing spending, and using the windfall receipts as an excuse to ignore the longer-term impacts on the public finances. The report of the Commission on Taxation and Welfare has been swept under the carpet as an inconvenient Cassandra where it is kept company by the Fiscal Council’s annual reports. Without the windfall, the Irish government would be running annual deficits at a time of strong economic growth and record employment rates. This profound failure of governance is making Ireland more vulnerable to future shocks and to factors outside of our control.
The government’s own Future forty Report provides for a range of scenarios for the trajectory of Ireland’s public finances which are based on different assumptions for productivity, investment, population and labour supply. The central scenario projects a fiscal deficit of 7.9% of GNI* in 2065 and a debt of 148%. The scenario projections for deficits range from 0.8% to a wholly unsustainable 21.8%, and for debts from 27% to a similarly unsustainable 424%.
It’s all echoing of mistakes past.