In this week's blog by NERI Co-director Dr. Tom McDonnell, he discusses the outcomes of Budget 2022.
Budget 2022 was a place-holder budget. It clearly wasn’t a fire-fighting budget in the vein of Budget 2021, but nor was it a truly post-pandemic budget either. For example, the EWSS will be retained until April and the VAT cut until August of next year.
The EWSS decision was welcome. The TWSS and EWSS have protected hundreds of thousands of jobs and the economy’s productive capacity. It would be wise to use the experience gained to develop a new short-time work scheme that can be applied in future recessions and as part of the response to the zero-carbon transition.
The economy is growing robustly with personal consumption expected to rise very rapidly next year as households wind down their excess accumulated savings. Underlying business investment and exports are also likely to grow. In this context, there was arguably a countercyclical case for deflationary measures on the taxation side.
However, a tighter budget would have been unadvisable given the ongoing uncertainty around Covid. Unemployment is still high and concerns about overheating are very much premature.
Cost of living
Ostensibly, the budget was focused on a set of expenditure measures designed to support firms and to protect household incomes against rising cost of living pressures, notably the bounce-back in energy prices.
HICP inflation is likely to be somewhere in the region of 2.5% next year, although there is significant uncertainty around price developments and the duration of higher inflation. Global trends are driving much of the increase in prices. There are substantial supply constraints and disruptions world-wide and it’s as yet unclear how long these constraints will last.
Many of the measures – such as the €5 increase in the pension - are unlikely to keep pace with inflation.
The additional resources for child-care are welcome though it remains to be seen what impact it will actually have on childcare costs. More fundamental reform of the sector will be required over the medium-term. The current model is broken and doesn’t serve the interest of the parents, the workers or the businesses themselves.
Distribution
The ESRI’s post-budget analysis shows that middle-income households marginally lose out relative to higher income and lower income households. However, the overall impact on disposable income is modest for all households. The ESRI modelling suggests small income losses in real terms for lone parents and retired couples, with no overall change to income inequality.
Inevitably, there were a slew of new or expanded tax reliefs. The poorly designed and targeted help-to-buy scheme will, unfortunately, be retained for another year. This regressive and expensive measure will merely push up house prices given the ongoing supply constraints in the sector.
The increase in the income tax was regressive and will only benefit middle and higher earners. USC and PRSI thresholds were mainly unaffected by the budget. Overall, the tax cutting component of the budget and the erosion of the tax base were short-sighted given the future pressures on spending arising from ageing demographics and the cost of the zero-carbon transition.
The regressive carbon tax increase and the increase in tax on fossil fuel cars were both necessary measures. There was arguably a case for even higher increases given the need for transformational behavioural change and the evidence that such measures do indeed reduce emissions. The new zoned land tax is welcome and could help with the housing crisis.
The 2.9% increase in the national minimum wage (NMW) will mostly be swallowed up by the rise in the cost of living. The living wage technical group increased the living wage by 4.9%, meaning that the NMW will fall even further behind the living wage in 2022.
Investment
Significant investments in climate, housing, childcare, R&D and healthcare services will be required in the next few years. It makes sense to borrow to pay for the cost of the net zero-carbon transition. Tackling climate change will require enormous capital investment by the Irish government over the next 30 years.
The higher level of capital investment should help to address the twin housing and climate challenges although there are concerns about labour supply constraints in construction, and the increase in retrofitting of social housing is lacking ambition. Indeed, it’s unclear whether the construction sector will be able to match demand for housing over the medium-term.
Fiscal Sustainability
Tax receipts have grown strongly in 2021. The government’s Economic and Fiscal Outlook projects that the national debt will fall over the forecast horizon (from 106.2% of GNI* in 2021 to 89.5% in 2025) and that the budget deficit will be almost eliminated as of 2023. The government balance is expected to be in surplus by 2025.
The improvement in the public finances reflects the withdrawal of temporary supports combined with the reduction in unemployment and strong economic growth. Overall, the fiscal position looks sustainable.
Choices
Eventually, we will have to choose between higher capital and current spending, and tax cuts, but that decision was postponed for another year. Corporation taxes (relative to GNI*) and taxes related to road transport (absolute terms) are both likely to fall over the next 10 years. What will replace these revenue streams?
As predicted last week, we will continue to be a low spender on per pupil education and on public R&D. Class sizes will remain amongst the highest in Europe. The cost of childcare will also remain amongst the highest in Europe. The housing supply problem will persist. The big decisions on climate still remain to be made. We can’t afford to keep treading water.