Where is the strategy? An uninspiring and questionable budget

In this blog, NERI Co-director, Dr. Tom McDonnell gives his opinions on Budget 2025.

Fiscally questionable
Budget 2025 contained a range of spending increases and tax cuts totalling about €10.5 billion of which €2.2 billion was once-off in nature. Ostensibly the public finances are in great shape with a projected general government surplus of €9.7 billion in 2025 (2.9% of GNI*) and over €6 billion going towards longer term investment funds. Surpluses are projected out to at least 2030 and the net debt ratio will be just 41.8% of GNI* in 2025. Unfortunately, the headline pictures masks vulnerabilities. Most notable are the unknown sustainability of the corporation tax yield and the longer-term structural fiscal deterioration that will arise from ageing demographics, the costs of the climate transition, and other factors.

The NERI’s post budget seminar was held earlier this week with presentations from Dr. Rory O’Farrell of TU Dublin, Susanne Rogers of Social Justice Ireland and Michael Taft of SIPTU. A video of the seminar will be posted on the NERI website next week.

My own view is that the scale of the budget was questionable in the current economic context. An expansionary budget makes little economic sense when the economy is operating at close to full employment. There are already significant capacity constraints due to labour shortages and infrastructure deficits. While the budget will add somewhat to inflationary pressures this will at least be relatively modest in scale.

Budgets should be counter-cyclical. In other words, if the economy is doing badly governments should act to boost the economy, and if the economy is booming they should try and slow things down. Unfortunately, budget 2025 is pro-cyclical and pours extra money into an already hot economy. It harkens to the reckless pre-crash budgetary strategies although the chances of a similar collapse are fortunately very slim in the short-run.   

Clearly the budget owes more to short-term electoral concerns than it does to sensible fiscal management. We are using potentially transitory corporation tax receipts to fuel a pre-election giveaway. Without these receipts the budget would be in deficit. The Department of Finance are estimating an underlying deficit of €5.7 billion next year despite the fact that the economy is performing so well and therefore benefiting from cyclical factors (i.e. lower than average unemployment payments and higher tax receipts). The structural deficit which adjusts for cyclical factors and the corporation tax windfalls is estimated at 2.7% of GNI* next year. 

The entirety or at least a larger proportion of the vulnerable component of the corporation tax yield (estimated at circa €15.4 billion in 2025) should be going into a combination of the longer-term Investment, Nature and Climate Fund (INCF) and the Future Ireland Fund (FIF).

Regressive tax cuts
There were €1.4 billion (net) in tax cuts. Most of this went towards cuts in personal taxation with the benefits primarily going to top half of income earners. The main tax cuts (€40 million or higher) were:

1. Income tax (€1.12 billion in first year, €1.29 billion full year cost): Increase of €2,000 in the standard rate cut-off (now €44,000), tax credits were increased by various amounts ranging from €60 to €300. Employee and personal tax credits both increased by €125.
2. USC (€470 million in first year, €540 million full year cost): Reduce 4% rate to 3%. Increase in 2% rate ceiling by €1,622.
3. Housing tax break - Help to Buy (€185 million full year cost) – scheme extended to 2029
4. Reduced 9% VAT rate for gas and electricity (€110 million) – extended until 30 April 2025 
5. Inheritance tax (CAT) (€88 million full year cost) – increase in each of the tax thresholds – by €65,000 in case of category A 
6. Sectoral tax break – Audio-visual sector (€67 million full year cost) – relief for unscripted production
7. Tax break - Rent tax credit (€65 million) – Increase of €250 for individuals and €500 for joint assessed units
8. Business tax break – Relief for Investment in Corporate Trades (€46 million) – Increase in investment limit for various schemes
9. Housing tax break – Mortgage interest Relief extended for a further year (€40 million)

The main tax increases (€40 million or higher) were:

1. Carbon tax increased to €63.50 (€122 million in first year and €157 million in full year)
2. Stamp duty on residential properties above 1.5 million (€80 million in a full year)
3. Cigarettes – pack of 20 up €1 (€69.7 billion full year)

The overall tax package is largely regressive. A single worker with no children on €30,000 will see a €5 increase in take-home pay whereas a similar worker on €75,000 will gain €20. Other non-minimum wage groups will gain somewhere between these amounts with the higher paid tending to do better.

Some of the wealthiest families will benefit by over €21,000 from the increase in the inheritance tax (Capital Acquisition Tax) threshold to €400,000. In comparison, a worker on €40,000 would pay around €64,000 in taxes after 10 years working, while a minimum wage worker would have to work for most of a year to earn the value of the inheritance tax cut. 

We can also see that the budget contains the usual collection of regressive tax breaks such as mortgage interest relief, help to buy relief and various business reliefs. Overall, the big winners from the tax changes will be the wealthiest families and those on higher incomes that stand to benefit from all of the changes to personal taxes. The relative losers are those without wealth and workers on lower incomes.

The evident preference for using tax breaks to address perceived or actual policy challenges is problematic. The Department of Finances estimates revenue foregone of about €8 billion in 2023 around circa 3% of GNI*. In addition to being economically distortionary and generally regressive, tax expenditures also narrow the tax base. This shifts the tax ‘burden’ on to other groups and tax bases or reduces the scope for public spending. The Commission on Taxation and Welfare recommendation that the use of tax expenditures should be scaled back over time for transparency, equity and efficiency reasons made little impact on this budget. 

The tax cuts will eventually push higher taxes on to future and younger workers. This is because we will soon need to grapple with the fiscally very costly megatrends of an ageing population and green transition as well as a swathe of other challenges. Even so, the tax package was at least relatively modest. The economy-wide tax burden will fall marginally from 40.4% in 2024 to 40.2% in 2025.

Over-reliance on once-offs will not protect the most vulnerable

The ongoing reliance on ‘temporary’ universal cost-of-living measures is unfortunate. Once-off measures will not protect vulnerable households from material deprivation and poverty in a context of permanent structural price increases. Such measures at best postpone the loss of real income from rising prices. 

Most welfare supports have failed to keep pace with the price increases of recent years so that once the once-off measures are withdrawn we will likely see a rise in the rates of poverty and deprivation. It is also perhaps no coincidence that much of the value of the once-off supports will go to households later in 2024, around or before the general election. The government could have chosen a different path. For example, it could have introduced a second tier of child benefit that would have lifted tens of thousands of children out of poverty.

Infrastructure announcements are welcome
The budget announcements regarding infrastructure were a rare bright spot and very welcome. Notably, the AIB and Apple money will be allocated to roll out infrastructure in the years ahead. This is crucial as Ireland has very significant deficits in housing, energy, water, transport and other areas. These are all constraints on the economy. 
However, it is not clear whether the government has a strategy to encourage the supply of construction workers. There will need to be much greater emphasis on funding for apprenticeships as well as better terms and conditions in the sector if we are to solve the housing crisis and simultaneously make the investments needed for the green transition.

Expanding universal services
Finally, the measures designed to reduce the cost of using public services in areas such as public transport and in education and health are welcome. Over the longer-term these types of measure should be greatly expanded. Free or subsidised universal public services available to all are fundamental to any coherent long-term strategy for reducing cost of living pressures.
Ultimately budget 2025 will be remembered as a lost opportunity when we could have grappled with the crises in childcare, housing and numerous other areas but failed to do so. Hopefully we will see better in the upcoming party manifestos.

Conclusion
The medium-term fiscal structural plan is the next order of business although we will not see a worked-out plan from Ireland until after the next government is established. While the EU fiscal rules will not impact Ireland to any meaningful extent the 5-year plan will nevertheless hopefully address the current lack of adequate multi-annual budgeting or medium-term forecasts. It will also be interesting to see whether the plan engages with the recommendations of the Commission on Taxation and Welfare and whether we will see reforms that move policies away from the annual big bang announcements on budget day. One thing to watch for is whether or not the new government moves towards the benchmarking and indexation of welfare payments and tax bands. 

Fiscal space was a big theme in the 2016 election. It will be interesting to see if fiscal sustainability is an issue in the next one.