Quarterly Economic Observer - Autumn 2017 - "Revenue Sufficiency and Potential Reform in the Republic of Ireland"

This edition of the NERI’s Quarterly Economic Observer (QEO) outlines our latest expectations for the economic outlook in the Republic of Ireland and Northern Ireland (Section 1) and examines public finances and revenue sufficiency in the Republic of Ireland (Section 2).

Economic Outlook for the Republic of Ireland

• The Irish economy is growing strongly and is likely to continue to do so for the remainder of this year and well into 2018. We project growth of 4.5% in 2017.
• Labour market conditions should continue to improve in the short-term with strong employment growth but with modest increases in real wages. The unemployment rate is projected to fall below 6% sometime in early 2018.

Macroeconomic performance & projection, Republic of Ireland

• There is very little evidence of overheating in the economy:

• Total employment and the employment rate are below pre-crisis peaks while the employment rate is below the EU average.
• Price inflation is close to zero while average hourly earnings are growing at just 1.6% year-on-year
• The recent growth in consumption follows close to a decade of stagnation so a period of fast growth partially reflects pent-up demand.
• Consumer credit is less than half of its 2009 peak.
• Underlying investment, while growing quickly, is doing so from a low base.

• Risks to the forecast are mainly skewed to the downside. The outlook for 2019 is particularly uncertain. Brexit and the potential for a UK exit from the single market and the customs union remains the most significant downside risk although it is impossible to quantify the scale of the potential damage.

Revenue Sufficiency and Potential Reforms in the Republic of Ireland

• Measured on a per capita basis combined taxes and social contributions in the Republic are significantly lower than in comparator high-income EU countries.
• There is no evidence the Republic’s taxation system is onerous in comparison to other high-income European states. In fact, the evidence is clear that the Republic is a low tax state.
• In light of this, and in the context of substantial areas of under-spend in certain public services and in infrastructure, the case for further cuts in the aggregate level of taxation is very weak.
• We find that there is a strong case for increasing taxes on wealth (inheritances, gifts, net wealth, property, land) as the Republic is a particularly low tax country when it comes to levies on stocks of wealth and the international evidence suggests that these taxes have minimal negative consequences for growth and, if designed properly, are highly progressive.
• The most substantial revenue deficit is in the area of labour taxation - specifically social contributions. The bulk of this deficit relates to employer PRSI. Substantial reform is needed in this area.
• Finally, we point out that tax expenditures damage growth by distorting resource allocation, by creating inefficiencies in production and consumption and by diverting economic activity toward rent-seeking behaviour. Tax expenditures also tend to favour high-income households so their elimination would have positive equity implications.

Outlook for Northern Ireland

• The Northern Ireland labour market weakened in the three months ending in July 2017. The unemployment rate dropped by 0.1% but the employment rate also dropped by 0.5%.
• More than a year on from the Brexit referendum the fall in the value of Sterling continues to weigh heavily on the economy. Whilst this provides a boost to exporters and the tourism sector, there are concerns that it will soon be outweighed by a decline in consumer sentiment within the domestic economy.
• Whether the positive effects of Sterling’s depreciation can outweigh the negative impacts will determine the short-term future of the Northern Ireland economy. Any longer term outlook is still very much rooted in the outcome of Brexit negotiations.