Quarterly Economic Observer - Summer 2018 - "Rebalancing Fiscal Policy in the Republic of Ireland for Sustainable & Inclusive Growth"

This edition of the NERI’s Quarterly Economic Observer (QEO) outlines our latest expectations for the economies of the Republic of Ireland and Northern Ireland (Section 1) and proposes changes to the levels and composition of both public spending and government revenue in the Republic to boost the long-run productive capacity of the economy (Section 2).

Economic Outlook for the Republic of Ireland

• The short-term outlook for the Republic’s economy remains positive. We project real GDP growth of 5.8 per cent in 2018 and 3.8 per cent in 2019.
• The labour market should also continue to improve with projected employment growth of approximately 100,000 over the period 2018-2019. The unemployment rate should range between 4.5 and 5 per cent through 2019.
• With falling unemployment and rising job vacancies the tightening of the labour market should also improve conditions for real wage growth. We project average hourly earnings growth of 2.9 per cent in 2018 and 3.4 per cent in 2019.

Macroeconomic performance & projection, Republic of Ireland

Economic outlook for Northern Ireland

• Uncertainty surrounding Brexit and the absence of devolved government continue to weigh heavily on the outlook for the Northern Ireland economy in the short term.
• Weakness in the Manufacturing sector is holding back output growth whilst the quality of new employment is a key concern for long-term, productivity based growth.
• Though headline figures for unemployment showed record lows in the first few months of 2018, issues with low levels of participation persist.

Rebalancing Fiscal Policy in the Republic of Ireland for Sustainable & Inclusive Growth

• There has been a significant improvement in the fiscal position of the Irish state over the past number of years. The government deficit, public interest payments and general government debt have declined as a portion of both output (however measured) and government revenues. Gross public debt is still relatively large however, and revenues are precariously dependent on volatile receipts flows from corporate tax.
• Conventional comparisons of tax revenue across states tend to measure a country’s tax take as a portion of output, usually GDP. By this measurement, Irish government revenues are low by international standards. However, this particular metric is problematic in an Irish context, as GDP represents an inaccurate measure of fiscal capacity due to the unique distortionary effects of multinational activity on output. Alternative measures such as GNI* reduce the extent of the gap relative to comparator countries, but do not eliminate it. We can make a more meaningful analysis of Ireland’s comparative position by measuring tax revenues as a percentage of the potential tax base (Implicit Tax Rate, or ITR), or on a per capita basis.
• In ITR terms, Irish tax revenues are low under the headings of taxation on Labour and Capital. Revenue comparisons in per capita terms reveal a significant aggregate shortfall in revenues relative to other high-income EU states of almost 10 per cent. The shortfall is a function of the relative absence of taxes on Labour, itself mostly due to the relative shortfall in employer social security contributions. This is borne out in comparisons of tax paid for a single person on average earnings. The effective personal tax rate and total tax wedge in Ireland in 2016 of 19.2 and 27.1 per cent respectively, were the lowest observed in the EU-15 and even lower than rates observed in the United states.
• Per capita tax receipts in the areas of Consumption Taxes and Capital Taxes are above the comparator average in contrast.
• Comparisons of public expenditure based on output are similarly problematic. Per capita measures likely present a less biased picture. Aggregate spending (excluding interest on a per capita basis) was significantly lower than in other high-income EU states in 2017. This is largely accounted for by underspends in Social protection and Defence. While this might be partly a function of demographics, other factors such as child demographics, population density and dispersion, and price levels likely bias spending in the opposite direction.
• From a longer-term growth perspective, Ireland displays shortfalls in key expenditure areas. Public funding for R&D is only two thirds of the comparator average, and education per pupil shows significant relative deficits particularly at tertiary level. OECD data also show low spending for early-childhood spending and care in Ireland, which can inhibit labour market access.
• We conclude that fiscal policy should be reoriented to address these shortfalls. The growth literature indicate that taxes on property, wealth and passive income are pro-growth and pro-equity. A substantial revenue deficit occurs under this heading in per capita comparisons, implying some capacity to raise revenues in this area. However, the bulk of the revenue deficit is a function of the relatively low levels of taxes on labour, and specifically the low levels of social contributions.