It must be made clear how Government will cut debt after pandemic

Light may be appearing at the end of the Covid-19 crisis with lower infections and the vaccination programme building. But the winter has taken a heavy toll on the public finances: support measures needed since the budget and lost tax revenue have cost several billion euro.

Next month, the Government will publish its annual stability programme update. A new fiscal plan is needed for 2021 given developments this winter. The Covid contingency allocated in Budget 2021 is on track to be used up, while extended employment supports will put pressure on the economic recovery fund.

The huge budget deficit will narrow as the pandemic eases, reducing the number of people on government supports and increasing tax revenue. There are many scenarios for the recovery, but stimulus support for the economy will be needed this year and likely beyond.

For Ireland, the debt ratio will eventually need to be brought to a lower and safer level over time, not least to restore the capacity to address any future crisis.

The Government has also promised to deliver in the stability programme a roadmap for how Ireland will return to a broadly balanced budget in the years ahead.

How to build the 15-minute city

---

Decisions on AI displacing workers can’t be left to elite

---

The Irish Times view on the sounds of the pandemic: Tunnel of silence

---

Jennifer O’Connell: Who wants a Taoiseach who acts as a passive observer?

---

Budget 2021 forecast government debt to peak at about 115 per cent of national income this year, a high level by historical comparison. However, interest rates remain very low, despite recent rises, and combined with economic growth this will tend to reduce the debt ratio. There is a lively debate internationally about how far to use these favourable debt dynamics to support demand, including around US president Joe Biden’s $1.9 trillion stimulus package.

Fiscal stimulus

The Irish Fiscal Advisory Council brought together some of the world’s leading economists at a recent conference to explore this question. The favourable debt dynamics have allowed a strong response to Covid-19 and provide some room for manoeuvre. Nevertheless, there remain many questions about how much expansionary policy is needed or how sustainable this would be. In the euro area, the case for investment-driven fiscal stimulus is strengthened by sluggish pre-crisis growth and weak inflation.

However, we cannot expect interest rates to stay so low forever. A new paper from the fiscal council shows how higher initial debt translates into a more unstable path for government debt, increasing the risks of fiscal adjustments.

For Ireland, the debt ratio will eventually need to be brought to a lower and safer level over time, not least to restore the capacity to address any future crisis. Running a balanced budget would lower the debt burden at a steady pace. Some measures may be needed to achieve this in the later years of this Government, although nothing like what Ireland has experienced in the past. Compared with other countries, the recovery in Ireland may be strong and the Government has already embarked on a major programme of public investment of about 4.5 per cent of gross national income – the total amount of money earned by Ireland’s people and businesses each year – far above the European Union average.

Beyond the questions of temporary stimulus and restoring balance, there lurks a much bigger question about how to fund ongoing current government spending in the years ahead.

The public finances face substantial pressures from the legacy of the crisis and long-standing issues. First, pensions spending is rising by about €500 million a year. Second, the programme for government commits to the implementation of ambitious programmes, including the Sláintecare health reforms that bring wider publicly-provided healthcare coverage. Third, excessive reliance on corporation tax needs to be reduced. Fourth, measures to address climate change may have significant costs.

Fiscal space

The programme for government complicated this picture by taking a large range of tax and spending measures off the table. The fiscal space has been further narrowed by permanent spending increases of up to at least €5.4 billion already made in Budget 2021.

Fundamental questions now need to be answered about how to prioritise the competing pressures on government spending

Post-Covid budgets will look very different from what we have known. In past years, the growth of tax revenues pre-crisis was more than enough to match the rising costs of public services and welfare payments, leaving a significant amount for the government to allocate on budget day to new projects. This was further aided by health spending increases largely coming through unplanned overruns financed by unexpected corporate tax receipts. The “growth dividend” will disappear in the coming years as the rising costs of “standing still” in policy terms will outstrip revenue growth because of increases in pension costs. There will need to be a real prioritisation.

The Government needs to set out in April a roadmap that is more than just a forecast for how the budget eventually returns to balance. Uncertainty remains high, but we now have a clearer picture of what lies ahead than a year ago with multiple vaccines and a Brexit deal.

Fundamental questions now need to be answered about how to prioritise the competing pressures on government spending and what role changes in tax will play over the life of the Government. The Commission on Pensions and Commission on Taxation may play an important role, but these are ultimately political choices.