Decades ago, the Netherlands discovered hydrocarbon deposits in the North Sea, and then spent the initial proceeds. The extra spending was in excess of its economy’s capacity to absorb it, so the outcome was high inflation. Economists now call such profligate behaviour “the Dutch disease”.
When Norway found oil, its Government did not immediately spend all the revenue bonanza. Had it done so, extra spending on that scale could have led to skyrocketing prices. That would have left Norway just a little better off, but with an inflation headache.
Instead, over the years, prudent Norway wisely invested the revenues in a fund to generate a long-term return. Today around a fifth of the Norwegian government’s income comes from the profits of this fund. This income will continue long after the oil runs out.
Our corporation tax bonanza is a bit like an oil find, bringing massive but temporary revenues, currently amounting to around 4 per cent of national income; however about a fifth of our bonus revenue accrues to the EU, as it affects our contribution to the EU’s Budget.
The Irish economy has grown rapidly in recent years, how long can it continue?
On this week’s episode of Inside Business with Ciarán Hancock, Chief Economist at Davy, Conall MacCoille, explains why labour shortages and capacity pressures are putting the brakes on growth in some sectors here. And Irish Times Economics Correspondent Eoin Burke-Kennedy runs through the headline details from both the exchequer receipts and the Summer Economic Statement.
Unlike an oilfield, happily these revenues are largely climate-neutral, but like an oil find, they are probably temporary. Changes to US tax law could wipe out much of what the top 10 companies pay in corporation tax to Ireland.
The current Government plan is to save the exceptional revenue in an investment fund. If the government were to succumb to the temptation to spend much of this revenue next year, they would get poor value in our fully-employed economy, and shove up prices.
Both the Commission on Taxation and Welfare, and the Irish Fiscal Advisory Council (IFAC) have warned we are facing big future challenges that will need extra funding.
With an ageing population, IFAC estimate our tax take would need to rise by around a quarter by 2050, taking in between 7 per cent and 9.5 per cent more of national income, in order to maintain current pensions and healthcare for the growing share of older people.
The new fund should be invested outside Ireland, to insulate it from any serious shock to the Irish economy, though not making it immune to any global setback
Over the coming decade, the cost of tackling climate change will amount to a further 2 per cent of national income. This will accelerate the pressures on public expenditure out beyond 2030. Hopefully from 2040 onwards, climate-related spending can ease off as we approach our targets, provided green investment is done effectively, and Ireland decarbonises as planned.
Building up a fund to pay for this inevitable future rise in spending will ease the need to raise taxes in the future. At my age, it’s not likely to be of personal concern how high the tax bills will be in 2050, but I know that investing the exceptional corporation tax revenue over the next few years into a fund will pay major dividends for future generations.
A recent Department of Finance conference noted that a previous National Pension Reserve Fund, established around 2000, proved invaluable during the financial crisis that began in 2008. While not the original intention to cover a short-term need rather than fund long-term liabilities, it did provide important leeway for the government in managing that crisis, buying time to deal with some peremptory demands from the Troika.
Hopefully it will be much more difficult for future governments to raid this pension pot than its predecessor, and it will be used for what it is intended – to cover the costs of an ageing population.
The advantage of the fund approach is partly presentational. Another option might be for the government to use windfall corporation taxes to repay national debt. To most people, national debt is notional, not a big topic of everyday conversation. However, everyone can recognise the costs that ageing brings. Paying for future pensions and healthcare from a fund is much more tangible than wiping out past debts.
Corporation tax receipts tend to be more volatile than other forms of taxation. Any fall in the profits of the Big 10 firms would naturally reduce payments into the fund. That’s easier to live with than a sudden cut in current spending or a delay in critical infrastructure investment, if we were to rely on this volatile source of revenue for those purposes.
The new fund should be invested outside Ireland, to insulate it from any serious shock to the Irish economy, though not making it immune to any global setback. Given that our windfall taxes come from a few high tech firms, the fund should also not invest in those firms, to avoid a double loss if any of them get into difficulty.
