Compelling future governments – by law – to divert significant exchequer resources (€6 billion annually) into two investment funds, effectively limiting their spending and tax-cutting options, was the most significant and potentially far-reaching decision taken in Tuesday’s budget.
The aim – to “future-proof the public finances” – might sound a bit grand but it will go down as a serious attempt to dilute the short-termism that trammels so much of our budgetary deliberations.
Future governments could, of course, revoke the law with sufficient Oireachtas support but Minister for Finance Michael McGrath and Minister for Public Expenditure Paschal Donohoe have placed a significant obstacle in the way of finance ministers who might be tempted to splurge for political reasons or who might wish to use bumper tax receipts to paper over cracks in day-to-day spending, ironically two things this Government has been accused of.
Mismanagement of the public finances lies at the heart of so many of the State’s problems, particularly those in housing and health.
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Periods of reckless spending in the past have typically been followed by episodes of enforced cost-cutting and austerity. And the first thing to get snipped in any period of retrenchment, history tells us, is the capital budget. Politically, it’s easier to pare back capital spending than announce tax hikes. Hence we’ve had extremely volatile capital spending and big infrastructural deficits in housing, health and transport.
Harnessing windfall tax receipts from the multinational sector to break this boom-and-bust cycle marks a new departure.
For the moment, diverting €6 billion of excess corporation tax receipts – €4 billion into the new “Future Ireland” fund and a further €2 billion into a separate infrastructural fund – doesn’t seem like much of a handicap for finance ministers. Not with corporate tax receipts expected to hit a record €23 billion this year – and they could yet exceed that – or with the economy at full employment and growing at a relatively strong (in the context of an international slowdown) 2 per cent.
In reality, the level of receipts being earmarked for the two funds is only about 50 per cent of what the Department of Finance has classified as the windfall element of corporation tax.
Headwinds
But the economic outlook here is dotted not so much with storm clouds but with what the department describes as “headwinds”.
In its economic and fiscal outlook published alongside Tuesday’s budget, the department pinpoints three.
– First, the pronounced slowdown in the EU, British and US economies which will hit exports. This year has already seen a reversal in pharma exports, the first in several years – albeit affected in part by the slowdown in Covid vaccine demand.
– Second, the prospect that core inflation, which strips out volatile energy and food prices, will remain higher for longer with the dampening effect that is likely to have on consumer spending and therefore demand.
– And third, the corrosive effects of tighter monetary policy.
The fact that we are still experiencing full employment, relatively strong consumer spending and economic growth after 10 consecutive interest rate hikes from the European Central Bank (ECB) has been something of a head-scratcher for analysts. But as the department noted in its report, “monetary policy acts in a slow-burner manner: it works its way through to real economic activity with a lag”.
The delayed impact of higher interest rates prompted the department to cut its growth projection for the Irish economy for next year to 2.2 per cent, down from 2.5 per cent previously.
Economist Austin Hughes believes the main risk to the short-term economic outlook is a fragile geopolitical climate globally “made riskier by electoral cycles in the US and Europe”.
“It’s certainly possible to imagine a range of event shocks that could put world growth and/or inflation on a very threatening trajectory in the year ahead,” he says. “Even if a big destabilising event is avoided, uncertainty and risk may lead businesses and consumers to delay big spending.
“In addition, those much mentioned long and variable lags mean the full impact of the aggressive global central bank tightening has yet to be felt worldwide. So, there are plenty of headwinds to global growth over the next 12 to 18 months,” Hughes says.
“Unfortunately, it seems clearer that progress in addressing the key risks to economic and social fracture in the years ahead – such as housing, health, climate change and other infrastructural constraints – is likely to remain uncomfortably slow.
“In that regard, I think the balance between the two funds announced in the budget is skewed too heavily towards long-term challenges that could be eased meaningfully in the interim by a notably greater commitment of funding to deal with large and immediate challenges to sustained growth around infrastructure and climate change,” he says.
It’s not all downside, there are tailwinds as well. The resilience of the labour market here and the Government’s financial firepower – courtesy of bumper corporation tax receipts – are notable positives.
But it might be that the last two giveaway budgets, which have allowed the Government to spend, cut taxes and run large budgetary surpluses simultaneously without the typical trade-offs, are as good as it gets.
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Everything looks likely to get tighter from here on in. The Government’s much-trumpeted €65 billion of cumulative surpluses projected for 2023-2026 have already been revised down to €46 billion.
The Irish Fiscal Advisory Council (Ifac) noted that this figure would fall to a meagre €2 billion without windfall corporation tax receipts. “Health overruns and unbudgeted Ukrainian supports beyond 2024 could mean cumulative underlying deficits,” it said.
The Government is projecting a surplus of €8.4 billion in 2024 after this week’s budgetary measures. Relative to the Central Statistics Office’s bespoke gross national income (GNI) measure, this amounts to 2.7 per cent and still compares favourably with the rest of the euro zone.
The average deficit (as opposed to surplus) in the euro zone is estimated to be 2.5 per cent of gross domestic product (GDP) in 2024, with Cyprus being only other country expected to be in surplus next year. Ireland remains a financial outlier in the international terms.
Minimising the inflationary impact of the budget with an economy at full employment and with an abundance of exchequer resources at its disposal while facing into an electoral cycle was perhaps one of the principal economic objectives of the budget. How did the Government fare in managing these competing interests?
“In our view, it was a mixed bag,” says Goodbody chief economist Dermot O’Leary. “On a positive note, the Government managed to keep core expenditure growth relatively close to its 5 per cent target (6.1 per cent core expenditure growth expected).”
“This is an acceptable outcome in the context of the high inflation environment and the surge in need due to population growth,” he says.
However, the series of noncore expenditure measures has been repeated once again, he says.
“While these were necessary as a contingency against a hard Brexit, as a counterbalance to the Covid lockdowns and for supporting businesses and households against an energy price spike, there is less justification at a time of full employment, falling energy prices and disinflation,” he says.
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“Some of the tax and spending measures are targeted (such as mortgage interest relief), but some are universal in nature (energy credits and the child benefit bonus). This will augment inflationary pressures in an economy already at full capacity,” O’Leary says, echoing warnings from Ifac and the Central Bank.
In its report, the department warned that while headline inflation is expected to fall below 3 per cent next year, core inflation, which strips out volatile energy and food prices, is expected to remain elevated at 3.4 per cent. Price pressures could easily persist. Oil prices rocketed this week following Hamas’s attack on Israel.
There is rarely an economic outlook pertaining to Ireland that doesn’t contain big downside risks or caveats. The State is, after all, a small, open economy driven by exports and large levels of foreign direct investment, meaning it is at the mercy of international trends and conditions.
For the last 10 years, since the low point of the financial crisis in 2012, these trends have been favourable, allowing the economy here to grow rapidly. The number of people at work in the State hit a record high of 2.64 million in the second quarter of 2023.
Budgetary calculations are now increasingly about dealing with the pressures posed by a bigger workforce, which needs better infrastructure, and by an ageing population, which will require greater pension coverage and healthcare provision.
The latter combined with other financial pressures related to climate and digitisation are expected to cost the exchequer an additional €8 billion in “standstill” costs by 2030 at the same time as the shift away from traditional fossil fuels will see the Government lose up to €5 billion in tax receipts.
The two investment funds will attempt to address these financial challenges. With contributions and a return from investments over the longer term, the new “Future Ireland Fund”, the bigger of the two, is expected to grow to €100 billion by 2035. Instead of simply using it to pay for pensions, the Government could increase PRSI rates instead and leave the fund to generate annual returns for the exchequer similar – albeit on a lower level – to what presides in Norway.
The lead-up to this year’s budget was dominated by cost overruns in health, a perennial difficulty for the Government. While cost control is a problem in many areas of the State – the children’s hospital being the most obvious example- much of the rising cost of healthcare provision here stems from demographics, namely a bigger and an older population.
The CSO’s recent population statistics estimate that the number of people over the age of 75 in the State rose by 20 per cent in just four years between April 2019 and April 2023.
According to Health Service Executive figures, attendances at emergency departments of those aged 75 and older were up 21 per cent in comparison to 2019 while admissions from emergency departments to hospitals of those aged 75 and older were up 15 per cent.
“If we don’t plan for obvious pressures, we’re going to keep burying our heads and eventually seeing the overspends later in the year,” says Eddie Casey, Ifac’s chief economist. “A more realistic budget would identify these huge pressures in advance, which are fairly predictable. We might then be able to have a better discussion of how to deal with them. For instance, where can the savings be generated?
“But we can’t have that important conversion until the budget numbers are more realistic as a first step.”
Ifac and the Government have been at loggerheads in recent months about the latter’s decision to abandon its own 5 per cent spending rule. Regardless of the rights and wrongs, Ireland’s budgeting process needs to move away from the heavily politicised budget day “reveal” towards a more strategic multiyear approach.
