Things move fast as you come out of a pandemic. The bounceback in the economy transformed the sums behind Budget 2022 . They meant Ministers Paschal Donohoe and Michael McGrath could deliver on the planned €4.7 billion package, while aiming for a much lower level of borrowing than signalled during the summer.
You would wonder for just how long the Department of Finance knew there was that much extra money behind the sofa, but feared that letting everyone know would lead to pressure to bust the expenditure ceiling which they had already set out.
Donohoe and McGrath are betting that a steady approach, an economic upturn and an improvement in some of the crunch issues like housing and health can slowly move the political dial back in the Government’s favour.
The carbon budgets which will be published by the Government together with a new action plan, will outline starkly the challenges faced in cutting carbon emissions
But Sinn Féin is arguing that the budget did not go far enough in key areas. And while it did not have any particular banana skins, Budget 2022 does not put too much cash directly into people’s pockets either.
In trying to keep the public finances on a safe track, while nodding to the political agenda by introducing chunky spending increases, did the ministers get it right? Here are the five key points out of Budget 2022.
1. The benefits of the bounce
Forecasters have had trouble keeping up with the speed of the rebound, particularly in the domestic economy. This has pushed up tax revenues sharply and meant that borrowing is much lower than anticipated.
Borrowing this year is now estimated to be just over €13 billion, some €7 billion lower than anticipated. And the Department of Finance’s background budget documents say the improvements should be sustainable, meaning they have cut their borrowing predictions for the next few years.
State borrowing, using the EU general government deficit measure, is now forecast to be €8.2 billion next year, compared to expectations in the Summer Economic Statement that it would be over €14 billion. That is a big difference.
Borrowing is falling because the two ministers decided to stay within the previously announced ceilings for the amount of cash the State will spend next year, meaning that the benefits of stronger revenues flow through to lower borrowing.
This in turn knocks on to improved metrics for all the key public finance and debt measures over the coming years and led the Irish Fiscal Advisory Council (Ifac) – the budget watchdog – to conclude that, as a result, "the Government has the economy on a more prudent path that will reduce borrowing and the debt ratio in the years ahead".
There are two things to note here. One is that the forecasts are made on the basis that economic growth will, after the initial rebound from the pandemic, remain strong. It seems reasonable to expect momentum to continue into 2022, provided doubts about the pace of removal of the remaining restrictions don’t turn into something worse. Beyond that, it is just hard to know.
And of course as the corporation tax rules change internationally, Ireland faces some uncertainty here, though losses rising to €2 billion per annum are written into the budget forecasts.
The second issue from the revised public finance forecasts is that it will open up the debate on how much Ireland should borrow to invest in the next few years.
On the Government forecasts, borrowing would fall to just €1 billion by 2023. Sinn Féin and Labour have argued for a more expansionary policy and the willingness to borrow more. The Government argues that this would be to run too many risks, given the uncertainties we face.
There are also questions about whether a booming economy could deal with more State cash in the short term – even if more cash was put into housing, for example, do we have enough builders and industry capacity to construct even more?
2. The days of big budget tax giveaways are over
It is all about spending. The Government made some noise about the changes in tax credits and the entry point to the higher 40 per cent income tax rate. But as inflation and wage increases pick up, these are really just indexing the tax system for inflation.
You could argue that this – and indexing welfare and pensions – should be normal, rather than budget “giveaways” but ministers always like to be seen to be generous. And the Department of Finance likes to have the option of not indexing the tax and welfare systems as doing so fully every year would pre-commit a lot of revenue.
Income tax gains of just over €400 a year for a higher rate taxpayer are not insignificant. But in political terms, the budget is all about spending – on health, education, childcare, housing and so on.
Core spending is to rise by another 5.5 per cent next year – and effectively some of the extra Covid emergency spending is becoming permanent.
While the welfare and pension rises are widely debated, the really significant political point is whether the Government can be seen to make progress on the hot button issues, especially housing but also health and childcare. Delivery will be everything, And as the Ifac pointed out, with investment spending now rising to a highish level by EU standards, the pressure to deliver on major projects will be enormous.
3. Jobs bonus
The upside of the recovery is that the number of people at work is rising quickly and there is a sharp fall in the unemployment rate. PUP numbers have now fallen below 100,000 and could fall further by Christmas if reopening goes relatively smoothly – though clearly there are now some question marks on this as case numbers rise.
The Department of Finance now expects that the Covid-19 adjusted unemployment rate – which includes everyone on the PUP – will fall to 9.25 per cent this year and for the jobless rate to drop to 6.5 per cent by the end of next year. The number of people at work is expected to exceed pre-pandemic levels next year .
Indeed, talk to businesspeople today and the issue is getting hold of people to work – in all kinds of jobs. In many cases this is leading to wage pressures. A big issue for the jobs market is whether this Covid-related disruption can now settle and the market can regain some kind of equilibrium.
In its budget commentary, the Ifac made the point that the high level of Government supports through the pandemic, combined with the rapid bounceback in the economy, can combine to reduce the so-called scarring impact of the pandemic – in other words the long-term, lasting damage, notably in the jobs market.
A key issue here is whether thousands of smaller businesses across the State can wean themselves off wage subsidies as they are gradually run down by next April, having been extended in the budget.
4. Inflation danger
There don’t appear to have been any political bombshells in the budget of a kind which we have occasionally seen over the years. However, there could yet be some buried explosives in the outlook for inflation.
A key element of the budget was increasing a range of welfare payments, including special fuel allowances, to give households some cushion against rising prices, particularly against rising energy costs. It also made the decision to push ahead with the carbon tax rises – now mandated by legislation.
All this was done in the hope that the rate of inflation, now 3.6 per cent, will fall back closer to 2 per cent next year as many of the once-off factors related to the recovery from Covid start to wash out of the system.
This may happen – and the Department of Finance analysis points to the small number of individual prices that are pushing up the overall price level, at least some of which are expected to moderate. But there is a risk of inflation taking hold and of the wider supply chain and labour market upheavals feeding through to a more permanent rise in the inflation rate.
The Department of Finance is forecasting a rate of 2.2 per cent on average next year but, looking at the risk factors for next year, it also draws another scenario in which the rate goes to 3.5 per cent. A key issue will be how the public and businesses view this – in other words does an inflationary psychology become embedded after years when, apart from house prices and rents, average price levels have been pretty flat.
As well as the economic and political impact of this on the economy next year, it could also increase pressure for the ECB to wind back its emergency Covid supports more quickly and eventually move to increase interest rates.
Borrowing costs will probably remain low for some time to come. But the importance of the ECB withdrawing supports is that investors will again start to look more closely at how individual countries are managing their budgets – the backstop for investors of selling bonds to the ECB will be no more.
5. Three big issues for . . . the next budget
This year might be seen as a transition from the pandemic emergency back to some kind of more normal times and more normal politics. It raises again the question of how Ireland is to pay for the “big three” – the bigger State, the Green agenda and an ageing population.
Goodbody Stockbroker economist Dermot O’Leary estimates that the level of State spending as a percentage of modified national income (GNI*) is now 35 per cent, its highest level since after the financial crisis when the private sector had collapsed. As he pointed out, this trend to a bigger State will have to be paid for.
Minister for Finance Paschal Donohoe has established a commission on tax and welfare to examine a lot of these issues. It is no coincidence that it will report next summer, before Budget 2023.
We already have the controversial recommendations of the pensions commission on increasing the retirement age. And senior civil servants, in unusually blunt language, pointed out in pre-budget papers that they believed PRSI needed to increase for employers, employees and the self-employed to close the gap in the social welfare fund out of which benefits like the pension are paid and to underpin the whole system for the future.
Meanwhile, the carbon budgets which will be published by the Government – probably later this month – together with a new action plan, will outline starkly the challenges faced in cutting carbon emissions. And here too there will be big budgetary issues, not only for spending but also for tax, with motor tax revenues set to fall sharply and big questions on the balance between stick and carrot needed to get consumers and businesses to change their behaviour.
Economic growth, if it continues, will make facing all these challenges easier. But it will not pay for them all – not by a long way.
This is all likely to make next year’s budget a good deal livelier and more controversial, as starting to address these longer-term issues cannot really be delayed a lot longer.
