Further tax cuts could overheat economy, warns ESRI

There is no room for further tax cuts in the upcoming budget, the Economic and Social Research Institute (ESRI) has warned, adding that such a move risked overheating the economy.

In its latest quarterly commentary, the think tank said the Irish economy was now running close to its full potential, having recovered strongly from the financial crash. That necessitated a neutral fiscal stance in October’s budget.

The case for such a policy, it said, was compounded by rising levels of personal consumption and retail sales combined with an acceleration in employment growth evidenced in the recent Quarterly National Household Survey.

“This suggests that economic activity does not need to be further stimulated by reducing personal taxation levels,” the institute said.

The Government has already signalled plans for a €1 billion budgetary adjustment with €300-€400 million likely to go towards further reductions in the universal social charge (USC), which is to be phased out over the next five years.

The ESRI did not refer directly to the Government’s plan but warned against any policy that might remove a substantial portion of the exchequer’s tax base.

Economist David Duffy said the significant pace of economic growth experienced by the Irish economy over the past number of years argued for a neutral fiscal stance in the forthcoming budget.

‘Prudent policy’

In its report, the ESRI said any additional spending should be directed towards improving the productive capacity of the economy, while noting the Government’s spending commitments on social housing represented a “prudent policy”.

The institute reduced its growth projections for the Irish economy on foot of a deterioration in global demand linked to weaknesses in the Chinese economy and Brexit-related issues.

It is now predicting the economy will expand by 4.3 per cent this year in terms of gross domestic product (GDP) and by 3.8 per cent next year, which represent significant downward revisions on its summer projections.

It said the UK economy was forecast to contract economically for the remainder of 2016, while the outlook for 2017 has been “dramatically revised downwards” in light of the June referendum result.

Uncertainty

The ESRI said there was a cloud of uncertainty now hanging over Irish economic growth as a result of recent revisions to GDP, which put growth for last year at an implausible 26 per cent.

“Clearly no one believes that the Irish economy grew by 26 per cent in real terms in 2015 or indeed by almost 9 per cent in 2014,” it said, while acknowledging the Central Statistics Office was compelled by international accounting standards to produce the results in the way it had.

Adopting an output-based estimate of domestic growth, the institute suggested the economy probably expanded by about 5.5 per cent last year in real terms.

In its report, it predicted unemployment would average 8.3 per cent in 2016 before falling to 7.3 per cent by 2017.

The ESRI’s Kieran McQuinn noted that there was now a considerable contrast between the domestic and external components of growth.

While net exports fuelled the initial phase of recovery, the current level of growth was being driven by investment and consumption, he said.