Beware unusually high tax receipts

Public finances

 

The latest Exchequer returns provide both reason to cheer and cause for the Government to worry. Tax revenue for October was boosted by a strong rise of €803 million in corporation tax receipts. It means that after 10 months, corporate taxes are €2 billion above the Department of Finance’s target. The Government will be relieved the budget deficit is likely to be less than 2 per cent of gross domestic product (GDP) by year-end and the public finances strengthened before a general election. However, it should become increasingly concerned about the department’s huge underestimation of corporate tax receipts – a recurrence of an old forecasting failure.

Between 2004 and 2006, as the economic boom accelerated, the department greatly underestimated tax revenue. Then, as the economic downturn began in 2007 and 2008, it overestimated tax receipts. A major mistake made by government during the boom was to base spending increases on temporary tax revenues collected from an inflated property market that was fast reaching bubble proportions. As the economic recovery accelerates, is the Government in danger of repeating past errors of its predecessor by again over-relying on a transitory revenue source – this time buoyant corporate tax receipts – to finance higher spending that may also prove to be unsustainable? The Government has been advised by the Revenue Commissioners that the surge in corporation tax payments last month reflected strong trading conditions rather than exceptional one-off factors. And the increase may well reflect a major US multinational booking more of its profits in Ireland rather than offshore.

Before last month’s budget the uniform external advice to Government from various agencies was to frame a cautious budget and not to favour a pro-cyclical fiscal policy for an economy already growing rapidly. However, it chose to disregard that advice and plans to boost spending by an additional €1.5 billion before year-end. This will make it easier to stay within the required 2 per cent benchmark for spending growth in 2016.

However there are signals that the Troika, who visit Ireland this week, will raise questions about this spending strategy. While the Troika itself has little influence on Irish affairs any more, one of its members – the EU Commission – has a formal role in monitoring our budget and its comments will be closely watched.

Outgoing Central Bank governor Patrick Honohan, in a pre-budget letter to the Minister for Finance, warned of “the danger of using windfall fiscal gains to justify long-lasting spending commitments”. Given the uncertainty surrounding the OECD’s proposals for new tax rules for multinationals and how they may affect Ireland’s low corporate tax rate, the dramatic rise in tax receipts may prove temporary and cannot serve as the basis for “long-lasting spending commitments”.

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