We can’t afford to double our bets on avoiding a no-deal Brexit

Budget 2020: It is vital that initial plans for next year are modest

Minister for Finance  Paschal Donohoe: Brexit makes an almost impossible backdrop for budget planning. Photograph: Niall Carson/PA Wire

Minister for Finance Paschal Donohoe: Brexit makes an almost impossible backdrop for budget planning. Photograph: Niall Carson/PA Wire

 

Two scenarios, but just one budget. Framing the Government budget is never easy – inevitably it is based on forecasts for the year ahead which may, or may not, provide accurate. But this year the problem is particularly acute. How do you deal with a problem like a no-deal Brexit?

Picture the possible scene. Minister for Finance Paschal Donohoe gets up on October 8th to deliver his budget. Nine days later the last EU summit before the date set for Brexit – October 31st – takes place. UK prime minister Boris Johnson is saying the exit date must be respected.

There isn’t much point going any further in the scenario planning. The UK could easily head for a general election. The other EU leaders could agree to give the UK a – bit – more time, but only if it asks for it. All we can say, now, is that a no-deal Brexit is a real risk, either at the end of October or, some observers believe, around the end of the year.

Either way this puts a huge question mark against the figures for Budget 2020. If a no-deal Brexit is avoided, the outlook for the economy in 2020 looks OK, notwithstanding all the issues in housing and some fears about international growth.

But a no-deal Brexit is another level of danger, threatening a sharp shock to the economy and one which is very difficult to predict. Brexit is an unprecedented event. Forecasters can – and have – made a stab at looking at the possible impact on trade and the economic knock-on. But cutting trade ties overnight adds another layer of danger, and compresses a lot of the risks into a very short space of time.

There is no way to avoid this uncertainty. Delaying the budget would be messy in terms of submitting plans to the EU on time and, more importantly, would send out the message that our economic future is all about Brexit.

The Government has to bite the bullet. Its strategy, as outlined in next week’s Summer Statement – the Minister for Finance’s first indication of his budget approach – is likely to go along the following lines. He will stick to the figures previously indicated, allocating some €2.8 billion-€2.9 billion to extra spending and tax measures in 2020, which will mean the budget will be in surplus next year, perhaps by about 0.4-0.5 per cent of GDP. Assuming we avoid a no-deal Brexit.

‘Automatic stabilisers’

If the worst does happen, then the idea would be to allow the budget to slip into deficit next year. This would happen for two reasons. First, slower growth pushes down tax revenues and increases demands on general spending. Second, cash will be needed to support certain sectors which are hit hard – particularly agriculture and food. The rural economy will be the area worst hit by Brexit – arguably, Dublin won’t do too badly. So measures directed at rural Ireland will be important.

In economic jargon, the fact that the budget slips into deficit when a shock hits is known as using “automatic stabilisers”. It is the way things are meant to work, and the opposite to the way things have normally worked here. We have tended to spend money in the good times, meaning we are forced to slash spending and hike taxes when trouble hits.

Had we controlled the budget a bit more tightly over the last few years, we would have more leeway now. Unfortunately a big surge in tax revenues, led by corporation tax, has pretty much all gone into extra spending with health, in particular, running well over budget year after year.

The key job for Donohoe now is to get his colleagues to keep their demands for 2020 within the roughly €2.8 billion which will be available. The problem – politically – is that the vast bulk of this is already accounted for by planned increases in investment, public pay and other spending increases.

A nasty hit

There will be little left for budget day “giveaways”, precisely the opposite of what politicians like in what will probably be the last budget before a general election. And this could be eaten away further if the department of health overspends on its budget again which, on the basis of the first five months, looks highly possible. New revenue sources will not be easily found – carbon tax may be hiked, but even here the threat of a no-deal Brexit may give the Government pause for thought.

Forecasting the impact of a no-deal exit is near impossible, with any degree of confidence. Suffice to say that, on the forecasts we do have, it could turn a surplus of about 0.6 per cent of GDP next year into a deficit of up to 1.5 per cent of GDP on ESRI/Department of Finance forecasts, and perhaps 3 per cent of GDP deficit on more pessimistic Central Bank figures. *The assumption is that the economy would gradually emerge from this short, sharp shock, albeit with some significant ongoing costs. This is not 2008, but it would still be a nasty economic hit.

The Minister will, presumably, use the threat of a no-deal Brexit to keep his colleagues in line. He will plan to present a pretty plain budget. If the no-deal Brexit does happen, then new measures would be announced later in the year or early next year to respond.

It is an almost impossible backdrop for budget planning. But it is vital that this year’s budget is kept on track and that initial plans for next year are modest. Otherwise we are doubling our bets on avoiding a no-deal Brexit which – given events across the water – does not look very smart.

* This sentence was adjusted to correct a factual error in relation to a previous official forecast

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