Budget 2024 a prime example of tension between politics and economics

In the eyes of the Irish Fiscal Advisory Council (Ifac), the Central Bank and the Economic and Social Research Institute (ESRI), the Government is being imprudent, even reckless, in announcing an expansionary €14 billion budget during full employment and high inflation.

Even the left-leaning, trade union-backed Nevin Economic Research Institute says there is “little or no rationale” for an expansionary budget now.

Economic logic insists that if you add to demand (through tax cuts or additional spending) in an economy already running at full capacity, you will stoke further price inflation. This, in theory, will require more public spending down the line (to pay for the higher cost of goods and services), leaving the Government – in effect – chasing its tail.

It’s not that energy credits, tax cuts or mortgage reliefs are intrinsically inflationary. It’s the use of additional public money to fund them that poses a problem.

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Economists typically want governments to use their annual budgets to smooth out the economic cycle. In practice that means spending in a downturn to boost demand or cutting back when the economy runs too hot. It’s sober, boring, Scandinavian-like and runs entirely counter to the political cycle and the political pressures governments typically find themselves under, especially so close to a general election.

In the build-up to the 2008 financial crisis we used excess tax receipts from a buoyant property sector to egg on an already overheating economy with predictable consequences.

We doubled down on this pro-cyclical stance after the bust by embarking on a swingeing austerity programme just when the economy needed a lift.

Budget 2024 is a prime example of this tension between economics and politics. Minister for Finance Michael McGrath on Tuesday flitted between defending his budget against attacks that it wasn’t enough to help struggling households to defending it on the grounds that it wasn’t too inflationary.

Ifac’s criticism centres on the Coalition’s revised spending plans, which it notes, will see the national spending rule “repeatedly breached” every year out to 2026.

Because of Ireland’s warped gross domestic product (GDP) numbers, the European Union’s fiscal rules no longer apply. So the only anchor on Government spending has been abandoned – permanently it seems – despite previous assurances that we would gradually move back in line with the it.

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The decision to dump the spending rule comes as Sinn Féin’s poll lead over both Fine Gael and Fianna Fáil grows and as the public clamour for measures to deal with the cost of living gets louder.

Presiding over a fiscally restrictive budget when you have arguably the worst housing crisis in Europe and a treasure trove of tax receipts from the multinational sector might seem like political suicide on Government benches.

But the infrastructural bottlenecks at the heart of the Irish economy stem directly from the mismanagement of the public finances previously.

Budget 2024: What it means for households and businesses

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Successive Irish governments have repeatedly been forced into periods of austerity and cost-cutting because they’ve failed to keep a lid on spending.

For obvious political reasons, the first thing that gets slashed in a period of retrenchment is the capital budget. It’s easier for Ministers to cancel capital projects than to announce tax increases. Infrastructure is the fall guy.

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There is no quick fix for decades of underinvestment in housing but prudent management of the public finances is a necessary starting point.

McGrath’s plans for two long-term investment funds – one to tackle the State’s looming pensions problem, the other to buttress capital spending in the event of a downturn – provide the State with the ammunition to break this cycle.

About €4.3 billion (or 0.8 per cent of GDP) of excess corporate tax receipts will now be diverted each year into a new sovereign wealth fund called the Future Ireland Fund. With contributions and return from investments over the longer term, the fund is likely to grow to €100 billion by 2035, providing future governments with a significant financial platform.

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He also announced plans for a separate infrastructure fund – the Infrastructure, Climate and Nature Fund – to ensure that capital spending regardless of the economic outlook. An investment of €2 billion will be added to this fund each year from 2024 to 2030, building to a total of €14 billion by 2030.

“We have a window of opportunity now that we must grasp. Budget 2024 marks a step change in how we plan for the future, by putting in place a long-term plan that will make the economic future safer for all,” McGrath said.

The other takeaway from Budget 2024, namely the explosive cost pressures in health, relates directly. While cost control is a problem in many areas of the State, much of the rising cost of health here stems from demographics, an older population. The Government is not budgeting for this and we’re having repeated cost overruns in health as a result.