I thank the committee for the invitation to appear here today and for the opportunity to discuss a range of economic and fiscal issues.
The core function of the ESRI is to produce rigorous, independent research to inform policy debate and policy-making. The primary route through which we fulfil this function is the publication of reports. However, we see direct engagement with policy makers as being an equally important route through which we inform the policy process. We also benefit from hearing the views of public representatives on the challenges facing the country so we look forward to the members’ questions.
This presentation will begin with our view of economic developments and the implications for the overall fiscal stance, followed by some remarks the topic of Brexit and finally, some specific policy issues.
The economy looks set to register significant growth in 2017 following a continuously impressive performance since 2013. Unemployment is set to fall to approximately 5.5% by the end of the current year and to just over 5% by the end of 2018. Taxation revenues, which had shown some softening during the first quarter of the year, now look more robust in terms of year on year growth. Taking the increases in taxation receipts with the strong increase in employment, we believe the economy is now growing at approximately 5%.
From a budgetary perspective, a crucial question which arises is whether the current rate of growth is sustainable, namely, is the economy operating at or near its potential level? This is a difficult question to address at present, especially in light of the national accounting issues which have been widely discussed. However, our current position incorporating an assessment of the financial sector is that the economy is not overheating. There would still appear to be some spare capacity in the labour market, especially if we consider the migration channel and credit growth in the economy is still somewhat limited. In light of this, we believe budgetary policy should be neutral, in that it should not seek to actively stimulate or contract the economy. Overall, a budgetary package of around €400 million, the net fiscal space figure in the summer economic statement, is broadly in line with this concept.
Projections on the near-term performance of the economy are currently of continued steady growth and an improving fiscal position. Looking slightly further ahead, however, the impact of Brexit on the economy is a source of considerable concern. There is currently a great deal of uncertainty both in terms of the timing and severity of disruptions to trade patterns and other linkages between the two countries. The central scenario examined in ESRI research has been one of a hard Brexit, with the UK exiting the Single Market and World Trade Organization, WTO, tariff rates being imposed on Irish-UK trade. The long-term impact of this on Irish growth is estimated to be in the order of a 4% reduction in GDP.
The impact of Brexit is likely to be spread very unevenly across sectors and regions. Agriculture and food exports are likely to be the most severely affected, both because the tariff rates on these sectors are among the highest on the WTO schedule and because these sectors also tend to be more reliant on the UK as a main export destination. This differing exposure across sectors also suggests that the impact is likely to also be unevenly spread across geographically and to disproportionately affect Irish-owned SME exporters.
While this hard Brexit scenario has been estimated to have a reasonably substantial impact on the economy, the changes to the competitive environment in the UK market in the event of an exit from the customs union could pose even greater disruption to Irish business and to movement across the Border. A further note of caution should be attached to the timing and path of the impact as in the absence of a clear transition arrangement being put in place, disruption to trade could be felt very suddenly in a short space of time, perhaps overshooting the long-term projections. On the other hand, any potential benefits such as an increase in FDI are likely to take much longer to become apparent.
From the perspective of this committee, the question arising from this is to what extent the budgetary process can or should be used to alleviate this shock. Encouraging greater diversification across export markets will be critical in mitigating this risk to Irish exporters. To do this, opportunities in new markets will need to be identified; for example, in the event of a hard Brexit, Irish exporters may lose some access to the UK market but UK firms will also face barriers to exporting into the EU. The UK exports three times as much agricultural and food products to the EU as Ireland exports to the UK suggesting a substantial gap in the broader EU market for Irish exporters to explore diverting towards.
Firms will need to have sufficient access to financing to ensure that they can avail of opportunities and to undertake any adaptations of their products that might be needed to compete outside the UK marketplace.
Ensuring that the infrastructure is in place to enable firms to identify and maximise opportunities for diversification will be a key factor in minimising the overall impact of Brexit on the Irish economy.
Given the pace of growth in the economy, the Government must be especially careful that any future investment does not cause the economy to experience the same overheating difficulties experienced prior to the 2007-08 financial crisis. One area where investment is warranted is in extra provision for social housing. At present, expenditure on social housing is approximately €800 million a year. This contrasts with expenditure of approximately €1.4 billion per annum in the period as recently as 2010-11. In addition to the direct provision of social housing one other policy option, aimed more at facilitating greater levels of private sector housing, is the implementation of a site tax which would tax empty development sites. This would incentivise those who may be hoarding land to either fully develop the sites or to sell them.
In general, Government policy in the housing area needs to be very carefully considered. For example, there have been calls recently for incentives to be provided to property developers as a means of increasing housing supply but recent research conducted by the ESRI on behalf of the Department of Finance would caution against such measures being introduced. Furthermore, other research conducted by the ESRI argues that apart from a site tax, Government measures aimed at housing markets across countries have had mixed fortunes in terms of achieving the desired outcomes.
We were asked to comment on the possible integration of USC into the broader tax code and we will offer one observation on this. We expressed concerns at this committee last year about the suggested abolition of USC and we remain concerned about possible revenue losses. However, if there is a move towards the integration of USC and PRSI, this might present an opportunity for an innovative approach to yet another policy challenge, namely, pensions.
In a paper published by the ESRI in 2007, Dr. Shane Whelan of UCD proposed that the PRSI system be expanded to provide an earnings related pension for lower and middle income people. He showed how both risk and administration costs could be reduced under such a public system, allowing for more generous pensions payments for the same costs as might apply in a private system. The pension challenge for middle income people in Ireland has been shown in more recent research by our colleague Dr. Sanna Nivakoski. Using replacement rates as an indicator of the effectiveness of pension coverage, Dr. Nivakoski has shown how the Irish pensions system works well for lower and higher income people but less so for those in the middle.
We were also asked to comment on population ageing. We will make some specific remarks on the issue, but we will also place population ageing among a number of other issues which will put upward pressure on public spending in the coming years. It is now generally recognised that Ireland’s population is ageing. While this is to be celebrated, there will be some costs associated with that. For example, the Department of Finance has projected that spending on public pensions will rise by 3% of GDP between 2013 and 2040. This is a large figure but suggestions that public pensions are unsustainable is possibly overly alarmist. While it might not be a popular proposal, our colleague, Dr. Karina Doorley, has shown that across Europe, the costs of population ageing could be offset fully by extending the pension age to 70. The actual policy approach to population ageing will more likely involve a mix of increased contributions, delayed payments and extended working lives and there is a value in thinking now about how these components might be best achieved.
We have already referred to some drivers of public expenditure but will list them now. In addition to population ageing, it seems clear that infrastructural needs and climate change will also add to the upward pressures. On infrastructure, we have mentioned housing already but the committee knows well the other areas which include health, education and transport, to name but a few. On climate change, costs will arise in one of two ways. Failure to meet targets on emissions will result in fines. If we are to avoid those fines, we may need to invest more heavily in areas such as public transport and renewable energy.
These predictable pressures on the public finances led to us to raise concerns about tax cuts last year at this committee and this, understandably, was met with resistance from some members. Part of our concern relates to the difficulty of raising new revenue sources and recent years have provided ample evidence on this point. We will end these remarks by pointing to joint research by the ESRI and the Department of Finance on options for a wealth tax because it illustrates well the challenge of raising revenue. It is estimated that a 1% tax on wealth across the board in Ireland would raise €3.8 billion and would affect 86% of households. Clearly, such a tax is unrealistic and it is more likely that a range of thresholds and exemptions would be applied.
The paper illustrates how the tax take is reduced as the system is amended. For example, if the parameters of the French wealth tax system were applied, only €22 million would be raised. If we adopted the Dutch system, €706 million would be raised but almost a quarter of households would be affected.
Our purpose in undertaking that research was not to be prescriptive on whether or not a wealth tax should be introduced. It was a purely mechanical exercise exploring the options. In the context of future spending pressures, this wealth tax example serves as a useful illustration of the difficulty in raising new revenue and hence how care should be taken in reducing current revenue sources.