We can hear the Chairman now. This is a perfect situation for a dialogue.
As always, we thank the Chair and members of the committee for inviting us. Joining me remotely are council members Dr. Martina Lawless, Professor Michael McMahon and Ms Dawn Holland, as well as our chief economist and head of secretariat, Dr. Eddie Casey. We hugely value our engagement with the Oireachtas and see these meetings as an important part of our work.
As committee members knows, the Irish Fiscal Advisory Council is an independent body established under the Fiscal Responsibility Act 2012. Its mandate is to endorse and assess the official macroeconomic forecast, assess the budgetary projections, assess compliance with the fiscal rules and assess the fiscal stance. This focuses on the overall fiscal stance rather than on individual tax measures or spending items and priorities.
The council's fiscal assessment report was published last week and assesses budget 2020. In terms of the economic outlook, Covid-19 continues to have a major impact on the Irish economy. The budget projections imply a 6% decline in real modified gross national income, GNI*, this year, followed by a muted 2% recovery in 2021.
November’s Covid-adjusted unemployment rate remains high, at 17.4% for those aged between 25 and 74. However, the outlook has improved since the spring. The domestic economy recovered strongly in the third quarter. Consumption has rebounded and multinational enterprises have supported activity.
For budget 2021, the Government assumed that a vaccine would not be widely available until at least 2022, and that trade between the UK and the EU would be based on a hard Brexit. This was prudent, given the uncertainties and risks involved. However, it did not factor in a tightening of the Covid restrictions, as we saw in October. The budget forecasts cover just one year ahead, compared with the normal five-year horizon. This gives an extremely narrow picture as to how today’s policies might impact on the economy and on public finances. While medium-term projections are uncertain, they help to promote medium-term oriented fiscal policy. A return to five-year forecasting is essential for next April’s stability programme.
In our report, we developed three scenarios to 2025 to help frame some of the medium-term challenges that Ireland faces. The extended budget 2021 projections would see the economy recover to pre-crisis levels of activity by the end of 2022. A milder scenario, with an effective vaccine next summer, and perhaps we have got closer to that, and an EU-UK free-trade agreement, could see the economy recover to pre-crisis levels somewhat earlier in 2022. By contrast, a repeat waves scenario, with further level 5 restrictions necessary in 2021 and 2022, could see the recovery delayed until well into 2023.
The outlook remains highly uncertain and the impacts of the crisis might be felt for a very long time. Sectors such as retail, hospitality, transport and the arts are especially vulnerable to the pandemic. Counties more reliant on tourism and hospitality have also been worst affected, especially in the western and Border regions. The impact of Brexit also is still unclear and could be much different from what is assumed. Ireland is also exposed to international tax policy changes.
Turning to the public finances, Covid-19 has led to massive Government spending on job supports, health responses and measures to stimulate demand. Tax revenues have fallen sharply in some areas, notably VAT. Yet corporation tax and income tax have fared better than expected. A very large deficit close to €20 billion, or approximately 10% of GNI*, is likely both this year and next year. This will lead to a sharp rise in the debt-to-GNI* ratio, which was already at high levels pre-crisis - the sixth highest in the OECD at the time.
The council assesses that the Government’s decision to continue to borrow to support households and businesses through the Covid-19 crisis and to provide stimulus is appropriate, including up to €12 billion of supports in temporary stimulus for 2021. These measures should help to lessen the lasting damage of the economic crisis, and ultimately lead to a more sustainable path for Government debt. The council welcomes the use of contingencies in budget 2021 to cope with any additional costs of Covid-19 and Brexit and the use of the recovery fund, which has not been fully allocated at this point. Temporary and targeted supports should fall out of spending as the need for emergency measures diminishes and as the economy recovers, although there is some risk that some temporary spending may become permanent.
Budget 2021 also includes substantial, permanent increases in Government spending of at least €5.4 billion, however. Rather than being temporary and targeted, these will remain after the pandemic has passed. They are surprisingly large in the context of past budgets. Since 2015, budgets have included packages closer to an average of €3.5 billion a year. The permanent increases could even be as high as €8.5 billion as it is not possible to ascertain the nature of some of the increases in non-Exchequer elements of the public finances. This reflects ongoing transparency problems in areas outside of the Exchequer that have traditionally not been the focus of the Department in budget discussions.
The council assesses that permanent increases in spending without identifying sustainable funding is not conducive to prudent budgetary management. To be clear, the council is not opposed to increased spending itself, and the debt-financed stimulus at the moment is appropriate. However, there is no sense from the budget of how the lasting increases will be financed sustainably over the medium term. The programme for Government rules out tax increases and spending reductions over large parts of the tax base and existing spending. The risk is that this will tend to lead to larger deficits and leave debt on a riskier path.
Looking ahead, the council’s simulations suggest that Ireland’s budget balance by 2025 will be in deficit of between 2% and 3% of GNI* in the extended budget scenario. Assuming interest rates remain reasonably favourable, debt ratios, although high, should fall over the medium term except in a repeated wave scenario.
The €5.4 billion of core spending increases planned for 2021 will slow the pace of debt reduction. They will add to the deficit even by 2025 and they will contribute to debt being higher than it would have been otherwise.
The Government faces a number of significant challenges once the economy is on a path to recovery. Fiscal adjustment may be needed to put debt on a safer path and there are long-standing pressures on the public finances. These include Ireland’s rapidly ageing population, which is set to add approximately €850 million a year to Government spending to 2025, measures to address climate change, reducing the over-reliance on corporation tax, which now amounts to €1 in €5 of Exchequer revenue, and fulfilling ambitions to upgrade the public services.
The Government must use its medium-term strategy in April 2021 to deliver credible plans. This should include five-year forecasts; details on non-Exchequer areas; plans for sustainably financing the large increases in permanent spending; proper costing of major reforms such as Sláintecare; and an explanation of how budgetary plans would change if revenues fall short. Three reforms would also help: debt targets set in GNI* terms; tools to save temporary receipts such as unexpected corporation tax; and setting sustainable growth limits for spending.
I thank the members and we look forward, as always, to their questions.