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Joint Committee on Finance, Public Expenditure and Reform, and Taoiseach debate -
Wednesday, 13 Jul 2022

Summer Economic Statement: Irish Fiscal Advisory Council

I apologise for the late start. I was delayed coming to the committee room. I understand that we must be finished at a particular time, so we will manage to keep to the time. I remind witnesses and members of privilege, and to ensure they do not name anyone in such a way as to make him or her identifiable. When the committee met earlier we adopted our minutes of 6 July 2022.

We are here to discuss the summer economic statement. I welcome our guests. The guests will make their opening statements and then members who are in attendance either here or online can ask questions. I appreciate the witnesses attending.

Mr. Sebastian Barnes

The Irish Fiscal Advisory Council, IFAC, thank the Chairman and members of the committee for inviting us to appear before it for the first time. I see some familiar names and faces from the members' colleagues on the Committee on Budgetary Oversight. We value our engagements with the Oireachtas very highly and see these opportunities as an important part of our work. Joining me today are council member Dr. Adele Bergin, and Mr. Killian Carroll and Mr. Kevin Timoney from the council’s secretariat.

IFAC is an official independent body established under the Fiscal Responsibility Act 2012. Its mandate is to assess and endorse the official macroeconomic forecasts, assess the budgetary projections, assess compliance with the fiscal rules, and assess the fiscal stance. Its focus is on the overall fiscal stance rather than on individual tax measures or spending items.

Following two difficult years due to the Covid-19 pandemic, the Irish economy is now facing the challenge of a surge in energy and food prices due to the Russian invasion of Ukraine. Together with other price pressures as the economy recovered from Covid-19, inflation in Ireland has increased to its highest rate in a generation. The strength of the pick-up in inflation in recent months was not anticipated. The Government’s projections in April were for annual consumer price index, CPI, inflation of 6.2 % this year, while the inflation rate for June was already estimated to be 9.6 %. Globally, forecasts for inflation have been revised up, while expectations for growth have been scaled back. Higher energy and food prices, together with higher interest rates, will dampen growth in advanced economies. Uncertainty is very high, including around energy supplies in Europe this coming winter.

Despite this, recent economic data for Ireland have remained robust. Consumer credit card spending has continued to grow in recent months. Employment and tax receipts remain strong. Looking ahead, the Irish economy will inevitably be impacted by global and European developments, although Ireland’s direct exposure to Russia is less than for some other countries. Our specialisation in fast-growing digital and pharmaceutical activities may continue to be a source of resilience. Nevertheless, high inflation is likely to lead to the first annual fall in overall household real income in a decade. The impact of the higher cost of living creates real hardship for low-income households, who spend more than a third of disposable income on energy and food, and some other vulnerable groups.

Against this background, the Government published its summer economic statement on the 4 July. This sets out its strategy for budget 2023 in September and updates the overall amounts the Government plans to spend in the years ahead, although it did not revise the full economic and budgetary forecasts compared with April.

Strong tax revenues have led to a new official projection for a budget surplus in 2022, one year earlier than anticipated. This primarily reflects stronger than expected tax receipts, particularly from corporation tax. The Government faces a delicate balancing act in the budget between protecting the economy and poorer households from higher energy and food prices, while avoiding adding to inflation through second-round effects. Fiscal policy cannot permanently shelter the economy as a whole from higher prices.

In last October’s budget, the Government set out plans to increase core spending by €4 billion in 2023 to €84.1 billion. Core spending is Exchequer spending excluding one-off measures and unemployment benefits. This was consistent with a new fiscal rule to grow core spending in line with an underlying sustainable growth rate of the economy of 5 %. The IFAC welcomed this new rule as an anchor to keep the public finances on a sustainable path and to reduce the debt ratio to a more prudent level. The summer economic statement now plans to raise spending in 2023 by €5.3 billion, a growth rate of some 6.6%, with an additional €400 million in measures from this September, taking the level in 2023 to €85.8 billion.

The 5% spending rule is a significant strengthening of Ireland’s fiscal framework, although some aspects of its design need to be clarified. It is welcome that the Government has continued to use it as a reference point, even while deviating temporarily from the rule for the year ahead. The rule provides a useful signal that policy should not try to compensate fully for higher inflation. It is sensible, however, to allow some leeway during this period when inflation is very far from trend.

The summer economic statement further increased the size of the planned tax package from €500 million to just over €1 billion. Inflation tends to raise the tax burden because it draws more income into the higher tax bands. The upward revision to the tax package would help to prevent the tax burden from rising substantially. Well-targeted temporary measures can also help to smooth the transition to higher prices or address one-off events, such as Covid-19 or the immediate needs of refugees, without impacting the underlying dynamics of the public finances. The amounts that have been allocated will allow existing measures to be extended or could allow for some new temporary measures to be put in place.

Taken together, the plan outlined in the summer economic statement would strike a reasonable balance between creating space to support the economy and more vulnerable households, and avoiding adding to inflation by increasing demand excessively in an already inflationary environment. The Government will, however, need to make difficult choices in the budget. Increases of €2.7 billion in permanent core spending remains to be allocated after taking into account the planned rise in public investment, rising pensions costs and the existing pay deal. This amount is relatively large compared with those in recent budgets, but much of it is likely to be required just to stand still in terms of maintaining the existing level of public services, and welfare and pension rates. Indeed, given the current trajectory of inflation, this amount would likely be insufficient to fully index public sector pay and welfare rates.

There is very limited space for new policy initiatives beyond cost-of-living measures at this time. Better targeting of supports would improve the trade-off between helping those most exposed and risks of second-round inflation. The council’s full assessment of the budget package will depend on the details of what is announced on budget day, together with economic developments over the coming months.

Overall, the public finances have recovered well from the Covid-19 pandemic. Prior to the surge in inflation, the budget balance was set to reach a sizeable surplus in the years ahead. Combined with lower interest rates and underlying growth of the economy, the government debt ratio would fall significantly in the coming years. The high average maturity of debt and large cash reserves provide some insulation in the near term from higher interest rates. Nevertheless, the debt ratio remains high by historical standards and compared with other small advanced economies. The over-reliance on corporation tax flatters this picture. Taking the council’s estimates that €6 billion to €9 billion of these receipts are excess compared with fundamentals, this implies that the current surplus is equivalent to a substantial deficit. Corporation tax last year represented nearly €1 in every €4 of Exchequer tax revenue, amounting to nearly 7% of national income.

A large share of this is paid by just a handful of multinational corporations. While these revenues could remain strong for some years, they depend on developments and decisions made outside Ireland. These revenues are volatile and subject to the risk of a sudden large fall.

The Government should take measures to reduce its reliance on corporation tax by, at a minimum, capping and preferably reducing over time how much of this money is spent. This would reduce the risks of a reversal in revenues and avoid overheating the economy. The reduction in exposure could be achieved in various ways including paying down debt more quickly, making contributions to the rainy-day fund or by reinstating the National Pensions Reserve Fund in order that the corporation tax boom would be used to reduce the need to increase taxes in the future.

Looking ahead, major policy commitments and challenges need to be properly costed and factored into the Government’s medium-term plans. These pressures on public spending raise significant questions about how they will be accommodated within the Government's spending rule alongside existing policies. There are three main challenges.

First, Ireland’s population will age rapidly in the years ahead due to people living longer and the coming retirement of Irish baby boomers. Annual spending on pensions is set to rise by about 1.5% to 2% of national income by 2030. The pensions commission’s preferred option involved raising the State pension age and substantial increases in PRSI rates, amounting to almost €1,000 per year for a worker on a typical wage of €35,000. Maintaining the retirement age at its current level of age 66 would add approximately another €800 in PRSI payments for a worker on a typical wage.

Second, the Government is required to halve Ireland’s greenhouse gas emissions by 2030 compared with the 2018 level. This will be a major change to the way our economy and society functions. However, the impact on the public finances has not been fully assessed or factored into budgetary plans. Estimates from Mr. John FitzGerald put the cost at an additional 1.7% to 2.3% of national income on average over the years 2026 to 2030.

Third, the Government has not costed its major healthcare reforms under Sláintecare beyond this year. There is no clarity on how much progress has been made to date and what the overall cost is likely to be.

The public finances can play a key role in helping to address the impact of the higher cost of living, particularly on lower-income and disadvantaged households, but it must be done in a way that does not add to inflationary pressure to ensure that higher inflation does not become entrenched. While Government borrowing was key to protecting the economy during the pandemic, the fiscal response now needs to be more balanced. Fiscal policy cannot permanently shelter the economy as a whole from higher prices. Despite the urgency of current pressures, it is important to maintain the economy and public finances on a sustainable path and address the longer-term challenges for the public finances. I thank the committee very much. We look forward to members' questions.

I thank Mr. Barnes very much. I call Deputy Doherty.

I welcome members of IFAC. Its presentations are always valuable and maybe I will start off with that. We know the council is mandated to do an assessment and endorse the macroeconomic forecast provided in the stability programme update, SPU. IFAC does not have the mandate with regard to the summer economic statement, however. Therefore, it does not produce any report after the summer economic statement. While there have been few deviations, there have been changes. Obviously, we do not have concrete projections for inflation in the summer economic statement. In addition, some other things are missing. Does Mr. Barnes believe the mandate of the council should be expanded to allow it to carry out an assessment after the summer economic statement is published as opposed to him coming in here and giving his views as a normal witness? Would it be helpful if there were a formal process?

Mr. Sebastian Barnes

I thank the Deputy. That is a very good question. It is one the council has not thought about or discussed. We will take note of, think about and discuss that to see if it is something we want to raise. From our perspective, we have a formal mandate with these four pillars. We actually have a formal mandate to make reports twice a year on the SPU and on the budget. We always felt that if we just did that, however, we would not necessarily be doing the best service for the Irish people or for what the legislation was intended to do originally.

For a number of years, we published a pre-budget statement ahead of the budget, which we sometimes discussed with Oireachtas committees. We have often commented on the summer economic statement in the past. This time, there is obviously quite a lot of substance in it. There is a slightly curious position where the European requirement is focusing on the SPU in April and the draft budget in October but, of course, the summer economic statement and national economic dialogue are important parts of the Irish discussion. The question raised by the Deputy is, therefore, a sensible one. We will take note of it and see if others have views. I think it is a good question.

I will delve into some of the figures now that make up the summer economic statement. We might look at existing levels of services, which the council commented on with regard to its assessment of the SPU and again today. The summer economic statement provided €2.2 billion in respect of maintaining existing levels of services and €800 million in respect of pre-committed increases in capital ceilings. Last year, that figure was approximately €1.6 billion in terms of services for 2022.

Mr. Barnes pointed out that in its report in May, the council noted that the 3% increase that underpins this allocation has changed from the SPU despite higher inflation. Given the fact that we are seeing higher inflation and that the numbers have not changed, from what we have seen, in more than a year, how much of the discretionary money does Mr. Barnes think will be eaten into when we factor in what is happening in terms of inflation? Mr. Barnes also made the point that existing pay agreements are factored into the existing levels of service but not future pay agreements, one of which we know is under consideration. He might give an indication of the impact the offer that was on the table, which has been rejected, would have on the discretionary funding the Minister has available for new policy measures in September were it to be accepted.

Mr. Sebastian Barnes

It is welcome that the Department of Finance now uses this kind of existing level of service concept, which is similar to what the council talked about in terms of standstill. In any typical budget, many of the spending increases are needed just to maintain wages and pay. That is a welcome change.

One of the difficulties with the SPU is the existing level of service beyond the current year. There are no real details about how finance gets to it. Usually, it is a more realistic number than some of the numbers we have seen for spending in recent years. There are no very clear underpinnings so it is harder to work out exactly how we would adjust that.

In terms of the Deputy's bigger question on the higher inflation that is now expected next year, which is important, if we were to make up for the unexpected inflation this year, which will actually be a much bigger number that, our assessment is that if we were to just stand still, the total amount of spending that was allocated for next year in the summer economic statement would not be enough to index all these bits fully in line with inflation if we take into account wages, welfare rates, pensions and other parts. Our assessment is that the costs of standing still are higher than the total amount for spending next year. That means within the overall spending limit the Government has set, choices will have to be made between different aspects of it. There may be some aspects where it is desirable not to fully index them. There are obviously some areas within that which would be priorities. As I noted earlier, there is obviously not going to be much space for any additional spending on new programmes unless, of course, taxes were to increase, which, not relative to the rule but in economic terms, would make a difference.

In terms of the Deputy's specific question on pay, we have not made that calculation so I do not know what the impact of that pay deal would be. Obviously, given that space is limited within that spending limit, it may be that the more pay is increased, the less space there is, for example, increasing pensions and welfare payments.

Let us tease that out a bit further. Mr. Barnes mentioned welfare and pay. When the Government talks about its allocation for next year in terms of existing levels of service, it is not talking about welfare increases. The latter will be provided under the discretionary amounts it has available.

The existing pay deal is included in existing levels of service, but a future pay deal will not be. I understand it will be shy of €1 billion if it were to be accepted for next year, which reduces the amount available for other programmes and policy measures such as social welfare increases significantly. In terms of existing levels of service alone, we understand that is for the running of the Departments of Health and Education and all of the rest. The food bills in our hospitals have gone up. Hospital costs relating to laundry have gone up. Energy costs for hospitals have gone up. The Department has calculated €2.2 billion just to keep all those services going. How appropriate is that figure to maintain existing services as opposed to what the Government might do in social welfare or the pay deal, which will come out of the other €2.7 billion?

Mr. Sebastian Barnes

We just make a very general assumption about inflation. We looked at this very briefly. In some of those other areas, inflation would be quite similar to the inflation that households face and will be fairly well approximated by general inflation. In other areas, there might be specific pressures. The existing levels of service numbers in there are very much based on the previous forecast for inflation. This extra amount will be allocated in the budget. Choices will have to be made about to what extent we stand still in different areas. One of the major uncertainties in all of this, and also on the tax side, is what will happen to wages. It is very hard to predict how wages will change over the next year. That will obviously affect the cost of providing Government services and will impact how we think about the public sector pay deals.

Mr. Barnes spoke about insulating people from inflation, and not just the inflation we are expecting next year. There is no figure for that in the summer economic statement. Where does IFAC expect inflation to be next year? Will it be in the range of 4% to 5%? Social welfare increases will need to insulate people from last year's increases. As the Government has done nothing this year, it will also need to compensate them for cost increases of almost 10%. It is actually more in view of the fact that inflation rates for social welfare recipients will be higher. What increase in social welfare payments will be needed to insulate people from the spike in inflation this year and next?

Mr. Sebastian Barnes

The Deputy asked a couple of questions. I will start at the beginning. We do not have an updated figure for inflation. That is one of the reasons we will make a fuller assessment in September. The pick-up in inflation in recent months has been really strong, and far greater than anyone had anticipated. Some of that relates to major uncertainties about energy prices, wheat prices and other food prices. We have seen movements in different directions there. Coming into the winter, we might be much clearer about energy prices. Some of these prices might fall. We have seen a fall in wheat prices in recent weeks, but there are different pressures in other areas.

The euro is also weakening against the dollar. Many of these things are priced in dollars, which will also add to inflation. There are other sources of inflation with tightness in the labour market and other issues in the economy. It is very difficult to know. The most useful thing may not be to look at the year-on-year inflation but, rather, to try to work out the underlying dynamics. It is very unclear as to whether there will be new shocks to inflation. It will also take time for the shocks we have seen to work through the economy and in particular the effect on wages. These things are very uncertain and we should have a bit more information in September.

In our models of the standstill, we index welfare payments, including pensions. When we do it to prices, we do it to the economy-wide measure of prices. The Deputy is right that in order to strictly speaking maintain the real living standards of people on welfare or pensions, we would need to use the inflation rate relevant to them. This is likely to be significantly higher than the overall rate of inflation because we know they spend much more on things that have increased such as food and energy. Partly because I do not have a clear view on inflation and much less for those groups, I do not know what is appropriate. How that compensation should be made is really a choice for the political system. It clearly makes sense to protect groups and sectors that are far more exposed than others.

Mr. Barnes mentioned that the summer economic statement has revised up the Government's taxation package from €500 million to slightly over €1 billion. He said that the upward revision of the tax package would help to prevent the tax burden from rising substantially. I wish to tease that out. Last month, Dr. Barra Roantree from the ESRI noted that the benefits from changes to the standard rate band is concentrated towards the top of the income distribution. Therefore, changing the upper band gives no benefit to 80% of tax units. The IFAC income assessment report in May noted that high-income households which would benefit from a tax change such as this would simply increase their savings, increasing their spending power. We know that 80% of tax units do not pay tax at the top rate and only 20% would benefit from a change to the standard rate. To have secondary effects and so forth, tax cuts can be provided to people who will increase their spending power and possibly fuel inflation. Is that the best measure in terms of tax cuts?

I take two things from Mr. Barnes's opening statement. I see a change in his position to the effect that tax cuts to the standard rate are required - so a tax rate for 20% of income earners. An inference could be drawn that the increase in the tax package from €500 million to €1 billion is actually for this purpose. Without second-guessing the Minister, I would suggest it is not. I suggest that the Minister will and should extend the 9% VAT rate on petrol, diesel, kerosene for three months into 2023, which would be the bear minimum and would cost a few million euro shy of €250 million on its own. Has IFAC changed its position on those changes which it claimed in its May report would simply increase people's savings and the ESRI said is concentrated towards the top of the income distribution with no benefit to 80% of income earners?

Mr. Sebastian Barnes

The council's job is to look at the overall budgetary stance. We do not take a view on either the design of specific temporary measures or of tax measures. We were setting out that if the Government were trying to keep the tax system the same in economic terms as it was before - regardless of whether people think that is a good idea - the higher inflation now would draw more income into the higher band, leading to an overall tax increase. In order to maintain it as it was before would require more of an adjustment to those tax bands in cash terms. By increasing the amount allocated to that, the Government is making it more likely that there will be less of an increase. In previous years, the Government has not always fully indexed the tax system, which has been a source of real tax increase. As the Deputy says, it falls mostly on higher earners; that is how it works. Sometimes it has introduced other measures to offset it. There is often much confusion about the indexation issue and the impact of inflation on taxes.

If one wanted to keep the system as it is then today, in economic terms, one would basically have to index the bands by more. That would show up as larger measures, in the sense that the Government is using it, and bigger cash changes. In economic terms, the impact would be the same. So it is not really changing taxes in an economic sense at all.

Obviously, that depends on wage growth rather than inflation.

Mr. Sebastian Barnes


So people receive wages and the value of those wages must be maintained. The point has been made, and rightly so, that the budget will come down to choices and targeted measures. The Government has increased the taxation package up to €1 billion. After one subtracts the public pay agreement, there will be less than €2 billion in discretionary expenditure. Once social welfare increase are taken out of that, we are talking small numbers. Mr. Barnes has argued that we need targeted measures. He also stated that we need to ensure that we do not have second-round effects. Taxation is quite expensive. Is it a case, therefore, that indexation of the standard rate band would, at this point, be an appropriate targeted measures in light of what we are seeing in the context of inflation?

Mr. Sebastian Barnes

The Deputy has asked an important question. There are choices to be made. One choice is about how one allocates a given amount of spending between different uses. The other question is whether one wants to raise taxes to create more space. One option would be, for example, to do less with indexation, which would give the Government, subject to one qualification, more space. In that way, it could allocate more towards helping other groups in society through higher spending. There is a case for doing that. There is also a case for taxing people who earn higher incomes - and, perhaps, incomes that have done quite well in the past few years, as we discussed in our May-June report - and using that to help the more vulnerable groups.

One important caveat and one concern of ours is about the design of the spending rule. The Government's spending rule is purely about spending. If one takes, for example, the European spending rule, then that takes into account changes in tax policy. If, for example, under the European rule, one increased taxes, and that could include through not indexing the tax bands, it would give more space to increase spending because, in terms of the overall balance, that would be neutral, which is what we really care about. It is just that one reaches that point in a different way. At a minimum, it would be good for the Government to clarify how that is treated. From an economic point of view, however, it would be a very good improvement to allow discretionary tax measures to enter into that spending equation. There are a lot of other good reasons for doing so as well. It also closes down any incentive that the Government might have, in different circumstances, to cut taxes because it cannot do anything on the spending side politically. In this context, it is very sensible that the Government should at least have the option within the spending rule to also change the tax and spending mix. The council is not taking a view as to whether that is a desirable thing or not in terms of whether that should be done regarding the mix of spending and taxation that one wants. The spending rule, which should really be about hitting a particular balance, should give the Government the option to raise taxes and give itself more space for spending.

I hear what Mr. Barnes said to the effect that lower indexation would lead to more expenditure. The summer economic statement has set out a net taxation package of €1.05 billion. This means that, regardless of the increased taxes, the cut will be €1.1 billion. Obviously, one of the big concerns we have all had for years is the issue of corporation tax. In the context of the council identifying between €6 billion and €9 billion of excess corporation tax, how prudent would it be to have that type of package? I am not making suggestions, one way or the other, I am simply asking the question.

Mr. Sebastian Barnes

The corporation tax issue, as everyone is now well aware, is a major issue and a big problem that needs to be addressed. It is a big risk to the public finances. There could be some sudden reversal that could leave us with a big hole in the public finances. The more this goes on over time then the more it gets baked into the system. It also brings money into the economy that could ultimately contribute to overheating, so there is a real need to address the matter. It is a quite a broad and complicated issue so a plan is needed. For example, capping payments in respect of dependants at last year's level or having a plan to gradually reduce that would be preferable. Then one could think about how to use the money to reduce debt, increase the rainy day fund or revive the National Pensions Reserve Fund. I would not link it to tax changes in the budget because it is on a different scale.

Gabhaim buíochas le baill na comhairle as teacht os comhair an choiste arís. I thank our witnesses for attending again. I listened with interest to the earlier conversations and have a number of questions.

On housing delivery, we know that inflation has increased for construction costs. We also know that there is a national development plan calculation for Housing for All and that the capital ceilings are fixed for housing under the national development plan. With inflation affecting construction, how does the council view the amount that has been allocated? Will there be fewer houses than is planned for under Housing for All?

Dr. Adele Bergin

There is a risk in a high-inflation environment. With inflation in building and construction running quite high in recent months and with investment levels remaining the same, the targets may be more difficult to achieve.

Has the council calculated how much of an additional allocation is needed in order to even keep the number at a standstill?

Dr. Adele Bergin

No, we do not.

Mr. Sebastian Barnes

No. We have not looked at those calculations. I guess that we will look at them in the context of our updated forecast in September. At that point, we will look at how many houses have been built. There is inflation in the materials, and there have always been issues with skills and what the capacity of the housing construction sector actually is. We will look at that again, and we can provide an updated account in our next report.

We know that housing is a key issue. Also, for the people we on this committee represent, the delivery of social and affordable housing is going to be crucial in the coming months and years. Obviously, it would be extremely concerning if the level of inflation, as projected, happens as it will impact on the delivery of housing. Does the council expect inflation relating to construction to continue to be an issue? In light of the amount of funding that has been allocated, will inflation have an impact in terms of the number of houses that will be delivered?

Mr. Sebastian Barnes

It is very likely that inflation will be much higher than expected, particularly as we know what is happening to raw material prices and the energy inputs are quite high as well. There are other constraints apart from the budget and in recent years it has always been a bit of a struggle to get the number of units actually built. It is hard to say exactly what the impact will be. This is an issue of concern and one that the Government should think about.

I am aware that there are other concerns. If we do not have the budget to deliver the houses, we cannot even begin to tackle the other issues.

I have a question on the unspent money to support those fleeing the war in Ukraine. What is the council's view in respect of using any of that money on one-off measures?

Mr. Sebastian Barnes

The Deputy is right about the amount that were initially allocated. Basically, it looks like the amount was overestimated. The Government allocated some temporary space in that regard. I do not think we have a very strong view as to whether that money should be used for something else or whatever. In terms of public finances, the big concern is always permanent measures. Most of what we talk about in the context of the budget, welfare increases and pay and pension increases relates to permanent increases that will last forever and that will have a lasting impact on public finances. That is also true for the rising cost of pensions.

Temporary measures have an impact but not a huge one because they are a kind of one-off. We saw that with the pandemic. They obviously contribute a little to demand and the inflationary pressures but again the amounts involved are not huge, so it is a judgment call as to whether that money should be used or how it should be used. It is partly about smoothing the transition. We are all facing the fact that food and energy prices are likely to be permanently higher than they were before. Most people will not have the extra income to deal with that. It is a judgment call as to how much the Government can help people in the short term by giving them some extra money in order that they avoid a very sudden change in their incomes. These measures are very important for people and they are important for the public finances, but I do not think we have a strong view either way.

Mr. Barnes touched on climate change. I have had a few meetings over the past few days where the talk was about the actual cost and what kind of figures we are talking about in order to genuinely tackle climate change. When we go outside and the weather is the way it is at the moment, it reminds us of the fact that the past ten years have been the hottest for thousands of years. I am wondering what calculations the council has done in respect of climate change and, specifically, on what the costs will be on an annual basis.

Mr. Sebastian Barnes

This is a major area. As I said, this will involve a massive social and economic transition. The country is going to look very different after we have made these changes, which are, of course, absolutely necessary because of the urgency of the climate situation. For some time now we have been concerned the Government has not provided an assessment or full costing of how it thinks these forces are going to play out, either for the economy or for the public finances. One of the costs is going to be higher investment in energy, insulation and these kinds of things and our sense is much of that is included in the national development plan, so it seems to be accounted for.

What is less certain is the kind of current ongoing spending that might be needed and also things, for example, like compensating those whose incomes are adversely affected by these changes. What we see now with the higher energy prices is partly related to that. There is also the impact on the tax system if we are all driving electric cars in ten years. The Government makes a significant amount of money from motor fuel taxes. What is going to replace that? How is that going to be managed? There are a lot of really big questions to be answered. Some of the work is starting to be done. We see the paper I mentioned from Dr. John FitzGerald that has estimates of about 2% of national income per year. That gives you a sense of the kind of numbers. This is an area the council is working on. I think the Central Bank is working on it too. The Climate Change Advisory Council has put out some more data as well, which is helpful, so I think we are getting there. Most countries in Europe are in the same situation as we are, that we are basically a long way behind in our analysis of this major change, but I hope there will be some progress in the time to come. It should be a major priority of the Government to work out the impact of this, because it is going to huge.

Does Mr. Barnes think any revised fiscal rules would need to reflect the level of spending that would be needed?

Mr. Sebastian Barnes

It is something to have in the background. With the fiscal and economic situation, however, you need to look at the overall package. The environment is just one part of that. I do not think you should-----

If the world burns, we will not have any. We will not be worrying about budgets.

Mr. Sebastian Barnes

There are some proposals that would just exempt green spending from the rules. That does not make sense. You can think about maybe whether you modify the rules in light of green spending, but simply excluding it is too crude because it has to fit into the overall package of the public finances. That is very important.

Out of interest, why does Mr. Barnes think that would be too crude?

Mr. Sebastian Barnes

It is not like a sort of separate issue that is on the side. It really is something that is going to have an integral effect on many things. These investments are needed but they will not necessarily generate a financial return to the Government. Some of them do, for example in the energy sector, but it is not just building a toll road in circumstances where you hope that you are going to get your money back. Some of this is just building flood defences, which is good because it will stop the cities being flooded, but you are worse off than if there had not been climate change. The returns in respect of a lot of this investment are quite uncertain as well, so there are a number of reasons why simply easing the fiscal stance because of the climate issue is not necessarily a good thing.

It would also run against the same economic constraints. Already we have very high public investment. If we were to create extra space for public investment on top without some offsetting reductions somewhere else that will contribute to overheating and stretching the supply side of the economy. If you look at it, one the achievements of the public finances, one of the good things about the way the public finances have evolved over the past couple of years, is that we have got to record levels of public investment as a share of national income, by our own standards, and very high levels by international standards and we have done that within the existing budget and within the rules. This shows that it can be done with appropriate management of the economy.

I will finish on this point. I have a bit of an obscure question I hope the council can assist me with. I have asked a number of people and I cannot get an answer to it. Do any of the witnesses know much about the price regulation as it applies to network charges, that is, the retail price index minus X that there is in Britain. If they do not, that is okay. I am trying everyone.

Mr. Sebastian Barnes

My knowledge on that is rather limited. From what I remember from my undergraduate days - I am not sure they even still have that system - it was used at a time when they were beginning to privatise and regulate, and it was a slightly crude way of bringing down prices as they needed to come down. Beyond that, I know nothing.

The last time they looked at the revenue cap was 2020, but the whole basis of this is it is usually reviewed every five years. It was done in 2020. I am trying to figure out, because things have changed, whether it is going to be looked at. I will have to continue my quest for another day. I thank the council very much for that.

I thank the Deputy. She will have to trawl Google.

I have done that as well.

I understand Senator Higgins has gone to take part in a vote, so Deputy Tóibín is next.

Go raibh maith agat a Chathaoirligh agus míle buíochas le gach duine a tháinig isteach agus as a gcur i láthair freisin. I have a couple of points. It is quite incredible that the Government has not fully costed the costs of climate change or Sláintecare outside the current year, particularly as these are two large aspects I imagine are going to hoover up a significant amount of funds over the next number of years.

On the national debt, has any work been done on what the expected interest rate increases over the next number of years? How much this will cost in terms of the State funding it on a budgetary basis in the coming years?

Mr. Kevin Timoney

Forecasting interest rates is tricky. They obviously relate to lots of factors outside Ireland. We have done some work on forecasting interest rates but only over the long term. Two summers ago, we had the long-term sustainability report and we forecast interest rates based on market projections of safe interest rates at the euro area level. You have information from the Euribor six-month based on what the market expects interest rates to be. They have increased quite a lot since then but it is hard to say how much that feeds through into Ireland's national debt and Ireland's national debt interest. It is different for various countries depending on their maturity profile of debt. Ireland's maturity profile of debt it quite long at the moment relative to the profiles of other countries in the euro area. It is hard to say, over the short term especially, exactly what the impact will be but there are some factors in Ireland's favour relative to other countries, including the longer profile of debt maturity.

Mr. Barnes mentioned that the level of debt is comparatively high historically, and internationally among countries of a similar size. What I understand from Mr. Barnes is that, given all the knowledge we have, we are not going to be returning to a situation where our interest rates will be decided on the basis of our ability to be able to repay debt, which was the major factor in our experience ten years ago.

Mr. Sebastian Barnes

There are two factors with interest rates. There is the risk spread associated with Irish debt specifically and then there is the euro area risk-free interest rate. If we continue to manage our public finances properly, there is no reason why the spread should not remain quite low, although there are risks. We have seen tensions in the euro area as interest rates have increased, in particular as regards countries with relatively high debt. As Mr. Timoney said, it is very hard to know what will happen in terms of interest rates. There is a general view among economists that interest rates will ultimately rise from where they are today, but that they probably will not go back to the same sort of rates we saw in the past. There has been a trend of declining interest rates over time. As he also said, in the Irish case, something that gives us some protection in the short term is the fact that we have locked in low interest rates for much of our debt for many years ahead. The fact that we borrowed to build up cash reserves means we have had to borrow more. This means we have got a stock of low-interest debt. In an environment where money is likely to be quite tight because of all the pressures on spending, this is one extra thing that will not help but it should not be a decisive factor. In the long run, the higher debt you have, the more exposed you are, and it will come in a bit more.

I thank Mr. Barnes for that. The big question floating around relates to corporation taxes and how best to use them. Mr. Barnes mentioned the rainy day fund, paying down national debt and, potentially, reviving the National Pensions Reserve Fund. Are large capital projects not a good use of corporation taxes, given that they are typically once off, and they have a big return in the long term to the State? The funding is not going into the running of the State. I would add that the building of houses into those capital projects could be a good use of corporation tax.

Mr. Sebastian Barnes

There are two responses to that. The short answer is "No". There are two reasons for this. First, as the national development plan reflects, investment needs be permanently higher in the future because we are going to move towards a more capital-intensive economy. Whatever we do, it is going take us a long time to catch up on housing, energy production and other things. It is not just a sort of temporary one-off that we invest in something and it will be done. We have to build it into the baseline because it may not be as high, but investment will be higher than it has been historically. There is obviously a difference between taking that money and spending it on investment compared with spending it on health. Health is actually a poor example, but on truly current spending which has no future benefit, because there is a longer term benefit in the case of health.

One of the things that is important is that the money needs to be taken out of the economy. This is money where basically a big chunk of it is coming from multinational companies in profits on worldwide or European trading activity. It is not being generated within Ireland in the way that the revenue of a pub might be. This is money coming into the economy. Essentially, with this very large amount of money coming in, if you spend it, that will contribute essentially to overheating the economy further. If you bring more money in, prices will go up and housing will become more expensive. It is quite important not to spend it. It is important to invest it, probably outside the economy. That is a way of keeping the economy on a balanced path. This is the experience of Norway, which has a similar but much bigger issue with the oil revenue. In the early 1990s what they did is they spent the oil money as it came in and their economy had a huge boom and then a big collapse at the point where the money came down. It is at that point that they decided to set up a sovereign wealth fund, which invests the money. One rule of that investment fund is that it must not invest any money in Norway. It is all invested internationally. If you go to Norway, you still see the impact of the oil money. It is very expensive to buy anything there. Some of the oil money is still coming into the economy in a way, but compared with what it would be like had they spent that money even on investment projects that yield a future return, it would have been very much more destabilising to their economy. While it seems attractive to use these moneys for investment - and definitely using it for investment is better than using it for current spending - it is ultimately a question of trying to keep the economy on a balanced path.

We are in a bit of a difficulty here because our capital investment has been incredibly low historically. For about ten or 15 years we were probably investing the second lowest in terms of GDP in the EU. Depreciation has hit our capital stock quite significantly over that period.

The second element, which Mr. Barnes mentioned a number of times, is the danger of overheating. What research has been done in terms of the capacity that exists within the different sectors before we get into a position of overheating? I have heard the Government say in recent times, even in the housing market, that money is no longer an issue any more, that it is actually capacity. Is there a quantification of existing capacity in the housing sector and in other sectors so that we understand better how we can invest without overheating?

Mr. Sebastian Barnes

This is the right way of thinking about it. The level of investment that we have now is historically the highest share of national income. Government investment is somewhere around 6% nationally. Most European countries are possibly at around 3% or 4%, so this is a very high level of investment. As the Deputy rightly points out, the real constraint is not actually finding the money to finance it, it is the capacity of the economy and the construction sector to absorb this without running up costs. We wrote a paper about this a year ago but, unfortunately, the people who wrote it are not with me today and my memory is a little bit sketchy. Thousands of extra workers will be needed to meet the Government's target in the housing sector alone. We are in a period of very low unemployment, and there are not a massive number of people around, either with the right skills or even just around, who could contribute to that. The real constraint on all of this is the capacity at which we can build houses and insulate houses, which is very important for climate change, and at which we can build other forms of infrastructure. That is the limit. Trying to increase capital spending even more is likely to run up higher costs, as we were discussing earlier.

In terms of the overall macroeconomic imbalance, we could achieve this by funding it through higher taxes as well. That would only help with the overall macroeconomic balance, however. It would not necessarily mean that there were more people around who could lay bricks or fit windows.

It strikes me that the Government ring-fenced the carbon tax for the purpose of deep retrofitting of homes. It is breaking that fence because it does not seem to have the capacity to be able to deliver on that particular job.

It also strikes me that Ireland is very much a country with a two-tier economy. We have a very robust foreign direct investment sector, but we do not have the same experience in the domestic sector. Many countries across Europe are concerned about recession. Would it be possible that in the coming years we would not be in recession in overall terms but that the domestic sector might be?

Mr. Sebastian Barnes

I think that is possible. The two-tier economy is a simplification, but it captures something very important, which is that we know the digital sector, the pharma sector and some others have been powering ahead in recent years. Some work by Mr. Timoney in recent months has been very interesting in terms of looking at incomes, for example.

The rate of creation of high-paid jobs and the rate of pay increase in these sectors are phenomenal. That has created a benefit and is one of the reasons income tax receipts are so strong in recent times. There is a benefit to the economy that speaks to the wider point in that, when you add up the economy, having those sectors that are doing well means the aggregate number is fairly resilient. There is also a feedback between that as well, whereby people who are earning good money in digital and pharmaceutical sectors are also spending it. They are paying taxes that are used to fund public services. That adds to the overall resilience of the economy, but it also increases the exposure on the corporation tax side because, obviously, those activities are undertaken by multinationals. It does partly add to those risks as well.

The rate of creation of high-paid jobs and the rate of pay increase in these sectors are phenomenal. That has created a benefit and is one of the reasons income tax receipts are so strong in recent times. There is a benefit to the economy that speaks to the wider point in that, when you add up the economy, having those sectors that are doing well means the aggregate number is fairly resilient. There is also a feedback between that as well, whereby people who are earning good money in digital and pharmaceutical sectors are also spending it. They are paying taxes that are used to fund public services. That adds to the overall resilience of the economy, but it also increases the exposure on the corporation tax side because, obviously, those activities are undertaken by multinationals. It does partly add to those risks as well.

It is possible that those in the two tiers could have a different experience going forward. Mr. Barnes mentioned that there is positive feedback between the foreign direct investment sector and indigenous sector. It is possible that the indigenous sector could suffer while the overall picture would be better.

I have a number of questions to finish on. We hear in political discourse that everyone is suffering due to the cost-of-living crisis, inflation and the war in Ukraine. Has IFAC carried out any comparative analysis on inflation in Ireland and the cost of living? Most of the indicators we see show that Ireland is at the very top of the list, if not among the top three most expensive countries to live in. Does competition play a role in this? Historically, Ireland has had structural competition problems whereby we have not had enough players within a given market to drive prices down, create efficiencies, or even prevent profits that are too high from being made. I can think of a number of such sectors from retail, electricity supply and, historically, the legal system. What work can we do to reduce inflation and the cost of living? Can we do work on those structural problems in order to have an ultimate benefit?

Mr. Sebastian Barnes

These are not issues that we have looked at directly, but it is a good time to look at them. They are important for our international competitiveness, when businesses think about locating here, but also with all the cost-of-living pressures people have. This is obviously a time where we are much more aware of the costs. These are good levers and, ultimately, increasing competition may be a better solution to these problems than using public finances to offset them.

Sin é. I thank the witnesses for their time; I greatly appreciate it.

Both of the Senators who wish to contribute are voting in the Seanad, so I will ask a question or two. Mr. Barnes referred to Sláintecare and the fact that there is no clarity on how much progress has been made to date on the overall cost of the reforms, but Sláintecare did receive funding. Does Mr. Barnes have a view on that funding and if it was too low? He said that it was not funded properly. Will he elaborate on that?

Mr. Sebastian Barnes

That is a very good question. There was a cost estimate for Sláintecare, but it was done in 2017. There has literally been no update since then. Obviously, many things have changed since then with overall health spending being much higher than it was in 2017. Wages in the health sector are significantly higher. There have been lots of changes. Covid knocked the health system around quite a lot as well.

The Government provided some estimates on how much has been spent so far, but without providing an estimate of what the overall amount is. When we say that we do not know how much progress has been made, what we mean is that the Government has said how much it has spent so far, but has not provided a revised estimate of the total amount or of the number of the reform measures that have been implemented. That means we do not know, beyond this year, how much Sláintecare will ultimately cost. We are not health experts nor experts on Sláintecare, but we think the Government should produce a revised estimate of the ultimate cost and of how much is still to be spent.

Let us say that Sláintecare is a process of ten steps. The Government has taken two of those steps to date. Does Mr. Barnes want to know what two steps have been taken and the costs relative to those steps, as well as what is left in the context of the remaining eight steps and their costs? Mr. Barnes is saying that nothing has been forecast and that there is nothing transparent about it.

Mr. Sebastian Barnes

The bottom line is that we want to see how much the Government thinks it will cost, from here on in, to implement Sláintecare. If it gave us the kind of details suggested by the Chair, it would allow us to work it out.

Has IFAC looked at the state of the healthcare system from an economic point of view? We constantly hear that there is a lack of IT systems to report on and monitor up-to-date expenditure.

Mr. Sebastian Barnes

This is something we have had big concerns about. Wrote a paper on it a number of years ago. One of the things that was frustrating in writing that paper was, as the Chair said, the information that is available is incoherent and incomplete, which made it difficult for us to make an assessment. We are not health experts and are not trying to second guess the way the health system should run, but our interest is in the budgeting.

The pandemic has been an unusual period for the health system. There have been significant pressures on the system and the people within it. For example, even now we know that the health system was sanctioned for a large number of posts that it is unable to fill. The big question is whether those posts will be filled. If there are filled, that will create a big pay pressure. We do not really know if that is budget for.

We had concerns from before the pandemic when the background was a bit more stable. The budgeting process around health was very unsatisfactory. Usually, the Government put in an amount for health that did not allow for the irregular stand-still and wage increases. What used to happen was that there would be big health overruns during the year, but they would often only appear in October or November. At this time of year, officially it would look as though the health spending was on budget, but we would discover at the end of the year that there was a big hole in it. In the years before the pandemic, that was running at about €500 million or €600 million a year of overruns. That hole was essentially being filled by corporation tax, which was a very unhealthy dynamic during that period. Many things have changed since. The pandemic makes is hard to know what the underlying situation is now. It remains an area of concern, however. It is a big area of spending where we know there are naturally big pressures. In the past, the budgeting relating to it was very poor and created risks for overall public finances.

IFAC's business is budgets, figures, projections and all of that. If IFAC cannot get a handle on the figures in health that would allow the council to be confident about making a projection in respect of the budget, how can the Department do it? Is it a guesstimate? Is it a wild guesstimate? Mr. Barnes is concerned about the impact of the type of spend on the whole budget process. How does the Department reach a decision that it will provide an additional €1 billion this year? Does the Department measure outcomes? What does it measure to come to that figure?

Mr. Sebastian Barnes

As I said, things have changed and the pandemic period has made it harder to reach a guess, but one of our concerns in our paper was that an allocation was being made on a top-down basis that did not correspond to any bottom-up reality of how many people were going to be employed or how many operations were planned to be done. There have been some improvements in some areas since we wrote the paper to which I refer. For example, the HSE used to put out its strategy, but the figures on the number of staff relating to that strategy would only appear at the end of the year. They needed to be part of the original strategy. There were a lot of budgeting problems which, from our perspective, meant we did not have confidence in the projections for health spending.

To be fair, since the pandemic the health budget has been more predictable than it was in the past, which is surprising in light of what happened.

I think it is because extra money went into the system and some regular normal operations did not take place. There were a number of offsetting occurrences. We still have big questions about the budgeting arrangements.

Does IFAC raise this issue with the Government in its reports? If so, does it get any response?

Mr. Sebastian Barnes

It is something we consistently put in our reports. To be fair, it is an issue of which the Government and people in Departments are aware. With regard to how to solve it we look at the overall budgetary position. We are not experts in healthcare budgeting and management.

It is just the budgets that I am interested in. I can never fathom how an increase in a budget can be agreed without knowing the full facts of how the money allocated in the previous year or the year before that was spent. It seems that the only thing the Government is doing is throwing money at what is a big black hole. There is no measurement of real outcomes. It is difficult to understand because it is a vast amount of money and a big organisation. I imagine if it was a corporation it would have reporting systems to give it the projections it need. The HSE does not seem to have this.

Mr. Sebastian Barnes

The Chair's assessment of these issues matches what we found. From a fiscal forecasting point of view, the problem is a mismatch whereby the top-level top-down forecast does not correspond to the underlying dynamics or the objectives. This is a concern. The Chair is also correct that from a longer-term public finance perspective, there are probably a lot of inefficiencies. The information that is useful for forecasting is also useful for understanding where efficiencies and productivity can be increased. If the health system is not as efficient as it might be it increases pressure on overall public spending. There remain big concerns in the area.

There are a number of issues I want to focus on, including the overlap between the medium-term challenges and climate and the report on wages produced by IFAC in May. The report on wages raises a question on the approach of using tax measures as opposed to other measures. There is also the need for an increase in the minimum wage to living wage levels because of inflation. This has been highlighted by Social Justice Ireland and others. The IFAC report highlighted that incomes in the top five sectors have been increasing while we have had static incomes in lower sectors. The report states there has been a long-standing divergence between the higher paid sectors and other sectors in terms of the hourly wage. By contrast, hourly wages in the lowest-paid sectors have barely increased in cash terms. In real terms this is a decline when we have inflation, including inflation in basic costs such as the cost of food.

Will the witnesses comment on the need for fiscal measures that do not just address the cost of living in a general sense but are very much targeted to addressing lower incomes? A few years ago, there was an International Monetary Fund, IMF, report that was compiled over 30 years across a number of economies. It highlighted that when the incomes of the bottom 10% increase, it has a positive impact on the economy whereas increases in the incomes of the top 10% do not have the same effect in the economy and can have a negative effect. I say this in the context mentioned by Mr. Barnes, namely, that while Covid had a negative impact on many, there are some whose wealth increased. A report by Oxfam states that the wealth of just nine billionaires in Ireland increased by €16 billion during the Covid period. In this context, the concern is that tax measures, even if they are about shifting the index point, would benefit those in the higher bracket but we are still not having a conversation about a potential third tier of higher tax or measures to address the widening of the wealth gap and the income gap.

I have questions on two of the three medium-term challenges identified. I might follow up on them later. There is another shorter-term issue I want to highlight. We know the fiscal rules have been suspended at EU level. One of the reasons this is important is because it allows for front-loading, not only for day-to-day spending but also for investment. Mr. Barnes mentioned that investment needs to be treated differently. With regard to front-loading, what is long-term investment with potential long-term rental returns, I am concerned that a narrow approach to annual spending ends up costing us. With the very rigid application of the fiscal rules in the decade since 2008 the EU and individual states lost a lot of time and opportunities to invest in public services and public service infrastructure. Now we see gaps in public services, and these have been highlighted. We have also lost time for the transition needed for climate change.

A specific area where fiscal reticence on spending may be driving inflation is housing. We know the fiscal rules were cited, and continue to be cited even though they no longer apply at EU level, as a reason Ireland has adopted a leasing approach rather than a direct build and purchase approach for social housing. The guarantee of leases with a profit margin, which are subsidised by State for investment funds, has incentivised investment funds to compete in the purchase of housing. This has also had an inflationary impact on the cost of housing more generally. This is an example of how not having public spending and creating a reliance on a market structure has driven up the cost of housing. Will Mr. Barnes comment on these points? I will then ask questions on the medium-term challenges he identified.

Mr. Sebastian Barnes

I thank the Senator. There is a theme that will run through my answers to these questions. IFAC's concern is with the overall balance of the public finances and their sustainability and how much money the Government is putting into the economy compared to how much it takes out. It is about making sure it is not destabilising to the economy and that we are not contributing to economic booms or busts.

On the Senator's first point, Mr. Timoney is the author of a paper that is extremely important in the context of understanding the Irish economy. We have really had a trend divergence between higher income earners, in particular these are people working in certain sectors such as technology and pharmaceuticals, and others. Many high-paid jobs are being created in these sectors. The people who have these jobs have seen very big wage increases. Other people in other sectors have not seen very much. Although these trends are probably especially strong in Ireland, partly because the economy is growing quite fast, we see them in many other economies also. The returns for a digital worker having certain digital skills and certain high skills have increased over time while the returns for other jobs that require lower skills or lower levels of education have fallen behind or stagnated. It is very important to think about these trends. This could also be added to the medium-term challenges. The council does not take a view on what the right response is.

That is a matter for politicians and the Government.

This raises an important question, namely, if this is what society is like, what does that mean for the Government in the future? We have already seen that thanks to Ireland's progressive tax system, this dynamic means that more income is going into the higher tax brackets. It is too early to be very confident about it, but it looks like this is leading to a permanent shift in the economy towards paying more tax as a share of national income because more people are now earning at higher rates. That money is available for other things, including for redistribution to other people in the economy. Again, we are not saying that is what should happen. However, it is illustrative of some of the big questions that need to be considered.

That leads to the question of investment. There was a period following the crisis where public investment in Ireland was too low. That was a concern raised by the council at the time. Usually, we would not go so far as to comment on particular items, but we became worried that the level of public investment was so low that public capital stock was getting to a level that would be problematic for growth. We raised those concerns at the time. In many countries, there is a strong incentive for short-termist politicians to cut investment because the cost of that does not becomes immediately apparent and current spending can be kept at the same level, rather than making the choices they should be making which may be more difficult in terms of cutting or pulling back on other areas of spending or raising taxes.

As it happens, in Ireland's public investment has, fortunately, more than recovered. We are at the highest share of national income we have ever seen on a sustained basis. It is very high by international standards. That is being done in the context not of massive public borrowing, leaving the pandemic aside, but because of the way policy has been run in the past couple of years. That is quite a significant achievement. As we discussed earlier, the real constraint on public investment now is the capacity of the economy to deliver on public investment and avoid inflation in those sectors and more generally.

The question of treatment in the fiscal rules is a different question. In terms of the situation Ireland is in, we are managing to combine a very high level of public investment with sustainable management of the public finances and economy.

Housing is an example of public investment, but it is routed through a short-term mechanism in terms of leasing. Under Housing for All, quite large amounts of money are being directed towards a leasing model. It has been well documented that a flood of investors are seeking to capitalise on the 25-year social housing contracts that are more costly to the State in the medium to longer term. While inflation is increasing generally, housing inflation is out of synch. Can Mr. Barnes comment on that?

Adding income disparity as a potential medium-term challenge was mentioned. Could Mr. Barnes discuss the importance of measures that seek to address not just the redistribution of social protection but also the cost-of-living measures that may be introduced and the need for measures to target those at the bottom tier? A medium-term piece on income disparity was mentioned. Could he address housing, which is both an immediate and medium-term issue, and the specific issues of leasing and additional costs? I ask him to address the inclusion of profit margins as an additional cost to the State and the creation of inflationary pressure. For example, increased social housing on a not-for-profit basis might have a deflationary effect.

I wanted to pick up on two of the three medium-term challenges Mr. Barnes identified. He mentioned the pensions commission report. There is a real problem with it in that it explicitly excluded one of the largest forms of expenditure on pensions in the State from its discussions. In terms of fiscal planning for pensions and treating that within a closed loop of PRSI when we have another strand of public expenditure, namely, tax relief on private pensions, that does not seem to have been taken on board and properly considered. A few years ago, we spent €2.7 billion on private pension tax relief. Research has shown that the money is largely going to those persons in the higher and ever-growing income strata that were mentioned. Surely fiscal prudence would involve examining the tax expenditure on pensions, as well as PRSI, when we configure how we plan prudently for a pension for everybody in the State.

Carbon targets have been factored in in terms of expenditure. It is a question we as a committee raised with the EU Commissioner for Budget and Administration. Sustainability was mentioned. Fiscal sustainability needs to be understood within the sustainable development goals and the wider frame of sustainability. We are working within very set planetary thresholds. Our fiscal and financial policies are, to a degree negotiable, but they are sitting inside a non-negotiable planetary boundary in terms of the available emissions space and our carbon budgets. I ask Mr. Barnes to comment not just on the idea of expenditure on climate and environment policies but also on the proofing of our fiscal policies to ensure that they are sitting within a very rigid carbon budget. I am aware that this is a discussion at EU and global level, as well as in Ireland.

I ask him to comment on housing, in particular the fiscal prudence of targeted measures towards lower incomes. The IMF has said targeted measures towards those on lower income tend to stay within the economy and have a less inflationary effect, in that such money tends to go on basic expendables. In terms of preventative spending, the health impacts, for example, of cost of living issues at a lower income level can be very negative, such as people going hungry.

Mr. Sebastian Barnes

There are a lot of questions there. On housing, we do not look at the details of such measures like different methods of delivery. Obviously, it is helpful to the sustainability of the public finances if things are delivered in a more, rather than a less, cost-effective way because that reduces pressure and create space to do other things. We have not looked at that specifically. It is obviously unhelpful when things are driven by attempts to game the fiscal rules. Things should be judged on their own merits.

Perhaps it is an area that needs a specific inflationary analysis. Could that go on the long-term research agenda?

Mr. Sebastian Barnes

In terms of whether tax measures should be targeted, that, again, is a political question for the Government and the political system. We do not take a view on it. Whatever choice is taken, it is obviously good to have as full an analysis of the impact as possible. There are some areas where we would be more concerned that we are missing bigger effects, in particular on the climate side but also in terms of Sláintecare.

The work of the pensions commission was important. Taken at face value, the commission's proposals would essentially address most, if not all, of the future rise in pension costs. Those costs are going to be very big because people are living longer.

There will also be a 50% increase in the number of people reaching retirement age. There are huge pressures there, and it is important that an adequate response is made to that. Already, the tax measures that were included are quite substantial. They may be the price that people are willing to pay to maintain the pension system as it stands. However, it warrants careful consideration and a proper debate based on the choices available. The easiest thing is to do nothing. The longer we wait, however, the more expensive it will be to fix.

Specifically on tax relief, that was not included in our own modelling either. It is a good point, and something we plan to revisit in the second wave of that modelling. The amount of tax relief will vary over time as the demographics of the population change. Pensioners are not taxed in the same way as people of working age, so there is also an effect to be built in there too. We did not look at the public sector pensions particularly well either because of a lack of information. There is work that can be done to improve the model. I think we will do that when we next revisit the modelling.

On sustainability, the Senator is correct that these things must be seen in a wider context, including climate. There is the cost of trying to avoid climate change and reduce emissions as well as mitigating its impact, especially in the Irish case, with protection against flooding and insurance risks from extreme weather. There are many things there, and that is one reason the Government needs to have a full assessment of the economic and budgetary impact of these things.

I am glad that Mr. Barnes has indicated an intention to use it in IFAC's modelling. The need to address private pension tax relief was an issue that was identified back in the days of the troika memorandum of understanding. It was one of the only ones that was not acted on. It is designed on a marginal rate that disproportionately benefits higher earners.

I refer to gender and equality-proofing measures and the sustainable development goals. IFAC is looking at these, but, as the witnesses answer other members' questions, I ask that they comment on the gender and equality-proofing, which has been identified as a key preventative expenditure policy.

I apologise to our guests for my going in and out. We have had votes in the Seanad on the mica Bill. I also apologise for any repetition in case my questions have already been asked.

Enormous credit is due to the council for the work it has undertaken since it was established. It has been very important in adding to the understanding of the fiscal position in the country. I found this in my former life, but I also find it now. IFAC has done some really important work, and I want to acknowledge that.

While I am conscious that much of the council's work relates to the fiscal position, I am particularly interested in the distributional impact of any policy. Take the budget that is being proposed now. It will be a very sizable budget by any standard. The key issue is what it will deliver for various people. I am looking at the tax package. Mr. Barnes's opening statement contained a very carefully-worded paragraph about the tax package and how inflation effectively draws more income into higher tax bands. We have seen a fiscal drag with the tax bands for many years. You would have to have an enormous increase in the standard rate of tax threshold to bring it up to the average earnings. In September, there is likely to be just over €1 billion in a tax package on offer. The Government has said that it will widen the tax bands. If it does so by about €1,500, an average worker will get about €5.60 more per week. My question is about the macroeconomic impact of that but also the distributional impact. What is IFAC's view of the effectiveness of spending money on putting €5 in a lot of people's pockets compared with an alternative source of spending? What would be the macroeconomic impact? Has IFAC done an analysis of that? What is its view of the fiscal and distributive impact of increasing the tax bands?

Mr. Sebastian Barnes

The increase in tax bands is of the order that would be needed to compensate for the fact that as people's wages go up a bit faster than usual because of inflation, more income would be dragged into the higher marginal tax rates and they would pay more if the bands remained fixed. This very much depends on exactly what happens to wages, but in economic terms it keeps the tax system as it was before in real terms. There is no real economic or distributional impact; it is keeping the system as it currently is. If you did not make that adjustment more taxes would be going up and more income would be dragged into those higher categories. In recently years we have seen partial indexation. That means there has been some offset for that but not completely. One of the reasons why income tax has grown quite strongly is that there is more income being drawn into those upper categories. From an economic perspective, this is essentially neutral. You can take a view as to whether you think it should be neutral or not but those sorts of changes would broadly be neutral in the real amount of tax people are paying as a share of their incomes.

What about the distributional impact and the economic effectiveness of spending money in that manner by giving a small amount to a lot of people rather than putting it to an alternative use? I am sure the council has looked at the labour market, the challenges relating to it and the great need for childcare. What views has the council taken on this?

Mr. Sebastian Barnes

The council's stance is one of explaining the options available. One option available, that of keeping the income tax system as it is, would involve making these kinds of adjustments to the bands and people paying the same as a share of income. An alternative would be to keep the bands where they are. That would mean a real tax increase for people whose incomes fall under the band. That would generate additional resources that could be used for something else, such as for childcare or to compensate people for the higher cost of living. That is a political choice. Those are two different ways that it could be organised. As we noted earlier, one of the concerns with the Government's spending rule is that it does not allow for an offset on the tax side. With the European spending rule, there is a certain amount that you can spend but you can increase that amount by having an offsetting tax increase, a revenue increase. The spending rules that the Government has specified do not allow that to happen. That is a weakness of the rules for several reasons, one of which is that it does not give the option to the Government to raise taxes to create more space for higher spending.

It is not just a political choice or issue; it is an economic one because the failure to invest in certain areas has a long-term cost on the economy.

There are various views on where the pension age needs to go. The Taoiseach commented on this in recent weeks. Undoubtedly, if we assume a fixed number of workers in the economy over the medium to long term, then the cost to the State of pensions will be enormous. However, I feel labour force participation and how it may change or expand over time has been absent from the debate. I am particularly struck by the fact that the largest measure of unemployment pre pandemic was 17% or 18%. That was for people who would like to work but who were not actively seeking work.

Regarding the analysis of the pensions question, I wish to understand better the extent to which the council takes a view in respect of the number of workers effectively being fixed as a share of the population. Has modelling been undertaken in the context of significant increases in labour force participation in future years?

Mr. Sebastian Barnes

We produced a long-term sustainability report that we published in July 2020. It involved a full modelling exercise, and it modelled trends in participation. Those participation rates were already quite high. If we were to go back to the 1960s, or to a period like that, then there would have been areas of low participation that may have been caught up. There is also a role for migration. The number of workers is going to increase because net migration is expected to increase. I do not know if any of my colleagues can remember the details of the assumptions we made in this regard. We also assumed, however, that older people will participate more. As a result, those effects are built in. This will help us because it will mean there will be more workers in future for these reasons, but that will not offset the fact that many more people will be retiring than was the case before.

To pick up on something Mr. Barnes said, is it the general view of the council that labour force participation is as high as it is going to get and that there is no further scope for increases? This is an important point. There have been great improvements in the past two and a half decades. Female labour force participation rates were a huge part of that change. However, there is still scope to increase participation rates further. I would like to hear Mr. Barnes' views on whether he thinks labour force participation rates are where they need to be or if there is further scope for growth?

Mr. Sebastian Barnes

There is some scope to go further, but it is much less than it was historically. When we think about these things, we factor in some of the gains in participation, including migration and some of the other things that have been helpful in this regard. Even when we take all those things into consideration, though, they are dwarfed by life expectancy beyond the age of 65 increasing by about one year every six years. Our children will probably live five or six years longer than we will. I think of this happening like a tree growing. From year to year, there is not that great a difference. If we come back in ten years, however, it will be radically different. What people find harder to understand is that we have these large cohorts of individuals born in the 1970s and 1980s who are going to be retiring and that this will mean a 50% increase in the number of people reaching the age of 65.

We have these two pressures at the same time. They will lead to a huge increase in the future cost of pensions. There is a tension in the pay-as-you-go system we run whereby we get existing workers to pay for the current generation of retirees. We have had uneven population growth. This means we are now in a period when many people are working relative to the number of people retired. We are one of the youngest countries in Europe in this regard. This situation, though, is going to reverse. In response to the findings of the Commission on Taxation, the council suggested that perhaps we should be raising PRSI rates earlier to enable us to get tax revenues from this generation and save them to pay for pensions. This is a choice, of course, but otherwise we are basically leaving the bill to younger people. It will not be our grandchildren. Anyone under the age of 50 will be subject to these kinds of tax increases.

I am conscious that there has already been a discussion on corporation tax revenues and the need for greater capital investment. I do not intend to replay it. One thing I would like Mr. Barnes to clarify is the role of depreciation. I heard what he said about us having record levels of investment now. Regarding net investment levels, however, I was struck by the research IFAC carried out some years ago highlighting the significant catch-up and the high depreciation in this regard. As a share of overall investment now, what value is being assigned to depreciation? I ask this because many of us would believe catch-up required in this context is still significant.

Mr. Sebastian Barnes

Regarding a good way to think about this aspect, we went through a period where, and the Senator may remember our reports better than we do, depreciation was not far away from the level of investment. I do not recall whether it was higher or lower. That was problematic because it meant the capital stock was not growing in line with the economy. The national development plan runs out in ten years, but at the end of those ten years, as the Senator said, investment will still be high. We will still have these rates of 6% of national income, which is high by historical standards. What we do not have a sense of is what will happen after that. It might be natural that investment would fall a little after that period, but it will not fall back to the low levels we had at some points in the past.

One of the reasons investment will not fall to such a low level is because we will need to keep investing to maintain what we have built in the past ten years. We will have a bigger capital stock. In order to maintain that, we will have to invest more money. This is exactly the kind of factor that medium-term budgetary plans need to build in. This is a less pressing issue now because we are ramping up the capital stock heavily. The new investment is big relative to the depreciation of existing investment. This future context is a real thing. A common problem in the public finances of many countries is that people like to build new things, but it is less exciting to tell people that existing capital infrastructure will be repaired. This means we end up with capital stock that gets depreciated and, essentially, gets lost. Over the longer term, I would expect investment to be permanently higher than it has been on average in Ireland in the past.

That is enough for me. I thank Mr. Barnes.

I have just three questions. The first relates to the members who have contributed and Mr. Barnes referring to various papers in response. I ask him to send us the links to those documents.

Mr. Sebastian Barnes


We can then read them at our own leisure and understand them. Turning to the issue of halving our greenhouse gas emissions by 2030 and the impact of that on public finances, the council has stated that this impact has not been fully assessed or factored in. Is the council talking about the agricultural sector, for example? The Irish Farmers Association has proposed a cut of 22% in emissions. The Government may then say it should be 30%. Is Mr. Barnes saying that there has been no analysis of the impact such emissions cuts will have on agriculture or on other relevant sectors in the context of the changes to come?

Mr. Sebastian Barnes

That is right. We are still discussing how we are going to achieve these changes. We have seen emissions increasing all the time, particularly since the recovery. We see them going up again now. There must be agreement on what the plan is. There must also be some costings of the different options. As I said, there will be some direct impacts. If we all move to using electric cars, for example, then we will lose revenues from motor fuel duties. Those duties represent a substantial part of the public finances. We will then either have to find something else to replace them or we will have to make some other adjustment.

As I said, regarding the investment aspect, we think the national development plan has allocated significant amounts of money to the transition we will need. The situation in other areas is much less clear. One of the big questions everywhere is how we can bring about the changes we want to achieve. In a purely economic sense, we could regulate people, tell them they cannot make a certain emission anymore and that they must do this. The reality of the situation, however, is that we will probably have to offer some incentives to get people to change their behaviours or to provide some compensation to those who suffer as a result of these changes. It will be difficult to work out what these amounts will be. The point is that we do not know what they will be, but they could be significant.

Electric cars continue to be expensive. Many countries have incentive schemes to subsidise people to move to electric cars or to subsidise the infrastructure to support such a change in other ways. All those endeavours involve a cost. If, therefore, we are going to rely on such policies, we need to figure out how much we think the Government will need to pay to get people to change their behaviour in that way. We can think of sectors that will have adverse impacts from this transition and it may well be that the Government will choose to compensate people, provide them with incentives or to help them with the transition. All these allocations of funding would have an impact on the public finances and these costs need to be worked out.

It will be announced in the next few weeks what figures will apply to each sector concerning cuts in emissions. If we take a major part of this context, agriculture, and the suggested 22% cut in emissions there, whole industries are based on this sector. I refer to our beef and milk production. Jobs and exports rely on this and so on.

In the past ten years or more, farmers have been encouraged, financially and in other ways, to expand their herds, produce more milk and so on. The Government is now saying that is not the business model for today and that farmers have to cut emissions by 22%, which could lead to a reduction in beef production, milk production and so on. Mr. Barnes is saying that he has not seen any modelling in that regard, or calculations that might indicate loss of jobs, farm income, export potential. There is no analysis of that, or is there?

Mr. Sebastian Barnes

Not that I am aware of.

IFAC has not carried out analysis of it.

Mr. Sebastian Barnes

We have not. These are big problems that are facing many countries. One of the things the IFAC does is to participate in a network of European fiscal councils. We have discussions on this issues. There are certain countries, such as the UK, the Netherlands and Denmark, that have done good analysis on this issue. Most other countries are in the same situation as us. That should not make us feel comfortable; it is just a fact. There has been analysis in terms of the kinds of measures that could be taken and what measures would lead to that reduction in carbon emissions.

There are two pieces missing. One is the policies that will be put in place to achieve that. It would be possible to just tell people to do it and force them to do so through regulation but it may be the case that the Government wishes to use incentives, subsidies and other measures and provide compensation. The other is the question of what will be the fiscal impact of that. A fair amount of work has been done on the first leg. The next two legs are missing. There is not a significant amount of time in which to do this. In terms of climate, 2030 is not that far away. There is urgency to this. That information on how much it costs should be fed back into the choices in terms of the design of policies that are put in place and how it is going to be achieved. Potentially, the costs of this are massive. If it is done in an inefficient way, that will add to the scale of it. The changes should be made in the most effective way. Mr. Carroll has been considering these issues. I do not know if there is anything he wishes to add, particularly in terms of modelling.

Before Mr. Carroll comes in, Mr. Barnes mentioned other countries. Is Holland an example? It is ahead of us in this regard. Is it an example of how things might go, or might go wrong?

Mr. Sebastian Barnes

I know about the Dutch experience because I did some work in a different context. In general, the Dutch are very good at modelling. Their fiscal council, the Netherlands Bureau for Economic Policy Analysis has been around since 1945. It is a very powerful organisation. There is a similar organisation for climate there, and they work closely together. They have done good analysis of this but, ultimately - this is a warning of a very different sort - they had a number of court rulings regarding the fact that they were not meeting their emissions goals but also regarding air pollution. The Dutch authorities have had to take drastic action in terms of taking measures that are very costly but were needed to meet these short-term objectives. That is partly a lesson that we need to plan and start taking action quickly because if we do not, we may have to make much more violent changes. I do not know whether it happened, but there was a time when the Dutch were discussing a drastic limitation of speed on motorways as a way of getting air pollution down. That is the kind of measure one does not particularly want to have to take. It shows that if one does not plan ahead and make enough progress, one can end up having a much more costly transition.

Is there not sufficient information from the experience in Holland to tell us how a reduction of 22% in terms of agriculture can be achieved, to take just one set?

Mr. Sebastian Barnes

The Chairman is correct. We should definitely learn from international expertise. We are drawing on that expertise in our work. The Office for Budget Responsibility, OBR, our counterpart in the UK, has done a very good report that we are following quite closely. Its climate change council has done some good work that allowed the OBR to do good work on the fiscal side, albeit not in agriculture. There are many other aspects where the UK is quite similar to Ireland, however, in terms of the challenges. We should definitely learn from each other because we need to learn as quickly as possible. Ultimately, the Government should prioritise the carrying out of a really thorough assessment of what it will mean specifically in the Irish context. Some of these issues such as the beef and dairy sectors might be specific to Ireland. There may be other examples.

Mr. Killian Carroll

The Environmental Protection Agency recently produced estimates on the projections for emissions out to 2030. Its analysis included all the measures that were in the climate action plan in November. If all those measures are implemented, agriculture will reach that 22% reduction, but that is not the case for other sectors. Other sectors would have to do more than what is in the climate action plan. As regards the employment effects of that, I have not seen any such modelling to date.

My final question relates to how much the country owes in debt. What is the view of the witnesses on that? Have we borrowed appropriately and for a length of time that will give us some sort of comfort in dealing with the debt issue?

Mr. Sebastian Barnes

The debt ratio relative to GNI*, which is a better measurement of the national income, is approximately 100% in gross terms, or approximately €240 billion, and 85% of the national income in net terms. We have approximately 15% of cash reserves.

I ask Mr. Barnes to explain that. We owe €240 billion.

Mr. Sebastian Barnes

In cash, we owe €240 billion in total. Relative to national income, that is approximately 100% of national income. Within that, however, we have approximately 15% of cash assets that we hold. If one subtracts them, one gets the figure of 85%.

What kind of cash assets are those?

Mr. Sebastian Barnes

They are cash reserves that were built up. First, it is good management for the Government to have cash on hand to meet its short-term liabilities if markets were to be disrupted or whatever.

In monetary terms, what amount of cash does the Government have on hand?

Mr. Killian Carroll

At the end of May, the National Treasury Management Agency, NTMA, had approximately €30 billion in cash.

Mr. Sebastian Barnes

Part of it is that it is a good idea to have cash on hand to meet short-term liabilities, just as it is good for a household to have a little bit of cash flow for unexpected outgoings. It is also because the Government borrowed quite a bit during the pandemic when it looked like it would have to borrow more for Covid supports. In the end, that money was not used, so the Government is sitting on unusually high cash reserves. Taken together, it is a high level of debt by historical standards. It is high compared with several other small euro area countries. There are several factors. It is a concern.

There are a number of factors that are quite favourable to Ireland's position. One is that the NTMA does a very good job, which is very helpful in terms of the financing position. As Mr. Carroll mentioned, the maturity on debt is quite high, so we do not have to repay too much each year and it will be a long time until we have to replace the whole debt stock. Even if interest rates went up, we would only be paying on any new borrowing we have, and we do not need to take out much new borrowing. The budget is in reasonably good shape, at least in headline terms. There is also the fact that the economy is likely to grow much faster than the rate of interest. That naturally tends to bring the debt ratio down. If we had not had the cost-of-living crisis and all these distortions, the debt ratio would have been on a fairly good downward path, which is consistent with the fact that the economy is growing fast, we are benefiting from the corporation tax boom and unemployment is low.

There are a number of favourable factors but there are also risks. Of course, the higher the level of debt, the more one is exposed to those risks. One risk we discussed is higher interest rates. As we stated, that could take time to feed through but would ultimately add pressure. As all present are aware, there is not a huge amount of space for extra spending, even beyond the cost-of-living measures and the immediate crisis. The other big risk is a shortfall in growth. If something were to happen to the Irish economy, such as the multinationals all going somewhere else or that kind of thing, that could make our debt position look a lot worse. The big risk is probably on the growth side. The other risk relates to the public finances.

The plan to have a 5% spending rule is a good one. It would keep debt on a good trajectory. If the Government of the day were to deviate from that on a persistent basis, if these pension, health, climate pressures and other things were to lead the Government to run a very different fiscal policy from the one it plans, those things are a risk to the public finances when there are high levels of debt.

Is what we are doing this year really an option? Is it better to have it as a once-off than to repeat it next year or the year after?

Mr. Sebastian Barnes

Exactly. We think this spending rule is a very welcome innovation. If it is adhered to, it will help to anchor the public finances and place debt on a downward path. This year, inflation is going to be exceptionally high and very different from the assumptions that are built into the spending rule. That is why we think it was reasonable to deviate somewhat, temporarily, as the Government has set out in the summer economic statement. It is important that it is a temporary deviation. Obviously, if we have a spending rule and then we break it every year it is not a rule any more.

What is the normal debt ratio? What would IFAC like to see that at?

Mr. Sebastian Barnes

That is a very good question. It is also a very difficult one to answer. Economists debate it endlessly. There are two perspectives. One is about how much debt we want, how much we want to pay for things now and how much we want to pass the debt on to the future, which is a moral philosophical question to which there is no easy answer. The other question is what is sustainable. If there were a shock, if interest rates were to go up, if growth were to fall, what starting debt ratio would avoid us getting into a position where debt is spiralling out of control and where we have to make a big fiscal adjustment? The higher debt is, the higher that risk. We have done some quite sophisticated modelling that draws on the work of the former IMF chief economist, Olivier Blanchard. He expresses it as a probability of debt becoming unsustainable. The most recent estimates indicate a probability of about a quarter that we could have shocks that would put debt into a situation where we would have to adjust the budget to try to restore the public finances.

Was he talking about Europe?

Mr. Sebastian Barnes

This is a framework he set out that we have applied to Ireland. Very few countries and bodies have done these kinds of estimates. We found it quite helpful. Our view is that at its current level, there is a risk that debt could become unsustainable. We would have to take some action in the budget if things turned out very badly. However, we think that risk is at a fairly acceptable level at the moment. Of course, the lower debt is, the less that risk is. Some of the big pressures on the public finances are not really coming from debt; they are coming from these medium-term challenges. Pensions is the major one.

There are a lot of things that we have to be concerned about. Prudent management is going to be essential.

Mr. Sebastian Barnes

Prudent management of the economy and the public finances is essential in the short term as we go through this cost-of-living crisis, which is a very complex and challenging thing to deal with. The longer term is almost the bigger issue. We now have a fiscal framework that, hopefully and in principle, will anchor things. However, it involves making choices about things. We cannot just have more spending and less tax all of the time. We need to make sure the two things are in balance. It is the combination of climate change and pensions, which are happening at the same time. People often focus on one or the other, but they are actually going to be hitting people at the same time. Those in charge of the public finances and households are going to have to deal with the impact of climate change. People may have to insulate their homes. They may lose their jobs. They may have to do things differently. At the same time, we are going to have to meet these pension costs that are going to increase considerably. That is one of the reasons we are concerned about the lack of implementation around the pensions commission report, particularly in the context of signals in respect of not raising the retirement age. Already, the package proposed by the pensions commission involves quite a substantial increase in taxation. That may be occurring at a time when other increases in taxes may be needed because of climate change, for example. PRSI rates will already have to go up just because there are going to be more people reaching retirement age, even before there is a decision not to raise the State pension age.

I thank the witnesses for coming along today. That is all very interesting. I thank the members for their contributions.

The joint committee adjourned at 3.45 p.m. until 12.30 p.m on Wednesday, 14 September 2022.