On behalf of my colleagues in the economics and banking divisions in the Department of Finance, I thank the committee for the opportunity to attend today to discuss Future-proofing the Public Finances – the Next Steps, which we published on 10 May.
I am the principal officer and head of fiscal analysis in the economic division of the Department of Finance. I am joined by my colleague Mr. Colm Roche, also from the economic division and Mr. Pat Leahy, principal officer in the banking division and is likely to be in charge of bringing forth the legislation on the fund.
The Department of Finance has been very active in highlighting the near- and long-term risks to the public finances. In September 2022, in De-risking the Public Finances – Assessing Corporation Tax Receipts, we published an analysis of the risks posed to the public finances stemming from the level shift in corporation tax receipts. That paper showed that in 2022, around €1 in every €4 of all tax collected came under the corporation tax heading. Furthermore, corporation tax receipts were, and still are, highly concentrated among firms. In 2021 the top ten firms paid 53% of corporation tax receipts, or approximately €1 in every €8 of all tax collected. The key output from the paper was that using a range of methodologies, we produced an estimate of the amount of corporation tax receipts which were potentially at risk, or were windfall in nature. This was in the region of €4 billion to €6 billion in 2021. The estimates for windfall receipts have only increased since then.
Building on this work, in budget 2023, a new metric was introduced called the underlying general government balance, or GGB*. We apologise for introducing a new "star" acronym into our language. This metric strips out the estimated windfall receipts from the headline budget balance to give a better picture of the underlying health of the public finances. Using this metric, last year’s headline budgetary surplus of €8 billion would have been turned on its head with an underlying deficit in the region of €2.75 billion.
In parallel to this work, the Department has also examined some of the medium- to long-term fiscal vulnerabilities on the expenditure side, most recently in Population Ageing and the Public Finances in Ireland, which was published in September 2021. That paper highlighted that by the middle of this century, age-related spending will be approximately €17 billion higher in real terms than it was in 2019. I will return to the issue of demographics shortly.
Taking all of this into account, on taking office, Minister for Finance, Deputy Michael McGrath, asked the Department to prepare a paper outlining the merits of setting aside windfall corporation tax receipts to a long-term fund which could contribute to future budgetary pressure such as those relating to an ageing population and the twin transitions of climate and digital.
I will outline the main findings from the paper which was published in May. As I mentioned, the Department of Finance estimates that windfall corporation tax receipts have increased significantly in recent years. The paper published in May updates this estimate and finds that around €11 billion of last year’s €22.5 billion of corporation tax receipts were windfall in nature and this year it is projected to be around €12 billion. The paper also highlights the risks that the costs of ageing I mentioned pose to the public finances. While Ireland currently has a favourable demographic profile, this is set to change significantly in the coming decades, when we are projected to have one of the most rapidly ageing populations in the EU. The projected ageing of our population is demonstrated most clearly by the dependency ratio, that is, the number of working age people to each person over the age of 65 years. This ratio for Ireland currently stands at around four, however, by 2050 it is projected to fall to just over two. This significant shift will mean that there will be around half as many people of working age to support each person of pension age. In addition to the demographic challenge, the paper also stresses that there are other forthcoming pressures on the public finances such as those I mentioned relating to the climate and digital transitions. However, it does not go into these in great detail simply because they are not as readily quantifiable as the ageing costings.
The main exercise presented in the paper simulates a range of design options for a future-focused fund which could help protect the public finances from both an over-reliance on windfall receipts and from structural expenditure pressures such as an ageing population and the climate and digital transitions. Specifically, the paper sets out the results of a series of illustrative scenarios which model how such a long-term saving fund could be built up. It presents three options for capitalising the fund, which range from assigning approximately one third to all of the estimated annual windfall corporation tax receipts until 2030. In addition, there are two real rates of return simulated, namely, 3% and 5%.
The results show that if drawdowns did not begin until 2035, they could cover 16% to 82% of the projected increase in age-related costs by that year depending on the fund’s design and the rate of return. A key take away from the paper is, therefore, that under none of the capitalisation options simulated, or under either the 3% or 5% real rate of return assumption, would drawdowns from the fund cover all ageing-related spending increases by 2035. In fact, even under the most optimistic real rate of return assumption and while transferring the entirety of the estimated windfall corporation tax receipts annually out to 2030, which would be €12 billion a year in today’s terms, the drawdowns would only cover four fifths of the projected ageing costs. This finding indicates that such a fund would be a complement to and not a substitute for other necessary reforms, such as increases to the rates of PRSI.
In conclusion, Future-proofing the Public Finances – the Next Steps presents a range of indicative options for establishing a future focused fund to save a portion of windfall corporation tax receipts and budgetary surpluses and which could help contribute to future expenditure pressures. Work is ongoing within the Department that the Minister can bring detailed proposals to Government for the establishment of such a fund.
My colleagues and I are happy to address any additional questions which the committee would like to raise.