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.
