The budget balance weakened substantially in 2020 and the deficit is expected to remain very large
There are risks that health spending will overrun, which could be masked by an overperformance in corporation tax receipts again as has happened in recent years.
In 2021, revenues are set remain weak and continued strong supports are expected, hence reducing the deficit only slightly to €20.5 billion (or just under 10 per cent of GNI*).
High spending will remain the key driver of the deficit
A large gap between government spending and government revenue opened up in 2020 amid the costs of the pandemic.
This reflects a substantial increase in spending on health, income and business supports associated with the impact of the pandemic. Revenues have fallen amid weaker economic activity.
Government spending rose sharply in 2020 and is expected to reach 52.2 per cent of GNI* for the year. Revenues are likely to be equivalent to 41.5 per cent of GNI* this year.
Budget 2021 shows that the gap should close somewhat next year. Spending would be lower again for 2021 should contingencies set aside for a no-deal Brexit and risks associated with Covid-19 not be utilised.
The Government debt ratio has reached a very high level
As a share of modified gross national income (nominal GNI*), gross debt is set to rise to 114.7 per cent of GNI* in 2021.
Net debt, which excludes cash and other liquid assets, is forecast to rise to 103.8 per cent of GNI* in 2021.
The Budget is based on a modest recovery
The official forecasts suggest a modest recovery in the Irish economy.
This is evident in official forecasts for the unemployment rate, which—even with substantial wage subsidies—show it remaining close to 10 per cent by end-2021.
The outlook is based on the assumption that the UK leaves the EU in a disorderly fashion and that a vaccine for Covid-19 is not in widespread use in 2021. Upside risks could therefore materialise if a trade agreement is formed between the EU and the UK or if health risks and prospects for treatments and/or a vaccine improve.
Unusual uncertainty
The economy has suffered a deep contraction in 2020 due to the pandemic but has recovered to some extent.
However, the outlook is exceptionally uncertain. There are uncertainties associated with both Covid-19 and from Brexit. While Budget 2021 assumes that the EU and UK will not agree a trade deal by the end of this year, it is possible that an agreement could be formed.[1]
Economy well below its potential
Official estimates suggest that the Irish economy has fallen well short of its potential in 2020.[2]
This means that there are lots of unused resources in the economy and plenty of scope for activity to be boosted. Indeed, good economic management suggests that policy should act to support demand as restrictions are lifted and when unemployment remains high.
The estimates produced by the Department suggested that the economy would only recover to its potential between 2023 and 2024.
Substantial supports and stimulus have been introduced amid the pandemic
The Government has introduced sizeable fiscal supports and stimulus to lessen the adverse impacts that Covid-19 has on the economy and society.
In addition to tax and spending measures outlined since March, Budget 2021 includes a further €6.4 billion of spending measures to respond to Covid-19, some €0.3 billion of tax measures and a €2.1 billion “Covid Contingency Reserve” that can be drawn on in 2021. In addition, a €3.4 billion Recovery Fund has been introduced to support additional measures as needs arise.
Temporary and targeted budgetary supports should remain broadly in place to support vulnerable workers and businesses for as long as is needed, even if there may be scope to adapt them as circumstances evolve.
Significant increases in recurring spending are planned
Budget 2021 sets out significant increases in “core” gross voted current spending for 2021. This recurring spending is unrelated to Covid-19 and Brexit.
The recurring spending increases include €1.8 billion in Health spending and €0.5 billion for Education plus Research, Innovation and Science areas.
There is little indication of how these increases will be financed on a sustainable basis after the immediate crisis has subsided and once the recovery has become well entrenched.
There is also a risk that some of the spending related to Covid-19 becomes more long-lasting than is currently planned.
Annual public investment spending is set to remain at high levels
Public investment spending is planned to be €9.8 billion in 2021 (4.7 per cent of GNI*).
This represents an increase of €580 million compared to spending in 2020 and is €6.3 billion higher than in 2012 when investment levels were at their lowest in recent decades.
Growth before and after the budget
The policy measures announced on budget day as part of Budget 2021 are estimated to boost growth in underlying domestic demand by almost 0.5 percentage points in 2020 and by 1 percentage point in 2021.
This is based on a comparison of the pre-Budget forecasts (endorsed by the Fiscal Council) and the post-Budget forecasts.
Key taxes are expected to remain weak in 2021
Income tax, VAT and Excise tax receipts are expected to remain relatively weak throughout 2021 as a result of the impact of the pandemic and an assumed hard Brexit.
This chart shows the tax heads seasonally adjusted and set relative to their January 2020 levels (set as equal to 100 for that month). It highlights the sharp fall in receipts as confinement measures took hold from March 2020 onwards, followed by the recovery in receipts as these measures were lifted.
Corporation tax risks
Tax revenues are now very reliant on corporation tax receipts and are expected to reach a record of almost 21.7 per cent of tax revenue this year. The average for 1995-2019 was 13.8 per cent.
The strength of corporation tax receipts has been a key factor in terms of the overall resilience of tax receipts during the pandemic.
Budget 2021 forecasts suggest this reliance will remain, with corporation tax revenues expected to remain high at 21.5 per cent of tax revenue in 2021.
Long-term risks include ageing costs and climate change
The Government plans to publish a medium-term recovery plan in spring 2021 that will set out its strategy for emerging from the crisis.
In the medium term, the Government will need to balance competing pressures. These include a weaker underlying budget position, the need to reduce public debt, rising ageing costs, reducing the overreliance on corporation tax, addressing climate change and meeting social objectives as set out in the Programme for Government, particularly around health and housing.
In the long term, the Fiscal Council estimates that, under current policies, ageing-related costs will add to the government debt burden over time. Around half the government debt burden in 2050 would reflect unfunded ageing costs.
The Government deferred a planned pension age increase previously legislated for in 2021. The pension age was set to rise from 66 to 67. The Government will set up a Commission on Pensions to consider future changes to the pension system but has not set out a timeline.
See the Council’s recent Long-term Sustainability Report for more information.
An improved budgetary framework would help
Dealing with the challenges posed by Covid-19, an ageing population and climate change will require careful planning and monitoring
The Government has committed to producing a fiscal strategy in spring of next year. It is vital that further delays are not introduced.
The Council assesses that three key reforms to the fiscal framework would help to chart a prudent path for managing the public finances in coming years. These would include: debt ratio targets; an enhanced rainy day fund; and sustainable spending limits. Read more in our recent Pre-Budget 2021 Statement.