Fiscal Assessment Report, December 2020

This is the Council’s nineteenth Fiscal Assessment Report. The report assesses the fiscal stance that the Government set out in Budget 2021. It also assesses the Government’s macroeconomic and fiscal forecasts, and it monitors Ireland’s compliance with the fiscal rules.

  1. Assessment of Fiscal Stance
  2. Endorsement and Assessment of the Macroeconomic Forecasts
  3. Assessment of Budgetary Forecasts
  4. Assessment of Compliance with Fiscal Rules

Boxes

Appendices

Summary Assessment

Covid-19 continues to have a major impact on the Irish economy and public finances. The Government based its Budget 2021 forecasts for 2020 and 2021 on the view that a vaccine would not be widely available until at least 2022. It also assumed that trade between the UK and the EU would be based on a hard Brexit with WTO terms from January 2021. This was prudent, given the uncertainties and risks involved.

State supports have cushioned the impact of the unprecedented fall in demand for workers. However, there are risks that the economic impacts of the crisis might be felt for a long time. The Budget 2021 projections imply a 6 per cent decline in real GNI* this year, with a muted 2 per cent recovery in 2021. Sectors like retail, hospitality, transport and the arts are especially vulnerable to the pandemic. New analysis in this report highlights some of the regional differences in activity lost due to Covid-19. Western and border regions, areas that are more heavily reliant on sectors like tourism and hospitality, have been worse affected.

The Council has developed three economic and fiscal scenarios to 2025, given the uncertainties and need for medium-term fiscal planning. The extension of forecasts to 2025 is necessary because, rather than the usual five-year horizon, Budget 2021 only provides one-year-ahead forecasts. This gives an extremely narrow picture as to how today’s policies might impact the economy and public finances. While any medium-term projections are uncertain, such forecasts help support a medium-term orientation for fiscal policy and enable monitoring of potential economic imbalances.

The extended Budget 2021 projections suggest that activity in the domestic economy is unlikely to return to its pre-crisis levels before the end of 2022. The lasting impacts of the shock to the economy from the pandemic are still unclear, including how resilient firms will be. A “Milder” scenario could see the economy recover more quickly if effective vaccines/treatments become widely available by mid-2021 and if a free-trade agreement is reached between the EU and UK. This could see real GNI* recover to its pre-crisis levels of activity earlier in 2022. By contrast, if surges in infections lead to heavy restrictions being reintroduced in both 2021 and 2022, this would see a more stunted recovery. In this “Repeat Waves” scenario, real GNI* might not recover its pre-crisis levels until Q3 2023. In addition to risks around the impact of Brexit, there are other risks, including potential changes to the international tax environment.

The Covid-19 pandemic has led to a substantial increase in government spending. The Government expects to run a deficit of just over €20 billion this year. Budget 2021 projects a deficit of €21.6 billion or 10.7 per cent of GNI* for 2020. This reflects massive government spending on job supports and measures to stimulate demand. Although tax revenues have fallen sharply in some areas, other areas such as corporation tax receipts and income tax receipts have fared better than expected. The deficit projections for 2020 are better than was expected at the time of April’s SPU 2020 forecasts, when a 13.3 per cent deficit was forecast. This reflects how a better-than-expected tax performance more than offset the introduction of new policy measures. The recent tightening of measures to contain the spread of the virus is likely to weigh on public finances and may offset some of the improvements projected in Budget 2021. This could raise the deficit in 2020 by a further €1.6 billion (0.8 per cent of GNI*).

For 2021, Budget 2021 sets out a large-scale support and stimulus package, which will result in a substantial deficit being run once again. The budget balance is forecast to improve only slightly next year, with a deficit of €20.5 billion (9.8 per cent of GNI*). This includes contingencies of €2.1 billion for Covid-19-related expenditure and €3.4 billion for unspecified measures to support the economy in response to the pandemic and Brexit.

The three scenarios developed by the Council in this report suggest that the government debt ratio will climb to between 109 and 127 per cent of GNI* in 2021 from 96 per cent in 2019. At the end of last year, Ireland had one of the highest debt ratios in the OECD. The sizeable budgetary response necessitated by Covid-19 will see the debt ratio rise substantially. However, the extended Budget 2021 projections suggest that the debt ratio would fall towards 100 per cent of GNI* by 2025 due to favourable debt dynamics. In a Milder scenario, the debt ratio could fall faster. However, in a severe Repeat Waves scenario, the debt ratio could stagnate at high levels, close to 130 per cent of GNI*, without any policy responses such as spending cuts or tax increases.

The Government’s decision in Budget 2021 to continue temporary supports for households and businesses through the Covid-19 crisis, as well as measures to stimulate demand, is appropriate. These measures, though costly, should help to support activity in the economy and lessen the lasting economic damage of the crisis. Despite the fiscal costs, this should ultimately lead to a more sustainable path for government debt ratios. Low interest rates will help to support higher debt. The Council welcomes the allocation of the €2.1 billion for contingencies to cope with any additional costs of Covid-19, and the allocation of a Recovery Fund of €3.4 billion to support recovery. These temporary supports should be targeted and should end as the need for emergency measures diminishes and as the economy recovers.

However, Budget 2021 also included substantial and permanent increases in spending amounting to €5.4 billion without long-term funding. This includes additional non-Covid-related spending and hiring in health, education and other areas. This spending is likely to remain long after the pandemic. The increases are surprisingly large in the context of uncertain growth prospects and compared to previous Budgets. The permanent increases could even be as high as €8.5 billion as it is not possible to ascertain the nature of some of the increases in non-Exchequer areas. This reflects ongoing transparency problems in areas outside of the Exchequer that are traditionally not the focus of the Department.

The Council assesses that the permanent spending increases included in Budget 2021—without a sustainable plan to finance them—are not conducive to prudent economic and budgetary management. These permanent measures are substantial. There is no sense as to how this spending will be financed sustainably over the medium term. These unfunded commitments will add to future fiscal pressures. The Programme for Government rules out tax increases and spending reductions in many areas. In addition, there is a risk that some of the estimated temporary spending increases included in the 2021 projections, for example in health, end up becoming permanent.

The Government should use its medium-term strategy in April 2021 to deliver credible plans. It is essential that the Stability Programme in April 2021 presents a five-year forecast horizon and that it sets out detailed and transparent budgetary forecasts. The Government should clarify how large underlying increases in spending introduced for 2021 will be funded sustainably and how other fiscal challenges will be addressed. With a substantial amount of spending going towards permanent increases in health spending—some €1.9 billion— the Government should clarify how this relates to the Sláintecare reforms and provide a costed plan for how this will be implemented. Furthermore, the Government should set out how medium-term budgetary plans would be modified if government revenues fall short of expectations.

The Government faces a number of significant medium-terms challenges once the economy is on a path to recovery. Once a recovery from Covid-19 and Brexit is underway, there may be a need for fiscal adjustment. The Council’s simulations suggest that this could be avoidable, with debt ratios likely to fall over the medium term except in a Repeat Waves scenario. However, the unfunded permanent spending increases included in Budget 2021 will make it more difficult to bring the debt ratio back down at a steady pace. In addition, major longstanding issues remain. These include Ireland’s rapidly ageing population, climate change, over-reliance on corporation tax and ambitions to embark on large-scale Sláintecare reforms of the health sector. All of these will add to budgetary pressures over the coming years and decades.

The Government should introduce three reforms to help reinforce its budgetary framework to better navigate these challenges. First, it should develop debt targets that are specific to Ireland. These would help guide the government debt ratios to safer levels over the medium term and allow scope for a countercyclical response to be introduced, as was possible in this latest crisis. Second, the Government should use a Rainy Day Fund and Prudence Account to save temporary receipts, such as corporation tax, rather than use these to fund permanent spending. Third, the Government should anchor permanent spending growth to specific limits based on sustainable levels and growth rates.

The fiscal rules give leeway for a sizeable budgetary response to the public health emergency and the economic crisis both this year and next. The relaxation of the fiscal rules in 2020 and 2021 will help to facilitate an adequate response to the public health emergency and economic crisis arising from the Covid-19 pandemic. Based on the Council’s Extended Budget 2021 forecasts, in 2022, the deficit to GDP ratio is forecast to fall below the 3 per cent deficit limit in the SGP. However, for Ireland, GDP is not an appropriate measure to base assessments of the fiscal rules on. It would be more appropriate to specify the domestic fiscal rules, outlined in the Fiscal Responsibility Act 2012, in terms of GNI*. However, this would require legislative change.

Return to top