The international economic outlook has deteriorated in recent months. While the situation is volatile and evolving, the risks of a hard Brexit are high. Advanced economies are already in a mature phase of the current cycle and there are signs that growth in the US, UK and Euro Area is slowing. Furthermore, a harder-than-previously-expected Brexit now looks increasingly likely. Notwithstanding the risks of an external shock, the domestic economy continues to perform strongly and risks overheating if major shocks do not materialise. Some sectors could continue to outperform and potentially overheat (such as building and construction), even if others are severely affected by Brexit (such as Agri-Foods).
Ireland’s net debt ratio is the sixth highest in the OECD. When set against an appropriate measure of national income like modified GNI*, Ireland’s net debt burden is 89.9 per cent at end-2018, the sixth highest in the OECD below France, Portugal, Italy, Japan and Greece.
The pace of spending increases in recent years has been fast. The pace of annual spending growth has risen from 4.9 per cent in 2015 to 6.7 per cent in 2018. The acceleration partly reflects large within-year spending increases over and above what had been budgeted for, including in Health.
The underlying budget balance excluding interest costs appears to have deteriorated since 2015. Revenue growth has been strong in recent years. But this reflects the strong cyclical recovery and surges in corporation tax receipts. Much of the recent improvement in revenues is therefore likely to prove temporary.
Corporation tax surges mean that receipts are at record levels and this has masked repeated spending overruns. Corporation tax receipts accounted for a record 18.7 per cent of tax receipts in 2018. The practice of using corporation tax outperformances to achieve budget balance targets carries significant risks. These revenues are more volatile and unpredictable than other sources of Government revenue. They are also subject to potential reversals in future years, depending on firm-specific developments and changes to the global tax environment. By contrast, most of the new expenditure measures being funded by these receipts are likely to be long lasting.
Within-year spending increases—above and beyond previous plans—look set to occur again in 2019. Health spending looks likely to overrun this year (overruns have averaged €0.5 billion in recent years) and the Christmas bonus has not been provided for but is likely to be paid (estimated to cost €0.3 billion). In addition, the base level of spending on social payments in 2018 was higher than expected, though official forecasts for 2019 were not revised up accordingly. This could mean an upward revision of €0.5 billion to general government spending in 2019. Taken together, general government spending in 2019 could turn out, on this basis, to be as much as €1.3 billion higher than previously budgeted.
These slippages would repeat the pattern of within-year increases observed in recent years and would be inappropriate. They would imply a looser fiscal stance and contribute to further overheating pressures. They would also reduce the scope for budgetary policy to support the economy further in the event of an adverse shock materialising in the near future.
For 2019, the Government must deliver on its spending plans. Existing plans should be met and offsetting savings found in other areas if spending overruns occur. This means that “supplementaries” (additional spending allocations to Departments for the current year) should be avoided or overruns offset with savings in other areas. Making larger than planned spending increases this year reduces the scope for planned increases in 2020.
The Government should not rely on further surges in corporation tax receipts, which could prove unsustainable, to fund more slippages. Corporation tax receipts were strong in the key month of June this year, and are likely to experience a further overperformance for 2019 as a whole. It is possible that a further overperformance could mask the effort of any spending slippages on the budget balance in 2019 as has happened in recent years. However, there is considerable uncertainty around these receipts and the budget balance could be much worse for 2019 if an overperformance does not materialise.
For 2020, the Council assesses that the Government should stick to its plans for a €2.8 billion budgetary expansion compared to the planned 2019 level as set out in the Stability Programme Update (SPU 2019). This increase would be consistent with previous plans and slightly below what would be implied by the sustainable growth rate of the economy. The assessment reflects the risks associated with a disorderly Brexit, the reliance on corporation tax, possibilities of overheating, and the rapid rise in spending between 2017 and 2019. There is a case for more caution owing to the risks associated with Brexit and the worsening outlook for the external environment.
While Brexit could entail further budgetary costs, depending on the outcome, the Government should offset these slippages in core spending with other budgetary measures elsewhere in 2019 or in 2020.
If spending overshoots for 2019, this would reduce or eliminate the space for any new measures on Budget day and the government could need to scale back pre-commitments for 2020 to achieve this objective. Additional spending or tax measures would need to be financed by spending or tax measures elsewhere. Targeted measures to address the transition costs related to a hard Brexit should, however, be accommodated as far a possible together with any associated shortfalls in revenues or increases in social spending. It is worth noting that the Government is already increasing spending at a fast pace even before additional measures associated with Brexit are considered.
Trade-offs in a severe Brexit outcome could be very challenging. If there is a disorderly Brexit, then outcomes could be materially worse than is currently planned and budgetary costs will be higher. Should a more adverse shock materialise, the policy response would need to be carefully assessed. However, the Government should in principle support the economy during any period of unusually weak demand. A large budget deficit could emerge due to falling tax receipts and rising unemployment-related costs even before potential customs infrastructure and sectoral supports are considered. The Government might need to cut spending or raise taxes to prevent debt ratios from rising indefinitely.
The Government should follow through on indications that it will develop a more credible medium-term plan in time for Budget 2020. The Council has repeatedly criticised the Government’s medium-term plans for not being credible. This is due to its forecasts relying on technical assumptions that entail implausibly low spending growth in later years, a lack of a medium-term anchor for net spending increases, a poorly developed debt ratio target, and no clear plan to set aside excess corporation tax receipts. The Minister has noted that some of these issues will be explored by the Department with recommendations to be put to the Government in autumn. Changes to medium-term spending forecasts made in the Summer Economic Statement 2019 make them more plausible, but they still rely on arbitrary assumptions rather than the likely path for spending. The Council has a number of suggestions as to how to address these and other weaknesses, including the development of a Prudence Account to save excess corporation tax receipts.