Professor Alan Barrett:

I wish to begin by thanking the committee on my behalf and on behalf of Professor McQuinn for the opportunity to appear today. We welcome the fact that greater parliamentary oversight of Ireland's budgetary process, as recommended by the OECD, is now becoming a reality. Before turning to the specifics of our opening remarks, I would like to wish the committee well in carrying out its important work.

While we might get to explore a broad range of issues in response to any questions, we have aimed to restrict the opening remarks to the principles on which budgetary decisions should be made while also giving a brief overview of our outlook for key budgetary variables. Some of these themes may well be familiar to members of the committee but we maintain there is value in placing the later discussion in the context of those principles.

The first question to arise in the construction of a budget is the macroeconomic question of the appropriate size of the budget package. Economists tend to disagree on many issues but on the question of macro fiscal management there is broad agreement. When the economy is growing below its potential rate, a stimulatory budget can help to move the economy back to its potential growth rate. When the economy is growing faster than potential, contractionary fiscal policy can assist in avoiding overheating.

In the current context we now believe the Irish economy is growing at its potential rate and so neither stimulatory nor contractionary fiscal policies are required. Instead, a neutral stance is required. While there are differing definitions of neutrality, a budgetary package of approximately €1 billion - the net fiscal space figure in the summer economic statement - is broadly in line with this concept. These comments on economic growth are based on a view that the economy is growing at a rate in the region of 5% and not at the headline rate as published by the Central Statistics Office recently.

When arriving at the figure of €1 billion, the Department of Finance adjusted the gross fiscal space figure of €1.7 billion by subtracting estimated impacts on spending from the Lansdowne Road agreement and demographic pressures. This is appropriate but ESRI researchers tend to go a step further by explicitly indexing social welfare payments and tax bands and allowances to projected wage growth to arrive at an opening budget position. This is not to suggest that the Department of Finance is incorrect in its approach – this approach is based on the notion that indexation is a political decision made within the budget. The ESRI approach comes from a different perspective and is based on the notion that distributional neutrality can only be achieved if welfare payments and tax bands and allowances are indexed to wages.

Whether indexation is implemented in a budget, our view is that budgetary figures and analysis should be presented with a baseline of indexation applied. In this way, any failure to index tax bands and allowances is explicitly shown to be a tax increase. Any failure to index social welfare payments is shown to be a cut in relative living standards. In this way, the policy choices become more transparent.

Even if the overall budgetary position looks healthy, we know from recent experience that the tax base can be fragile. For this reason it is desirable that the tax base is broad and that reliance is placed on the tax heads less sensitive to the economic cycle. The ESRI has been exploring this issue under a programme of research with the Department of Finance. One of the themes that has emerged is the relative stability of income taxes and hence the desirability of maintaining such taxes as a sizeable share of total revenues.

Although we aim to focus on principles in this opening statement, it is difficult not to mention proposed cuts in the universal social charge in the context of discussing the need to maintain the breadth and stability of the tax base. The USC has many desirable features as a source of revenue: progressivity, transparency and stability, to mention three. For this reason we are unconvinced that moves to abolish the USC are wise. In light of my earlier remarks on indexation this is especially the case if the non-indexation of tax bands and allowances is used to fund any reductions. More generally, the need to protect the tax base leads us to urge caution in respect of any reduction in the aggregate tax take. This point has come into sharper focus because of the potential vulnerabilities associated with Brexit and the Apple tax decision.

I will outline three remaining principles before moving to questions. The first, drawing from our medical colleagues, is to do no harm. While this is generally true, I am making the point now partly in response to fears that there may be plans to provide support to house buyers in the budget. Depending on the design of any proposals the potential exists for any supports to simply inject further demand into the market with direct effects on prices but no net benefit to the group being targeted. In a paper before last year's budget we analysed the potential impact of a range of tax incentives in the housing market and showed how the incentives could fail to produce an increase in supply under plausible assumptions. The lessons from that paper are relevant this year as well. In the context of taxation and the property market, however, we see potential merit in site taxes and can expand on this later in the discussion.

Second, again in the context of learning a lesson from the past, all tax incentives should be reviewed periodically to ensure they are still relevant. We are unsure whether the tourism-related incentive introduced by the last Government is still needed but the case needs to be explored.

Third, as with all policies, where possible evidence should be used to assess proposals and alternative approaches to achieving the same goal should be considered. Again, I will use the USC as an example. It is sometimes argued that high tax rates are a disincentive to work. At some point this is probably true but we can ask if is there evidence to suggest that the current tax rates are leading to widespread withdrawals from the labour market. The most recent figures show that employment increased by 56,000 in the year ending quarter 2, 2016, or almost 3%. Evidence on this issue should be gathered in a more sophisticated manner but even this simple approach raises the question of whether tax is acting as a significant disincentive to work. It could be the case that child care is a greater disincentive. If this is true, then a greater effect on labour supply could be achieved through child care subsidies as opposed to income tax cuts, including USC cuts.

Finally, we believe capital investment that increases the productive capacity of the economy to be desirable, including spending on housing. I thank the committee members for their attention and we look forward to taking questions.