Dr. Tom McDonnell:

I will be as brief as I can. I thank the Chairperson for the opportunity to appear before the committee. I will discuss those three issues within the broader context of how the economy is doing. I will also speak about the budget.

The most recent national accounts were published at the end of last week. The headline figures are that there has been real GDP growth of 5.5% in the first half of 2017. Every sector grew on an annual basis in both the first and second quarter with the exception of financial and insurance activities. The construction sector expanded by a fifth in the first half of 2017 compared to the same period last year. Our forecasts are now for GDP to increase by between 4.5% and 5% in 2017. Perhaps more interesting that GDP is the new measure of modified domestic demand which the Central Statistics Office, CSO, have developed. It gives a more accurate measure of activity in the domestic economy by stripping out intellectual property investment and purchases of aircraft by leasing firms.

Modified domestic demand grew by 2.4% in the first half of this year, which is slightly below what my expectations were, given how strong employment growth has been. The relatively strong growth should continue into 2018 as, in our view, the economy continues to approach its potential and, on the back of this, unemployment should fall below 6%. Employment growth should continue at a strong pace in 2018. Clearly, the outlook for 2019 is much more uncertain, not least because of Brexit, but also because of other factors such as the potential for interest rate increases by the European Central Bank, which would dampen domestic demand in the Irish economy.

The public finances are improving. The general Government deficit will be close to zero in 2018 and 2019 on current forecasts, but it must be borne in mind that the gross debt level remains elevated and is greater than 100% if expressed in the new GNI* metric, though that metric is itself problematic. Our view - and this is currently one of the debates between some of the institutions such as the OECD, the ESRI and others - is that there is limited evidence of overheating in the economy. Total employment and the employment rate are still below pre-crisis peaks. The employment rate is indeed below the EU average, despite the assumption that the Irish economy is rocketing along and doing really well. It is doing really well compared with how it was doing, but its employment rate is below the EU average and significantly below the top performers such as Sweden. The unemployment rate is also still relatively high; it is higher than in such countries as Germany, the UK and the US. The recent growth in consumption that we saw in 2016 follows almost a decade of stagnation and therefore partially reflects a working through of pent-up demand. At the same time, consumer price inflation is only 0.4%, while average hourly earnings are growing at just 1.6% year on year, again after years of stagnation. Underlying investment is admittedly growing strongly but is doing so from a very low base, while consumer credit is less than half its 2009 peak.

Some of the more traditional metrics used to attempt to understand whether an economy is overheating include the current account balance. Unfortunately, it is impossible to measure the real current account balance at present. Technically, it is in surplus. The current account*, which is the new metric, is in deficit but there is a lot going in and out of that which perhaps does not reflect the real economy and its sustainability.

Property prices are growing very quickly but, again, are less than three quarters of their peak value, and the recent price growth should be understood as essentially a market failure in the housing market, with supply running well below projected long-run demand, something that is likely to continue for the foreseeable future.

The committee invited me to comment on income taxation, labour market participation and demographics. Regarding income taxation, according to OECD data, the total employee tax wedge - that is, income tax, USC and employee PRSI - for a single person as a percentage of gross wage earnings is 19.2%. This is the lowest in the EU 15 and less than half that of Belgium and Germany. It is also lower than that of the United States. Ireland is also the lowest tax country if we compare the same person's tax wedge as a percentage of total labour costs. This would include employer PRSI. If we compare per capitareceipts from taxes on labour in Ireland with per capitareceipts in the other high-income EU countries - I am talking again about income tax, USC and PRSI - we find that receipts in Ireland are almost €2,000 lower. It is the low level of social contributions, namely, PRSI, that really explains this difference. The OECD also compares earnings from 50% to 250% of average incomes for a range of family types and finds that Ireland is a consistently low-tax jurisdiction. The graphs I have provided in the supplementary materials show that labour taxation in Ireland is very progressive. However, given the high level of gross income inequality - that is, market income inequality - in Ireland, this is only sufficient to move Ireland to the middle of the EU pack in terms of net income inequality. If we were to reduce that progressivity, we would become one of the more unequal countries. Finally, this progressivity is mainly attributable to the structure of the income tax. The USC is only modestly progressive, although it does have the advantage of being immune to almost all tax expenditures, most of which are regressive in nature. Pension tax relief, for example, tends to accrue to the top 20% of earners.

Regarding labour force participation and demographics, the most recent cross-country data from the OECD, which is for 2015, shows that Ireland had a labour force participation rate of 70.1% for persons aged 15 to 64.

This was below the EU average of 72.7% and significantly below the UK’s 77.6%. Ireland is more than 11 percentage points below Sweden and 17 percentage points below Iceland.

One notable barrier to labour force participation in Ireland is the extremely high cost of child care. This is particularly relevant in the case of second earners and lone parents and mainly effects female labour force participation. The implication for budget 2019 and beyond is clear. It is necessary to increase State spending on child care subsidies and to reduce the cost of child care. Budget 2018 was a very important start, but we are still far from best practice in terms of the quantum of State supports for child care.

Ireland has very favourable demographics compared with most other advanced economies. Our working age ratio of 65.2% is broadly in line with that of the EU as a whole. The important difference is that we have a much larger young person ratio than the EU and a much smaller elderly population. This means the Irish economy has a higher growth potential than that of the EU, which is very positive. On the other hand, Ireland’s relatively small elderly population, which at 12% is just two thirds of the EU average of 18%, makes our long-run fiscal position appear stronger than it really is. This position will deteriorate over time as the population ages. Elderly people require additional spending on health and social protection and are generally out of the workforce. Finally, our fertility rate of 1.9 is well above the EU average of 1.5. This is positive in terms of long-term economic growth. However, this fertility rate also implies deteriorating demographics over time in the absence of inward migration, as 2.1 is the replacement rate.

In respect of fiscal policy, the remaining fiscal space available is less than €500 million in 2018. This is concerning given the severity of the housing crisis and the evident need for additional State support in this area. In addition, our analysis shows that Ireland underspends on a per capitabasis compared with other high-income EU countries - those with a GDP per capita of €30,000 or more - in a number of areas. Notably, we estimate that the State underspends in a number of areas fundamental to long-run economic growth, specifically education, infrastructure and research and development, where the cumulative underspend is in the order of €2.5 billion to €3 billion. There is a particularly large underspend on primary education, especially in the area of ancillary supports, and on tertiary education. In this context we argue that long-run economic growth, employment and equity goals can best be achieved by prioritising use of the available fiscal space to increase public capital investment levels, increase spending on education, and increase direct spending and subsidies for research and development. Here, we are going beyond budget 2018 and talking about the period to 2021.

On the other hand, measured on a per capitabasis, combined taxes and social contributions in Ireland are significantly lower than in comparator high-income EU countries. Taxes and social contributions are combined by the OECD because they are compulsory payments. The OECD sees social contributions as taxes in effect. Ireland is particularly low when it comes to taxing stocks of capital, for example, property taxes, inheritance tax or wealth tax, and when it comes to social contributions from employers. Overall, there is no evidence that the Irish tax system is onerous compared with other high-income European states. In light of this, and in the context of substantial areas of underspend, the case for further tax cuts is extremely weak. Indeed there is a strong argument for increasing taxes in certain areas.