Mr. Sebastian Barnes:

The council would like to thank the Chair and members of the committee for inviting us to appear before them to discuss the council’s pre-budget 2023 statement. We value our engagements with the Oireachtas and see it as an important part of our work. Joining me are council member Professor McMahon and Dr. Casey from the council’s secretariat.

The Irish Fiscal Advisory Council is an independent body established under the 2012 Fiscal Responsibility Act. Its mandate is to endorse and assess the Government’s official macroeconomic forecasts, assess its budgetary projections, assess compliance with fiscal rules and assess the Government’s overall fiscal stance.

While still strong in many respects, Ireland’s recovery following Covid-19 may have lost some momentum in recent months. Official data suggest that consumer spending slowed early this year, pulling down on domestic demand, though the data are mixed. All of this comes as prices have risen, reducing household spending power. The global recovery has been hindered by the sharp increase in the cost of energy. At the same time, central banks have responded to rising inflation by tightening policy and raising interest rates. These factors have contributed to a downgrading of the growth forecasts for Ireland’s major trading partners.

The current outlook for oil and gas, including the cutting off of Russian gas supplies, suggests that prices, while expected to fall eventually, will stay higher for longer than previously thought. This would add to, or prolong, the current high rates of inflation, particularly if wages were to respond strongly.

There are major risks to the economy going into this winter, particularly around the gas shut-off. Covid-19 and Brexit still pose uncertainties. Financial conditions could tighten further. Domestically, we could see competitiveness issues and capacity constraints arising from labour shortages, rising wages and housing costs.

The Government entered the pandemic with one of the highest debt ratios in the OECD and borrowed significantly during the crisis. At the end of 2021, its net debt ratio was 82% of national income. This puts it at the tenth highest in the OECD. Only three small open economies in the OECD have larger debt burdens. Strong tax receipts are likely to push the Government’s budget into a headline surplus of around 2% this year but corporation tax receipts have contributed and continued to surge and are likely to overtake VAT as the second-largest tax heading. Without the excess corporation tax receipts, those unexplained by the performance of the domestic economy, a deficit of close to €5 billion would be likely this year. That is around 2% of national income.

Over-reliance on corporation tax carries large risks. These receipts are highly concentrated and ten firms accounted for around half of last year’s receipts. These receipts are unpredictable. They depend on company-specific developments and there are risks associated with changes in the international tax regime. The Government should cap and, over time, reduce its over-reliance on excess corporation tax receipts, including by saving them in the rainy day fund or a new National Pensions Reserve Fund so that these resources are available to meet future needs.

In terms of budget 2023, the Government faces difficult choices.

Its budgetary stance must strike an appropriate balance between creating space to help those who are vulnerable to the rising cost of living and avoiding stoking inflation further. The summer economic statement in July set out plans that entail a 6.5% increase in core spending for 2023, with core spending €4.9 billion higher than earlier plans, and a larger than expected tax package. This pushes the budgetary expansion beyond the Government’s 5% spending rule introduced last year, the pace that in normal circumstances would be considered sustainable. A temporary deviation from the 5% spending rule is sensible given the exceptional rate of inflation. The pace of expansion planned is less than what would be implied by tracking higher price rises in full. It is now important that the Government sticks to its announced budgetary plans. This would support economic stability and would imply saving any additional excess corporation tax receipts. Further temporary measures may be warranted and the Government should stand ready in case the situation this winter is more severe than expected.

Within the overall spending envelope, the Government faces difficult choices on budget day and needs to prioritise what it wants to achieve. Tracking wage and price increases in full this year and next and implementing existing plans could mean core spending would have to increase by almost €7 billion in 2023. However, this would exceed the available space under the Government’s spending ceiling for 2023. Choices will, therefore, need to be made between how far to uprate public sector wages, pensions, and social welfare payments and to what extent existing spending plans, or any new permanent spending or tax initiatives, are pursued. The proposed public sector pay deal, which increases pay by less than the full amount of expected inflation, would help to create space to support the more vulnerable households. Improved targeting of cost-of-living supports would be less costly and would help to get the balance right. Ireland’s welfare and income tax system offer useful avenues through which to better target supports.

At the same time, the Government needs to set out how it will address major medium-term challenges. Tackling the costs of an ageing population, halving Ireland’s greenhouse gas emissions by 2030, and implementing other policies such as implementation of Sláintecare, will be expensive and need to be built into budgetary plans. Ageing is likely the biggest challenge. Annual spending on pensions is set to rise by about €4 billion to €5 billion in today’s prices by 2030. The Government has yet to respond to the Commission on Pensions' recommendations, but it has indicated a costly decision not to raise the retirement age. The increase in employee and employer PRSI contributions for a worker on a typical wage of €35,000 by 2040 would be around €1,800 in today’s terms if the pension age remains unchanged, compared to €1,000 if the pension age were increased as proposed by the Commission on Pensions.

Strengthening medium-term budgeting would help meet these medium-term challenges. The 5% spending rule should be reinforced to recognise the impact of tax measures, give it legislative status and capture the full range of general government spending, and link it to debt targets. Multiyear baseline expenditure plans should be published alongside the headline ceiling.

Looking ahead to the budget specifically, the documentation should be improved to increase transparency. First, the White Paper, an important pre-budget document covering a no policy change scenario, should be modernised. This should include a full breakdown of the expected no policy change forecast for expenditure and revenue on a general government basis. Figures should be presented on a gross basis rather than on a net basis, which tends to mask underlying developments when there are offsetting transactions. Second, the budget forecasts should cover at least the next five years out to 2027, as the Department has committed to in the past. This would help to ensure sound medium-term planning and make clear the future costs of current policies are properly accounted for. Figures for expected spending for each Department should be included over the full forecast horizon.