Dr. Tom McDonnell:

We thank the Cathaoirleach and the members and staff of the committee for the invitation to appear to present our views on the economy, the budgetary package and compositional issues. I am accompanied by my colleague, Ciarán Nugent.

A correct understanding of whether the economy is overheating, in recession or somewhere else along the cycle matters greatly for budgetary policy and for the appropriate fiscal stance taken by Government. If the economy is in a downswing, it makes sense for Government to stimulate the economy in a Keynesian fashion. The opposite is true if the economy is overheating. Unfortunately, Irish Governments have a long and unhappy history of pro-cyclical budgets.

Our analysis is that the economy is close to overheating. While it is difficult to estimate whether something is overheating or to definitively answer these questions, that is our broad sense of where it may be at the moment. Employment rates and hours worked are at or close to record levels, with employment growing by 3.5% in the year to the second quarter. The unemployment rate of 4.1% and the long-term unemployment rate of 1.2% are also highly suggestive of a tight labour market. There are evident labour shortages and capacity constraints in areas such as construction and ICT, although a caveat is that the most recent release from the CSO just this week indicated that the labour market was starting to soften a little bit. Consumption and retail sales continue to grow at reasonably strong rates year on year. Demand has been supported by the winding down of savings from their pandemic era highs, as well as by fiscal stimulus. What has been happening is that we have experienced a period of pent-up demand post Covid as people run down their savings to normal levels to a large extent, and that process has now essentially ended.

Price inflation remains a significant issue, however, with the consumer price index, CPI, increasing 6.3% year on year in August. In particular, there is concern that inflation is becoming sticky, with core inflation at 6.4%. Real wage growth was negative in the second quarter as hourly and weekly earnings growth failed to keep up with inflation. We are confident that positive real wage growth will resume by the end of this year, although this is predicated on no major upward shocks to inflation.

The outlook for the next six to 12 months is mixed. Tightening monetary policy is exerting downward pressure on trading partner economies and will gradually depress demand in the Irish economy. Consumer sentiment indicates a broadly negative perception of future economic activity and prospects, amidst high inflation and pressure on household finances. Construction and manufacturing purchasing managers’ indexes, PMIs, imply a broadly stagnant outlook, although the services PMI suggests some positive growth momentum in that area. Overall, there is a clear sense of winners and losers. Net household wealth has reached record levels and corporate profits are healthy but deprivation rates are on the rise.

The short-run fiscal position is healthy. This is mainly due to the surprisingly robust and potentially unsustainable performance of the corporation tax yield. The risks underlying reliance on an elevated corporation tax yield are well understood, with circa €12 billion in receipts potentially transitory in nature. Even so, the shift to a 15% rate will likely further boost receipts in 2024. Ireland is expected to be just one of two euro area countries to run a surplus in 2024 while Ireland’s debt level, expressed as a percentage of GNI*, is below the euro area average. However, it should also be noted that with the economy and labour market performing so strongly, the structural budget balance is actually somewhat worse than the headline budget balance.

The medium- to long-term fiscal position is extremely challenging. Age-related expenditure is projected to increase by 3.3% of GNI* from the start of this decade up to 2030 and will rise further in the following decades. Climate action will lead to diminished revenues from fossil fuels and to greater expenditure in a range of areas while the corporation tax yield is extremely vulnerable to evolving tax games and decisions made in other countries. Ireland’s per capitapublic spending is low relative to peer high-income EU countries. To meet the challenges of the future, for example, demographics, decarbonisation and digitalisation, we will need to increase public investment in health and social care, childcare, education and training, energy and water infrastructure, broadband, public transport and the direct costs arising from demographic change and from the green and digital transitions.

Overall, we strongly agree with the analysis of the Commission on Taxation and Welfare, COTW, that Government revenue must increase materially as a percentage of national income. Tax cuts are obviously problematic in this context, particularly when we are so reliant on potentially transitory corporation tax receipts. It would, therefore, be unwise to use windfall receipts to fund current spending increases or permanent tax cuts. Adjusted measures of the budget balance that exclude these receipts are, therefore, helpful in properly framing the debate.

The Department of Finance is proposing to use the transitory receipts to set up a State savings vehicle to part pay for future ageing costs. There is certainly some merit to this strategy. Once the fund is large enough, the annual return will effectively amount to a new revenue stream, akin to a new form of tax receipt coming in, that reduces medium to long-term pressure to increase taxes. However, there is scope to do this and to set up one or more infrastructure funds, for example, to support the green transition over the next 20 years and potentially to address the housing crisis. Regardless of how we use the transitory funds, we will still need significant structural revenue increases over the medium term to pay for future ageing and other costs.

Budgetary policy should be countercyclical. When the economy is overheating, it is generally prudent to adopt a relatively tight fiscal policy andvice versaduring periods of underperformance. The budget, in its current form, will modestly add to overheating and to inflation, while proposed income tax cuts will disproportionately benefit the better-off.

We note the Irish Fiscal Advisory Council’s most recent estimate that standstill costs for core current spending will amount to €4.6 billion. This exceeds the summer economic statement’s proposed current spending increase of €4.3 billion, which has implications for public services. Crucially, the fiscal rules allow us to increase spending by as much as we want each year provided there are offsetting measures that increase taxes.

Clearly, there is a tension between successfully addressing the cost-of-living crisis and simultaneously avoiding further inflationary pressure, yet cost-of-living pressures are not universal. Household savings are above the historical average and household net wealth is at record levels. Median net wealth was in excess of €300,000 for owner-occupiers in 2020 but just €5,300 for renters. We need to protect low-income households from cost of living pressures, not half-heartedly through once-off measures, as was done last year, but through structural uplifts in child, working age and old age payments that adequately benchmark against wages and the cost of living. Increases to all welfare payments should fully compensate for the surge in price inflation that we have experienced. The minimum wage should be increased to a genuine living wage. In addition, targeted reductions in end-user costs for public services such as transport, health and education would help to alleviate cost of living pressures without stoking inflation.

Once-off measures only make sense if we expect the inflation rate to be negative. This strategy should not be repeated in budget 2024.

A related point is that we need to move to multi-annual budgeting, and to an holistic and evidence-based approach to incomes policy that is actually based on adequacy and the cost of living. We support the commission's proposals for a second tier of child benefit and an enhanced working family payment based only on income. However, we strongly caution against tax cuts in budget 2024. The evidence is clear that cuts to income tax or the USC will be highly regressive in the sense that higher income households will disproportionately benefit from changes to rates and bands. Finally, tax cuts of this nature will not just make it more difficult to meet pre-existing and future challenges but they will also be procyclical and inflationary.