Oireachtas Joint and Select Committees
Wednesday, 7 September 2022
Committee on Budgetary Oversight
Updated Economic and Fiscal Position in Advance of Budget 2023: Discussion
We will begin the Committee on Budgetary Oversight's pre-budget 2023 review. This is session one. I welcome Mr. Barnes, Professor McMahon and Dr. Casey from the Irish Fiscal Advisory Council, IFAC, and Dr. Doorley, Ms Disch, Dr. Lynch and Dr. McQuinn from the Economic and Social Research Institute, ESRI. There are other people in the room and I apologise for not calling their names out.
Before we begin, I wish to explain some limitations to parliamentary privilege and the practice of the House as regards references witnesses may make to other persons in their evidence. The evidence of witnesses who are physically present or who give evidence from within the parliamentary precincts is protected pursuant to both the Constitution and statute by absolute privilege. However, witnesses giving evidence remotely, and we have a couple of people doing that today, from a place outside the parliamentary precincts may not benefit from the same level of immunity from legal proceedings as a witness physically present does. They are reminded of the long-standing parliamentary practice to the effect that they should not criticise or make charges against any person or entity by name or in such a way as to make him, her or it identifiable or otherwise engage in speech that might be regarded as damaging to the good name of the person or entity. Therefore, if their statements are potentially defamatory in relation to an identifiable person or entity, they will be directed to discontinue their remarks. It is imperative that they comply with any such direction.
Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the Houses or an official, either by name or in such a way as to make him, her or it identifiable. I remind members of the constitutional requirement that members must be physically present within the confines of the place where Parliament has chosen to sit, namely, Leinster House, in order to participate in public meetings. I will not permit a member to participate where he or she is not adhering to this constitutional requirement. Therefore, any member who attempts to participate from outside the parliamentary precincts will be asked to leave the meeting.
I invite Mr. Barnes to give the opening statement from the Irish Fiscal Advisory Council.
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.
Dr. Karina Doorley:
I thank the Chair for the invitation to the ESRI to appear before the committee. I am joined by my colleagues, Dr. Muireann Lynch, Dr. Kieran McQuinn and Ms Wendy Disch. We are grateful for the opportunity to appear before the committee today to provide our views on budget 2023 and additional one-off measures for 2022. Despite unprecedented uncertainty in the global economy, both domestic and international sources of growth have demonstrated a certain degree of resilience this year. We expect modified domestic demand to register positive growth in 2022 and 2023 of 4.4% and 3.7%. The relatively strong performance of the domestic economy this year is particularly evident in the labour market and the Government Exchequer returns. Unemployment is now set to reach 4% by the end of the year, while tax receipts are increasing across all the main headings. Over the winter there is a possibility that energy costs will increase putting significant pressure on many households. Government may decide to provide further support to households most affected. This could result in significantly greater Government expenditure in 2023 than is now forecast.
Based on the significant increases in tax receipts and likely trends in expenditure observed for the year to date, we now believe the public finances will witness a surplus in the general government balance, GGB, of 0.5% of GDP in 2022. In 2023, we believe the Government will run a more modest surplus. However, that forecast could be revised in light of developments in international energy markets.
Developments in global inflationary pressures have contributed to significant downward revisions in global output and are likely to continue to feed through into domestic prices. Inflation in Ireland and the euro area stood at 9.1% and 8.9% respectively in July. Food and energy are the areas experiencing the most acute inflation globally and in Ireland. Increases in the cost of food and energy items have accelerated rapidly over the past year reaching a high point of 28.6% per annum in June 2022. Despite signs that food and energy related price growth may be slowing, prices of non-food and energy items have continued to increase. As of July 2022 prices of these items had increased 6% on an annual basis suggesting that inflation is becoming more broadly based.
Due to differences in the composition of household expenditure, inflationary pressures are heterogeneous across households. The lowest income households experienced inflation just above 10% in June. Contributions of food and energy costs are largely responsible for the varying rates of inflation. When budget 2022 was announced inflationary forecasts for 2022 ranged between 2.2% and 2.9%. Most tax and benefit parameters were increased by factors in the region of this projected inflation rate. This would have left most households no worse off in real terms had projections for inflation been correct. However, inflation has far exceeded these forecasts over the course of 2022, averaging 7.2%. A number of extra policy measures were introduced this year to help households with rising inflation. These have resulted in average household income gains of around 1.5% of disposable income, with higher gains for lower-income households. Some households may also have benefited from wage increases this year, although low income and elderly households, which contain fewer earners on average, will benefit less from this development.
One option available to policymakers to compensate households for rising inflation is indexation of the tax and welfare system. Indexing tax and benefit parameters in line with price growth would keep the purchasing power of households that are reliant on welfare constant and reduce the tax paid by working households. Indexation in line with wage growth would keep the distribution of income constant and reduce the incidence of households losing eligibility for social welfare because of inflation-driven wage increases.
Indexation leaves less scope for targeted measures. Given prospects for sustained high levels of inflation, policymakers may wish to consider greater targeting of measures to limit the cost of future supports and the risks of fuelling further inflation. Increases to welfare payments and lump-sum payments like the electricity credit are well targeted at those most affected by inflation. These types of measures have advantages over indirect tax cuts on energy as they do not disincentivise investment in energy-saving technology. Measures to specifically target low-income earning households could include the expansion of the working family payment and increases in the exemption limits for PRSI and the universal social charge, USC. Broader based tax cuts would benefit middle and higher income households.
The existence of windfall gains in energy markets and their taxation has been raised in the context of record energy prices. The majority of the windfall gains currently being made in the global energy sector accrue to fossil fuel companies. In Ireland, fossil fuel extraction is limited to the Corrib gas field which is small and dwindling. Any potential windfall gains are therefore limited to non-gas fired generation in the electricity sector. Estimating the magnitude of this windfall gain is challenging and the potential gain from a windfall tax is also difficult to estimate. There is evidence that some energy companies are using greater than expected profits on the generation side to offset losses on the supply side, which puts downward pressure on customer prices. Taxing windfall gains in the generation sector might only place some upward pressure on consumer prices.
Energy security continues to be a concern with the electricity supply, in particular, coming under pressure this winter and next. Balancing net demand with supply in real time will be increasingly challenging and may only be possible with active participation from the demand side. The prospect of further reductions or a complete shutdown of Russian gas to Europe remains a possibility which may result in gas rationing across Europe. Despite the fact that Ireland does not source gas directly from Russia, curtailment of supply across Europe may result in the need for rationing. In this case gas-fired electricity generators would be prioritised in order to avoid further pressure on electricity supplies. Large industrial gas users would be first to see their gas supply reduced before any impact on households and small businesses.
Despite significant uncertainties in the global economy, the Irish economy is in a relatively strong position in the run-up to budget 2023. This affords the opportunity for some targeted spending to mitigate some of the impact of inflation on those worst affected by it. However, the Government must take care to ensure that any package that is adopted minimises the possibility of additionally stimulating the inflationary pressures which are present.
Thank you, Dr. Doorley.
I will now open up the floor to Members. I remind them that we have two sessions today, the second beginning at 4 o'clock. Therefore, I will be a little stricter on time than I usually am. Our first speaker is Deputy O'Donnell.
I will split my questioning into two areas: the upcoming budget and energy costs. The witnesses might answer the first question within the timeframe I have.
First, I wish to draw attention to the IFAC pre-budget statement. On page 5 the council effectively states that government receipts will be €3.5 billion higher than forecast and that this will lead to a surplus of €4.5 billion, whereas the surplus projected under the summer economic statement was €1.2 billion. That is a differential of €3.3 billion. If €500,000 of that is put into a rainy-day fund, and we will deem the extra €3.5 billion to be the non-recurring element of corporation tax, what scope does that provide to the Government in the form of once-off payments to hard-pressed households and businesses in 2022? I ask the question on the basis that the sum is paid out as once-off payments and, therefore, does not feed into core spending. That means that the Government will still be able to meet its metrics under the summer economic statement, namely a surplus of €1.2 billion and a 0.5% general government balance. It is a very specific question. What scope do the witnesses believe that provides to the Government, and would they support that €3.3 billion, which would allow the Government still to meet its target under the summer economic statement, being spent on once-off measures in 2022? In addition, what should those measures be? I will start with Mr. Barnes and then go to Dr. Doorley and Dr. McQuinn of the ESRI.
Mr. Sebastian Barnes:
That is a good question. Deputy O'Donnell is right to point to the fact that we expect the budget balance to be much stronger than was expected. A good chunk of that is driven by corporation tax. Another chunk is driven by the strength of income tax, which has been an ongoing theme, and VAT. We will see where we are at the end of the year. I would not particularly relate the outturns to the decision the Government should take. The real issue for the Government is getting the balance right between, on the one hand, supporting people, which is a reasonable thing to do, and, on the other, not adding to inflation too much. The Government's own plans allowed for another €2.5 billion of temporary measures. Originally, that was planned for the Ukrainian refugees. In the end the costs there have been lower than anticipated.
Does the stream of income coming in this year present an opportunity for once-off payments in this current year which will not impact core spending going forward? What opportunities does that provide, and what should that spend go into?
Mr. Sebastian Barnes:
I am just saying that, personally, I would not particularly link those things. What I would look at is the needs that there are and balancing them against the second-round inflation. Of course, there are different numbers the Government could choose. The number it had for the €2.5 billion in temporary measures is probably a number we would be comfortable with, but I think there is no real link between that and the corporation tax. The corporation tax is helpful as it means that the public finances are in some sense in better shape. As the Deputy rightly pointed out, however, using it for temporary measures is appropriate. Obviously, using it for permanent measures is not.
Mr. Barnes would therefore have no issue with the non-recurring gains of corporation tax being used. Their use does provide an opportunity.
I assume the Irish Fiscal Advisory Council is deeming the temporary measures of €2.5 billion to be once-off measures.
With the growth in taxes, would the Irish Fiscal Advisory Council be against going above the figure of €2.5 billion in temporary supports for very hard-pressed householders and for businesses in the area of energy?
Dr. Eddie Casey:
No, I appreciate the question and I think it is a sensible one to ask. However, we have seen in the year to date that 90% of the measures that were introduced and that were supposed to be temporary actually were universal measures that were not targeted and went to everyone. That added to the inflationary pressures we already have seen this year and they are estimated to have added up to 1% inflation over the medium term. There is therefore a big risk, in terms of getting the balance right, if we do too much, too fast and it is not targeted. Trying to put a fine point on it and to give an exact number is hard for us to do in our position when we do not know what those measures are going to be.
Dr. Kieran McQuinn:
Of course. The point is that if these were ordinary times and if we did not have these huge inflationary pressures, we probably would be advocating for a mildly contractionary budget because of the pace at which the economy is growing and because of the dangers of inflation. This is particularly the case when you look at developments in the labour market where unemployment is quickly approaching a rate of below 4%. Typically, in the Irish case, when unemployment goes below 4%, there are significant price pressures. The key point is targeting the households that need it the most. That is the key point in terms of what the budgetary parameters should be and for ensuring whatever measures the Government takes get to those households. As has been pointed out, this is because the danger is that more general and more universal measures tend to feed into inflation.
This feeds into my second question, which is on energy costs. On the ESRI report, I want the institute to explain some evidence, which is that some energy companies are using the greater-than-expected profits on the generation side to offset losses on the supply side, thereby putting downward pressure on customer prices. My question to both the Irish Fiscal Advisory Council and to the ESRI is what should be done. Measures will be taken in Europe on decoupling the price of using electricity being benchmarked to the price of wholesale gas. What measures can the Irish Government now take that would bring down the price of energy to the end consumers, that is, households and businesses? Second, I take the point on inflation but at the end of the day, people at home who cannot pay the electricity bill - there are businesses whose bills are going up twofold and threefold at present - are not particularly worried about the inflation measures, they need supports. Can the witnesses deal with both sides of the coin? What can the Irish Government do to bring down the cost of energy to households and businesses? Second, what additional financial supports should be put in place? I am thinking of the windfall gains, the corporation tax and the figure of €2.2 billion about which Mr. Barnes spoke. Is there more scope in that area? I ask the witnesses to deal with both issues briefly.
Dr. Muireann Lynch:
On the issue of energy costs themselves, there is little that can be done to bring down the price of wholesale gas or oil. That price is as it is and that is set at a global level. It has gone really high for all the reasons we know about. On the electricity side, Europe is moving quite quickly on this. It is definitely preferable to move in tandem with the European Union in terms of electricity market design. If it were not for the fact that we were moving in such a direction right now, I might have all sorts of things to say. Right now, however, I am saying we should wait to see what happens on Friday.
In the Irish context, wind is putting downward pressure on electricity prices. Believe it or not, they would be much higher than they are were it not for the wind. We will see the PSO levy go negative this year.
On supports that can be put in place, it is a good idea to keep the supports in monetary terms rather than on the price side. A report was done by colleagues on energy poverty a couple of months ago, which we can forward to members. Cash payments are better; targeted cash payments are best. The worst options are excise duty, messing around with carbon tax, etc., because that tends to accrue far more to the higher income households whereas flat-rate is the middle choice, and using the tax and welfare system-----
Okay. The Minister stood up on the floor and said the Government expected a budget deficit next year of €8 billion and could not go back to the situation of "If we have it, we spend it". That was an issue. We had to reduce the deficit and there was a pathway there. We have seen a bonanza and a €13 billion turnaround, yet IFAC says the Government should not do anything more than what it planned last year in the contingency fund of €2.5 billion. That will not cut it for many families. It will not stretch. When we look at prices increases for average families of over €2,000, that will not cut it in terms of one-off measures, will it?
Mr. Sebastian Barnes:
It is a reasonable question for people to ask. I will try to explain why this is the appropriate thing, even if it is a difficult message for people to hear. First, in terms of public finances a much better measure is to focus on the balance without the excess corporation tax. That is particularly important when focusing on permanent measures, as we discussed with-----
Mr. Sebastian Barnes:
Exactly. That is just in terms of the context. In some ways a better measure of some of the forces going on in the economy is that there is a deficit of 2% in national income, which is a different picture and a tribute to the size of the wedge.
The real constraint comes down to the issue of not triggering second-round impacts on inflation. That occurs if we pump too much money into the economy, though one could argue about where "too much" kicks in. The more money you put in, the more inflation you will have. These policies risk being counterproductive. And the ultimate-----
Is that always the case? Say we do not do as Mr. Barnes suggests and just use the €2.5 billion; say we use €4 billion but it is properly targeted. If you offset the price increases in energy for low-income deciles, you are not creating inflationary pressure.
It is only if you do what the Government did the last time, which was 90% untargeted, that you create inflationary pressure.
Mr. Sebastian Barnes:
Whatever money you put into the economy will, in some ways, contribute to higher inflation. That is the constraint. The difficulty and underlying problem here is that we import energy and food which, as everyone recognises, are things we essentially have to have. That is particularly true of energy. The difficulty is that the people who gain from increases in prices are not, by and large, people in Ireland but people in other countries that sell us oil and gas. There is therefore a net loss to the economy and that has to be paid for in some way. We cannot fully compensate everyone for these higher prices because there is a net loss to the economy. That is really where this constraint with regard to higher inflation comes from. To be clear, we are not suggesting the really textbook approach of not providing any help and just letting it ride. We are not saying that. We are saying that there is a legitimate case both to help the more vulnerable households and to smooth this shock, which is very big. People are going to find very big bills landing on their doorsteps during the winter. There is a balance to be struck in managing compensation and managing inflation. Targeting improves that trade-off. It means that more help can be provided to those who need it most while causing the same amount of inflation than if measures were not targeted. The balance is much better but that does not change the fact that putting more money into the economy adds to inflationary pressures.
How does the Irish Fiscal Advisory Council arrive at the view that €2.5 billion is the appropriate figure for one-off measures? Is it just because that was announced last year, before we had a cost-of-living crisis, or has it carried out assessments as to the impact of this crisis on these families?
Mr. Sebastian Barnes:
To be clear, we are not saying that €2.5 billion is the appropriate number; we are saying that it is within the range of appropriate numbers. There are trade-offs which might be struck in different ways. What is clear is that the more money that is put in, the more these kinds of inflationary pressures are contributed to. Ultimately, what we are doing is using our professional judgment and looking at the kinds of tools and models we have and we see that these kinds of measures would contribute somewhat to inflation. We also know that there is a lot of pressure and demand in the economy. The Irish economy is continuing to grow quite quickly so we believe that, while there would be higher inflation with this, it would not radically change the picture. It seems to us that it strikes the balance.
Mr. Sebastian Barnes:
It should be borne in mind that the Irish economy is in an unusual situation relative to other economies. There are parts of the economy that have been powering ahead for many years, including during the pandemic. That means we have a higher-end trend rate of growth. Unemployment is coming down very quickly and employment is still growing. The economy is therefore performing quite well in some ways. It will be a big shock for people when they get these big bills in winter. Exactly how bad that will be will depend on what happens to prices, how it cold it is this winter and how tight energy shortages are. There is a lot of uncertainty and that is one the reasons we have said the Government should stand ready to take additional measures if things get much worse than expected but we are not quite in that position at the moment. We believe there is space to take temporary measures. What the Government has already put out there is one reference point. It is not the only number that could be chosen. However, there is also the constraint that the more money we put into the economy, the more other prices will go up. We would then just be chasing our own tails.
Dr. Eddie Casey:
On that point, we are not seeing a contraction in growth in the first two quarters. Growth is actually still powering ahead. Even though it is moderating, the domestic economy is still moving at a fast clip. The other thing is that unemployment is at a once-in-a-generation low level. In these types of conditions, in which there are pressures from the Government adding more stimulus into the economy, we are likely to see even higher inflation. That is why we are saying that, while we do not have a perfect number in respect of possible temporary measures in the future, the Government needs to stand ready and watch for a turning point.
Dr. Eddie Casey:
We did not look that far ahead in the pre-budget statement. I would say the number will change massively depending on what happens in the coming weeks. Things are really hectic in respect of what the gas futures are saying and what the outlook is for the economy. It could change very rapidly.
If we go to budget 2023 and look at the package that has been outlined, we see that there is an expenditure envelope of €2.65 billion. However, when you take away the public sector pay deal, if approved, the number is reduced to about €1.6 billion.
In the context of a cost-of-living crisis, a healthcare system that is falling apart and needing more investment in housing, €1.6 billion will not cut it in expenditure. Forget about indexation; it is not going to cut it. This is worse than a standstill because hospitals, schools, youth clubs and everything else are costing more to keep level because of the cost of energy. Support in the amount of €1.6 billion is tiny in comparison with what is required. Would Mr. Barnes not agree? How can he suggest it is appropriate?
Mr. Sebastian Barnes:
The numbers I have in mind are the core spending by the Government. The measure the Government has in the raw would go up by close to €5 billion next year, so higher than the figures suggested by the Deputy. What is true is that if one compares that with the cost of fully uprating pensions, pay and welfare to this year's inflation and to the July forecast for inflation, that would cost close to €7 billion. That assumes the public sector pay deal will be fully tracking inflation, however, which it will not. If one does that, there is not much of a gap between the full indexation of pensions and welfare, and the Government's other existing spending commitments. It is around €2 billion in the context of the envelope. Those things more or less line up. Of course, the Deputy was correct to say that does not leave a lot of space for doing other things. On the investment side-----
Mr. Sebastian Barnes:
It is a little unclear from where those numbers come, which is why I set them aside. I think they were based on lower rates of inflation, so those numbers are now outdated. That is why I gave the committee the most useful and updated figures. As the Deputy correctly identified, the bottom line is that it does not leave the Government a lot of space to do other things. Specifically on the point of investment, the national development plan is still there and the Government is investing a huge amount by historical standards, including significant amounts on housing. The main constraint there is probably a supply constraint on the ability of the economy to produce more housing. That is a specific issue but, in general, there is not a lot of space for the Government to do other things, and that is natural.
Mr. Barnes is saying there is not a lot of space. We are in a far better position than we were last year. There is not a lot of space because the Government has set out in its summer economic statement that this is what it is going to do. Mr. Barnes is concurring with that. There is space if one wants it. I am dealing with families in Donegal who are homeless, kids who are in hostels and people who cannot get an appointment to see a consultant for more than a year. Then there is the number of people who are fearful of opening the envelope to see their bills. There is space if we want to have it. Mr. Barnes is concurring with this allocation of €1.6 billion to deal with the crisis that we have but it is not good enough, it is not big enough and it is not going to cut it. The package is far too small. We can wrap it up in billions of euro and all the rest. An allocation of €1.6 billion will not fit when one takes into account the social welfare payments that have to be significantly increased, a tax package that needs to be directed at low and middle incomes, investment in health and additional capital for housing.
Mr. Sebastian Barnes:
Our point is there is a real need to prioritise as a consequence of higher energy prices that essentially make welfare payments and pensions more expensive to provide. if the Government wants to do that, which most people think it should, that is going to cost it a lot and that means it has to make choices relative to other things. There are many pressing things facing the country and this raises real questions about how that is going to be done. Of course, there are other ways of doing it. One could prioritise away from other spending programmes or increase taxes. Those are all ways of doing it in a sustainable way. The danger of just spending the money that we have is that would add to inflation in an already high inflationary environment and also make us more reliant on corporation tax, which would essentially be storing problems up for the future. There is a very important debate to be had about-----
I welcome our guests. I have what might seem like an unusual point in context of the two opening statements.
One of the issues from socialising the impact of what is happening is the remoteness of a war in Europe, and neither the ESRI or IFAC mentioned that in their opening statements. In terms of the Government doing its job, what we have seen, as some have said, is the weaponising of energy. That should be upfront in the opening paragraphs from the witnesses because the remoteness of the war is being lost on ordinary people in the street. We would not have the discussions we are having were not for the organising of energy and the fact Russia invaded Ukraine. That is the backdrop to everything and it must feed into all of the narratives. That may seem trite to the witnesses, but it is important. It frames every discussion we will have in the run-up to the budget.
My response and questions will be in scattergun form. We had a number of presentations prior to the recess. Indexing pensions and welfare obviously comes at a price. One of the things we were told in a presentation is that indexing pensions, for example, would require an increase of up to €23 in the old age pension in order for people to keep in step with inflation. I would love to see it, but if there is a pension increase of anything remotely approaching that it will clearly come at a cost at some other end of the scale.
I will again put it on the record during this, my sixth year on the Committee on Budgetary Oversight, that IFAC was established to institutionalise the memory of the crash. In this sixth year of my membership of this committee, the witnesses have reminded us of that. I feel like saying to them that they have lied to us about the fallibility of corporation tax. It has been said for six years and we may disregard what they have said. I would like to hear the response of the witnesses, because we are told that it cannot last but they can never tell us why.
Mr. Sebastian Barnes:
It resembles the housing debate in many ways. The structure of the problem is different, but for many years people warned about that. Eventually people thought that perhaps those people are not so right after all, but in the end it came crashing down. One of the difficulties with corporation tax is that it is unpredictable. We have had a whole string of shocks and surprises. We thought that when the OECD BEPS process kicked off it would be bad, but it was not. That shows how complex these things are.
We have done more work on this over the summer. What is difficult is that we cannot see where the money is coming from. We suspect there are a few big companies. We can count them on the fingers of one hand. There is no actual data that would tell us who those companies are and exactly how they are making that money. That is one of the things that should give us pause for concern.
There are a number of risks. One is the political risk, in the short run, but things can turn around very quickly, in particular in the US political system, and can be very slow as well. It can go both ways. People are always looking at this kind of money. A lobby is trying to reform these things in the US, and we need to be aware of that. The main risk is around a handful of companies. Those companies have done really well over the past couple of years and may continue to do well because they are in the digital or pharma sectors which are the future of the economy.
Those companies make huge profit margins compared with almost any other company. At some point those companies might become less successful. They may have a few products that flop or a CEO who is not very good. They might decide to reorganise themselves, split up or do all sorts of things. They might decide not to have a base in Ireland anymore. All of these things could lead to a big change in revenue. A lot of revenues coming through Ireland are really European revenues. Europe may go through a bad time. Advertising revenue is very cyclical. There are a lot of specific factors that we do not really understand, but the problem is that we are very close to them. If an individual company, or a couple of companies or sectors, did badly, profits could fall by quite a lot. That would leave us with a significant hole in the public finances.
We have tried to be balanced. It would not surprise me if those revenues went up in the next few years, but it would also not surprise me if they went down. It is a genuine risk and it is difficult because we cannot put our finger on what will happen. That fact shows that we should not rely on that revenue.
Dr. Kieran McQuinn:
I wish to add very briefly that it points to one issue which people may not have been aware of, that is, the notion of what we call the upside risk.
We always talk of risk as a downside factor because when it hits us it hits us very bad. There is an issue, and the Deputy is correct in what he is saying, in that each year we forecast, like everybody else, what the corporation tax receipts are going to be and each year we are wildly off. This argues that there should be a plan in place, which most of us would agree with, as to what one does with the unprecedented levels of tax that come in. Otherwise, one runs into a scenario where it is just treated as an addition to current revenue and spent accordingly, instead of having some sort of a plan whereby if it goes above a certain benchmark rate of increase, we would use it for a particular once-off capital investment or whatever. In that case, if it was to fall in an unprecedented fashion, it would not affect the current expenditure base we have. Again, it is about that notion of upside risk, which we probably do not think about frequently enough.
I just want to repeat where I was coming from on corporation tax. I have been consistent on this and on the Irish Fiscal Advisory Council's role for six years. I hope there are not too many constituents watching this discussion. I suppose I am playing devil's advocate but committee members are here to interrogate certain issues.
The Government has already expended €6 billion, which is substantial. Some of the measures are clearly not adequate but the measures on diesel and petrol succeeded in keeping prices dampened a little, although they later went up. Fuel prices dropped a little. We were seeing prices well in excess of €2 per litre but people can now get unleaded petrol at a price of €1.81 per litre. It is 30 cent dearer than it was but the Government reduced excise and it costs €9 and €12 less for a tank of diesel and petrol, respectively. That is not enough.
Some measures worked very well. One issue I highlighted in my party was the change to monthly medical expenses, for which the threshold dropped from €120 to €80 in the space of 18 months, giving a significant saving. It is a very helpful and clearly targeted measure. I favour the kinds of measures that stop money leaving people's pockets as much as those that put money into people's pockets.
The challenge for the Government is that the once-off measures we are talking about in September will run out, by and large, on 1 January 2023. The package worth several billion euro will run out and we will have to look at another package. On the other side of that coin, what is stopping the Government from taking the approach it took during Covid when it fulfilled its side of the social contract by shoring up people and businesses? I have received many inquiries from people, particularly owners of small retail businesses, who are suffering hugely. Other members noted that fuel bills in schools have doubled or tripled and we are not even into winter time. We are talking about some of the catastrophic measures that might be required against the backdrop of energy being weaponised. What is stopping the Government from shoring up the economy, society and people in the way it did at the height of the pandemic?
Professor Michael McMahon:
This goes back a little to the answer we gave to Deputy O'Donnell and the reason not to link the two. Covid would be the example. If there is a plan that is targeted and has taken into account, as best we can with all of the uncertainties, how to minimise the inflationary impacts of the measures, there is nothing to say that if it was not from extra income, we could borrow it. Ireland remains able to borrow. The National Treasury Management Agency, NTMA, has done a fantastic job. That option is, therefore, available.
A point we would go back to is one the Deputy touched on when he mentioned the opening statement. The one thing that would help here is multi-annual planning frameworks. The right seasonal context to think about what we are dealing with now is not the period until the end of December and then to start anew in January. We really should be thinking about the period from November until February or March. We know that gas consumption is much lower during the summer. Thinking about these things in a multi-annual way would help. All of these packages that are targeted would also help to ensure that people who are lending money to the Irish Government see this as sensible policy.
As Mr. Barnes was saying, we can have debates about whether it is €2.5 billion or €4 billion and about how it is targeted. There are many possible discussions that can be had there. However, it will be costly, and this committee is one part of what helps to keep those costs down by checking the homework and ensuring we have a constant memory of how things can go wrong. We must have a credible fiscal framework. If it was decided that the package would be bigger but would come alongside other measures that would reduce the inflationary impacts of that, that is a choice that could be made and it is for the members, as elected officials, to make those difficult choices while there is a lot of uncertainty. We should emphasise that this is a world of incredible uncertainty. As Dr. Casey was saying, in the next two months, the futures curve for gas could go all over the place. What we know is that it will peak some time around the middle of winter. That is not the end of December or the middle of January but it could be throughout the winter. That is why coming up with a policy and a targeted set of policies is what helps constituents who are facing difficult times as well as businesses that are facing difficult times. It is also what helps to ensure the Irish Government’s planning and credibility remain intact. We must ensure that if we did not have corporate tax revenue or anything else, we could still borrow at a favourable rate to do what could be decided as the appropriate targeted measures to help people, as we did during Covid.
Dr. Karina Doorley:
The comparison with the Covid pandemic is an interesting one because it is a good example of how targeted and timely measures were introduced that did not fully insulate everybody from the impact of the pandemic but did fully insulate the bottom fifth of the income distribution from income loss due to job loss. The effects of the pandemic unemployment payment and the employment wage subsidy scheme were extremely progressive across the income distribution. They gave something to all points of the income distribution but focused on the bottom fifth and the second quintile as well. The bottom half of the income distribution was well-insulated. The measures taken were targeted and timely and they had run-out dates, which were then extended when it was required. It is a good example of how to implement measures like this in a way that is flexible and targeted.
I thank all of the contributors. There is so much to think about and we are covering so much ground that it makes the head spin. The idea of targeted measures is a mantra that has been trotted out but we need to spell out what it means. I would not mind hearing a little more on what the witnesses think it means. If targeted measures were to mean, for example, having lots of means-tested payments and a massive administration deciding thresholds and who is entitled to this or that, it would not be a good way to do things. Is that what we mean? Do targeted measures mean we should not give loads more money to corporations that are making super-profits? The interesting thing about this crisis, which is inflicting huge misery on ordinary families who are facing bills and rents they cannot pay, is that some people are doing well and the economy is doing well. The reason corporate tax receipts are up is that corporate profits are at record levels. Some people are, therefore, doing very well.
If targeted measures mean that we should not give further handouts to already super-profitable companies and already super-rich people, I am all for targeted measures. However, if it means that ordinary working people who, if we take all of the cost-of-living increases we have seen over the past year or two, are probably €4,000 or €5,000 less well off than they were a year ago in real terms just have to suck it up, then I am not for targeted measures because that would be unfair. It would also be economically and environmentally damaging.
As somebody said to me in the corridor today, when the demand for solid fuel wood is going up, we are not very far away from people chopping down trees - this is not a joke - to get fuel for their homes, which is not very good for the environment. That is where things are going if people cannot afford to heat their homes. What do we mean by targeted? I believe that as a minimum in this budget, pensioners and people on social welfare have to get increases up to the level of inflation, that is, of around 10%. Anything less will be unconscionable because in other words, we would be saying they are going to be poorer this year through no fault of their own and that when the economy is growing and super profits are being made, they must accept they must be poorer. That is not acceptable. I want to understand what the council means by "targeted". Is it saying those sorts of people - pensioners, students and ordinary workers - will just have to soak it up to some degree or by "targeted", does it mean we should not give handouts to those who are super-profitable or super-rich? Unless we start to define what we mean by "targeted", we are talking nonsense.
Regarding what we do with the bonanza corporate tax revenues, again, I want to understand exactly what the council is saying. If we say we are vulnerable in that regard because we are dependent on a small number of companies, as I agree we are, we are, however, facing an emergency, so it seems to me that we must use that revenue to address the emergency and protect people and get us from an unsustainable situation to a sustainable one, including in the medium term, as Professor McMahon was referring to, to have a sustainable economic plan. Is there anything wrong with saying we should be investing in areas that will help people now but also make us sustainable in the medium to long term? Housing is an obvious one. The current housing crisis is draining current Government revenue to a massive degree - by about €1 billion per year. Putting more money into building direct public and affordable housing would both help address an immediate crisis and make public finances more sustainable in the medium to long term. That is just one example.
Given that we have labour and skills shortages all over the place, if we removed obstacles to people getting into further and higher education, that would be good now and in the medium to long term. If we invested in a sustainable form of forestry, that would create employment, help shore up the rural economy in a difficult situation and be a good long-term investment from an environmental point of view. Those are just three examples. If we made public transport free, it would be a cost-of-living measure that would help now and would also move us in a positive direction from an environmental point of view and build up our infrastructure. Could Mr. Barnes comment on that? Is this a reasonable perspective?
Mr. Sebastian Barnes:
I think the ESRI probably has a better view on targeting. To be clear about targeting, the constraint is that there is only a certain amount of money the Government can put into the economy without triggering inflation or raising questions about fiscal sustainability. Therefore, within that, support should targeted at those who need it most. Exactly how one defines that is an inherently political choice on which the council does not have a view. To be clear, we do not just mean targeting the very poor. It is probably support that could go more widely in the economy but how far and to whom is a political question I will not get into.
Regarding corporation tax, which we discussed with Deputy O'Donnell, the link is not that mechanical.
If we did not have that money, we would also have the scope to borrow if we wanted to. The question is whether that is a good idea. The real question to ask is what is the correct policy in respect of managing the cycle and not triggering higher inflation. We must also have a view to fiscal sustainability. We have been talking about temporary measures, which can be financed either through borrowing or the excess corporation tax, since we have it. However, the amount of corporation tax we have does not determine the right level in that regard. Of course, it would be a big mistake to finance permanent measures such as raising welfare or pension rates through corporation tax. Those are permanent commitments that would be called into question in the event those amounts of corporation tax were no longer available. That is important.
At the end of his contribution, Deputy Boyd Barrett raised a very good point, which was also relevant to the points made by Deputy Doherty. Considering the medium term for the public finances, we advocated for and welcome the Government's 5% spending rule, which should keep spending on a steady path in normal times and ensure that the economy is properly balanced. It ensures the maintenance of the public finances on a sustainable path. We often highlight in that context major challenges such as the ageing of our population and climate change. Those are challenges that will have to be paid for because they are going to happen. We need to plan to deal with those issues. The Government needs to plan how it will deal with those issues and it is not doing so at the moment.
There is another point we may have been understating and this is a good occasion on which to discuss it. There are many other needs in the economy that we do not necessarily have to deal with in a mechanical sense, examples of which include health and housing. People have expectations, and society faces challenges, in that regard. Investment in schools is another example, and there other similar kinds of things. The Government also needs to think about these areas. Such considerations raise questions about the Government's spending priorities and what level of tax will prevail. These are big questions. As I say, we tend to focus on the things the Government will have to pay for, such as people getting older, but there are many other things the Government should be doing that are less mechanical than, for example, the costs associated with our aging population and climate change. All these things need to be thought about and addressed, and some difficult choices will need to be made in the years ahead in that regard.
May I ask one brief additional question? If we were strictly following the original rules around fiscal space and all the rest of it, how much fiscal space would be available in this budget?
Dr. Eddie Casey:
That might not be the case. It might be less. The way the rules worked was so pro-cyclical that it could have risen to higher levels. It is a moot point because the rules are in suspension. The Deputy is probably thinking of the spending rule in the EU fiscal rules. That rule is not in operation this year. It was not in operation last year and probably will not apply next year either. If the rule was active, could we have done more? It would not have been wise to do so. The Deputy has often heard us talk on this subject. We need to think about things in terms of net spending. If one wants to do more on the spending side, that is fine, but it should be financed sustainably through higher taxes or other revenue sources. That is what we are saying here. If we were to add more fuel to the economy in a situation like this, where unemployment is very low and growth is happening at a fairly fast pace, we would add to the inflationary pressures that are there. One way to prevent adding to those pressures is to take some of the heat out of the economy by raising taxes elsewhere.
I am going to ask questions of our guests from IFAC and the ESRI. Representatives of both organisations might like to take the opportunity to answer my first question. Are our guests concerned about the strategy being deployed by the European Central Bank, ECB, in increasing interest rates, and the trajectory it appears intent on taking, in the light of the vulnerability of the European and worldwide economy at the moment? This is a different kind of cost of living crisis than any we have experienced in recent history. The underlying factors that explain why we are experiencing this crisis and levels of inflation that are unprecedented, at least for this generation and the last, are different. It seems that the ECB is intent on raising interest rates. There is an inherent risk of a technical recession being experienced in that approach. It may also result in levels of unemployment that are of concern. Perhaps our guests from the two organisations could offer a perspective on the ECB's present position on interest rates, and the impact it may have on the Irish economy.
Professor Michael McMahon:
Even looking at the futures curve and what is expected to happen over the next four or five years, it is expected to go from zero, or essentially where it is now with official rates, to approximately 1.25% or 1.5%. We can compare that with the United Kingdom or the United States and see it amounts to much less tightening. In some ways, from an international perspective, the ECB is doing less, partly for the reasons mentioned by the Deputy. The area is probably a little more precarious, economically speaking, and there may be worries about the negative impacts.
There are two comments I can make. The first is that we can think about it in nominal terms but in real terms, high inflation erodes the value of debt. In real terms, the cost of borrowing is still relatively low. Of course, financial conditions can change very quickly, as we learned just over a decade ago. If that happened, I am sure the ECB would step in with other measures. At the moment that is not happening and, in general, there is still availability of credit. It is just a bit more expensive, although in real terms it is a bit cheaper.
The conundrum that central banks face - not just the ECB but globally - is they all initially try to use their credibility in fighting inflation to ignore the increase in inflation. Inflation has not just occurred from February this year. If we go back to September last year, it was already up at around 5% or 6% in Ireland and it was at a similar rate around the rest of Europe. They decided to try to look through that. The geopolitical factors that have clearly kicked inflation to a new and higher level have been difficult to deal with. If central banks are not seen to be taking inflation seriously, long-term interest rates will rise anyway because markets will start to expect higher inflation and demand it anyway.
It is a difficult balance for those policymakers and it is a tough time for everyone in policy. By raising a little bit, if they can prevent the sort of inflation component going up by more, they will do relatively better in net terms.
Professor Michael McMahon:
To be honest, I worry a little on the other side. By moving less than everybody else, the risk is the value of the euro will depreciate further, which would make everything imported into the euro area expensive. Of course, some of the big items imported to the euro area are gas and oil, which are already expensive. It is difficult and they are striking a difficult balance. They also do not want to kick the economy straight into a massive recession, which would get inflation down but at huge social cost.
Dr. Kieran McQuinn:
I take the points made by Professor McMahon but there are noticeable differences between the euro area and the United States, for example. The key issue is wage-price spirals, and there is a lot of indication from the United States about a pick-up in wage inflation and even feeding into expectations. It is very much less so the case in the euro area. The recent increase in rates was somewhat understandable in terms of setting or influencing expectations. Some of the most recent talk about the 0.75 basis point move-----
There is much discussion across society about targeted measures. I was quite hostile to the idea of the energy credit and I thought it was not a very smart use of finite public resources when it was introduced. The rationale provided by the Government was that it needed to get money into people's pockets very quickly. That being said, we all know and acknowledge that we have a sophisticated tax and social welfare system to perform a redistribution role. If the media reportage is to be believed - or the spinning - it seems we can expect another universal energy credit. It will, of course, by definition disproportionately benefit those who are better off. People who are better off will tend to live in larger properties and consume more energy. By definition, it would be a poorly targeted intervention. It seems the Government is preparing the ground for that kind of energy credit initiative again.
So severe is the matter that I may need to suspend my own reticence about this. The ESRI would initially have been quite hostile to the idea, from what I can recall of what happened in the spring. That was taking the principle of equity into consideration.
The organisation seems to have softened its cough in this regard now though, based on the introductory remarks. IFAC has also been clear that measures need to be targeted. What advice do the representatives of the two organisations have for the Government in this regard? Would they say to avoid this completely?
Mr. Sebastian Barnes:
We would not take a view on the design of specific measures. The Government is facing difficult choices and it is up to it, ultimately, to decide and for other people to have a view on that decision. The principle of targeting is important, but we do not have a view on exactly how it is to be done and how targeted measures should be.
I will consider that. To be fair, we are heading now to a point, based on the ESRI's own analysis, where we could very well end up with 50% of the population in energy poverty, as defined by 10% of people's disposable income-----
Dr. Muireann Lynch:
The principle remains the same, in that the flat-rate measure, by definition, is flat. It is obviously less targeted than something using the social welfare measure, but it is better than excise duties etc. because anything that subsidises the price of energy is going to accrue more to those higher-income households that consume more energy.
Dr. Karina Doorley:
I will address the last point as well. When we talk about targeting, this brings us back to the comment made by Deputy Boyd Barrett. What we are thinking about in this regard are those worst affected by inflation and we know those are people on low incomes, rural households and elderly households. These are also the households less likely to see wage growth this year. The Central Bank has forecast that wage growth this year will be approximately 3.3%, but those very low-income and elderly households are probably not going to see any of that.
The best way to target those households is through the social welfare system and existing payments that do not require new means tests or lots of administration. The next best way that is administratively simple is to use flat-rate credits or flat-rate cash payments, like the electricity credit. The electricity credit represents a higher share of disposable income for low-income households than it does for high-income assaults. This makes it progressive, even though it is a flat rate-paid to all households.
The tricky aspect is that it is hard to target middle-income households through the tax and welfare system. Most middle-income households earn too much to be in receipt of social welfare payments and they might not earn enough to benefit from tax cuts. Even if taxes are cut to target those people, most of the benefit of that expense will accrue to high-income households. Therefore, it is very difficult to target middle-income households alone, whereas it is much easier to target low-income households. The electricity credit is another way to do this. It goes to everybody, but as a proportion of disposable income, it represents more for low- and middle-income households than it does for high-income households.
I have one final question, or rather an observation. I am concerned about the situation energy-intensive industries will find themselves in from a job retention perspective over the next year or two. I have been a long-standing proponent of the introduction and embedding into our labour market policies of a German-style short time working scheme, based along the lines of the Kurzarbeit model, that can be taken off the shelf, dusted down and used at a time of crisis. I am perpetually amazed when we are shocked there is a crisis. Our own experience will tell us that we will go through a series of crises and that we are always underprepared. One of the primary reasons the German employment numbers were maintained during the great recession, if we can call it that, was because of interventions like that.
It can be undertaken relatively inexpensively in the context of what we are going to experience in the next few months and, arguably, years. I refer to introducing a model like the German measure, micro-targeted at even subsectors of the economy which are going to be under serious pressure. Manufacturing industries across the country are laying people off this week because of enormous gas bills. They are trying to transition from a reliance on gas to using renewables over the next two years and finding it difficult to do so. There will be no just transition if this proves to be the case. It will merely be a slogan for many of these skilled workers, such as engineers, electricians, fitters and so on. Once these manufacturing industries are gone, they are gone and they will not be replaced.
I have asked the Department of Enterprise, Trade and Employment to identify the number of jobs that may be at risk over the next period. I have not had a response yet but I expect to get it in the next few days. Once those jobs are lost they will be gone. We could end up with the hollowing out of our manufacturing base over the next two years if action is not taken. I can understand why officials and Ministers may ask why, when we have technically full employment, would we introduce a wage subsidy scheme into the market at this point. It is about retaining skills. Is there a view on that type of approach? Maybe the ESRI has a view. I think it has looked at these kinds of interventions before.
Dr. Muireann Lynch:
On the employment impacts and the impacts on businesses in general of increasing energy costs, unfortunately we are very limited as to the data available. I am not sure what the Deputy is going to get from the Department of Enterprise, Trade and Employment but it is quite difficult to estimate the impacts of those. An awful lot of the time there is very little one can do in the short term to deal with increasing energy costs, whether for a household or a business. Dr. McQuinn might want to say something on skills.
Dr. Karina Doorley:
On the Kurzarbeit scheme, we did look at that when the employment wage subsidy scheme, EWSS, came in. Very briefly, to give the pros and cons of schemes like that, they can be great in a crisis when there is risk of massive job loss because they help companies to retain employees on reduced hours with subsidised wages. The downside is that it only benefits insiders, that is, only those who are already in a job. In the situation we are in at the moment, with full employment, that is not so much of a risk. The other issue is that it can lead to stickiness in the labour market. If an industry is no longer viable, people are still staying in it instead of retraining and going elsewhere. That is the broad overview but it is definitely worth looking at. I think it was suggested that something like that would be examined in a longer-term perspective after the EWSS was wound down. I have not seen anything more concrete on that.
I welcome our guests and thank them for their statements. It is no harm to ponder what happened over the past couple of years and the advice we politicians got. We were regularly told there was no need for a rainy day fund, for example. We did not have a substantial rainy day fund but we did have borrowing capacity, which we would not have had if we had diverted our energies in a different direction and decided to spend and spend. Fortunately that was not done. We are now in a different, very challenging situation. Hopefully we can manage it, as long as the economy holds and as long as the corporation tax returns remain stable. It is said we cannot depend on them and that is correct; we cannot. At the same time, we have to rely on them to some extent as we move forward. If we do not, then we could be staring over a chasm that we might not like.
Let us look at the degree to which the economy is going to be challenged by inflation over the next couple of years. If one looks across the water, I have listened to some things in the last couple of days that frighten me in terms of energy costs that will do everything but cripple the economy. They have access to independent energy themselves; we do not. We are in a slightly different situation. We have to plan ahead because this international conflict can go further and for longer and can cause a lot of damage in its path. The present trend as far as Mr. Putin is concerned is to do precisely that in retaliation for sanctions. Given that is the layout, we need to decide what we are going to do next. It is not tenable over a long period to pay the household bills of the nation. That is spending on or supporting current borrowing. It never worked before and will never work. It is dangerous territory to rely on. We got into a situation previously in the 1970s, for instance, when there was an energy crisis.
At that time there was a cap, theoretically anyway, because Europe indicated it was not willing to pay the high prices that would prevail. The result was that the supply was cut off. There was nothing there. We had queues at filling stations all over the country. That can happen again; there is no question.
We must also be careful about how we punish those taking an unrealistic profit from the crisis. That must be done selectively and carefully, so that they do not react in the same way that oil and gas companies did in the 1970s because if they do we have a problem. We must consider the underlying importance of continuing high employment, because that is the basis on which we can go forward with some degree of reassurance. Otherwise it will be like we are bidding against ourselves at an auction. We can continue to support the domestic economy, beat inflation which in turn reacts to the money going in and so on. There has to be an estimate of how far we can go without damaging ourselves and our potential.
I will make my last point. Our guests can see I did not wait for any answers. I am operating on the basis of what happened before and what can and will happen again. It is essential that we prepare ourselves for the shock and at the same time we reassure the people of the country that we have the capacity to deal with the situation within reason. That capacity is our borrowing capacity which we still have.
We spent €48 billion on supports during the Covid crisis. That is an awful lot of money. If we had €48 billion more to spend now, we could win. If we had we not had to deal with Covid, we would have the €48 billion to spend in an emergency situation, which that was. I am not offering any solutions but I have seen this before. Everything repeats itself. That is the way economic phases go.
A point was made, incidentally, about interest rates going up in the USA and the UK. That is also a threat. It shifts the financial markets in their favour and against us and-----
What I mean is that I just have actual questions. I would like the answers. I will be as brief as possible and we may even be under the five minutes. I have two questions for the ESRI. Its opening statement mentioned the expansion of the working families payment. I have heard that twice from different groups in different contexts. I think I also heard it from IBEC and from a Fine Gael Deputy. I am interested in how that could be done and how many people it might assist.
According to the last page of the ESRI's opening statement, there is evidence that some energy companies are using greater than expected profits to offset losses on the supply side and that taxing windfall gains in the generation sector may only therefore put some upward pressure on consumer prices. Obviously there is a lot of anger out there. A lot of people are talking about the windfall tax because that is what people want to hear, to be frank. How could a windfall tax be structured in order that it would not have such an impact? Could it be based on the average rate of profit prior to the inflation crisis?
Dr. Muireann Lynch:
I will come in on that second question. The evidence for those excess generation gains being passed to supply arms is that, believe it or not, I would expect to see consumer prices being even higher than we are seeing were that not happening. That is based on a little bit more than back-of-the-envelope calculations but not much more. The reason it is not much more is because the way these costs and revenues are passed among the different arms of generation companies is not very transparent. It is also highly complicated because it depends on how they hedged, how did they buy forward and whether that was on gas markets, electricity markets or both.
The Deputy's second question was around how we prevent that happening, were we to tax windfall gains. The answer, unfortunately, is that it is really difficult if the Government wants to mess around with taxing or to try to target what we call inframarginal gains in the generation market itself, because we simply do not know what they are doing with those inframarginal gains. Particularly when it comes to renewable generators, we do not actually know where that gain is going to. Is it going to the generation company? Is it going to the supply company it contracted with? In some cases, it might even be going to the windfall owners themselves. Then, if they are in the new renewable electricity support scheme, RESS, it is going back to electricity consumers.
Much of this might prove moot, depending on what happens at a European level because it seems that the restructuring they are going after is to try to remove those inframarginal gains regardless. In that case, Government would have nothing to tax anyway. Leaving that aside, however, I think going after corporate profits would certainly be prudent. That way the Government is just taxing the profits, as opposed to trying to get to the gains inside. That would certainly clear up an awful lot of the issues the Deputy raised.
Dr. Karina Doorley:
I will answer on the working families payment. The working families payment is one of those payments that is actually very well targeted at low to middle-income households; that group of households that is very hard to target through the tax and welfare system. The working families payment actually does target them very well.
The working families payment was increased in budget 2022 by less than forecast inflation. It did not, therefore, keep pace with inflation whereas many other payments did. There is certainly scope there to index that this year. There are other ways to expand the working families payment. At the moment, it is payable to low-income families who have children, so it is really sort of targeted at families with children. In other countries such the UK and the US, their form of in-work benefit that is sort of similar to the working families benefit is also paid to low-income people without children. This helps to encourage people into the labour market. It increases the benefits of work compared to welfare and is a really effective anti-poverty tool. We did some work together with the Department of Social Protection earlier this year looking at all the possible ways to reach the consistent poverty target of 2% by 2025. The working families payment really delivers the most bang for your buck in terms of reducing poverty so for every extra euro spent on that, it reduces poverty by more than all of the other instruments. The only other-----
I am sorry; I only have approximately 20 seconds left, unfortunately. That is very interesting but it is just that I had heard about expanding it. I thank Dr. Doorley. The fact that it is more beneficial for people and that it is more targeted is quite interesting.
I have a few questions for IFAC. Deputy Lahart made this point as well. We hear about the over-reliance on corporation tax revenues every single time representatives from IFAC appear before the committee. The council has repeatedly raised the issue over the years. What measures does Mr. Barnes feel the Government has taken to mitigate the risk in all the years IFAC has been calling for it?
Mr. Sebastian Barnes:
One really important thing about it is just how much that exposure has increased. We have been talking about it for a long time but corporation tax in 2018 raised €10 billion. It would not be surprising if it comes back this year above €20 billion. Over four or five years, it basically will have doubled. The extent and the nature of that exposure has become massive. It was always a thing but now it has really become enormous. The Government essentially has not really explicitly had a policy about how to deal with it. We have called for contributions for some sort of rainy day fund. More recently, we argued for putting it through a new version of the National Pensions Reserve Fund. There has been no real action on that.
One improvement that was in the summer economic statement is to do budget numbers with an estimate of the excess taken out. That is the measure we were talking about earlier. If we look at the headline budget balance, we probably would have a balance of about 2% of national income this year but if we take it out, you have got a deficit of 2%, which is a more realistic way of looking at the public finances in terms of sustainability but also the flows of money of the economy.
As Dr. Casey has helpfully just reminded me, in some ways the 5% spending rule is a way of looking at it. If you follow the 5% spending rule and a lot more corporation tax comes in, it will not be spent. That is one important measure. It is not explicitly targeted at corporation tax but would have the same effect. It is important to help people to understand what is going on with these funds and that this money is being set aside for a good reason.
I get that. I was wondering specifically what had been done.
When I read Mr. Barnes's piece last week, the other thing that stood out was the whole idea of the 9% not being targeted. It did not get half the coverage that other points in the piece got and really should have been headline news. Dr. Doorley has mentioned how hard it is to target low and middle income earners who are really struggling. As public representatives, we get stopped in our housing estates and people tell us how they are struggling. They tell us things they would not tell their friends or family members. If Government policies had been targeted better at those on lower incomes, does Mr. Barnes think would we be facing into a different kind of winter? If future measures are targeted, will those on lower and middle incomes be in a very different place?
Mr. Sebastian Barnes:
The ESRI probably has more numbers on that point. When this shock first happened and we did not know how long it would last or what was going to happen, it was natural for the Government to scramble to come up with a solution fairly quickly. Now we see that the situation is going to last longer and as we go into the winter, which is going to be much more difficult than anything we have seen up to now, the case for targeting is even stronger. It is something the Government really needs to consider.
I will add one point. Often in this discussion, people look at the fact that people on lower incomes spend a higher share of their consumption on energy and food. However, another important point to note is that almost all the saving in the economy is done by the top 25% to 30% of people in the economy. If people have savings or if they are not spending as much as they have in income, when the price of stuff goes up they pay for it without a problem. However, the vast majority of people in the economy, those who basically spend their income each month, do not have any real margin to adjust. This is important in a social and an economic sense because these people will have to cut back their spending because they have no choice.
That was another point I was about to make because we discussed it the last time Mr. Barnes was before the committee and Deputy Boyd Barrett raised it in relation to the wages. As Mr. Barnes mentioned, we are seeing big price rises in food and energy, which are imports. Mr. Casey noted that we have seen growth in the first and second quarter but we are hearing soundings about a recession or slowdown. If there are no wage increases for those on lower levels of pay, who we know have to pay out on food and electricity, which we cannot do anything about, that money will not go into the local economy. Mr. Barnes mentioned that whole aspect.
Mr. Sebastian Barnes:
We have mostly been talking about the social impact which is obviously the most important aspect. There is an economic aspect as well which is that if people are suddenly hit by huge bills, they will rein back their consumption, perhaps on labour intensive things in the local community, and that will have an economic as well as a social impact. There is an economic case to smooth the adjustment of these things and manage the way it is distributed.
I thank our guests and apologise in advance if I am a little repetitive. I will put my question to IFAC first. Mr. Barnes referred in his opening statement to high energy prices contributing to inflation and he seemed to be advising against wage increases. How does he suggest we relieve the pressure on both workers and older people considering the price of items such as a bag of coal will reach €50 in the coming weeks? It is going to cost €1,500 to fill a tank with oil for home heating. Business people in a very small rural town tell me they cannot pay the rent for their businesses any more. Older people, particularly pensioners, are really worried that they are not going to be able to eat. They say they will have to choose between food or fuel. In terms of surplus and deciding between the rainy day fund and the National Pensions Reserve Fund, does Mr. Barnes have a preference for choosing one option over the other? What proportion of each fund does he suggest could be used?
We have heard a lot about inflation today. Deputy Doherty mentioned a wealth tax.
Can we get some insight on that?
On a question to the ESRI, I am conscious of energy inflation being a major concern. We hear it trotted out all the time about the war in Ukraine. Although I might be wrong, it is my opinion that it is not necessarily the war in Ukraine that is causing this energy crisis. We have known for quite a while that there is going to be an energy crisis and the inflation around that. I ask Mr. Barnes his opinion on the causes around this, whether I am right or wrong and how to deal with that. How much price gouging does Mr. Barnes think is going on? I think there is a great deal of price gouging going on currently and I wonder what Mr. Barnes’s opinion is.
Mr. Sebastian Barnes:
Let me respond on two points. The first is that although we have been emphasising a lot the constraints on what the Government can do, we can also look at it the other way around and say that the Government does have space to increase welfare rates, to increase pension rates and to take temporary measures. There is a lot the Government can do and we are just saying there are limits to that. The Government is probably not going to be able to meet everyone's expectations so it is going to have to make choices. That is why we would emphasise targeting within those constraints to be able to give the maximum amount of help to the people who are struggling to buy a bag of coal or struggling to pay their bills, rather than to that section of the economy and of the population which is actually relatively well-off and has seen big wage increases in the past couple of years. On the one hand, we are emphasising the constraints but we are also saying there is space to do things, which we should be very pleased about. In some past downturns in the Irish economy, the Irish Government has not been able to do that as it did not have the fiscal position to do it, so there is a positive context to this.
In terms of how excess corporation tax receipts should be saved, there are obviously different ways of doing it. One way would just be to run down debt. The rainy day fund is an idea that has quite a lot of traction and that might help us through a future downturn. In recent months, we have been emphasising quite a lot the idea of putting it into the National Pensions Reserve Fund. What is important in a way is to take this money and to lock it away so it is not the basis of our social welfare system. Also, putting that money into the national economy is another thing that is contributing to overheating risks and things like that, given that people who are well paid in these companies are bidding up the price of houses and all sorts of other things. Locking that money away, which is basically what they did in Norway, would be a very good model. We know we have these really big pensions costs coming in the future, so that would be a sensible way of smoothing it out over time but, of course, there are different ways of doing it.
Dr. Kieran McQuinn:
On the wealth tax, a colleague of ours, Martina Lawless, did a study some years ago – I am not sure if anybody has updated it since - on the possibility of a wealth tax or possible gains from a wealth tax, using fairly detailed household finance and consumption survey data which characterised the wealth distribution across the population. My understanding, based on my recall of the study and I am open to correction, is that it crucially depended on how we treated agricultural land. If we regarded that as legitimate wealth and taxed accordingly, then there were some gains to be got, but if we did not, then the actual benefits or revenue possibilities from such a tax were relatively limited. That is available on our website.
I am aware of the clock and that other speakers need to get in. The witnesses mentioned that an interest rate rise of 0.75% might happen. That is going to have a huge impact on mortgages and I am quite concerned about it. We have landlords who are selling up all around the place at the minute and there is nothing but eviction notices. What is going to happen or can we foresee any way around this if it happens?
Dr. Kieran McQuinn:
The whole issue of interest rate pass-through is quite complex in an Irish case. Obviously, it depends on the proportion of people on fixed, variable and tracker mortgages, because the trackers will be automatically hit and for the variable rate it depends on the policies of the individual banks concerned. We have a situation in Ireland where it has been complicated over the years. Our variable rates in the domestic market have been higher than what we have observed across Europe. There has always been a suspicion that the banks have a buffer there and they may actually use that buffer at this stage to soak up some of the policy rate increases, and there seems to be some evidence of that even in response to the original rate increase during the summer. Of course, with regard to how they fare going forward, if we have such a policy interest rate increase, they will almost certainly pass on some of it as far as the variable rates are concerned.
It is an additional cost in the market, and there is no doubt about that. The other thing I would say is that we need to be cognisant of the fact that it is an initial cost at a time when there are huge cost increases right across the board.
If we look at what is happening in the property market right now, we are seeing house price inflation of 15%, as we are all aware, and we have been seeing very high house price inflation over the past number of years. Interest rate increases are one way of calming the property market. There is no doubt about that from the evidence.
I want to bring in a couple of members who have supplementary questions. I have a question for Dr. Doorley before I call Deputy O'Donnell. She said something interesting regarding the working family payment, as mentioned by Deputy Mairéad Farrell. I am interested in child benefit in the context of the few welfare payments that reach everybody and have a particular impact. We have seen that payment not just stagnate but fall in real terms since the 2008 crash. Can we have the same conversation we just had about the working family payment but with reference to child benefit?
Dr. Karina Doorley:
The Chairman is right that, in nominal terms, the child benefit payment has been fixed for many years. The result of that, from a gender perspective, is that over the course of the financial crisis, the incomes of women, particularly lone parents, suffered more than the incomes of men. There are pros and cons to child benefit. It is a universal payment, which means it is not as targeted as other welfare measures. My view is that it is still a very important payment. It is a reasonable anti-poverty tool, going on the work we did earlier this year, but increases to qualified child payments are better at tackling poverty. However, I think there is still a role for child benefit in the entire tax and welfare system. There is also evidence that because child benefit is typically paid to the mother, it is more likely to be spent on the child than if it were divided between the mother and father or paid to the father.
In the current context of discussions around whether increasing child benefit at the moment is a good idea, it comes under the heading of the universal payments that represent a higher proportion of disposable income for low-income households than for higher-income households. Of course, a lot of the expenditure on child benefit goes to higher-income households, but it has the advantage of being relatively easy to administer and, therefore, easy to increase as well. The policy over the past few years has seemed to be to freeze the child benefit payment and instead focus on increases to qualified children, which are the increases that go along with core benefits paid to one or other parent. This is a good, targeted way to reduce the poverty rates of households with children, which are more likely to be in poverty than any other types of households. Children in this country are more likely to be in poverty than working-age or elderly households. There is a balance to be struck between child benefit, which is universal and easy to get out to people if needs be, and the increases for qualified children, which provide more targeted support to low-income families.
I am seeking clarification from Mr. Barnes on a particular point. In response to my initial questioning, he said the IFAC is expecting a surplus of €4.2 billion rather than €1.2 billion, which I calculate as a difference of €3.3 billion. However, he indicated that within that €1.2 billion, the Government is bringing forward €2.5 billion of temporary measures. Is that correct?
Therefore, it looks like the €3.3 billion on top is completely separate. The way I look at it - Mr. Barnes might not agree but it is factual, as I make it out - the Government can technically spend between €2.5 billion and €5.8 billion on temporary measures and still meet its targets as set out in the summer economic statement. I am not saying it will do that; I am just saying there is scope in that space. Even if €500 million were to be put into a rainy day fund, we are looking at a sum of the order of between €2.5 billion and €5.3 billion. Will Mr. Barnes clarify whether I am factually correct in this? I am aware of the inflationary aspects. What I am referring to here are once-off measures.
Mr. Sebastian Barnes:
No, it is not, really. I respectfully disagree. A very significant thing happened last autumn when the Government set out a new spending rule. We had advocated for this for a long time. It seems to be a fundamental shift in the way in which the budget is dealt with. In the past, the Government essentially relied on some decision it took over the summer. It would come up with some number, whether it was €2 billion, €3 billion or whatever, which would be its target in the summer economic statement. Exactly where that number came from was never very clear and it changed from year to year.
What it did last year was a fundamental change. It essentially moved to a more rules-based system and it basically said it would target this core measure of spending and increase it by 5% every year. It judged that to be the sustainable rate of growth of the economy and the tax base. That would help to stabilise the economy by having a smooth rate of spending and it would also help to bring debt down, which was needed. That should be viewed as the real target. It has not really changed, except that in the summer economic statement - rightly in our view because inflation is so far away from the assumption of under 5% - the Government gave itself a bit more space by going to 6.5%.
Mr. Sebastian Barnes:
In normal times, those revenues would be saved. They would go into a budget surplus and that would ultimately reduce debt. What the Government can do, instead of reducing debt, is put it into the rainy day fund or the National Pensions Reserve Fund. In the economic sense, it is quite similar, but if people see this big surplus and ask why the Government is not spending it, it is much easier to articulate that this is actually the-----
Is there ever a scenario in which, with €500 million put into the rainy day fund, that €3.3 billion in unexpected taxes can be used in a targeted way for once-off measures? We are in a wartime situation with energy prices. What is happening in Russia is partly the reason gas prices have gone up. Is there any circumstance in which we would use some of the €3.3 billion for the purpose of targeted, once-off measures?
Mr. Sebastian Barnes:
Absolutely. In these circumstances which, as the Deputy says, are extreme and have been provoked by war and in which people are really suffering, temporary measures are entirely appropriate. We can finance them in a way through the money that is coming through corporation tax but if we did not have that money, we could also finance it through borrowing.
What is the scope for the Government? I read Mr. Barnes's piece on our borrowings. There are low interest rates on bonds in the secondary bond market. The ECB has gone back into that market, which has brought down interest rates. If, in the coming 12 months, we have a catastrophic situation in which energy prices get out of control and this has a huge impact on growth, brings down tax revenues and puts pressure on our day-to-day functioning, what is our capacity, having borrowed heavily during Covid, to borrow should something so extreme happen?
I know other members have supplementary questions but we have to move to our second session, which is with the Nevin Economic Research Institute, NERI, and IBEC. I apologise to those members who did not get to contribute. I hope they can raise their issues in the next session. I thank the witnesses for attending for what has been an in-depth discussion.
I welcome Dr. Tom McDonnell and Mr. Paul Goldrick-Kelly from the Nevin Economic Research Institute, NERI, and Mr. Fergal O'Brien and Ms Hazel Ahern-Flynn from IBEC.
Before we begin, I wish to explain some limitations to parliamentary privilege and the practice of the House as regards references witnesses may make to other persons in their evidence. The evidence of witnesses who are physically present or who give evidence from within the parliamentary precincts is protected pursuant to both the Constitution and statute by absolute privilege. However, witnesses giving evidence remotely from a place outside the parliamentary precincts may not benefit from the same level of immunity from legal proceedings as a witness who is physically present. They are reminded of the long-standing parliamentary practice to the effect that they should not criticise or make charges against any person or entity by name or in such a way as to make him, her or it identifiable or otherwise engage in speech that might be regarded as damaging to the good name of the person or entity. Therefore, if their statements are potentially defamatory in relation to an identifiable person or entity, they will be directed to discontinue their remarks. It is imperative that they comply with any such direction.
Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the Houses or an official, either by name or in such a way as to make him, her or it identifiable. I remind members of the constitutional requirement that members must be physically present within the confines of the place where Parliament has chosen to sit in order to participate in public meetings. I will not permit a member to participate where he or she is not adhering to this constitutional requirement. Therefore, any member who attempts to participate from outside the parliamentary precincts will be asked to leave the meeting.
I invite Dr. McDonnell to give NERI's opening statement.
Dr. Tom McDonnell:
Let me start by thanking the Chair and the members and staff of the committee for the invitation to appear before the committee today. I am accompanied by my NERI colleague and economist, Mr. Paul Goldrick-Kelly.
NERI is very grateful for this opportunity to present our views on the economic and fiscal position. I will begin by discussing the economic context and labour market developments before discussing the appropriate role of fiscal policy and various options.
Western economies generally recovered quickly from the pandemic. However, the bounce back in demand came up against significant supply constraints and disruptions arising from the lockdowns. The resultant inflationary pressures were then exacerbated by the war in Ukraine and the further rise in global commodity prices. Rising prices have prompted central banks to raise interest rates and otherwise tighten policy. Rising prices have also precipitated a decline in real incomes and a worsening cost of living crisis in many countries.
Global growth is now weakening. The UK economy is projected to be in recession by the end of this year, with price inflation continuing to eat into real incomes and the volume of demand. Similarly, the emerging combination of tightening monetary policy, declining real incomes and weakening consumer confidence means that there is now a meaningful risk of the United States, and especially the euro area, falling into recession.
Ireland’s own recovery held up well in the second quarter with strong growth in investment in machinery and equipment, new dwelling construction and service consumption, although retail sales have softened in recent months. We do not project a technical recession in the short term but we anticipate a weakening of growth in demand.
The labour market is now close to full employment and hours worked in the economy is at a record level. The unemployment rate was 4.3% in August with the job vacancy rate elevated over pre-pandemic levels. The composition of employment has generally shifted towards more high value sectors – a very positive development. However, the Central Statistics Office, CSO, employee index suggests that net employment has stalled in recent months.
Real incomes and living standards will actually fall for most households this year, notwithstanding the tight labour market. Inflation projections are especially tentative at the moment, but our baseline view is that economy-wide price inflation is likely to average over 8% this year, but reach 10% for lower income households. This is because such households generally spend a higher portion of their incomes on the type of necessities such as energy, food and rent that are experiencing the sharpest price increases.
We will see a significant rise in deprivation rates for those on fixed incomes in the absence of meaningful fiscal or regulatory interventions from government. NERI's view is that all social assistance increases in budget 2023 should at least match inflation in order to protect real incomes and to ensure that no one is left behind by the cost of living crisis.
Budget 2023 can help dampen inflationary pressures by focusing on targeted measures to reduce the cost of using public services such as education, public transport and healthcare.
Once-off measures related to current spending generally make poor policy, particularly given that prices are unlikely to fall in the short to medium term. However, the ongoing energy crisis is placing considerable pressure on household budgets. The Government’s response must support households in need, while remaining consistent with longer term objectives of reduced energy use and decarbonisation of supply. The Government could explore direct payments and-or adjusted energy rates to soften the impact of these price shocks. We are happy to discuss this further during the questions and answers.
Fortunately, the public finances are in a reasonably strong position. Tax receipts have been buoyant this year, with a modest projected surplus in 2022 and 2023, although the position is flattered by the surge in corporation tax receipts. Most of our debt is fixed at low interest rates. Our view is that the expected €6.7 billion budgetary package for non-once-off measures is broadly appropriate in terms of the fiscal stance and strikes a good balance in supporting the economy while not being overly inflationary.
Budgetary supports should be targeted at those households likely to experience distress and the Government should not attempt to chase inflation for all households. Higher income households have generally built up significant savings during the pandemic with aggregate household deposits rising sharply. Many of these households can absorb the hit to their real incomes by reducing their rate of savings. Such households do not need fiscal support from the Government to manage the cost-of-living crisis and are unlikely to experience any qualitative decline in their living standards. In particular, the stated plan to cut taxes for higher earners seems unwise to us. Income tax cuts are very badly targeted in respect of helping households experiencing income adequacy issues, and such cuts would push against the need to temper inflation.
The Government should also remain conscious of the very significant medium- to long-run fiscal pressures from age-related demographic change, pressures from the investment and other costs of climate transition, and pressures from the gradual loss of receipts from fuel excises as Ireland, it is to be hoped, achieves its climate targets. This is before we even consider the existing spending deficits in areas like childcare, education, research and development, and public housing. The reliance on corporation tax receipts is a further concern as it means the health of the public finances depends on the performance of a small subset of firms. Our view, therefore, is that any tax cuts should be fully offset by tax increases in other areas, for example, by eliminating certain tax breaks and increasing taxes on capital.
The fundamental position remains relatively strong but falling incomes presage weaker demand, while high inflation is causing income adequacy issues for some households. We have the fiscal resources to fully protect vulnerable households provided the Government takes a targeted approach in the budget. Mr. Goldrick-Kelly and I are happy to take any questions or elaborate upon any of our points.
Mr. Fergal O'Brien:
I thank the Chair and members of the committee for the invitation to join them to discuss business priorities for budget 2023. I am joined by Ibec's economist, Ms Ahern-Flynn.
When we look at the backdrop to the budget, it is very clear that budget 2023 takes place at a turning point in the global economy. Changes in the global environment, including commodity, energy and financial markets, are reshaping the economy from the one we have recognised over the past decade. The era of record low interest rates, low inflation, and spare capacity that we have lived through since the global financial crisis is being overturned. For Ireland, as a small open economy, shifts in the flow of capital through the global economy can have a very outsized impact on our growth model. Our members are already experiencing these changes through tighter capital markets and very rapidly rising costs.
The outlook for Irish business is marked by growing concern at the rapid shifts in our competitive position. This now underlines the importance of controlling what we can here at home in the process of budget 2023 and fiscal policy beyond it. In the short term, the focus of the business community will be on dealing with the impact of a sudden escalation in costs, ongoing trade and supply chain disruption, and the major changes we are now seeing in our business model.
Energy is very clearly the biggest challenge now facing our society and economy. We are already in a significant energy affordability crisis and there is growing concern regarding security of supply issues. For many of our member companies across the business community, energy costs next year will be four to five times higher than they have been in recent years. Despite this, Irish business is very much committed to playing a proactive role in facing up to the multitude of challenges, including those relating to climate, and commitments that will arise in the coming decade.
Budget 2023 must provide a robust response to the immediate inflationary difficulties, while also meeting the long-term challenges we face as a society and an economy. It is crucial that the undoubted pressures of the here and now do not lead to us abandoning our focus on crucial long-term investments, which ultimately will raise living standards and improve the quality of life for everyone in the country.
While the Government is aiming for a modest surplus in 2023 there remains a danger of overcorrecting given volatile economic dynamics. The path of energy prices and security, the pace of global monetary tightening and the momentum in the broader global economy are all extremely volatile at present. If the economic environment continues to deteriorate over the winter, a more significantly expansionary fiscal policy may be needed to protect households and businesses. We believe that budget 2023 will have to remain flexible in its outlook and the Government will have to be responsive to these trends, regardless of the stance set out on budget day.
In light of high inflation and rising uncertainty, particularly the uncertainty around energy costs, we need to remain agile in terms of our economic stance, especially in relation to fiscal policy. To deal with the rapid escalation in energy costs for businesses, we are calling for a significant and immediate package of emergency energy supports to be made available under the new EU state id framework that has been agreed. These supports to help offset spiralling business energy costs are urgently needed and should be implemented as soon as practicable. In terms of labour costs, Government policy in the labour market is loading significant cost pressures onto businesses, particularly SMEs. While IBEC acknowledges the merit of many of these policies individually, the lack of co-ordination in their roll-out means that businesses will face rapid and considerable increases in their labour costs over the coming years. The Government must do much more to control and offset the policy-related labour costs which are impacting businesses. The most exposed businesses will need concrete support through this period of transition. This should take the shape of a time-limited labour market transition rebate, funded from the National Training Fund, NTF. That fund is rapidly approaching a €1 billion surplus and within three years it looks like it will have a €2 billion surplus. From a business and employer perspective, we really need to see those resources put to work in our economy to address issues around training, upskilling and productivity measures through a voucher-type model.
Regarding the low-carbon transition, IBEC supports the Government's commitment to a continued increase in the level of carbon tax. However, this must also be balanced by offsetting incentives for energy efficiency, the adoption of low-carbon technologies and alternative energy sources. This includes significant resourcing of Sustainable Energy Authority of Ireland, SEAI, grant schemes, considering further super-deductions for energy efficient investments, greening our VAT rules and support schemes for micro and mini generation.
Irish companies of all sizes have the potential to compete in an economy driven by mobile skills and intangible assets but for this to happen, we are calling for crucial investments in education, skills, childcare, research and innovation and the digital economy, of over €400 million in 2023. Finally, Ireland must continue to invest in the competitiveness and productivity of the sectors still feeling the impacts of Covid-19, particularly our experience economy across hospitality and related sectors. We want to see much more ambitious investment in our town centres and in skills and through the maximum and appropriate use of the €1 billion Brexit adjustment reserve, BAR, fund to support investment, upskilling and competitiveness in the worst affected sectors.
I thank our guests for coming before the committee and for their presentations. I have a number of questions. The witnesses from the NERI mentioned tax cuts and their effect. This is an issue on which a debate is taking place in the country at present. The theory is that there should be no tax cuts. I do not think this applies to all sectors. There are groups of people, in the lower to middle income group and in the higher to middle income group, converging from both sides. They find themselves in a rather difficult position and will continue to do so in the present economic climate, which is being caused by inflation and international events. These cohorts of people need to have some recognition that we realise what is happening to them.
Earlier I mentioned that some time ago we had calls for a wealth tax. We used to have a wealth tax in this country but it was discontinued for a reason, which was that it scared a lot of people out of the country. Worse still, it created a movement out of the country and a tendency by those with foreign direct investments to think again and either stay out of the country or move out of the country. We must be very cautious about whatever policies were followed in Venezuela, which has much bigger economy than ours, because unfortunately they did not work. It is a country with all of the resources in the world. It has massive resources in comparison to ours. I am not arguing with anybody; I am just stating it as it is. This is a fact.
We realise with regard to the retail sector, the economy in general and those on the front line that costs are increasing and this is challenging. Energy costs are the main cause of this. As I mentioned previously, it is frightening to look at the type of increases people are facing in the UK, which has independent means of producing its own energy. We do not. We are hanging out there. When we had an opportunity some years ago to upgrade the indigenous and renewable fuel industries through wind farms, some parts of the country took the opportunity but others did not. Other parts of the country spent their time objecting to them for various reasons, such as that they were bad for people's health, or due to electromagnetic pulses and white noise. The fact of the matter is that turbines are turbines and it does not make any difference whether they are on a river, at ground level or up on a pole. There are no more emissions coming out of them than there were from the old-fashioned hydroelectric schemes.
We need to recognise, and I fully appreciate, what IBEC is doing and has done to generate enthusiasm and urgency about our economy. This applies to the unions also over the past ten to 15 years. If we did not have the ability to borrow in the face of Covid, which has just gone out, can we imagine what it would have been like? A total of €48 billion was spent and it was possible to borrow to address these issues and help out in so far as this amount could. It did not solve all of the problems but it was certainly a help. Imagine what it would have been like if there had not been this capacity to borrow. We have been told over recent years that we should have had two bailouts, which we would have been paying back forevermore so far as I can see. We were told we would eventually have to do this and I am glad that we did not. When the crunch came, the urgent issue arose and Covid arrived on the scene, which nobody predicted, it was possible for the Government to borrow fairly extensively. The €48 billion to which I referred was a lot of money. It was necessary to do what had to be done at a particular time.
In the measures we take from here on, we must keep an eye on the target, ensuring that we leave capacity to borrow in the event of something else coming down the tracks. Remember that a war is a war and it has the ability to do an awful lot of damage over a longer period of time and we could find ourselves having to dip into that well once again. I hope that we will not have to do that.
One thing that has contributed to inflation in this country is house price inflation. That is serious. It is year-on-year. From time to time, people will say that it is only at a specific time, that it is unusual, that it is a hiccup, etc., but that is all rubbish. It is a consistent increase and there is inflation all the time. I am told, and this is subject to verification, that investment funds have to provide the greater amount of the money invested in house building. If that is the case, it is a serious issue. If the pillar banks are not doing so, and if investment funds are getting in between the two customers, that is, the developer or the builder and the customer, that results in an increase. There has to be an increase. The investment fund is not going to come in out of the goodness of its heart and provide the money needed to build. It will be at 2.5%, 4%, 4.8% or 10%, more than likely. That is inflation at a serious level. We have a serious housing shortage that must be tackled one way or another because it is a burden on our backs and on the backs of the people. It will continue to be so until we find the means of puncturing that particular balloon.
Dr. Tom McDonnell:
I thank Deputy Durkan for his important insights and very good questions. In terms of tax cuts, to be clear, what we said in our statement was that there should be no net tax cuts, which would open up the possibility of all sorts of compositional changes one might not wish to pursue. There are things on the income tax side one could do for low- and middle-income households, from increasing the threshold for the universal social charge, USC, to increasing tax credits or potentially even increasing the standard rate cut-off point. That could be offset in other ways, not necessarily through the income tax system but through capital taxes. There are other ways one could do it as well. If we are looking at an envelope of €6.7 billion, not counting once-off measures - we are happy to talk about those too - it has to be about looking at what is, I hope, a singular crisis and focusing on the households that are in danger of falling into greater poverty or deprivation and for this year certainly, not focusing on households that are not experiencing or likely to experience those problems. We will need additional supports for business too. That is the broader point we are making.
On the inflationary impact, almost anything you do in terms of public spending or tax cuts is going to have some inflationary impact. Tax cuts for higher earners will have a smaller inflationary impact because they save most of the money but, of course, that is the point. They are not suffering at the moment and can afford to save, except in the case of house prices, which would go up.
The Deputy is correct that there has been a house price inflation issue for a long time. We have had a housing crisis for two decades now. It is probably the single-biggest competitiveness issue in the economy at the moment. We all anecdotally know about people who cannot come back to Ireland. The income tax system is often cited as a reason. There may be some truth in that, but the one reason we always hear is housing and the absolute lack of housing, particularly in the greater Dublin area.
In terms of wealth taxes, there are different types. There is obviously net wealth tax and tax on inheritance. There are property taxes, which are a version of a wealth tax, and there are site value taxes. Even capital gains tax can be interpreted as a form of wealth tax. There are a lot of different ways that could be done. Broadly, we are saying that some of those types of measures may be appropriate and are likely to be appropriate in the coming years. The point is that if there are to be tax cuts, they should emphasise and focus on benefiting lower-income households in particular who are likely to be at the coalface in terms of experiencing food or energy poverty, especially over the next six months. That is our sense of that issue.
In terms of house price inflation, the Deputy mentioned investment funds. Our position is broadly that there needs to be a much more significant role for the State here. A State housing company could manage supply over a long-term period, thereby managing inflation. It could cool down the market or heat it up as appropriate over time. That is a medium- to long-term reform. It is not going to deal with the problem in 2022 or 2023. Unfortunately, that issue will be with us for many years to come, and supply will not catch up with demand probably for at least another half a decade.
Mr. Fergal O'Brien:
I will come in briefly on taxation policies, particularly in the context of the cost-of-living challenges we face. We believe wages for public and private sector workers will play a role in addressing those challenges next year. Social wage issues must also be addressed, particularly by getting to the core of some of the costs we have in our economy, such as childcare and housing costs. Crucially, the tax system must be addressed as well. The most significant challenge that comes through to us from an employer perspective is the entry to the top rate of tax. We are taxing people at the highest rate in this country at a very low level in comparison to the countries with which we trade and do business. That has all sorts of consequences not just for disposable income, but also for productivity and competitiveness across our economy. Our emphasis would be on taking more people out of that top rate of tax. We would see that as a priority for budget 2023.
On housing finance, I flag to the committee that we have concerns as the financial markets adjust to the new reality. We will have financing challenges in this economy for housing construction. We will not see the same scale of international funds in Irish housing investment as we have seen over recent years. That will bring its own challenges as we seek to replace that source of finance to maintain the supply of housing we need as an economy.
We have been very clear on energy costs. Some of the businesses we are dealing with are seeing their energy costs increase fourfold to fivefold. For a small business or an SME shop, that means €50,000 increasing to €250,000. For a large business, that is tens of millions. That is way beyond any profit margins those businesses can earn. We have to preserve those firms and those jobs. One of the lessons of Covid was that we could actually do that. We did that incredibly effectively to bring us back to 2.5 million people in employment, and to bring us to the type of tax revenues which mean we are heading towards a very large surplus for this year. I agree with the Deputy's sentiments that we have to preserve the fiscal position, but we have the fiscal power to do what is needed to address this particular crisis because we took the right decisions during Covid.
My point is that at the time, we did not have many computers or indeed the Internet. The reason it was discontinued was the cost of collection, so that is the fact. The country that previous speakers were trying to identify which operates a wealth tax with a larger economy is France. It is still operating it despite many changes of government. They are not just the Deputy's facts but-----
-----they are the actual facts.
Dr. McDonnell spoke about the overall budgetary package. He said he thinks it is appropriate. We know that the non-allocated expenditure that the Government has available to it for budget 2023 is €2.7 billion. That must accommodate the public sector pay deal if it is agreed. If it is agreed, the non-allocated expenditure will come down to approximately €1.6 billion. Does Dr. McDonnell believe that the package is sufficient or does it need to be increased?
Dr. Tom McDonnell:
That package will be gobbled up very quickly. The previous budget would have given some increases so it partially compensates for inflation this year. There is no doubt that for households on fixed incomes, given inflation in 2022 and 2023, the quantum described by the Deputy seems to be insufficient in terms of the cost of Government purchases that are likely to increase by close to 10% to get the same stock or the same volume.
Also, in terms of social welfare, it is very likely that welfare rates will have to increase to close to 10% just to ride out the storm. With a social protection budget in excess of €20 billion, that gets you to a figure of close to €2 billion very quickly. The short answer would be that I do not believe so. However, we can do things in terms of once-off measures. Again, it is about being flexible and agile and we have the fiscal space at the moment, which is a very positive position, regardless of what Deputy Doherty thinks about corporation tax receipts. We do not know if that is going to fade away. We have been told that it will for many years and I am still concerned about it, but we have not seen it yet. In any event, I think there is fiscal space to have a temporary fund which could kick in if the economy moved into recession, for example. It would be a form of contingent fund.
Obviously, that would make sense and we have been operating contingency funds for the last number of years. On the core expenditure, what would be available is likely to be €1.6 billion, but Dr. McDonnell is saying that it will not be enough because he has called for at least the protection of social assistance increases, which would cost €1.7 billion. That means one is not planning any additional homes, no more investment in hospitals, no additional beds, nothing in terms of education, nothing extra in terms of roads that are not set out in the national development plan, NDP, and so on, and there are all these other pressures. One-offs will deal with one-offs but in terms of inflation, and we are unlikely to have deflation, these costs are baked in. How big does the package need to become in terms of core expenditure?
Dr. Tom McDonnell:
I agree with Deputy Doherty that it is unlikely we will have deflation next year and that is why we had that comment about once-off measures not making sense. We should just deal with the issue of what we project inflation to be in terms of all the welfare rates. Ultimately, what we have said in previous years is that we think Government revenue needs to increase over the medium to longer term, and we do not see any reason that needs to be the case this year. We think there are many households that have the capacity to bear a higher tax burden, so our €6.7 billion figure should be considered broadly as a net figure.
We do not think there is anything to be fetishised about the figure of €6.7 billion. The budgetary figures are very strong at the moment and we do not have the fiscal rules this year. We can absolutely look at modifying that number through an additional package, if necessary and if a recession were to kick in which would immediately reduce the tax yield and lead to an increase on the welfare side. In addition, there has been discussion about a rainy day fund, and some people are advocating that should take up some of the space itself, but our view on that is that we have a rainy day now because of inflation, and that it will be ongoing, and that we have a rainy day in regard to climate change-----
I will move on to my other question because I used all my time the last time and did not get to question the ESRI. I appreciate the response from Dr. McDonnell.
I have a question for Mr. Fergal O'Brien. IBEC's pre-budget submission did not have any specific proposals on energy costs for business. There is huge volatility here and it could get really messy in the next couple of days, never mind the next couple of weeks with what is happening with Putin, gas and all of that. I come from rural Donegal and there are shops there that need freezers, fridges and so on. They do not have enough product going out the door to pay for their energy increases. We do have a major crisis in terms of the sustainability of certain businesses in areas where the footfall is not there, or which do not have the scale. What does it mean in reality? What would Mr. O'Brien say if the Ministers for Finance or for Enterprise, Trade and Employment were sitting across from him and asked what IBEC needed? We need a rescue package.
We have the toolbox following Covid. It was invented and it can be tweaked. What do we need to look at? Is it supports for certain types of businesses in terms of grant aid or is it the rates again? What needs to be done to ensure that businesses are able to trade through what is a war-time scenario in terms of the energy costs they are seeing at this point in time?
Mr. Fergal O'Brien:
We did not set out specific measures in the submission because we had hoped that this issue would have been addressed by now, to be honest. We have been working with the Government, in particular with the Department of Enterprise, Trade and Employment, for a number of months. What we are seeing taking shape is measures within the state-aid approval framework. Our concern is that those measures will predominantly support exporting companies. Those companies clearly need that support and that will take the form of grant aid, low-cost finance loans and a mix of the types of measures used during both the Covid-19 crisis and also during the last financial crisis. We are dusting down some of the tools that worked back then. We can see that package taking shape and it is going to be within the EU state-aid framework. We have seen an indicative amount for that but we think we will need to go well beyond that. To give the Deputy a sense of the quantum, Irish business has been paying in the region of €3 billion to €4 billion in energy costs in recent years but that is now heading towards €10 billion plus at the aggregate level. For many individual businesses we are looking at a four- to five-fold increase. Our particular concern around the way the policy schemes are currently being designed is that at the moment we do not see supports for indigenous companies, the retail sector, and our non-trading and non-export companies. Many of those businesses, as the Deputy rightly says, will struggle to stay in operation with those types of energy cost increases. We have the bones of a good framework for our exporting sector but we are probably going to need to draw on more of the Covid-type supports for the indigenous sector.
Mr. Fergal O'Brien:
It is going to have to involve grant packages in some shape or form. A CRSS-type scheme or something similar is a potential model but support cannot all be in the form of loans. Businesses are facing absolutely exceptional costs, way beyond any element of medium- to long-term profitability that could support them. Loans on their own will not be sufficient to get businesses through this. We are going to need a mixture of grant payments similar to what we did through Covid and loan schemes. The really important issue here is that we are working to design schemes through that state-aid package which predominantly focused on the export economy but we also have to help the indigenous sector.
I welcome our guests. I will set my timer for ten minutes again. If one is around for long enough, one finds that history repeats itself. I worked in Albert Reynolds's Government in 1992 when we had the devaluation and there was precisely what Mr. O'Brien just spoke about, that is, assistance for industry. The devaluation happened and we had interest rates of 15% and 16%, which makes everything that is happening today seem mild in comparison. A scheme for business was introduced and it involved not just loans but also grant aid.
There have been four contributors to this session today, all of whom have been really interesting but only NERI mentioned the war as a backdrop in its opening remarks. I am going to repeat a point I made earlier today because it is really important to note that energy has been weaponised as part of this process. We are in the position we are in because Russia invaded Ukraine. If there is any disconnect between public understanding of that and what the public is experiencing and what we are going to ask the public to endure in the coming months, that is not a good thing for the European Union. One of President Putin's primary objectives for a long time has been to destabilise the EU.
Any loss of will in the face of the arduous circumstances and the trying period ahead plays into his hands. I am disappointed in three of the four presentations today. They present the problem as though this is what is happening in the world economically without rooting it in its fundamental cause, particularly in the European Union and Ireland. There are other allied causes but its fundamental cause is the Russian invasion of Ukraine, particularly when it comes to rising energy prices.
I want to raise several points on IBEC's presentation. Mr. O'Brien is straight up with his title as director of lobbying and influence. Nobody is hiding behind anything in IBEC. It is straight up in our face and it is refreshing. There are several points I would like to tease out. Mr. O'Brien fleshed out a little bit on the emergency supports. With regard to labour costs, he said Government policy in the labour market is loading significant cost pressure onto businesses, particularly SMEs. I ask him to speak a little more on this.
Mr. Fergal O'Brien:
I thank the Deputy. We look at the individual measures that are adding to this. I refer to the policy measures rather than the general cost environment. We have additional days' leave, statutory sick pay proposals, significant increases in the minimum wage towards a living wage and the introduction of universal pensions. All of these on their own have considerable merit and we support the vast majority of them. It is very important that these supports in our economy are done in the right way and that we are protecting workers in the right way.
We have several challenges. One is that the cost burden, which we estimate to be 9% of labour costs on average, is predominantly going to hit small and medium businesses. Most of our larger companies have sick pay schemes and pensions but they do not have a high share of minimum wage workers. On the other hand, SMEs will be significantly exposed. The challenge we have is that all of these measures are being introduced in a very concentrated window. Hence, we have significant wage pressure, increasing costs and policy measures that are adding considerably to the cost of doing business and the cost of employment but, crucially, they are disproportionately affecting the SME economy. This is the core of our concern.
With regard to what we think we need to do, as I mentioned we have a surplus in the national training fund. It is likely to touch €1 billion this year. The most recent numbers we have are for last year, when it was just short of €900 million. It will head towards €2 billion by 2025. To us it seems unconscionable that this is employers' money going into a national training fund and we cannot seem to spend it. Our suggestion is to find a way to alleviate the pressure on the SME community and help them with the transition. We want these measures in our economy and in our labour market but SMEs should be helped with the transition. When all the measures come together, it will be far too much and it will sink many. Let us get that money out to those businesses, particularly SMEs, in the form of training vouchers to support productivity. It seems such a missed opportunity that we are accumulating a surplus when we have such skill shortages and we have productivity and competitiveness challenges. We need to do much more on upskilling. I would love to see the committee put some focus on the national training fund, where the surplus is going and how we can put it to work for the economy, for vulnerable employers and, crucially, for employees who need training.
I thank Mr. O'Brien for bringing that proposal to our attention. I am taken by it as I am sure are the Chair and other members. If we have time before the budget, I am sure we will look at it.
The reduction in the investment by foreign investment funds and pension funds in property in Ireland is a good thing. The witnesses do not deal with constituents. This is not the forum to discuss it but they have had a very negative impact on the availability of houses, rental prices and accommodation in Ireland. The model needs to be reset. I do not share anybody's enthusiasm for it. There is another forum to discuss this.
I would like to leave time for questions to the NERI representatives but I have another question for Mr. O'Brien. As a director of IBEC, will Mr. O'Brien give us some concrete examples and put flesh on the bones of the calls IBEC gets from companies on the challenges they face? Will Mr. O'Brien flesh them out rather than giving generalisations?
Mr. Fergal O'Brien:
Any area that is production- or manufacturing-oriented with high energy content, including sectors such as building materials, heavy engineering and large goods production. Food has a high energy cost, but given the nature of its production that will, by and large, have to continue unless businesses are facing absolute failure. In other industries, however, we would expect to see reduced hours, shifts and production times. We are going to see this in the coming weeks and months. Our members are saying to us that they simply cannot continue to run their production processes at these levels of energy costs.
Mr. Fergal O'Brien:
Yes, they could. What is crucial as well is that we are going to see falling demand. The international downturn is going to mean that some of these businesses will have less demand for their products. This is going to be the reality of what we are going to face, especially in respect of the international economy. In cases where companies are seeking to reduce production levels, it is important that their workers are supported, especially with short-time working schemes. If we do have to go to a three-day working and production schedule, then companies are not going to be building up heavy stocks in the context of these types of energy costs. They will probably be operating to a much lower production schedule. However, if we do have to face reduced production hours, employees and businesses will need to be supported so they can come out of this when energy costs normalise.
I thank Mr. O'Brien. I turn now to the witnesses from NERI. I have less time than I thought I would. Several points were made by the organisation's representatives. I disagree with one or two, including the assumption that higher-income households have generally built up significant savings. Is there evidence for that? What is a higher-income household now? Can they put a figure on it?
Dr. Tom McDonnell:
It is subjective as to what counts as higher income, but the Central Bank data suggest household savings have increased dramatically during the last two years. That will not continue. The point we are making, however, is that this crisis is qualitatively different for low-income households versus high-income households. Therefore, the focus during an emergency should be on protecting households - and I am talking about the household side rather than the business side - from poverty in the context of provision and that should take priority.
On Mr. O'Brien's points as well, we agree regarding what was said about the national training fund, education, childcare and all those types of measures. We have repeatedly emphasised them. We are not doing enough in any of those areas. We are not maximising our growth, employment or productivity opportunities. We have not been doing that. We would certainly support the use of these moneys for training and upskilling as well.
I have been harping on about apprenticeships since 2014. We are almost at, or at, full employment. There is an issue. The organisations represented here can play a role in the schools in this regard. We are still hung up on university education and we have left apprenticeships behind. The UK is way ahead of us. It set up a commission several years ago and its ambition was that every family would consider apprenticeships for their children. Whether that was followed through on is another thing, but the idea is that the same consideration is given to apprenticeships as to college.
There are points of agreement between the three presenters about the targeting of measures. It is not something that IBEC would necessarily be commenting on, but the ESRI and IFAC share that perspective. Would the witnesses like to flesh out this aspect a little more? We went into a little more detail with the witnesses from the other two organisations on this point.
Dr. Tom McDonnell:
To fully offset the cost of inflation for all households and businesses would probably take us beyond the scope of what is reasonable in a single year. Therefore, a certain degree of targeting is necessary. The point we are making is that there is a cost-of-living crisis for some parts of the population and therefore those parts of the population should be the first priority. Not every cohort in society is experiencing the cost-of-living crisis. From a qualitative point of view, their disposable incomes and wages are going to fall, their wages may not catch up, their property income may not match inflation in certain cases-----
Dr. Tom McDonnell:
Yes. Our current figure is evolving very quickly at the moment and has been for the last six, nine or 12 months.
As it is a rate of more than 8% this year and approximately 4%, next year, that is a cumulative rate of 12%. Obviously, there was an increase last year. Broadly, that is what we are talking about.
On the cost of living, if you do once-off measures on the energy side, that opens up scope for maybe doing slightly less in terms of cash payments but our initial position is that the cash payments dealing with the income adequacy side should be the first port of call in dealing with a cost-of-living crisis, rather than necessarily interfering with a market. My colleague, Mr. Goldrick-Kelly, is doing his PhD on carbon lock-in and he may have points to make on energy. Broadly however, that is our sense of the first policy response; not the only response but certainly the first one.
Mr. Paul Goldrick-Kelly:
The idea essentially is that history matters and that you can make decisions that could have unintended consequences and will narrow your choices going forward. The concern for carbon infrastructures is that were we to take choices now in the short term that may make sense, they may not be consistent with longer-term plans. We have to be very careful about constructing expensive new infrastructures that we may have to, for example, subsequently decommission. That is the idea.
The cost-of-living crisis is the big issue facing us all. IBEC has referred to some businesses that are in trouble and has stated that without support, they could go to the wall. Dr. McDonnell from the Nevin Economic Research Institute is talking about the need for targeted measures for those who are most adversely impacted by the cost-of-living crisis. I think we should always refer to the cost-of-living and housing crisis, frankly, because the two crises are running directly in parallel and are dire in both cases.
First, is it fair comment to state there are winners and losers in this situation? I seek the witnesses' opinion on that. We just have had the Irish Fiscal Advisory Council and the ESRI before the committee and among other things, they reported on how corporate tax revenues - even I was stunned by this and I am aware of how profits have gone up in the corporate sector - have trebled over the past decade. I think it was IFAC that projected that corporate tax receipts for this year could be €20 billion. Therefore, somebody is making money. It is obviously not the IBEC members who are saying they could go to the wall but obviously somebody is making money out of all of this. We certainly know the energy companies are making a lot of money at the moment and some big corporations are making a lot of money. I suspect the pharmaceutical industry is making a lot of money. Some of those who are involved in property speculation and so on have to be making a lot of money. Is it fair to say there are some big winners out of all of this and then there are many people who are losers? How then do we address that? I do not think we should be giving hand-outs to super-profitable companies, for example, or to super-wealthy people. They do not need them and are potentially benefiting from the current situation. Equally, when we get onto the issue of targeting support, to use the much-used phrase and to which Dr. McDonnell and the Nevin Economic Research Institute have referred, where is the threshold? People are a little reluctant to say this. I asked IFAC this question. Where do we begin and end with targeting?
I ask because sometimes it comes across as saying, "Well, we will help the absolute poorest", and we absolutely have to. It is vitally important that people who are already poor are not further impoverished or that more people are not driven into poverty. There is also a whole range of people - working people - who are taking a very severe hit. They may not be quite driven into poverty but they are seriously struggling. It is completely unjust if one takes as a reasonable estimate that they could be down €3,000, €4,000 or €5,000, in terms of the real value of their income, so they need help. Where is the threshold for targeted measures? I am interested in hearing how that can be done because, as policymakers, those are the decisions we have to make and sometimes the economists are a little bit reluctant. They say, "That is up to you guys". Those are the decisions we have to make. Should we be talking about redirecting or redistributing from the winners to the people who are losing in all of this? In broad terms, is that not the way to address the current crisis? If energy companies make super profits through nothing particular that they have done, some of those profits should be redirected to protecting those who are suffering as a result of this crisis, whether it is small business, working people, pensioners or whatever. I would like to hear the comments of the witnesses on that matter.
Is it the case that even before this crisis hit, the cost of living here in a number of areas mentioned was much higher than in the rest of Europe? I refer to childcare, housing, education and in a number of other areas, and that was pre-Ukraine and pre- the current round of the cost-of-living crisis. Why is that the case? Why do we have higher childcare costs than everywhere else? Why do we have higher rents and house prices? Why do we have the highest education fees compared to anywhere?
Mr. Fergal O'Brien:
I am happy to comment on that as well. In regard to winners and losers in corporate tax and everything in terms of what we see across the business base, the Deputy is right. We would agree with the IFAC estimate that we could well see corporate tax revenue hitting €20 billion this year and it is not that long since the figure was €4 billion or €5 billion. That situation reflects a couple of things. First, the engine of this economy with 2.5 million people at work is performing really strongly and I think that gives us the resources now to have choices to help those who need support during this crisis. Most of what one sees in the corporate tax revenue for this year is in the rearview mirror and that is the economy of last year. Many of those companies probably did quite well during the Covid period, whether they were technology, medical or pharmaceutical companies or related companies. Some sectors of our economy did really well and Ireland did well out of those sectors doing well globally. Right now, there are very few winners in this economy. The winners are in a different part of the world and that is the reality of energy inflation. When it comes to our energy companies and the very small number of companies that will have some potential upside with the way energy markets are working at the moment, clearly we are going to see an EU framework to address that in a co-ordinated way across the region, which I think is a sensible thing to do. We know from some of our members where they may be benefitting in one sector of their energy business, be it wind or whatever, then they have offset costs in other sectors where they have not passed through the full economic cost and full energy inflation costs that they have been facing. I do not think that we are going to get very large-scale revenue from whatever the EU framework will be on the energy side. The much bigger picture has been the strength of the corporate sector generally but we will not have corporate winners in the Irish economy from what we are facing right now.
That was from a different phase of the global economy. Even if we did not have this terrible war in Ukraine, we would have had inflationary problems because we created so much money in the global monetary system and from a fiscal policy perspective during Covid. We would have had inflation anyway. Do we have a high cost of living in Ireland? We do, but we also have very high income levels and relatively high salaries compared to the rest of Europe that drive the cost of doing business, especially in labour-intensive sectors.
The challenge is to address the accelerated cost of living but, from our perspective, we will not see winners in the business community from inflation. This is a tax on the entire economy that predominantly comes from energy-producing nations. Businesses in Ireland will not benefit from the energy price surge we are seeing coming through globally.
Dr. Tom McDonnell:
With regard to those winners and losers, Mr. O'Brien is right in that, obviously, the digital economy and pharmaceutical companies benefited enormously from the Covid crisis with regard to their bottom line. Ireland, as a European hub for many of those companies, likewise benefited from corporation tax receipts. The energy sector is not a strength for the Irish economy. We import much of our energy and I agree that the solution of windfall taxes or similar is probably best done at a European level.
Yes, the cost of living is very high. Ireland and Denmark are usually at the very top of that list. We are a high-income country, but we have very unequal market incomes, which is why our tax and welfare system has to and should continue to work as hard as it does in being redistributive.
Why is the cost of housing so high? The first reason is that supply has not been able to match demand for 13 or 14 years now. Obviously, many of the roots of that go back to the financial crash. There is a lack of workers in the sector and there are issues with financing. The State also stepped away from its responsibilities.
With regard to education, childcare and housing across the board, in Ireland our Government revenue as a proportion of income is low which means that we underfund many of these areas relative to other countries in western Europe. Therefore, the cost of living in those countries with regard to these types of expenses tends to be lower. They have a much stronger set of universal public services or universal basic services. One of the things we have emphasised in our opening statement and in our general commentary has been that the budget should focus on reducing the cost of those services. This type of spending by the Government would be disinflationary for labour costs for businesses and in the economy overall. We see that as a possible win area with the Government effectively reducing its appropriations-in-aid, thereby reducing the costs of education, healthcare and childcare in particular. There is scope in all of those areas to boost real or take-home incomes after all of the necessities; to reduce the cost of business, ultimately, in the sense that labour demands will be less of a feature; to be disinflationary; and to deal with fundamental problems in the economy such as the cost of childcare, which removes vast swathes of workers in their 30s and 40s from the labour force. Principally, those are the people with the very highest human capital, including women in their 20s, 30s and 40s. They often never come back to the same sector.
The point was made earlier about us being in full employment but that does not mean we have the right composition of employment. It does not mean people are working in the right sectors. In keeping with Mr. O'Brien's point about productivity, retraining and upskilling, we need to continually shift towards higher value-added sectors. Construction is not an especially higher value-added sector but we will need more people in those sectors, which means increasing participation rates by removing barriers related to childcare, disability, issues around working from home, flexibility and bringing people back to Ireland, which is a housing issue, and by dealing with a digital skills-type issues which allow us to move towards higher added value. We can affect the composition of employment over the medium to long term through proper policy measures. It is not that there is a rump of 2.5 million people who work. There are winners and losers.
I would respond to the Deputy's question about the point at which we are not willing to help people by saying it is tapered; it is about degree.
People on fixed incomes at the bottom are probably most in danger, which is why we emphasise that, but that does not mean there is no scope for dealing with cost-of-living issues to do with childcare, education, healthcare and so forth. For lower to middle groups, things like the working family payment can be improved for lower-income workers. Yes, there is scope for increasing USC thresholds and tax credits, and even the standard rate cut-off point can perhaps be not fully but partially indexed. There is scope in those areas to help those groups, albeit to a lesser amount than those who are really in trouble as the winter kicks in.
I welcome our guests. I am going to ask my questions consecutively because I am short on time too. I will start with Dr. McDonnell and Mr. Goldrick-Kelly and I will move on to Mr. O'Brien and Ms Ahern-Flynn.
On a question to Dr. McDonnell, the rate of unemployment is close to 4%. What support would he suggest to encourage those who have a partial ability to work? While I am aware that Mr. O'Brien previously spoke around the training funds and so on and that other speakers referred to apprenticeships, what else could Dr. McDonnell suggest in that regard? I was going to ask him about action to address the current inflation spiral but to be fair, he has mentioned all of that in response to Deputy Boyd Barrett's questions.
To move to Mr. O'Brien, are his members experiencing labour shortages and if so, what action would he suggest to address this? Mr. O’Brien referred to the greening of VAT rules in his opening statement. What is his interpretation of this? I want to know because I do not fully understand it.
Ms Hazel Ahern-Flynn:
Issues around labour shortages are something about which we have been hearing for a while now in feedback from our members. We came out of Covid with a much stronger labour market and much stronger employment figures than we would have expected even a few years ago. As for what is driving those labour shortages, there are two issues. One has already been touched on, that is, labour force participation. The main indigenous source of additional labour will just come from supporting and encouraging more workers into the labour force, which involves dealing urgently with a lot of those capacity issues around childcare and housing. The other piece is how to attract international workers, in particular high-skill, highly mobile workers and again, that ties back into capacity issues. Something we have heard from some of our engagements with the multinationals are questions around capacity, in that the fundamental prospect for continued foreign direct investment in this country is very strong but the question is whether we have the capacity to allow for it, simply in terms of housing an additional workforce. We would need to start seeing movement in those areas fairly urgently to provide for that.
On the second point around greening the VAT rules, under EU rules there is provision to provide a more favourable rate of VAT to energy-efficient technologies and that ranges through everything from bikes to solar panels to heating pumps. Very simply, what we are calling for in our budget submission is to make full use of the greening of the VAT rules to make sure they are a preferable option.
Dr. Tom McDonnell:
I thank the Deputy for the questions. I would not disagree with regard to greening the VAT rules. In terms of bars to employment, Ms Ahern-Flynn has already mentioned the labour shortages associated with childcare and housing and we certainly see that, particularly in respect of housing, but childcare has been an ongoing thing for at least a decade. It is always the first thing cited and it is overwhelmingly cited as the reason. The sheer cost of childcare is pushing many people out of the labour force or, in many cases, forcing them into part-time or into sectors that may not be in accord with what their skill set actually is. That means we have a major overqualification issue in some cases, where people are just working in the wrong sectors or are doing the wrong jobs, which means their potential is being wasted, which is obviously a loss for the economy as well. We see those as being significant issues.
Obviously, we can bring in extra cohorts through more flexible working from home arrangements, flexible hours and all of those things.
I know those are difficult knots. Such solutions are not always appropriate for every type of sector. It is, however, something on which the public sector could lead. We can also make it more viable for people to work beyond the age of 66 if they want to and where they have viable skill sets to do so. That would be an option in non-manual jobs, in particular. We would see those as the main options when addressing labour shortages.
As I have mentioned, childcare and housing are examples of difficulties in this regard that are often cited. There is also the issue of digital literacy. Ireland performs badly in that respect. There is an issue there. We see providing people with flexible skills that allow them to move into all sorts of different sectors as a fundamental part of the inevitable just transition that will take place the economy changes significantly in the coming 20 years. Those are the priorities.
I am sorry that because I was in meetings, unfortunately I did not get to hear all the contributions and the answers that have been given to the different questions. I attended the western IBEC meeting on Friday, which was very interesting. I noted, and was particularly interested in, a contribution that focused specifically on the expansion of research and development. The nature of the meeting on Friday meant we did not have much of a conversation on that topic. Could our guests speak to that point? How do they see that applying to work? We know Ireland is a long way behind in its investment in research and development. Representatives of IFAC were before the committee earlier. Every time representatives of IFAC attend meetings of this committee, they say that we are over-reliant on corporation tax and that the Government needs to build an alternative. Making research and development a part of our own companies is an interesting point in that regard. I would like our guests to speak to that point.
Ms Hazel Ahern-Flynn:
As the Deputy says, there is a lot more we could be doing in respect of research and innovation in this country. Although there are some immediate cost pressures, we would like the Government not to lose sight of some of the longer term strategic issues. One of the things we would like to see come out of the upcoming budget is investment in research and innovation, and education. We would like to see public spending on research and innovation increase by €100 million, which is approximately 20% of the total spend at the moment. In considering how to promote research and innovation further, one issue we have at the moment is that our SMEs are not researching and innovating in ways that increase their end productivity to the levels we see in the multinational sector. Part of the reason for that relates to the design of some of the tax incentives and supports we have put in place to encourage that kind of research. In the case of the research and development tax credit, there are issues around the qualifying limits of expenditure on-----
Ms Hazel Ahern-Flynn:
-----outsourced research. One of the issues for some of our SMEs, particularly start-ups, is that while they might have the ambition to conduct that kind of research and innovation, they do not have the resources to do so off their own bat. What Ireland has, and which stands to us as a country, is a strong third level and higher education sector. It is strong not only in teaching but also in research. We would like to see a tweak made to the research and development tax credit to allow increased expenditure for those institutions for research and innovation.
That point spoke to me when I heard it. To be frank, I disagreed with some of the proposals in Friday's meeting but that point about research and innovation stood out to me. I thought it was very interesting.
I found the opening statements made to this meeting very interesting. Our guests have responded to my colleague, Deputy Patricia Ryan. At one point in his opening statement, Dr. McDonnell from NERI said, "In particular, the stated plan to cut taxes for higher earners seems unwise to us." Our guests have also mentioned spending deficits in areas such as childcare. Representatives of IFAC and the ESRI were before the committee earlier. They spoke about how difficult it is to target those middle-income households.
The lower-income households are obviously really struggling but it is easier practically to target them. How can they be targeted? The ESRI referred to expanding the working family payment, for example. I think I heard IBEC suggest that at a meeting and somebody else had also said it. Obviously, what middle-income earners earn should be able to pay for what they are doing.
Dr. Tom McDonnell:
It is possible to target people at the bottom. It is not necessarily easy to target people at the middle. The emphasis, as it should have been for many years anyway, should be focusing on reducing the cost of living, which is very high in this country, while supporting the medium- to long-term strength of the economy. We regard childcare, education and housing as well as research and development as all being relevant to the cost of living. They are also all relevant in having a stronger productive and innovative capacity for the economy. All those areas can stand to benefit middle-income households.
Obviously, wages are a component of it. Certain types of tax cuts can also be a component of it. We need to find ways to reduce the cost of living in those pressure areas we have identified, which all of us around the table are well aware of in terms of childcare and housing but also education and healthcare costs. These are areas where the Government can directly intervene to reduce the costs to households and we see that as very important.
I agree with the points about having greater research and development linkages with the third level sector. We should develop what is often called a triple helix between Government, the higher education sector and business. We need to improve those linkages and attempt to develop a proper national innovation system. That is also a Scandinavian idea. It is really about the medium- to long-term development of the economy. At the moment public research and development spending is about €500 million. Probably €100 million is the most we could absorb in a single year. In the long term, or even in the medium term, we need to go significantly higher than that. For example, the Nordic countries spend well over €1 billion on research and development. We are not at the races there.
The strength of the US economy over the past 60 or 70 years has been based on spending on education and research and development, and those linkages with universities. In its case it is done through its military and industrial complex. Our focus, on the other hand, might be through the green transition, the digital economy or whatever it might be. The reality is that Ireland is probably too small to become a world leader in any one area, meaning it will also need collaboration outside Ireland. It is about Irish universities and businesses having those linkages with firms in other countries to get sufficient scale to allow us to be world class in multiple areas.
The Government having an equity stake at the start-up stage through the universities can also be part of that process. It does not necessarily need to have a controlling interest but just needs to be part of the process. It requires throwing a lot of darts. When it comes to innovation and new ideas, we do not necessarily know what will work, which means the risks to businesses are often enormous and in many cases they will not be able to yield all the benefits that ultimately accrue to that as technology diffuses through the economy. Therefore, it is very important for Government to take an active role in developing these high-potential startups based on ideas, knowing that most of them will fail, which is okay. However, they need to constantly try and try again while providing a safety net and funding for business.
Many of these are medium- to long-term reforms. I would agree with allocating €100 million in budget 2023. We would strongly support that.
Apple obviously came through the state investment initially and we probably wish we had kept that equity stake in it as it continued. That is quite interesting. As Dr. McDonnell said, some of it applies in the medium to long term and what we need for medium-income households, as we need for lower-income households, is what can be done immediately. We need a way to tackle childcare and housing issues. As one of my friends said, with €50 a day for childcare in Galway and rents being so high, it is just not possible for people and this pushes them out of the workforce, which disproportionately affects women.
I want to get a different take on this because I want to focus slightly more on business in this session. I have been talking to local businesses in my area and we are obviously all seeing the impact of the rising cost of energy. One of the things people in my local area said is that they would like to have seen flexibility with rates again. They would also like to be better able to access renewable energy such as solar panels themselves. We are talking about a much smaller scale so it is more difficult to try to tackle that. I am hearing that certain businesses are closing their food sections. They are literally switching on the lights in the refrigerated areas for drinks but are not switching on the refrigeration. In Britain they are talking about a guaranteed loan scheme. Many companies have warehoused tax debt and there are concerns in some quarters about the ability to pay that back. That is also something that businesses have raised with me. What are the witnesses' views on debt to equity, not for local corner shops but to look at it in that way? I am interested in hearing their views on that.
Mr. Fergal O'Brien:
I thank the Deputy. I am happy to touch on some of those issues. A I said earlier, given the type of cost increases, which are fourfold or fivefold in energy bills, significant supports will be needed for survival. However, we also have a strong and important window of opportunity to accelerate adoption of renewable and low-carbon technology. Many of our members want to avail of technology investment opportunities and right now the return on investment rationale, if they are competing for that capital within a group or whatever the situation, is much stronger.
We need to look at the immediate and short-term survival piece but also the investment from a low-carbon perspective. We would like to see the types of supports that are available through the Sustainable Energy Authority of Ireland increased and made more effective to be able to deliver those much more rapidly. That could all make a material difference very quickly.
With regard to the types of schemes the Deputy spoke about, such as loan-to-equity type approaches, given what we learned during Covid-19, I believe we are going to have to apply the same type of approach here. Speed is of the essence and while we will probably not get everything 100% right, what we saw during Covid-19 is that if we do it quickly, we will save jobs and businesses. Whatever these schemes are, it must be possible to implement them rapidly. That would be our priority.
Dr. Tom McDonnell:
I would not disagree with that. We should not let the perfect be the enemy of the good here. Speed will be of the essence. Having said that, it is important that the supports be temporary. It is important that they do not become embedded and that there is not an expectation created that these supports will be in place in perpetuity. Our response to the Covid-19 pandemic was appropriate and extremely successful. There is much to take from that playbook in terms of a part-time wage subsidy, short-term schemes and measures like that.
I made a point earlier about equity stakes in new firms. I would not necessarily see that as being necessary for existing firms in quite the same way. What we are saying here is that there has been an exogenous, and hopefully once-off, shock to the economy, similar to the pandemic, as I am sure there will be others in the future, and that this is a kind of no-fault situation. The additional cost here does not reflect a fundamental problem with the business model. In many cases, it is not the fault of the business. There is employment associated with these jobs, so a once-off temporary response to get them over to the other side is what is needed. It is likely that energy prices will be somewhat inflated from what they were in 2019, for example, possibly forever or at least as good as makes no difference in terms of the time horizons we are talking about of one to three to five years. We do not know the answer to that.
Again, there should be scope to continue policies going forward, but also to allow companies to wean themselves off oil and gas and make those investments in green technologies that they need. That is what we see. There is a short-term emergency response while we are baking in the response for winter 2023-24 and giving businesses time to get to the other side of winter and make the appropriate investments they need. There will have to be a very significant injection from the State to do all of this.
As was stated at the beginning, the fiscal situation is very good and the cost of borrowing is very low. Our debt per capitais very high, but so is our income per capita. It is often not necessarily fair to talk about those kind of rankings where we are one of the highest indebted countries, because we are also one of the highest income countries in the world. A certain degree of context is often important in these debates.
I will allow members to ask supplementary questions. However, before that, I will ask a few questions.
I was taken with a particular paragraph in Dr. McDonnell’s opening statement regarding how the State planned to cut taxes for middle and higher income earners. In this and the previous session, we talked much about inflation. The reality is that, as he said, our finances are not in a bad situation. However, considering the long list of needs and demands, we will not be able to do everything. It will be a situation where we will have to choose what is appropriate to do and what is not. In that context, there is a lot of discussion on wages versus inflation and taking decisions that might add to inflation. Would it be incorrect to say that cutting taxes for middle to higher income earners could have a similar effect on inflation?
Dr. Tom McDonnell:
Of course. It would only benefit that 23% or more than 600,000 people who are in that band. They would be the only ones who would benefit from that. Obviously, it would increase their real disposable income, which would have a positive effect on demand. We have a supply constraint at the moment, so increasing demand is like a wave washing up against it. Inflation will go higher. There is no doubt about that. However, as it happens, higher income households actually currently do not spend all of their income because they do not need to. They are not experiencing the cost-of-living crisis in the same qualitative way and, therefore, the inflationary impact might be lower than it would be if benefits were given to lower income households that have to spend all of that money. The exceptions might be that it might increase house price growth and things such as that, because that is the type of thing that those households might be looking at investing in. It might drive up house prices.
I apologise for interrupting. I will stop Dr. McDonnell there. A previous contributor said that the increase in interest rates might lead to a kind of suppression of house prices. However, if we were to cut income taxes, that could cancel that out.
Dr. Tom McDonnell:
Rather than saying “cancelling” it, I would say it would have a countervailing effect. When you put all of these things into a model, one thing will increase prices and another will reduce them. Therefore, sometimes you see prices might have gone up or down. That does not mean that a particular policy such as interest rate increases had no effect; it just means it was not sufficient to cancel out the pressures coming in the opposite direction. Obviously, if you increase real disposable income for higher income households that do not have to spend all of their income on necessities, that gives them more resources to chase house prices and things such as that or go on foreign trips or wherever it might be.
Interest rates will have a dampening effect. However, fundamentally, there is a supply and demand issue in the housing market. The demographics suggest that demand for housing is increasing, depending on the model used, by between 30,000 and 40,000 units every year.
Dr. Tom McDonnell:
No, that is based on household formation generally. Whereas supply is still well short of that, the gap is actually increasing every year. That will continue to increase house prices.
On the other hand, interest rates will reduce prices. Obviously, if we have a recession and real incomes are falling, that will also have a negative effect on house prices.
Dr. Tom McDonnell:
Income tax will be a contributory factor pushing in the other direction but it does not mean it will be sufficient to overwhelm all the other effects that are going on. There is no doubt that real incomes will decline. It depends on Government responses but it looks likely that real incomes will decline. It is unclear how much of an effect that will have on the cohorts that are in the housing market, unfortunately for them. Interest rates will have an impact. That will withdraw potential buyers from the market, thereby reducing demand and temporarily bringing house prices to a lower level of growth but fundamentally, those issues in the housing market will remain. It is a structural market failure that will take many years to resolve, unfortunately.
Okay. I will return to the IBEC representatives. I was very interested in their point on taking advantage of favourable EU conditions around greening certain VAT situations. Will they elaborate a little on that? Where is Ireland in EU terms in respect of the scale of taking advantage of those issues? Are there particular sectors where we are not in the middle of the pack, as our Minister likes to say so often? Are there particular areas where we are not doing a good job in taking advantage of those conditions?
Ms Hazel Ahern-Flynn:
In broad principle, we are taking advantage. Where we see an impact is whether we are keeping up to date, for example, on the lists of qualifying technologies and qualifying products. Are we staying ahead of technology? It is partly an administrative issue. Can we keep things such as the VAT rate on green technologies or other tax incentives for the uptake of green technologies? Can we keep those lists under constant review to make sure they are as broad as possible? Other areas are essentially just about simplifying how businesses engage with them.
Ms Hazel Ahern-Flynn:
The EU has white-listed a very expansive list of what VAT green rules are applicable to. We could go into quite a lot of depth. It does not necessarily include the cutting edge in high tech. I referenced bicycles earlier. All it is, in essence, is that we have the room to additionally cut VAT rates per the EU's framework on it. It would be sensible that we take full advantage of that, given the current climate.
It is a very interesting point because it was such a battle to get reusable menstrual products on the same VAT rate as the throwaway products. It is such a green measure but it was such a battle to do that. It is to be hoped that a Department would have somebody whose role is to constantly audit that list.
Ms Hazel Ahern-Flynn:
I suppose minds at EU level have been concentrated over recent years on movement around VAT. It can sometimes be quite difficult, when getting those frameworks in place, to see movement at the member state level. The lists, given their complexity and length and the fact that technology moves so quickly, can be out of date quite quickly. It is just a case of keeping them under review to make sure that we are making good use of the allowance for the greening VAT rates and, in a general sense, they are applying where they are most useful.
I will stick with IBEC and ask about access to credit at present. As has been said, and I completely agree, there will have to be Government movement and action, not just in making loans but in something more fundamental than that. In terms of outside Government, credit unions have recently attempted to make themselves more available to SMEs. What is IBEC's estimation of access to credit? I am talking about the very short-term bridging credit right up to something more substantial. Is it currently an issue?
Mr. Fergal O'Brien:
It is. It is a function of an economy that has probably been performing quite strongly, in addition to scarring effects from previous downturns and the financial crisis. We have never seen that recovery in credit to what we had prior to the financial crisis. For many companies, it will now be absolutely essential they have the liquidity supports, given the type of cost pressures that are coming at them.
But we have all the tools in our armoury. We have learned so much during the financial crisis and then during Covid-19 and there also are some schemes that we designed for Brexit. I think that we have the full design of measures and it is just a matter of putting them to work. Crucially, however, for a lot of companies, loans and debt will not be the solution to get them through this because the scale of the energy cost will be so high that they will need some sort of subvention as well.
Finally, if I can go back to the PhD, something strikes me. This may be a somewhat theoretical question but we are living in a very strange time where we are testing the limits of elasticity of demand in real time on things like carbon taxes because the price of everything has risen so dramatically. It is an inelasticity that people can only change so fast and so far. What is that telling researchers such as those in NERI about the current economic levers that we are using to make that transition to a more green economy?
Mr. Paul Goldrick-Kelly:
Yes, I agree with that framing. On carbon taxes specifically, you need all policy pulling in the same direction. The idea of lock-in would imply that if you have a system with a lot of inertia around it, you need every tool at your disposal to shift that. Potentially you want new infrastructures. In certain instances, lock-in can be a good thing. We want to lock in a green kind of pathway to accelerate it and give it a bit of momentum. The current crisis is showing what is needed on the energy side, namely, that we need extensive new investment and cannot be reliant on fossil fuels to this extent. It is showing that up. It is also a pressing security issue for supply in the State. To draw in some of the points that Dr. McDonnell made, it also encompasses other inducements to a positive behavioural change if, as the Chairman mentioned, there are individuals who do not have options around transport, say, where they have to bear those costs and they are inelastic. Provided there is a bit of a carrot on the other side, that is, extensive public transport infrastructure, those things paired together can begin to shift the ship and we need to be reliant on single measures such as cost.
Okay. We have concluded the session. I thank our guests for coming in this evening. The meeting has been at a bit of a breakneck speed because we have had four different bodies in today but the change to the budgetary cycle requires it. I do apologise. I am sure we will have both groups back before the committee again. I thank members for sitting during recess, which I really appreciate.