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Analysis: Minister Donohoe, this is what you should and shouldn't do tomorrow

Economist Victor Duggan has some good advice for the finance minister ahead of tomorrow’s budget.

Victor Duggan Economist

Updated Sep 26th 2022, 5:41 AM

SOMETIMES GOOD NEWS is bad news. News a month out from your annual budget announcement that the public coffers were brimming with unanticipated largesse was the last thing Paschal Donohoe will have wanted to hear. Why?

The natural and understandable inclination of any Irish finance minister, and of the Department at their back, is to be conservative, to guard jealously the public purse strings and to manage downwards the expectations of both colleagues and punters.

Someone has to take away the punch bowl before the party gets out of hand. This is an inclination inherited a century ago from His Majesty’s Treasury, the so-called ’Treasury view’.

Healthy balance sheet

A year ago, the Irish government was expecting €8.3bn for 2022. As things stand now, we are on course for the largest annual surplus since at least 2006, largely due to gravity-defying corporation tax receipts.

We’re not sure if, and we don’t know when, but we must at least acknowledge the risk that a significant share of this year’s corporation tax receipts will not be repeated indefinitely. It makes sense not to build in recurring spending pledges on the basis of revenue we can’t count on. We have made that mistake before.

But, using windfall revenues for once-off capital investment or current spending measures can be justified in economic and social terms, as can using a portion to pay down the national debt or set aside for a rainy day. These are the choices faced by the Minister for Finance this week. Divvying up a surplus is a good problem to have.

There is scope for both a multi-billion, once-off cost-of-living package and the squirrelling away of several billion more for a rainy day while still running a surplus for 2022. Heading into 2023, Ireland’s fiscal position is the envy of Europe.

So, starting from the ’Do no harm’ principle, here are my ten ’dos and don’ts’ ahead of the budget:

The Don’ts

Don’t make the cost-of-living crisis worse

There are two parts to this. From a macroeconomic point of view, the budget will not be inflationary so long as the budget balance doesn’t deteriorate in 2023 (i.e., a larger deficit or smaller surplus than in 2022).

In fact, fiscal policy has actually been strongly deflationary in both 2021 and 2022 as pandemic spending measures are wound down and economic recovery boosts tax receipts. From a microeconomic point of view, the government can have a direct impact on prices through taxes and regulation. Indirect tax rates (carbon tax) should not be increased, and temporary reductions (VAT, excise) should be extended.

Don’t try to supersize the surplus

Ireland’s debt-to-GDP ratio is less than the 60% EU limit and falling while we are one of the only EU countries likely to record a surplus this year. There is no need to prove our fiscal virility by further ramping up the surplus when it is already the largest in Europe.

Don’t lock in lower living standards

Budget day will be divided into two: part of this year’s surplus will be divvied out into a multi-billion package of once-off cost-of-living measures. Separately, tax and spending plans for the following year are to be set out in the traditional manner.

The problem is prices are highly unlikely to fall back to 2021 levels during 2023. So, the government can introduce further once-off measures in the future, or it can index welfare, wages, tax bands and departmental spending to price inflation. The other alternative is permanently reduced living standards for everyone.

Don’t raise carbon tax during an energy crisis

There are few economists that don’t agree with carbon taxes in principle. By increasing the cost of fossil fuels, they internalise the environmental costs of burning them and incentivise cleaner energy sources.

But, soaring energy prices on global markets are doing the heavy lifting on their own these past months. There is no need to rub salt in the wound. The scheduled €7.50 carbon tax increase should be postponed for at least six months.

Don’t repeat mistakes of the past with sweetheart tax breaks for landlords

House prices and rents have been surging, respectively reaching and far exceeding their Celtic Tiger peaks. Returns to property investors have been stellar, while their financing costs have been negligible until recently. They do not need tax breaks, and there is no social or economic justification for investors in passive assets to pay lower tax rates than workers do on earned income.

The Do’s

Do introduce a Vacant Property Levy and increase the zoned land tax from 3% to 6%

These measures will address our acute housing supply shortage by, respectively, incentivising the sale or rent of vacant homes and disincentivising land hoarding. If there are discrepancies, real or perceived, in the tax treatment of property investors, then consideration could be given to levelling up the regime governing Real Estate Investment Trusts (REITs).

Do ensure the capital housing budget is big enough, at a minimum, to deliver on Housing for All (H4A) building targets

Following a post-Covid construction rebound, housing starts have slowed through the first two thirds of 2022. It is important to invest in social and affordable housing therefore reflecting increased construction costs, while further efforts are needed to tackle those costs directly. Given that H4A targets are likely lower than annual housing needs, these should be seen as a minimum, not a maximum.

Do more to tackle the cost of childcare

Ireland has among the highest childcare costs in the world, and they have by no means been immune from broad-based cost-of-living increases. Taking further action to cap and, eventually, reduce these costs can tamp down economy-wide inflation while easing financial pressure on families with young children.

Do set out a multi-annual budget to deliver Sláintecare, with a near term focus on reducing out-of-pocket expenses

Sláintecare may not be perfect, but it is a plan, and it has broad cross-party support. Its Achilles heel is that it has never been backed by a credible medium-term funding plan. Budget day is a perfect opportunity to address this. To tackle the broader cost-of-living crisis, measures that cap or reduce the cost of treatment should be front-loaded. Weekly income limits for medical cards should be increased, at least in line with inflation.

Do set aside a cost-of-living contingency

From Brexit to Covid, the war in Ukraine to soaring prices, recent years have taught us to expect the unexpected. The government deserves credit for building contingencies into its budgets. So, for example, unused funds in the Covid contingency fund means there were resources to divert to housing Ukrainian refugees without blowing a hole in the public finances.

All of the abovementioned uncertainties are still in play to varying extents. It would make sense to repeat the trick for 2023 in case inflation does not ease significantly as expected. There may well be a need for more once-off measures next year.

Victor Duggan is an economist. 

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Victor Duggan  / Economist

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