Political pressure to cut taxes in response to large budgetary surpluses is now one of the key risks to the public finances, the Irish Fiscal Advisory Council (Ifac) has warned.
In its latest assessment, the budgetary watchdog also estimated that inflation-proofing the tax system by indexing income bands and credits would cost €1.3 billion in 2024. The Government has allocated just €500 million for tax measures in the budget.
Because workers drift into higher tax bands when their wages rise, they can end up losing more money than they gain.
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Ifac said the Government faced “a difficult set of choices” between adopting new tax and spending measures, maintaining existing spending and staying within its own 5 per cent spending rule, warning it could not do all three.
In 2021, the Government adopted a 5 per cent spending rule, that effectively seeks to tie expenditure growth to the estimated sustainable nominal growth rate of the economy, at 5 per cent per year.
The council’s intervention comes amid increasing tensions between Fine Gael and Fianna Fáil over tax cuts in the budget with Taoiseach Leo Varadkar championing calls for a €1,000 tax break for middle-income earners.
The cost of maintaining existing levels of public services — otherwise known as “stand-still” costs — would be €5.6 billion next year, it said, noting that staying within the 5 per cent spending rule while paying for stand-still costs would leave “little space” for other measures in the budget.
“Going beyond this, without offsetting tax increases or spending cuts, risks repeating the mistakes of the 2000s,” the council warned.
“It would mean using temporary revenues from corporation tax and an economy at full employment to finance permanent expansions,” it said.
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Ifac also warned that additional public spending over and above the spending rule risked fuelling further price and wage increases, given the current tightness of the labour market.
In its report, it said that overheating has now emerged as a serious risk to the Irish economy. Overheating occurs when demand exceeds the productive capacity of the economy, bidding up prices and wages and eroding competitiveness.
“Capacity constraints have emerged, with the jobs market exceptionally tight,” the council said. “Few construction workers are unemployed, housing output appears to have slowed, and wage and rent pressures could yet prove more persistent.”
In terms of the general economic outlook, the watchdog said Ireland’s growth looked set to recover as inflation eases.
“While high price increases and an uncertain outlook softened the volume of consumer spending in 2022, a rapid recovery following the pandemic has led to once-in-a-generation low unemployment rates,” it said. Unemployment in the Irish economy has fallen to a record low of 3.8 per cent.
Ifac predicts headline inflation in the Republic will fall to 4.9 per cent this year and to 2.5 per cent next year as the initial surge in energy prices subsides.
Budget surplus
The Government is forecasting a cumulative budget surplus of €65 billion over the next three years. Ifac said “exceptional inflows of corporation tax receipts” from foreign multinationals were boosting the public finances.
However, it warned that up to €11 billion of the €22 billion tax revenue generated from the business tax last year could be classified as “excess”, beyond what can be explained by domestic activity.
Nonetheless, it predicted the Government would run its first underlying surplus (when excess corporation tax receipts are excluded) in 17 years next year on account of strong growth in other taxes.
While the Government has made important steps towards long-term planning, it said the forecast spending increases in 2024 and 2025 did not include a number of likely costs, including those associated with Ukrainian refugees.
