Disorderly Brexit or loss of corporation tax could trigger debt spiral

A disorderly Brexit or a permanent loss of corporation tax revenue could leave the Republic as one of the most indebted countries in the world well into the next decade, a new report from the Central Bank warns.

In the economic letter – Debt and Uncertainty: Managing Risks to the Public Finances – the authors argue that a hit to corporation tax revenues or a troubled UK exit from the European Union could result in the State’s level of debt remaining above 90 per cent of national income “well into the middle of the next decade”.

The State’s current high debt-to-income ratio is a result of the financial crisis that left a legacy of government debt that, in 2018, was larger than the level of national income.

"Starting from this high stock of debt, there is a risk that a negative economic shock could cause the deficit and debt to start rising again, undoing the hard-won improvements of recent years," Thomas Conefrey, Rónán Hickey and Graeme Walsh wrote in their letter.

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The Government debt-to-income ratio has declined from a peak of 166 per cent of GNI*, an indicator of the size of our economy that strips out the activities of multinationals, to 104 per cent in 2018.

At the same time, the low interest rate environment has allowed the State service that debt at a low cost.

Despite those improvements, the authors note that Irish debt remains high by historic and international comparisons.

“The current macroeconomic environment facing the Irish economy is unusually uncertain. Although central forecasts are positive, the balance of risks to those projections is firmly weighed to the downside,” the authors said.

Magnified effects

In their letter, the authors modelled the scenarios of a disorderly Brexit and a reduction in corporation taxes separately. However, they noted that if both scenarios were to play out at the same time, “the effects on the economy and public finances would be magnified compared to the results we report”.

Under the disorderly-Brexit scenario, the authors noted that it would have negative implications for output and employment and lead to a reduction in consumer spending and investment. That would have the effect of reducing the level of output in the Irish economy by about 4 per cent in the short term and by 6 per cent after 10 years. The unemployment rate, meanwhile, would rise by more than 2 percentage points.

“The persistence of a debt-to-income ratio of greater than 90 per cent into the middle of the next decade would increase the vulnerability of the Irish economy and public finances to further shocks. There would also be an additional direct burden on the economy owing to the cost of financing a higher level of debt.”

Under their second scenario, encompassing a decline in corporation tax receipts, the authors flagged concern that this tax heading has become concentrated among a small number of multinationals. In 2018, the top 10 taxpayers accounted for more than 40 per cent of corporation tax revenue.

The authors assume a permanent €3 billion reduction in corporation tax revenue from 2019, a figure they consider to be conservative.

And as for suggestions on how to avoid these shocks, the authors have added their voices to an increasingly loud chorus of economists and experts who have called on the Government to use windfall fiscal revenues only for debt reduction, rather than for Government spending.

“This applies in particular to corporation tax given the uncertainty over the sustainability of the increases in revenues since 2015. Unexpected gains from this source should be saved rather than used to fund long-lasting spending commitments,” they said, adding that such a move would put the public finances on a sounder footing.