How long can public finances stay in fiscal sweet spot?

The 2017-2019 period – economically and financially – may go down as something of a sweet spot for the Government. Jobs-rich growth had driven the economy to near full employment, erasing the scars of the financial crisis. Buoyant tax receipts had delivered a budget surplus for the first time in over a decade while historically low interest rates had made the cost of servicing Ireland’s mega €200 billion debt, a potential albatross around the State’s neck, manageable.

To illustrate just how strong these favourable winds were, it’s worth going back to 2015 and looking at the then government’s budgetary forecasts. It predicted corporation tax would net the exchequer about €5.5 billion in 2018 and that the interest payment on the national debt would be about €8.5 billion.

As it turned out, the lower interest rate environment pushed the State’s interest bill down to €5.5 billion while corporation tax receipts rose to a record €10 billion, handing the government about €8 billion in additional funds and resources it hadn’t banked on. This was over and above the financial and budgetary improvements that had already been factored in or assumed in a fast-growing economy.

The full extent of this financial windfall has – to the best of my knowledge – never been reported and the additional revenue appears to have vanished into the budgetary ether. Much of it was swallowed up by additional spending in health. If ever the phrase “you’ve never had it so good” applied, it was then.

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As we exit the pandemic, many of these favourable winds are still there. Exchequer returns show corporation tax receipts are still climbing and look set to eclipse last year's record haul of almost €12 billion. The Central Bank is predicting a resumption of the jobs-rich growth we saw before the pandemic.

In its latest quarterly bulletin, it talks of a consumer-led spending boom generating 160,000 jobs over the next two years, reducing the jobless rate to below 6 per cent.

Domestic economic activity, it says, will return to its pre-pandemic level by the end of this year, significantly faster than previously forecast, and would be broadly back to its pre-pandemic trend by the end of 2023.

It also downplays the prospect of a major change in the global interest rate environment, seen as a major risk for highly indebted countries like Ireland, on foot of the recent uptick in inflation.The current upward pressure on prices is "transitory" and will ease next year, it claims, concluding Ireland's debt trajectory is high but sustainable.

Warning lights blinking

You could be forgiven then for thinking robust Government’s finances (even with the additional €38 billion of pandemic-related borrowing) will follow us into the post-pandemic period. There are, however, a number of warning lights blinking in the cockpit. We’ve been warned for several years that the current corporation tax windfall could vanish in an instant on foot of changes to the global tax system or because of the concentrated nature of the tax base here. The Government has put the cost to the exchequer of changes being agreed at OECD level at roughly €2 billion, while hinting a higher global minimum rate of 15 per cent, which has been agreed by most countries and, reportedly – despite its initial resistance – by Ireland, could be more corrosive.

There is also anecdotal evidence that multinationals here may be fast-tracking revenue from future years in order to pay their corporation tax liabilities on today’s terms ahead of a new deal. The frontloading of liabilities now could make the fall-off in receipts here up the line even steeper.

An even bigger issue facing the Government is how to pay for a bigger State with a bigger population needing more public services and better infrastructure, while investing in the green transition. The Government’s revised budgetary strategy – which envisages a series of bigger budget deficits to cater for additional spending on health and housing and climate-related infrastructure out to 2025– acknowledges the demographic pressures facing the State.

But with €2 billion in tax cuts built into the artithmetic and pledges to bring down Ireland's €240 billion debt, it may be over-reaching or at least attempting to marry too many objectives. The Irish Fiscal Advisory Council (Ifac) claims the Government is avoiding "hard choices".

And then there is the prospect that central banks have got it wrong on inflation – as many commentators and economists believe – and that it may be more than a transitory phenomenon and one that ultimately ushers in a new era of interest rate rises.

While most of Ireland’s debt is long-dated and therefore insulated from the immediacy of a upturn in borrowing costs, the country is carrying a welter debt burden. Even with the ultra low interest rate, servicing it has cost us €60 billion over the last decade.

“There is a much higher level of uncertainty surrounding the fiscal outlook than would normally be the case,” the Central Bank said in its latest bulletin.

“This reflects uncertainties directly linked to the pandemic, such as the final cost of support measures,” it said.

“It also reflects non-pandemic related issues such as broader government spending pressures and the potential impact of international tax reforms on corporation tax receipts,” it said.