A budget has rarely been drawn up in such a context of uncertainty. And rarely has there been such pressure to act; to respond to the cost of living crisis and to deal with longer-term issues in areas such as housing and health. The latest figures, showing inflation close to 10%, have further raised the political bar – and many price pressures have yet to trickle down to consumers.
A great battle is brewing over what to do, not only between the government and the opposition, but within the government itself. It’s framed by the contrast we’ve seen all year in the economy – strong growth now and vastly higher tax revenues, but huge uncertainty about how things will play out next winter and fears of a more fundamental economic downturn or reorganization the economy is at a turning point, we just don’t know how steep the turn will be. And in terms of fiscal policy, turning points are dangerous ground.
At first glance, there are significant resources to spend. Tax receipts for the first five months of the year are well ahead of target – well in excess of the billions. The question is what the situation will be next year, if growth takes a hit or if there is some kind of international recession. Dependence on corporate taxes at a time when big US tech players are under market pressure, and some could see their profits plummet, is a particular problem.
Frankly, who knows? You might as well talk to a military analyst or supply chain logistics expert as an economist
The tactic of the budget ministers – Paschal Donohoe and Michael McGrath – is to try to focus much of what might be called emergency spending on one-off measures, rather than permanent commitments. Thus, for example, the energy bonus of €200 for households could be renewed and there could be more one-off payments to those who benefit from the fuel allowance, or even more generally from the social protection system.
This same approach has been used during Covid-19, with some success, through measures such as the Pandemic Unemployment Payment and the Wage Subsidy Scheme. These are very expensive, but have done the job and could be phased out in the future, although in areas like health much of the increase seems to persist. This approach allows some time to see how things unfold without making too many long-term commitments.
The government will release economic and fiscal forecasts in the Summer Economic Statement due out Monday. He should point out that the rule announced last year to keep spending increases permanent at 5% is not fit for purpose in a world with much higher inflation. Larger increases will be needed in the face of rising inflation if the real value of spending is not to be reduced.
The existing indication that there will be €1 billion in new spending on budget day will be dropped – there will be a lot more.
How much more is the question? What is the right balance between being realistic and maintaining state services and actually chasing inflation and making the problem worse?
The Department of Finance will follow consensus estimates that the economy will continue to grow, just a little slower. But honestly, who knows? You would be talking to a military analyst or supply chain logistics expert as well as an economist. Or at Mystic Meg,
Clearly the world has changed post-Covid and with ongoing conflict in Europe. Everything feels upside down. But how transitory is it? Donohoe raised the possibility of a new era of lower growth and higher inflation, which would have big implications for public finances. The right fiscal response largely depends on the magnitude of the shock and upheaval we are currently witnessing and what this means for the Irish economy.
We just don’t know, so here are some principles that should be followed.
First, there are clearly groups who are suffering a lot from the price spike and who need to be helped. Significant increases in well-being are clearly expected. But beyond that, temporary measures can play an important role in helping people get through the winter. This can of course create problems when the temporary measures expire, particularly if inflationary pressures remain high.
Second, the income tax system must be adjusted to some extent, at least for inflation, otherwise a higher salary will mean a proportionately higher tax take. Thus, the first indications of a budgetary fiscal package of 500 million euros will be set aside. More will be needed to adjust tax brackets and credits and to extend the current excise fuel tax reductions. But the idea that tax levels can be “reduced” is a mistake.
Third, measures to provide greater public subsidies in areas such as childcare are reasonable, but the political system still does not accept that the increased role of the state will have to be paid for. So will population aging and climate change policies. Our politics is stuck in an era of zero interest rates, but the world has moved on.
The fourth key factor will be to set aside money from the abundant resources now available in some sort of rainy day fund. Because unexpected rainy days are more and more frequent. The emergency resources set aside this year for Covid and Brexit have proved useful, but not in the expected way.
The government cannot – or should not – sit idly by. There’s a lot it needs to do, although you can’t help but wonder how much money is needed in areas like health and housing to make decent improvements to services. The efficiency with which money is spent will never be discussed on budget day.
But for now the focus is on the short term. Whatever happens, it will be the biggest budget package for many years. But it’s about finding the right balance. Betting the house on the continuation of the current increase in tax revenue would be a very serious error. Failure to do so will require avoiding the traditional budget game of looking at how much money is available to spend and then arguing over who gets what. In the current political context, where caution does not seem to win many votes, it will not be easy.