The Government is adopting a “risky” budgetary strategy that “avoids making hard choices” and may ultimately overheat the economy, the Irish Fiscal Advisory Council (Ifac) has warned.
In a pre-budget statement, the budgetary watchdog said the Government’s recent summer economic statement, which envisages both higher spending and tax cuts out to 2025, marked a “major shift in policy” that could leave the State more vulnerable to future financial shocks.
The Government needs to prioritise between tax cuts planned, the pace of investment expansion and the speed of increase in current spending, the council said, suggesting it cannot do all three simultaneously.
“The Government’s summer economic statement sets out a policy to expand public services, ramp up government investment and cut taxes all at the same time,” Ifac chairman Sebastian Barnes said. “This avoids making hard choices and leaves the public finances more vulnerable to growth shortfalls or higher interest rates.”
In the summer statement, the Government altered its original plan to move to a balanced budget by 2025 in favour of running a sequence of larger budget deficits to allow for increases in age-related spending and greater investment in housing and green infrastructure.
High public debt
The revised plan will involve €18.8 billion in additional borrowing.
The council warned, however, that running “significant budget deficits” during a period of strong growth and with high public debt carries risks.
“Many factors would argue for a more cautious approach to budgetary measures in the coming years: the rapid budgetary expansions pursued in recent years; the likelihood of a strong recovery and risks of inflation and overheating from persistent government borrowing; and the need to set high debt ratios on a steady downward path,” it said.
It cautioned that borrowing and ramping up spending during a strong recovery could “backfire”, leading to higher costs for the same level of output should capacity constraints bind.
It also highlighted supply constraints in the construction sector as a potential inflationary trigger.
The upward revisions to spending contained in the summer statement increased the probability of the Government finding itself on an unsustainable debt path to about 25-30 per cent, a more than one-in-four risk, the watchdog said.
In its report, the budgetary watchdog warned that the Government would face mounting pressures in the coming years related to ageing, climate change, health spending and the continued over-reliance on corporation tax receipts.
It suggested “a more prudent approach” would be to limit current spending to a slower pace of increase or raise taxes at the same time as the ramp-up in public investment spending.
It warned that the spending increases planned in Budget 2022 were “at the limit of what is prudent”.
Minister for Finance Paschal Donohoe has signalled that next month’s budget will be framed around a €4.2 billion hike in spending with €500 million set aside for tax cuts.
“This is modestly above estimates of the underlying potential growth rate of the economy but would help to support the recovery,” Ifac said, describing the planned €1.1 billion hike in capital spending as “relatively fast”.
More generally, the council said the Irish economy was recovering swiftly as vaccinations progress and that an unwinding of savings accumulated during lockdown would result in a “faster bounce back”, which would limit the long-term losses associated with the pandemic.