Government has €200m to fund tax cuts in 2018 Budget

The Irish Government has just published the Summer Economic Statement which sets out updated economic  and fiscal forecasts, with emphasis on the 2018 Budget, scheduled for delivery in October.  Economic growth this year is still expected to be 4.3%, slowing marginally to 3.7% next year,  while the main change in the fiscal outlook over the medium term is higher capital spending, which means that Ireland continues to run a modest deficit until 2020. The new Minister for Finance also reiterated that a ‘rainy day’ fund  would be initiated in 2019, although now at €500mn per annum instead of the €1bn indicated by his predecessor.

Most interest will no doubt centre on the outlook for the upcoming Budget and the resources or Fiscal Space available to the Government to fund new spending or tax reductions. Under the existing euro fiscal rules an Expenditure benchmark is set and it now appears that Ireland will breach  the 2017 limit by some €500mn or 0.2% of GDP, so the Government now intends to undershoot the 2018 benchmark, albeit modestly.

The latter is determined by the European Commission and dictates that Ireland must limit  spending  next year to  €71.2bn from €69.6bn in 2017, a rise of 2.4% ( the benchmark excludes certain items, notably debt interest and some capital spending).  That gives a Fiscal space of €1.6bn or €2.1bn given that Ireland does not index its tax system (i.e higher prices and wages would increase tax revenue by around €500mn). Some  €800mn of that will be eaten up by demographic pressures on spending and prior commitments on pay, leaving a net figure of €1.3bn, which the Government has chosen to limit to €1.2bn.

That would translate into €1.5bn in cash terms ( because not all of any additional capital spending is included in the  Benchmark) and the Statement indicates that €1.1bn of this will take the form of additional spending ( €0.6bn current and €0.5bn capital ) leaving €400mn for tax reductions. Further, the carry over effects of last year”s cuts will use up almost €200mn of this , leaving just €200mn on budget day to fund  net tax cuts ( leaving aside any refund of water charges)

Of course it is always open for the authorities to free up additional resources by cutting  some existing spending programmes or indeed  raising indirect taxes if it wants to pay for a reduction in income tax or USC. To that end it is noteworthy that the Department of Finance has drawn attention to the cost of the cut in VAT introduced in 2011 to support the tourism and hospitality sector ( from 13.5% to 9%) . The cost of accomodation has risen by over 20% since that move, and reports suggest that the lower rate is costing the Exchequer around €0.5bn. On the available arithmetic the Government will not be able to fund any meaningful direct tax cuts unless it finds money elsewhere.

Irish Fiscal deficit may rise this year

Ireland’s GDP is unusually volatile, as is government revenue, which makes  for frequent forecasting errors in both. For the last three years the errors have proven positive, in that tax receipts have emerged ahead of Budget projections, resulting in lower than anticipated fiscal deficits as well as allowing the government of the day to augment spending in the latter months of the year.  Unfortunately that serendipitous trend appears to  be over, judging by the revenue figures available to end-April, and a tax undershoot for the year is looking more likely.

The 2017 Budget projected tax receipts of €50.6bn, and the Department of Finance still expects that to materialise, which requires a 5.8% increase on the 2016 outturn. Yet the annual increase over the first four months of the year is just 0.5%, with most headings actually down on last year, implying a serious risk of undershooting. Corporation tax has been the most difficult to forecast (exceeding the target by over €700m last year and by an extraordinary €2.3bn or 50% in 2015 ) and is currently some 23% down on 2016, with Stamp duty, Excise and Capital taxes also running well below the previous year in percentage terms.

The main exception is VAT, which is extremely strong, rising at an annual 14.5% or double the pace forecast in the Budget. This is curious given that retail sales grew by an annual  0.9% in the first quarter, but may reflect strong car imports and a rise in house completions. Income tax is also a puzzle, showing annual growth of just 1.2%, which appears at odds with other data implying a continuation of strong employment growth. The Budget forecast that Income tax receipts would end the year 5.6% above the 2016 outturn so , again, there is a lot of catching up to do if that target is to be hit.

The tax position against profile ( i.e. that expected on a monthly basis) is also  likely to be of concern to the Government, with a shortfall of €345m or 2.4%. VAT is running €257mn ahead but that has been more than offset by large shortfalls elsewhere, including €225mn in Corporation tax, €200mn in Income tax and  €120mn in Excise duty. The late Easter may be having an impact and Corporation tax is extremely lumpy on a monthy basis but the risk now is that the fiscal deficit will emerge above the current target of 0.4% of GDP. Moreover the 2016 outturn has now been revised down to just 0.5% so the 2017 figure may well be above this. A 2.4% shortfall in tax receipts at the end of the year, for example, equates to €1.2bn and all else equal would raise the deficit to 0.8% of GDP.

Does it matter?  The Exchequer’s cash position will  likely  be boosted by proceeds from the  sale of shares in AIB , so the debt ratio may well continue to fall. That transaction will not benefit the General Government balance, however, although Ireland has no longer to meet a  headline target for the latter under EU fiscal rules. In fact there are two, related constraints, which will come into play for 2018. One is that the deficit adjusted for the economic cycle  (the structural balance) has to fall by over 0.5% of GDP, and to aid in that process  a limit is put on government spending ( the famous Fiscal Space). The latter is already closing given an array of  spending commitments carried over into 2018 but the Government would not be able to use all the available space anyway if the  tax base emerged below forecast in 2017.