Budget 2022: addressing the post-Covid economic challenges
By economist Jim Power
Economist Jim Power
Leading economic analyst and commentator Jim Power will be guest speaker at our upcoming Budget 2022 breakfast briefing webinar. He will be joined by a panel that includes corporate finance partner Aiden Murphy and tax partners Lisa Kinsella and Cormac Doyle. The event, which will take place on Wednesday 13 October between 10.00-11.00am, will be moderated by audit partner Brian Geraghty. If you would like to join this webinar, contact colm.obrien@crowe.ie to register your interest.
The planning for any budget is always interesting, but particularly so during periods of turbulence and uncertainty. The past 18 months have obviously been difficult for the Irish and the global economy, but even as economic and business activity are being opened up, the legacy effects and the unanticipated consequences of Covid-19 are quite stark. What happens in the global economy has significant consequences for Ireland and the framing of budgetary policy.
The global economy is clearly bouncing back quite strongly as the restrictions are being lifted at differing speeds across the world. Not surprisingly, we are seeing a lot of pent-up demand coming back into the system, and this strong demand is meeting significant supply-side restraints. Commodity prices are rising strongly, with gas, oil and coal prices particularly problematical; shipping costs are soaring; labour shortages are evident and wage costs are rising; construction materials are becoming more scarce and more expensive; and global supply chains are generally under significant pressure. Headline inflation is rising strongly, but central banks are reticent about increasing interest rates and/or tapering back the bond buying programmes that represented the key response of central banks around the world, to Covid-19.
As a consequence of all of these developments, the outlook for the global economy, inflation, interest rates, bond yields and official interest rates is quite uncertain at the moment. While it is one thing to suggest that global growth will be driven forward by pent-up demand, the various legacies of Covid-19, particularly supply-side problems and elevated levels of government debt pose an enormous challenge. These are very unusual times for the global economy and global policymakers.
In Ireland, there is clear evidence of a strong and reasonably broad-based rebound in economic activity. However, growth is dominated by the multi-national sector, and some of the indigenous components of the economy are not performing as strongly.
Ireland was one of the few countries in the world to record positive GDP growth in 2020, but caution is required in interpreting Irish national accounts data. GDP expanded by 5.9% in 2020, but GDP grossly exaggerates the real health of the economy due to the distortions created by the multi-national sector in particular. Gross National Income* (GNI*) is a more accurate and representative measure of real activity in the economy. In 2020, GNI* contracted by 3.5%.
Official national accounts data for the second quarter of the year suggest an ongoing economic recovery. In the first half of the year, GDP was 16.3% higher than the first half of 2020, and GNP was 9% higher. Modified Domestic Demand was 4.3% higher. However, year-on-year comparisons with the first half of 2020 are misleading and it is more instructive to consider activity levels with the pre-Covid situation. GDP in the first half of 2021 was 20.8% higher than the first half of 2019, and GNP was 12.6% higher. This suggests a very strong growth performance despite Covid. However, growth was driven by the exceptionally strong performance of the multi-national sector. The indigenous component of the economy has performed less strongly. Modified Domestic Demand in the first half of 2021 was still 3.5% lower than the first half of 2019.
In overall terms, the dual nature of the Irish economy is very pronounced, but the indigenous economy is now recovering. However, there is still some catching up to be done.
In the first eight months of 2021, an Exchequer deficit of €6.7bn was recorded, but on a 12-month rolling basis, the deficit was €9.5bn. Total tax receipts in the first half of the year were 15.2% or €5.2bn higher than the equivalent period of 2020. Income tax receipts were 18.9% higher; corporation tax receipts were 8.1% higher; and VAT was 25% higher.
The strength of tax receipts reflects strong profitability in the multi-national component of the economy; a strong rebound in consumer spending; and the highest earning and highest tax-paying element of the labour force was not significantly affected by Covid-19. The very progressive nature of the Irish income tax system is ensuring that income tax revenues are remaining buoyant. The strong performance of multi-national profits is ensuring that corporation tax receipts are also buoyant.
Table 1: Tax Receipts (Jan-Aug 2021)
The economic growth projections will be crucial to the achievement of the budgetary strategy. Growth is projected to rebound strongly in 2021 and 2022, before settling down to a trajectory that looks consistent with Ireland’s growth potential. These economic growth projections look realistic based on what we know at the moment.
A core budget package of €4.7bn is targeted for Budget 2022. Of this total, €1.5bn will be set aside for new budgetary measures, with €500m directed at tax changes and €1bn for expenditure measures. The remainder is pre-committed. Budget 2022 will be a complicated affair and the real challenge for the government will be to wean the economy off Covid supports, start the process of restoring some semblance of order to the public finances, and ensuring that economic recovery is supported.
The debt objective is to stabilise the debt by 2023 and to reduce it gradually thereafter. Ireland’s government debt burden is dangerously high. However, in the period out to 2025 budget deficits are being planned for, albeit on a reducing basis.
The government is adopting an expenditure rule, whereby core (non-Covid) expenditure growth is tied to the estimated real trend growth in the economy. Government is going to allow permanent spending increase by 5% per annum in the post-pandemic years. If achieved, this would be a sensible, albeit generous strategy. Between 2022 and 2025, the government intends to deliver €49.4bn in capital spending.
Table 2: Economic & Fiscal Projections 2020-2025 from Summer Economic Statement
The planning for any budget is always interesting, but particularly so during periods of turbulence and uncertainty. The past 18 months have obviously been difficult for the Irish and the global economy, but even as economic and business activity are being opened up, the legacy effects and the unanticipated consequences of Covid-19 are quite stark. What happens in the global economy has significant consequences for Ireland and the framing of budgetary policy.
The global economy is clearly bouncing back quite strongly as the restrictions are being lifted at differing speeds across the world. Not surprisingly, we are seeing a lot of pent-up demand coming back into the system, and this strong demand is meeting significant supply-side restraints. Commodity prices are rising strongly, with gas, oil and coal prices particularly problematical; shipping costs are soaring; labour shortages are evident and wage costs are rising; construction materials are becoming more scarce and more expensive; and global supply chains are generally under significant pressure. Headline inflation is rising strongly, but central banks are reticent about increasing interest rates and/or tapering back the bond buying programmes that represented the key response of central banks around the world, to Covid-19.
As a consequence of all of these developments, the outlook for the global economy, inflation, interest rates, bond yields and official interest rates is quite uncertain at the moment. While it is one thing to suggest that global growth will be driven forward by pent-up demand, the various legacies of Covid-19, particularly supply-side problems and elevated levels of government debt pose an enormous challenge. These are very unusual times for the global economy and global policymakers.
In Ireland, there is clear evidence of a strong and reasonably broad-based rebound in economic activity. However, growth is dominated by the multi-national sector, and some of the indigenous components of the economy are not performing as strongly.
Ireland was one of the few countries in the world to record positive GDP growth in 2020, but caution is required in interpreting Irish national accounts data. GDP expanded by 5.9% in 2020, but GDP grossly exaggerates the real health of the economy due to the distortions created by the multi-national sector in particular. Gross National Income* (GNI*) is a more accurate and representative measure of real activity in the economy. In 2020, GNI* contracted by 3.5%.
Official national accounts data for the second quarter of the year suggest an ongoing economic recovery. In the first half of the year, GDP was 16.3% higher than the first half of 2020, and GNP was 9% higher. Modified Domestic Demand was 4.3% higher. However, year-on-year comparisons with the first half of 2020 are misleading and it is more instructive to consider activity levels with the pre-Covid situation. GDP in the first half of 2021 was 20.8% higher than the first half of 2019, and GNP was 12.6% higher. This suggests a very strong growth performance despite Covid. However, growth was driven by the exceptionally strong performance of the multi-national sector. The indigenous component of the economy has performed less strongly. Modified Domestic Demand in the first half of 2021 was still 3.5% lower than the first half of 2019.
In overall terms, the dual nature of the Irish economy is very pronounced, but the indigenous economy is now recovering. However, there is still some catching up to be done.
The fiscal situation
On the fiscal front, the public finances have moved into significant deficit since March 2020, but this is due to increased expenditure related to Covid-19, rather than a decline in revenues. In fact, tax revenues have held up remarkably well during the Pandemic. In total, it is estimated that the state has had to borrow €34bn more than it was planning to deal with the Covid-19 crisis.In the first eight months of 2021, an Exchequer deficit of €6.7bn was recorded, but on a 12-month rolling basis, the deficit was €9.5bn. Total tax receipts in the first half of the year were 15.2% or €5.2bn higher than the equivalent period of 2020. Income tax receipts were 18.9% higher; corporation tax receipts were 8.1% higher; and VAT was 25% higher.
The strength of tax receipts reflects strong profitability in the multi-national component of the economy; a strong rebound in consumer spending; and the highest earning and highest tax-paying element of the labour force was not significantly affected by Covid-19. The very progressive nature of the Irish income tax system is ensuring that income tax revenues are remaining buoyant. The strong performance of multi-national profits is ensuring that corporation tax receipts are also buoyant.
Table 1: Tax Receipts (Jan-Aug 2021)
| TAX CATEGORY | €m | % OF TOTAL | YOY CHANGE |
| Income Tax |
16,516 |
41.9% | +18.9% |
| VAT | 9,816 | 24.9% | +25.9% |
| Corporation Tax | 7,002 | 17.8% | +8.1% |
| Excise | 3,614 | 9.2% | +8.3% |
| Stamps | 995 | 2.5% | +14.3% |
| Capital Gains Tax | 273 | 0.7% | -2.1% |
| Capital Acquisitions Tax | 193 | 0.5% | +42.1% |
| Customs | 313 | 0.8% | +90.3% |
| Motor Tax | 643 | 1.6% | -1.9% |
| Total | 39,442 | 100.0% | +15.2% |
Source: Department of Finance
In Budget 2021, the Department of Finance targeted a deficit of €20.5bn (5.7% of GDP) in 2021. Based on the first eight months of the year and the stronger than expected growth, the deficit is more likely to come in at less than €17bn. While such an outturn would provide some comfort, it would still represent a significant level of borrowing.
The Summer Economic Statement
The Summer Economic Statement sets out the medium-term projections for economic activity and the public finances. Despite the strength of tax revenues and economic growth subsequently, the Minister for Finance has made it clear that the parameters set out in this statement will form the basis for Budget 2022.The economic growth projections will be crucial to the achievement of the budgetary strategy. Growth is projected to rebound strongly in 2021 and 2022, before settling down to a trajectory that looks consistent with Ireland’s growth potential. These economic growth projections look realistic based on what we know at the moment.
A core budget package of €4.7bn is targeted for Budget 2022. Of this total, €1.5bn will be set aside for new budgetary measures, with €500m directed at tax changes and €1bn for expenditure measures. The remainder is pre-committed. Budget 2022 will be a complicated affair and the real challenge for the government will be to wean the economy off Covid supports, start the process of restoring some semblance of order to the public finances, and ensuring that economic recovery is supported.
The debt objective is to stabilise the debt by 2023 and to reduce it gradually thereafter. Ireland’s government debt burden is dangerously high. However, in the period out to 2025 budget deficits are being planned for, albeit on a reducing basis.
The government is adopting an expenditure rule, whereby core (non-Covid) expenditure growth is tied to the estimated real trend growth in the economy. Government is going to allow permanent spending increase by 5% per annum in the post-pandemic years. If achieved, this would be a sensible, albeit generous strategy. Between 2022 and 2025, the government intends to deliver €49.4bn in capital spending.
Table 2: Economic & Fiscal Projections
| 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | |
| GDP | 3.4% | 8.8% | 5.1% | 3.7% | 3.3% | 3.2% |
| Modified Domestic Demand | -5.5% | 2.6% | 7.4% | 3.8% | 3.4% | 3.4% |
| Total Employment (000s) | 1,972 | 2,051 | 2,276 | 2,351 | 2,405 | 2,457 |
| Employment | -15.1% | 4.0% | 11.0% | 3.3% | 2.3% | 2.2% |
| Unemployment Rate | 18.7% | 16.3% | 8.2% | 6.7% | 6.0% | 5.5% |
| Total Voted Gov Spending (€m) | €85,285 | €90,720 | €88,200 | €85,100 | €89,040 | €93,230 |
| General Gov Balance (% GDP) | -5.0% | -5.1% | -3.4% | -1.8% | -1.6% | -1.5% |
| General Gov Balance (% GNI*) | -8.9% | -9.4% | -6.2% | -3.3% | -3.0% | -2.8% |
| Gen Gov Debt (€bn) | €218.2 | €241.5 | €252.3 | €262.3 | €273.4 | €281.7 |
| General Gov Debt (% GDP) | 59.5% | 60.3% | 58.9% | 58.1% | 57.7% | 56.7% |
| General Gov Debt (% GNI*) | 105.1% | 111.8% | 108.6% | 108.0% | 107.7% | 106.3% |
Source: Department of Finance, Summer Economic Statement, 14 July 2021
Key issues for Budget 2022
The prospects for economic recovery in the second half of 2021 and into 2022 are positive. The economy is now being steadily re-opened and economic activity is rebounding strongly. However, from a fiscal perspective, the legacy of government debt in the aftermath of the pandemic will have a significant influence on fiscal policy over the coming budgets. In addition, for those businesses most adversely affected by the Covid-19 restrictions and who are left with a significant debt legacy, it will take some time for full business recovery, and continued State support will be required.
Clearly, the fiscal parameters set out in the Summer Economic Statement suggest that the package of measures will be limited. There will be little scope for any meaningful tax reductions, apart from some indexation of bands and allowances, and spending will have to be brought back under control. The key issues that should guide Budget 2022 include:
- The economy is recovering, but there is a very pronounced dual economy. The indigenous component of the economy is lagging the very strong multi-national component of the economy. The provision of support to the SME sector in particular is important.
- Covid-related financial supports are being wound down. However, some of the worst affected sectors of the economy now have a significant debt legacy and will require ongoing support for some time.
- Labour shortages are evident in many sectors of the economy, so policy will need to incentivise labour force participation to the greatest extent possible and ensure that apprenticeships are expanded. An immediate ending of the PUP scheme would be appropriate.
- The public finances will have to be brought back into balance over the coming years. This will necessitate tight control over government expenditure and the maximisation of tax revenues. The objective is to eliminate the high level of borrowing that had to be put in place to deal with Covid-19 by 2023. Hence, this will need to be addressed in Budget 2022 and Budget 2023.
- The threat to future corporation tax receipts from international tax developments means that the public finances will have to be manged as prudently as possible. There is no guarantee that the current record levels of corporation tax will be sustainable, so it is important to plan for the eventuality of a significant reduction at some point in the future. Basing future expenditure plans on a tax base that may not be sustainable would be a risky strategy. This is what happened in the years leading up to 2008.
- Addressing climate change and ensuring the necessary incentives to change consumer behaviour are in place will be very important. This is particularly relevant for the transport sector. Carbon taxes will be increased in Budget 2022 and support will be given to avoid fuel poverty issues.
As is always the case, Budget 2022 will contain many small measures that will have very limited impact on the majority of citizens. It is important that anti-business measures are avoided in the current environment of post-Covid uncertainty and volatility.
Jim Power will be guest speaker at Crowe’s upcoming Budget Briefing webinar, which will be held on Wednesday 13 October from 10.00-11.00am. If you would like to join this webinar, please contact [email protected] to register your interest.
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