Plan for tax hikes to cool down economy: ESRI

House prices will continue to climb strongly over the next three years bringing closer the time when the Government may have to consider raising taxes to cool a potentially overheating economy, the country’s leading think tank has warned.

In its latest quarterly outlook, the Economic and Social Research Institute (ESRI) said the economy was not yet overheating but that the Government may have to start planning as soon as this time next year to take money out of the economy by raising taxes.

The ESRI said the budget next week needed to be “broadly neutral”, which may allow for small increases in spending and modest tax decreases in line with EU fiscal rules.

“Given the pace of growth over the past number of years, there is certainly no case for the Government to stimulate economic activity with the budgetary package,” it said.

But the Government will have to tread carefully in the coming years to ensure that capital spending does not bring the economy closer to overheating.

Plans by the Government to increase capital spending to €7.8bn by 2021 could hit Government finances and break EU fiscal rules.

“There needs to be investment, but it is how that is done in the next few years that is important,” it said.

Many new homes will be needed to meet housing shortages and before strong house price inflation is tamed.

Nonetheless, authors Kieran McQuinn and Conor O’Toole said the Central Bank does not need to tighten its mortgage lending rules, suggesting the Central Bank’s loan-to-income ceiling was set at an appropriate level at this time.

As the Government weighs the demands on capital spending, it said it favoured spending on social housing to tackle the homelessness, as well as investing in transport bottlenecks.

The ESRI said it would still use figures based on electricity connection figures to assess housing supply.

Goodbody said earlier this week that housing completions were much lower than official estimates which were based on power connections.

On the economy, the ESRI said it was more optimistic about the outlook.

The Government’s tax revenues had increased across most headings allaying earlier fears about income taxes and the health of the labour market.

And there was a still a “reasonable” demand for Irish exports even as the UK economy showed signs of weakening, and consumer demand will drive imports.

GDP will grow by 5% this year – matching the expansion of 2016 –and continue to grow in 2018, by 4%.

Unemployment will fall to 5.4% by the end of next year from 6.1% currently, increasing the risks of overheating.

“The most significant policy challenge facing both the current and next government is the challenge of successfully ‘managing the boom’.

Namely, how to progress from an economy such as Ireland’s which is rapidly recovering from a significant economic and financial shock and consequently enjoying elevated rates of economic growth into a more stable period of sustainable activity over the medium term,” the think tanks said.

It said that Brexit remained the greatest threat to the economy because the chances of the European Commission adopting plans for tax harmonisation were low.

On the Local Property tax, there needs to be a link between house prices when the tax is unfrozen in 2019, Mr McQuinn said.

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