Income taxes may need to be increased if the economy were to overheat, the Irish Fiscal Advisory Council (IFAC) has said.
The fiscal watchdog said there is still enough room in the fast-growing economy but plans to ramp up capital spending and the increase in the construction new homes may soon devour any remaining capacity and expose the country and Government revenues to new dangers.
Its latest assessment was nonetheless broadly positive about the outlook for the economy and comes as the Organisation for Co-operation and Development (OECD) delivered its brightest outlook for the eurozone economy for many years. But off-setting the potential risks of overheating for the Irish economy would require a more robust economic plan and the Government ought to be ready to take money out of the economy, if required, IFAC said.
Severe signs of overheating would mean the Government should be ready to forego any plans to cut taxes, and should be prepared to increase personal taxes, its chairman Seamus Coffey said.
The economy has “perhaps” been growing beyond its potential in recent times and, any large rise in construction of new homes could generate huge amounts of revenues from employment taxes on builders and Vat on home sales, which the Government should be encouraged to put aside. Spending tax revenues generated by the “tax rich” business of building and selling homes to fuel the economy further increases overheating risks.
IFAC estimates that there remains “some slack” but that the so-called output gap is narrowing and the economy is close to its potential. “We could go to a stable position in the coming years or we could overheat,” said Mr Coffey. IFAC was concerned about where the building workers will be sourced to build well over 25,000 homes annually that will be required in the short term to catch up for the housing shortages, he said.
The plan to increase capital expenditure will mean that Ireland’s spending on capital projects will jump from one of the lowest levels in the EU during the crisis to the highest in the EU in 2022.
The Department of Finance should redesign its proposed “rainy day fund” and lift the funding cap of up to €500m a year to better help absorb excess resources, if the economy were to continue to grow strongly, the watchdog said. It also echoed concerns by an EU staff report last week which raised concerns about Ireland depending on revenues based on transactions from a potentially unstable taxes on commercial property transactions.
The increase in stamp duty to 6% from 2% announced in October was the centrepiece of Minister Donohoe’s revenue-raising measures that helped him adhere to the EU fiscal rules by offsetting other spending increases. The Government aims to raise €376m a year from the tax.
Relying on corporation tax generated by multinationals was also risky. IFAC said that corporation tax receipts have climbed to almost €16bn, or 16% of all Government revenue. IFAC detailed that using conventional economic measures, Irish debt had shrunk to only 63.7% of GDP in terms of Government revenue in 2016. However, using the new method of measuring the size of the Irish economy, Ireland has the fourth highest debt among the advanced economies of the OECD.