David McNamara: Irish public finances buck a worsening European trend
European Commission president Ursula von der Leyen. The European Commission laid out its “AccelerateEU” energy plan, which allows member states to provide temporary supports and tax cuts to counter surging energy costs. Picture: AP Photo/Virginia Mayo
Recent positive momentum on markets gave way to further uncertainty last week, with some gains unwound. The swift rescinding of the opening of the Strait of Hormuz by Iran last week and stop-start peace talks have added to the sense of drift and uncertainty.Â
Oil prices have traded above the $100/ barrel mark in recent days, having reached $89 following the brief Iranian appeasement. Nevertheless, the existing ceasefires with Iran and Lebanon have been extended for a further three weeks, giving space for both sides to reach a compromise.
With countries bracing for a longer lasting shock, policymakers have begun to lay out fiscal supports to offset some of the shock. Notably, the European Commission has revealed its “AccelerateEU” energy plan, which allows member states to provide temporary supports and tax cuts to counter surging energy costs. Proposed changes to subsidies rules will allow countries to cover up to 70% of the cost of wholesale electricity bills until December, and up to 50% of the extra fuel costs. Many countries, including Ireland, have already jumped the gun in cutting excise duties and pausing carbon tax hikes due later in the year.
However, as I have stated here previously, wider fiscal deficits and debt will limit the ability of European governments to provide the level of support seen following the war in Ukraine in 2022. One exception is Ireland, with the release of the Annual Progress Report last week showing an even larger projected fiscal surplus in 2026 and 2027 than expected in last year’s Budget, of around €9bn - 2.5% of modified gross national income (GNI*) - in both years. This comes despite the Dept of Finance trimming its economic growth forecasts, on the back of the current geopolitical uncertainty.
The upward revisions primarily reflect larger corporation tax receipts, with €35.3bn expected to be collected this year, compared to a previous estimate of €34bn. Higher Vat receipts are also expected, amid rising inflation, enabling the Government to expand its expenditure ceiling - once again - by around €700m, and fund tax cuts to offset rising fuel costs.
However, as the Fiscal Advisory Council has pointed out, these surpluses are expected to dwindle towards 2030, with the Government planning to save just €1 out of every €6 collected in corporation tax. While sovereign wealth funds are being steadily increased in the coming years, debt will also rise in nominal terms by €30bn, suggesting that some borrowings will be used to meet transfer commitments to the funds.Â
While counterintuitive, if the investment returns from the wealth funds exceed Government borrowing costs, this approach can work well, but it does add a further element of risk to the Government’s fiscal strategy if interest rates shift in the medium term.
