Ifac warns that premature tax cuts could overheat the economy

Irish Fiscal Advisory Council warns that a downturn in the multinational sector would be a 'major fiscal challenge for Ireland'

The finance and enterprise departments have increased supports for businesses this year but Finance Minister Michael McGrath remains firm on his decision not to cut the Vat rate for hospitality. Picture: Brian Lawless/PA

The budgetary watchdog has warned government to show restraint this year when it comes to taxes, but a looming election could push politicians in the other direction.

The Irish Fiscal Advisory Council (Ifac) said the economy continues to “perform well” and therefore policymakers may be inclined to loosen budgetary policy through tax cuts, a move that Ifac suggested would be premature.

“Loose budgetary policy measures would add to price pressures and could overheat the economy,” said economist and Ifac chairman Michael McMahon.

However, a general election, which must be called before March 2025, is seemingly already weighing on politicians as stubborn costs continue to bite consumers and businesses.

Government departments, notably finance and enterprise, have already increased supports for businesses this year following lobbying activity.

However Finance Minister Michael McGrath remains firm on his decision not to cut the Vat rate for hospitality.

Ifac said cooling inflation has been mainly driven by falling energy prices but inflation in the domestic market continue to be elevated “particularly in cafes, restaurants and hotels". 

Softening budgetary policy may increase demand in the domestic economy and put further pressure on the economy, said Ifac.

Meanwhile, Finance Minister Michael McGrath defended the Government's "steady and prudent approach to managing the public finances", in response to Ifac's warnings. 

“Ireland has enjoyed several upgrades by debt ratings agencies, most recently from Fitch and can now borrow at rates on a par with or less than core eurozone countries such as France, Belgium, Netherlands, and Finland," said Mr McGrath. 

“This has been achieved at the same time as delivering substantial cost-of-living measures and investment in public services and infrastructure," he added. 

Mr McGrath also said a further surplus of €8.5bn is forecast for this year, following a cumulative budget surplus of just under €17 billion over the last two years,

However, Mr McMahon also predicted the Government will once again breach the 5% net spending rule despite an overall robust economy.

Mr McMahon said he expects the Government to increase spending by more than 5% this year and next year. He said: 

Since the rule was introduced in 2021, up to the end of 2024, the breaches add up to €8.5bn, or 9.7%. 

In its annual Fiscal Assessment Report, Ifac also reiterated concerns about the stability of Government revenue streams.

Ifac maintained its view that corporation tax receipts are highly concentrated and “could reverse suddenly.”

Mr McMahon added that while the risk exists he does not expect this to happen in the near future but called for increased savings into the Future Ireland Fund to insulate the economy from a downturn.

He also suggested that Ireland’s income taxes are vulnerable and “likely correlated with the performance of multinationals". 

Mr McMahon explained that a small proportion of highly paid employees pay a large portion of income tax receipts and these employees often work in multinationals.

Therefore a downturn in the multinational sector would be a “major fiscal challenge for Ireland,” said Mr McMahon.

In addition, the watchdog also said government spending on humanitarian aid measures should be included in future core spending projections as the refugee crisis is unlikely to be a temporary one.

“We still see problems with the continued use of reclassified things,” said Mr McMahon in relation to how humanitarian spending is communicated in government budgets.

“This fiscal gimmickry is undesirable and weakened transparency,” he said.