Giveaway budget could 'overheat economy' and cause inflation to spike, watchdog warns

Parliamentary Budget Office said Government's failure to adhere to national spending rule risks 'adding more pressure to an overheating economy'

Budget likely to include cost-of-living supports and once-off payments, as well as tax cuts for workers and social welfare increases.

The Government is at risk of “adding more pressure to an overheating economy” with a budget spending splurge, an independent body has warned.

The Parliamentary Budget Office (PBO), based within the Houses of the Oireachtas, highlighted the Government’s failure to adhere to its own spending rules could cause inflation to be almost 2% higher than it would have been if it had followed the rules.

It comes ahead of next Tuesday’s budget, set to be delivered by ministers Jack Chambers and Paschal Donohoe, which is expected to include €1.4bn worth of tax cuts and changes and €6.9bn of public spending.

It is set to include cost-of-living supports and once-off payments, as well as tax cuts for workers and social welfare increases.

But, the PBO said there would be fiscal challenges ahead even with the positive economic indicators at present in Ireland.

“Despite all the challenges seen in the last few years, Ireland’s economy is in a very strong position,” it said. “Employment levels have reached unprecedented heights, reflecting a robust recovery and a dynamic job market.

This recovery is not without its risks. The domestic side of the economy shows signs of overheating, necessitating a cautious approach in the upcoming budget. Fiscal policy should remain prudent to avoid exacerbating these risks.

Last year, tax receipts were 50% higher than they were in 2019 and this upward trend has persisted into 2024, with receipts up 12.1% in the first eight months of this year compared to the same period in 2023.

But the office warned the heavy concentration of tax receipts among a few payers means this remains a “significant risk”.

Turning to the Government’s national spending rule, it said this was introduced in 2021 to constrain spending and tax cuts to a sustainable level of 5%.

“This rate is intended to align with the long-term growth of the economy, to stabilise the economy, avoid fuelling inflationary pressures, and prevent the boom-and-bust cycles that have historically affected Ireland’s economy,” it said.

However, since its introduction, this rule has never been adhered to, and the Government is projected to break the rule again in 2025.

“Failure to adhere to the national spending rule at this time risks adding more pressure to an overheating economy. It also means that when an economic downturn occurs, or there is a shock to the public finances, the Government will have less room to manoeuvre and will be less able to use fiscal policy to protect incomes and households from the negative impacts, as it did during the covid-19 pandemic.” 

The PBO said Government policies and programmes should aim to address longer-term challenges such as the growing and aging population, as well as climate change.

It added prioritising infrastructure “at this point is important in order to underpin the sustainability of the country”.

“In the event of an economic downturn, allocating resources for infrastructure investment may be challenging, and the focus may shift to maintaining services,” it said.