Budget '25; giveaways that will lead to Boom and Bust or a balanced if imperfect set of measures?

If you rely on media headlines from the morning after Budget ’25, you might think? that it ranks as one of the greatest fiscal follies of all time.

The Irish Independent offers -‘Morally bankrupt, fiscally amnesiac and nakedly political – Budget 2025 has more money than sense in attempt to buy election’. The Irish Times notes -‘Budget 2025 repeats Ireland’s past mistakes of pumping billions into the economy when it is at full employment, says Irish Fiscal Advisory Council’. RTE proclaims - Supercharged expenditure this year, plus huge spending package’ and Budget 'fiscally irresponsible' – ICTU.

Is Budget ’25 really that foolish, that dangerous? In my clearly minority opinion, the answer is no. Is it perfect? Far from it but, in a far from perfect world, most of the mistakes it makes are on the right side in terms of the range of economic and social risks facing Ireland at present.

Nobody can predict exactly what will happen in coming years but we do know we have a substantial surplus in the public finances at present and even more substantial deficits in housing, healthcare and other economic and social infrastructure. Tackling these real deficits rather than still phantom overheating risks suggests that the real error would have been to do less than it did.

Let’s run through some of the major criticisms;

1.?????? The roughly 10bn increase in Government spending. Is it way too much?

Of this figure, roughly €5bn is to maintain the existing level of public services. Yes there are overruns in areas such as health that need to be managed much better, and some spectacularly large and small examples of runaway spend on projects but would it really make sense to cut back on public sector services as we head into winter (or towards an election)? Would we improve Public sector delivery overnight by refusing to fund often vital services when the State coffers are full?

The increasing cost of running Government is not a problem unique to Ireland although much domestic commentary might suggest otherwise. Look at the scale of deficits elsewhere. The US? at 7% of GDP and set to rise because of election promises, France, over 6% of GDP and the UK at around 4% of GDP and forcing the new Labour Government into all sorts of rule changes and climbdowns ahead of an end-October Budget causing ‘fear and foreboding’.

For me, this €5bn addition is an expensive, possibly poorly managed but, in the end, necessary cost of doing the range of things ?that Government is supposed to do. As such, I seem to be in a very small minority of economists who don’t see that this €5bn as an unfortunate unavoidable cost rather than as a spending splurge or a ‘giveaway’. ??

2. are tax cuts of around €1.5bn, social welfare increases of €1.2bn and a cost of living package of around 2bn not an excessive 'giveaway'?

Most reasonable people might expect Government interventions such as social welfare payments and tax adjustments not to leave people worse off when account is taken of inflation. On my reckoning, Aggregate household disposable income will be somewhere around €175bn-give or take- in Ireland in 2024. The three ‘giveaways’ above sum to about €4.7bn or roughly 2.7% of household income-just fractionally above the amount needed to ‘index’? tax and Social Welfare changes.

So, if you define keeping in line with inflation as a 'giveaway', then Budget '25 is a giveaway but if you take the view that indexing or correcting for inflation is neutral and probably the very least tat might be expected, you'd reach a different conclusion. In that case, the Budget should be seen as falling well short of a pre-election ‘bonanza’ and is altogether less generous than those seen in Celtic Tiger times.

In circumstances, where average household incomes have fallen in recent years, where increased risks of child poverty are only starting to surface in polite conversation and where still elevated energy costs represent a serious problem for many households, the side to err on is clearly to do more rather than less even if these difficulties are not as evident in the circles in which many economists and journalists move.

Granted some consumers don't need further energy supports or extra children's allowance payments but in circumstances where it is difficult to decide who is in fuel poverty or whose children are under financial strains, would it be better to include too many or exclude too many?

3.?????? The Government is stoking up inflation in Ireland?

The canary appears to have left the coalmine. Yesterday (October 1st) saw the release of preliminary Eurostat inflation data for September. Ireland now has the lowest inflation rate of the 20 economies in the Euro area at just 0.2%. The Euro area average is 1.8%. Admittedly, the low figure in Ireland and elsewhere owes much to a recent softening in energy costs but if the Government here was putting fuel on the fire Ireland’s inflation rate would be higher than elsewhere.

It is not true that ‘domestic elements of inflation are running at Celtic Tiger levels. It is generally argued that while ‘goods’ prices are driven significantly by international forces, services prices owe more to domestic influences. The graph below shows the CSO measure of Irish services price inflation excluding mortgage interest costs (because interest rates are set in Frankfurt rather than North Wall Quay).

As the diagram suggests, the latest reading for August 2024 shows a ‘domestic’ inflation rate of 2.3% well below the experience of recent years and far below the 5.1 per cent average seen between the Celtic Tiger era from the start of 1999 to the end of 2006.?Moreover, if domestic price pressures were building, we would have locked in the higher externally energy/food cost driven inflation of recent years rather than seeing the dramatic slowdown evident in the diagram below. ?

If the evidence of runaway Irish inflation is scant at present, perhaps it's bubbling under in some form and the assertion that we are back in the boom and bust territory of the Celtic Tiger might still be made.

Of course, one can always find some similarities between any two periods (wasn’t the recent summer much like the winter that preceded it?) But there are also clear differences. One ??marked difference is borrowing. Twenty years ago, private sector credit was increasing by about 25% year-on-year. In the year to August 2024, the increase was just 1.8%.

In the same vein, over the past five years, overall domestic demand in the Irish economy ( as captured by final modified domestic demand) ?grew on average by 3% per annum but the Irish economy’s supply side capacity, as very roughly proxied by employment, increased by a somewhat faster 3.5% per annum.

In stark contrast, over the nine Tiger years, demand ran far hooter than supply. From the beginning of 1999 to the beginning of 2008, demand increased by 9.9% per annum on average but supply (as signalled by employment) only increased by 3.3%. So, demand was running far hotter in absolute terms and relative to supply during the Tiger era than it is today- circumstances that might explain why our recent inflation record is altogether different to that earlier period. ???

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4.????Is the Government not costing us all an extra €1000?

While the IFAC post Budget ‘flash’ was carefully worded and stated that ‘Large budget packages in recent years have put money back in people’s pockets. But they have taken it away by pushing up prices. By breaching its rule, the Government is estimated to add €1,000 to the cost of a typical household’s yearly outgoings’ this doesn’t really tell the full story.

The €1,000 cost estimate from IFAC is based on Central Bank of Ireland research that looked at the impact of additional Government spending on the economy. That extra spend boosts activity and some of that extra activity spills into higher prices. However, the boost to spending power in the economy is much greater than the boost to prices as the diagram below from relevant Central Bank publication (CBI Quarterly Bulletin June 2024 p126) suggests, meaning that although inflation might be a little higher, consumers are a lot better off.

Indeed, on my reading of this piece, Government actions make households much better off because household spending power (as proxied very conservatively by domestic demand-this could be a significant underestimate) rises by at least 21/2 times the increase in prices? or around €2500 even if prices may be higher by €1,000.

These attempts to put the IFAC €1000 prices reference in a proper context suggests an altogether less damaging impact of extra Government spend, a full ‘disclosure’ might also mention that without substantial Government supports through the cost-of-living crisis, the average household spending power would have been reduced by a cumulative inflation surge of 14.6% in 20022 and 2023. Compared to ‘normal’ inflation of 2%, this surge would have reduced the spending power of the average Irish household by around €5,000. ?????

More generally, the Central Bank research might support rather than oppose the case for a bigger Budget boost. The diagram from the CBI shown above suggests real economic activity also rises much faster than prices for only a fractional worsening of the fiscal position. ?In the round, this CBI research might suggest that extra Government spending in recent years has been quite a positive development. ?

As an aside, in technical terms, the CBI research shows the fiscal multiplier is positive and, as the impact of the boost to demand on activity is much greater than on prices, the implied slope of the aggregate supply function is ?around 30 degrees-not 90 degrees as would be the case if the economy was at full employment. ?

More generally, significant elements of recent research appear to challenge at least some elements of the simplistic ‘Budget boosts are bad ‘ mantra so popular in many parts at present. Some recent research presented at an ECB conference on challenges for fiscal and monetary policy in July ( Fiscal Stimulus with Supply Constraints ( europa.eu ) found that in an economy with supply constraints ‘ A persistent fiscal stimulus, instead, may boost firms’ investment and productivity growth in the medium run, while having only a transitory impact on inflation’.

In the same vein, more recent research presented at the ECB’s ‘flagship’ research conference on September 19th, found that significant fiscal supports might enhance the supply side of the economy by alleviating financial stress (The Economics of Financial Stress ( europa.eu ) ).

In light of the strains discussed at length in the analysis of the September consumer sentiment survey, the case for substantial and wide-reaching supports in Budget ’25, to offset damaging financial stress impacts should not be understated. ???

5.?????? Is the Government fiscally irresponsible?

Of course, it might be argued that even if fiscal policy worked that we simply can’t afford it. Let’s take it as read that the condition of the public finances across most western economies is much worse at present (as the references above to the US, UK and France clearly indicate).

Even if we exclude a likely enduring and possibly too large estimate of corporation tax receipts ( as well as the Apple case funds) and further assume a marked slowdown in the economy, IFAC’s the resultant estimate of the ‘underlying structural ?position is one of a deficit of 2 1/2 per cent of GNI* or -what matters externally-1 ? per cent of GDP.

It should be noted that many of the cost-of-living supports are once-off rather than permanent in nature while corporation taxes are projected to be €14bn higher in 2030 than in 2023. In circumstances where the economy needs a sharp increase in infrastructure and many households are still struggling with living costs it would be politically irresponsible, economically illiterate and socially unconscionable to do less than Budget ’25 did.

6.?????? Might we have expected more from Budget ‘25

In light of the deafening roar of disapproval, it seems unrealistic to argue that the Budget could have been a bit braver on infrastructure spend even if this is the case. The use of the €3bn proceeds from the AIB share sale to support infrastructure spend will help but?a bit more might have been tried.

Given the looming election, the current Government couldn’t set out plans for the proceeds of the Apple tax case and it might be that the upcoming election manifestos will give us some sense of a much-needed step-up in infrastructure spend. Then again……….. ?

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