Tax Services

Medium-Term Fiscal Statement

Ernst & Young's reaction

Special Economic Advisor to Ernst & Young Graeme Harrison comments on the Medium-Term Fiscal Statement (November 2011)

Issues to welcome in the Statement and from recent performance

• There has been progress in 2011  to reduce the general government deficit in line with ECOFIN Council targets – this is especially important given the continued difficult economic backdrop domestically and internationally
• The statement maintains a pro business stance and reconfirms our position on corporation tax which will help boost our international reputation&
• There is continued emphasis on competitiveness and the importance of exports and Foreign Direct Investment – and indeed the improvements made to competitiveness recently and strong export performance. Ireland could easily have been in a much worse economic situation today and the economy is showing signs of coming out of recession with positive GDP data in Q1 and Q2
• Medium-term budget timeframe 2012-2015 – no longer an annual budget process – and creation of binding expenditure ceilings

Remaining challenges

There is greater fiscal adjustment emphasis on expenditure reducing measures. There is also acknowledgement of the outstanding challenges including:

• Difficult global economic environment in 2012 – GDP growth forecast has been downgraded
• Implementing further fiscal adjustments between now and 2015, following a number of years of austerity already
• Scale of the public debt challenge – debt to GDP ratio still as high as 90% in 2026 if  things go well, debt interest burden one-fifth of tax revenue
• Kick-starting domestic demand
• Unemployment will fall only slowly with jobs largely dependent on recovery in domestic demand
• Restoring business and consumer confidence

Details missing from the Statement

• While the Statement acknowledges risks to the economic and budgetary outlook, the high probability of some of these risks being realised is not adequately addressed
• The framework is rightly predicated on a baseline scenario but as the probability of the baseline is much lower than normal – due to the abundance of downside risks – more consideration should have been given to a downside scenario and ideally there would be a contingency fiscal framework is downside risks materialise.
• In this regard greater front-loading of fiscal adjustment may have been more prudent given the higher likelihood of under-performance, in order to remain on track to meet fiscal targets. When it comes to a trade-off between fiscal targets and growth, the reality is Ireland will have to prioritise fiscal targets.
• It is a difficult balance between even greater front-loading of fiscal adjustment and allowing the shallow economic recovery to continue. While the Government may have a choice on this issue now and has financing sources in place to meet its funding requirement until end 2013, wider market and sentiment changes, and external pressure from the EU/IMF, could force the Government’s hands.

How realistic is the framework?

• 1.6% GDP growth in 2012 – growth has been downgraded but still potentially optimistic given the state of the global economy
• 2.8% GDP growth pa 2013-2015 – this growth is part predicated on a positive net stock build up each year, any boost from stock build up is likely to be more temporary. A more realistic stock profile would lower GDP growth pa by approx 0.2-0.3% pa
• Overall GDP growth forecasts are a little on the optimistic side.
• Speed at which banking sector and lending will return to normal to support domestic demand growth is key. This is another unknown and perhaps the assumptions should be more cautious on this.
• Employment growth of +65,000 by 2015 – this would appear to be ambitious and dependent on the success of policies. This is higher than Economic Eye net job creation forecast.

Future risks which will impact the plan

• It is difficult to predict the appetite for lending to the Government by end 2013 when existing funding sources expire – debt to GDP ratio will still be rising and be over 100% GDP, and primary surpluses will need to be run for a number of consecutive years which is easier said than done. Ireland will not be ‘out of woods’ for 10-15 years – this needs to be emphasised more in the Statement that much remains to be done after 2015.
• A considerable weight is placed on the link between the savings rate and consumer spending, and the assumption that the savings rate will fall over time, allowing consumer spending to start to grow. Although difficult to model, there are a number of other factors that will impact on consumer spending that do not appear to be fully incorporated into the forecast. These include: the risk of future rises in interest rates, the extent of negative housing equity, out-migration (especially as unemployment is forecast to remain high), downward wage pressures etc. Again many of these are problems that will take several years to solve.
• Forecast investment growth, while relatively muted, also faces numerous downside risks, such as the overhang of housing supply, risk averse bank lending etc.

Tax Partner Joe Bollard comments on today's Medium-Term Fiscal Statement (November 2011)

Today's Statement provides for total adjustments of €12.4bn in the 4-year period 2012-2015.  This adjustment will involve expenditure reductions of €7.75bn and €4.65bn of additional taxes.  The adjustment will be front-loaded with €3.8bn slated for 2012.  Tax revenues are projected to increase €1.8bn in 2012.

Revenue raising details remain to be seen

The Government is fully committed to adhering to a GDP deficit target of 8.6% for 2012. While tax raising details will not be announced until 6 December the Programme for Government commitment to maintain existing income tax rates, bands and credits will be honoured, at least in 2012. This will require revenue raising measures in other areas.

Competitiveness

The Statement seeks to reduce the deficit while preserving Ireland’s international competitiveness and fostering an environment in which domestic recovery can occur. The Government has stated that it “will continue to develop and implement policies designed to improve the competitiveness of Ireland’s internationally trading sectors and enhance Ireland’s attractiveness as a place in which to set up and grow business”. The Government’s commitment to the 12.5% corporation tax rate as a cornerstone of industrial policy is a key part of this strategy.

VAT

The Government, as expected, has confirmed that indirect taxes such as VAT, excise duties and carbon tax are being examined to determinehow these can contribute to the deficit reduction. The question appears to be not if the standard rate of VAT will increase to 23%, but rather over what time scale it will occur. The previous Government in its 4-year plan had pencilled in almost €0.6bn increased tax revenues from a 1% increase in the rate in each of 2013 and 2014. It is also interesting to note that the previous Government had planned to raise €0.2bn from carbon taxation measures in 2012.

Capital taxes

The fiscal statement makes no reference to capital taxes. Given that the previous Government had planned to raise €0.15bn from capital tax measures such as reducing the level of reliefs and reforming rates, it is difficult to see this area remaining untouched in Budget 2012.

Conclusion

It remains to be seen how, with a projected GDP growth of 1.6% in 2012, the Government will raise the €1.8bn in additional taxes in 2012. The previous Government’s 4-year plan had anticipated an additional tax yield adjustment of only €1.1bn in 2012. If the then projected income tax yield from band reductions etc. is removed this leaves a significant shortfall to be filled from new measures or the acceleration of other aspects of the plan, such as the aforementioned VAT rate increases. The details will be published in Budget 2012 on 6 December.