Budget 2020 based on premise of no deal Brexit means no major policy shifts

Official forecasts envisage relatively contained Brexit hit to Irish economy

Public finances seen moving into a limited and temporary deficit

Small first step in relation to climate change policies. Tougher decisions lie ahead

Current year Spending overruns now an established feature of Irish public finances

Analysis by Austin Hughes, Chief Economist, KBC Bank Ireland

How wrong will Budget 2020 prove to be? Economic arguments around the stance of fiscal policy usually centre on whether a particular Budget package is too tough or too ‘easy’ for current economic circumstances. However, the outcome of Brexit is likely to push the Irish economy onto one of two radically different trajectories in 2019. So, setting a path for the public finances that will prove appropriate to entirely unpredictable circumstances is almost impossible.

Such circumstances might suggest that the best course of action for Budget 2020 would be to follow the spirit of the Hippocratic oath and first do no harm. In turn, this would require that it recognises the risk of a ‘no deal’ Brexit and is structured in a manner that attempts to cushion the Irish economy while retaining a careful grip on the public finances.

Of course, Brexit is just one, albeit the most pressing, of several important influences on Budget 2020. Quite apart from Brexit there is also clear downward pressure on Irish economic growth from a rapidly cooling global economy amid the threat of broader trade tensions. This broader ‘macro’ picture appears to be one where the risks of an overheating Irish economy if not negligible are notably reduced.

Budget 2020 was also tasked with two other requirements; to signal a policy path that would address climate change in a credible and consistent manner and, less publicly if also significantly, to prepare the economic terrain for a general election campaign in Ireland once Brexit issues are clarified.

This complicated backdrop means Budget 2020 needed to be about simple messages rather than surprising measures and, in that respect, by doing relatively little, it avoided large mistakes. However, there may be some concerns as to whether the absence of any broadly based adjustments to income tax and welfare rates may trouble an already nervous Irish consumer. Equally, there are grounds to repeat concerns raised about Budget 2019 that unplanned increases in public spending are creating pressures on the public finances that raise the dependency on a potentially unsustainable growth in tax revenues.

Dept of Finance opts for a softish hard Brexit

The sort and scale of measures adopted in Budget 2020 was primarily determined by the starting assumptions around Brexit. As the Minister signalled earlier, the budget was based on the assumption of a ‘no deal’ Brexit in late 2019 and the budget 2020 forecasts reflect the Dept of Finance’s assessment of the near term impact of the associated negative effects on the Irish economy in 2020.

The decision to opt for a ‘no deal’ Brexit as the basis for Irish government budget planning for 2020 is entirely understandable in terms of potential strains on the fiscal position. However, the Dept appears to take a somewhat optimistic view as to the likely scale of impact of a hard Brexit would have on the Irish economy in 2020, envisaging a hit to GDP growth of just 2.4 percentage points  and a pull-back in employment growth of around 1 percentage point compared to a deal scenario.

Our sense is that the near term impact of a no deal Brexit could be materially larger, probably of the order of 3 percentage points in terms of the negative impact on GDP growth and around 2% percentage points on employment. In such circumstances, we could envisage both GDP growth and jobs growth flatlining in 2020. It could be that similar views inform the wording of the Irish Fiscal Advisory Council’s endorsement of the Budget economic forecasts as they noted ‘Although the Department of Finance has taken on board the impacts of a disorderly Brexit in its forecasts, the potential impacts from such a scenario could be more severe, especially in the short run.’ IFAC endorsement letter 30/09/2019.

Public finances seen taking a relatively modest hit

The Dept of Finance’s expectation of a significant but not overwhelming Brexit effect on the Irish economy translates into a material but not major weakening of the Government finances which results in the General Government balance moving from a surplus of 0.2% of GDP in 2019 to a deficit of 0.6% of GDP in 2020.

The 2020 projection for the public finances incorporates a Brexit -related drop in underlying tax revenues of around €1.2bn (the nominal drop is around €350 million but a projected sharp rise in customs duties largely flows into the coffers of the EU rather than the Irish exchequer). 

Similarly, Brexit is expected to raise public spending for 2020 by approximately €1.2bn reflecting a Brexit response package entailing a  range of targeted support initiatives for sectors deemed to be at risk. If a ‘no deal’ Brexit is avoided, these funds would not be used (and presumably tax revenues would be stronger) implying the possibility of a small budget surplus in 2020.       

Budget 2020 threw up few surprises

The overwhelming shadow of Brexit meant Budget 2020 was  a relatively modest affair in terms  of major new initiatives. However, the Government did take a small step on what is likely to be a long and possibly contentious policy path to address climate change.

The €6 increase in carbon taxes is a relatively limited first step in this regard but concerns about competitiveness a growing debate about distributional aspects of climate change policy and limited scope to provide offsetting income supports all played some role in this regard. As Minister  Donohue noted that ‘ climate change is without doubt the defining challenge of our generation.’, this is likely to become a more central consideration in future budgets. 

The Minister also, as expected, announced the retention for a further two years of the ‘help to buy’ scheme for first time homebuyers of newly built properties, a decision that may have one eye on the next general election but likely owes more to a material cooling in the residential property market of late. Increased allocations for social housing envisage just a modest pick-up in supply (1-2k properties) in this area over the next couple of years suggesting no early easing in current pressures in this area.

As had been signalled in recent weeks, Budget 2020 did not provide across the board increases in benefit rates or easing in income taxes.  Our sense is that this decision could weigh on sentiment and spending power in early 2020 and conjure up fears of a return to austerity policies. It is understandable that Brexit considerations inevitably led to difficult decisions but the absence of any form of indexation means the spending power of already nervous consumers will be squeezed at a time when other headwinds may be restraining economic activity in the new year.

Public spending overruns now a feature rather than a bug?

Our concern in terms of the absence of small adjustments to income tax and social welfare rates is that this has happened it comes in circumstances where increases in public spending continue to significantly out-pace budget plans. Day to day public spending is set to increase by 4.3% in 2020, only marginally faster than the 4% increase initially envisaged for 2019.However, it now appears day to day spending will rise by 7.4% this year (thereby also boosting the base for  next year’s increase).

The continuing inability to set out credible public spending plans remains a key feature of the budgetary process. For example, relative to the spending plan for 2020 set out three years ago in Budget 2017 documents, day to day spending in 2020 is now expected to be some€3.3billion higher.

In the same vein, the projected three year increase in health spending out to 2021 envisaged in last year’s budget documents was some €398 million, a figure that is only marginally above the €335 million overrun in 2019 for which a supplementary estimate is now included for the current year.

In uncertain times, it is inevitable that public spending plans have some elasticity but the consistency and scale of spending overruns in health and elsewhere makes it almost impossible to establish medium term trajectories for public spending and taxation. 

Budget 2020 may not be too wrong. Could it have been more right?

As noted in the introduction, it would have been virtually impossible to frame a budget package that is sufficiently flexible to suit the range of potential paths facing the Irish economy in 2020. In an important sense, A budget that makes few leaps but holds out the promise of some measure of policy support to vulnerable sectors probably strikes a broadly correct note.

In the same vein, it could be that forecasts suggesting a reasonably contained hard Brexit hit to growth and employment reflect a desire not to frighten the horses. Our preference would have been to address such nervousness with some limited but broadly based adjustments to income tax and welfare rates in addition to the promised sectoral support.

It could be that concerns about an adverse financial market reaction also fed into projections of what appears to be a very limited weakening of the Irish fiscal position in the event of a no deal Brexit. While such forecasts are unlikely to encourage substantive support from our EU partners, the associated picture of a continued commitment to domestic fiscal restraint to the point of not adjusting income taxes and welfare rates may prove more helpful. The impression of significant but not fatal economic impacts might also counter suggestions that Ireland would face a vista of unbearable difficulty in the event of a no deal Brexit that surfaced in some sections of the British media of late.

While Brexit is front and centre of Budget 2020, it remains the case that, as in previous years, 2019 is set to see a material over-run in public spending relative to initial projections. In circumstances where global economic pressures could see fiscal space and scope open up material in the next few years, it would be altogether preferable to be able to plan more ambitiously and control spending more assuredly. Of course, the run-up to a general election might see no shortage of proposals in relation to the former.