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Better than expected tax revenues suggest double digit economic decline can be avoided
Details still point to weakness that warrants further significant fiscal support
Resilient taxes and controlled if large increases in public spending suggest fiscal deficit may be less than feared
Public finances dynamics altogether different and less threatening now than in 2008
Scope for substantial stimulus package without exceeding previous deficit/GDP forecasts
Exchequer returns for June hint that the damage both to the Irish economy and the public finances at least in terms of the initial impacts of the coronavirus could be less than widely feared.
However, the risk of a significant shortfall in activity levels once the economy fully re-opens, leaving a significant cohort of businesses unable to sustain employment and incomes at pre-pandemic levels, still argues for an early and aggressive fiscal stimulus in coming weeks. Importantly, the mid-year exchequer returns suggest that this may prove notably less costly in terms of the eventual trajectory of public deficits and debt.
While the first half of 2020 has seen a substantial deterioration in the public finances, the nature and extent of this weakening is notably different and consequently less threatening to that which emerged in 2008. In the earlier episode, the key driver was the evaporation of tax revenues. In this instance, the main factor has been a deliberate and temporary albeit massive increase in public spending on income supports to cushion the hit from the pandemic.
Voted spending in the first six months of this year was €6.8 billion higher than a year earlier and as the Dept of Finance notes ‘primarily reflects increased departmental drawdown in response to the Covid-19 pandemic, particularly in relation to the Department of Health and the Department of Employment Affairs and Social Protection. ‘
In marked contrast to the freefall seen in late 2008 as the financial crisis took hold, tax revenues for the first half of 2020 were 0.7% higher than the comparable period of 2019 and a massive €4.31 billion higher than expected in the past two months made up of roughly equal overshoots in May and June. This is not to say that tax receipts aren’t set to weaken materially through the balance of 2020, it is simply to suggest that the nature of the decline looks altogether less fundamental and frightening than was the case just over a decade ago.
While a €1.9 billion overshoot in corporation taxes was the largest contributor, this heading represents a little less than half of the extent to which taxes exceeded expectations. Significantly, income taxes (€941 million above profile) and VAT (€611 million above profile) have proven notably more durable than expected. These elements hint at some greater resilience in incomes and spending than many have feared and together with a solid profitability profile at the aggregate level suggested by corporation taxes should provide greater bulwark against what in spite of the better than expected tax revenues is still an exceptionally severe downturn.
These trends suggest that, if appropriately supportive fiscal measures are undertaken in the next couple of weeks, the Irish economy may be able to avoid the sort of double digit declines in employment and consumer spending as well as in GDP that many are now predicting.
Importantly, however, the details of the exchequer returns still argue the case for a strong fiscal stimulus. Although better than expected of late, income tax receipts for the month of June alone were still a substantial 20.8% lower than a year earlier. Similarly, while better than expected, VAT receipts for the first half of the year were 20.5% lower than in the first half of 2019. So, the figures paint a picture of major weakness in the Irish economy at present.
The better than feared outcome for income taxes could also reflect an important distributional element to the downturn with the sectors most directly affected by the pandemic typically making up a much larger share of economy-wide employment than economy-wide incomes. This might point to potentially greater ‘scarring’ effects reflecting skills and mobility constraints on re-entry to the workforce if their exclusion is more than temporary. Again, this would argue for targeted if time-bounded measures to broaden the potential sweep of recovery.
Encouragingly, the fact that substantial increases in public spending in the first half of 2020 are largely the result of policy measures rather than out-of-control outlays and tax revenues are not vanishing in the manner that they did in 2008 suggests the possibility that the General Government deficit could be materially lower than the Dept of Finance’s April projection of a €23 billion shortfall. The range of possible outcomes is still wide but we think the figure could be about €5 billion lower.
As we continue to believe that fiscal multipliers are likely to be materially above 1 in the current environment, this would suggest the possibility that a substantial fiscal package could be delivered without materially breaching a deficit to GDP ratio of around 7 to 8% in 2020. Indeed, the continuing buoyancy in corporation taxes could point in the direction of a material upward revision to Irish GDP for 2019 that would reduce that ratio further. Our strong sense is that under-delivery in terms of tageted and time-bounded fiscal support will put the public finances and the Irish economy on a weaker trajectory in coming years than needs to be the case.