Surge in corporation tax receipts  set to result in surplus after 10 years of deficits

Surplus likely to be marginal at 0.1% of GDP but two years earlier than expected

Improvement in Irish public finances in recent years down to hard work but 2018 surprise reflects buoyant corporation taxes rather than to fiscal stance or booming Irish economy

Figures point to solid rather than spectacular Irish economic conditions

Overruns in public spending still raise key questions about sustainability of fiscal path

Budget 2019 boost may cushion Irish economy somewhat from poorer external outlook

End year exchequer returns data suggest the Irish government finances likely recorded a marginal surplus in 2019, two years earlier than a return to surplus was envisaged. The progress made in the public finances in recent years reflects sustained hard work but the better than expected outturn for 2018 is largely fortuitous and the divergence in both taxes and spending from original targets should be a warning of how volatile Ireland’s public finances can be.    

Exchequer figures to end December do not provide the definitive measure of the Irish fiscal position for 2018 for a range of reasons. Based on Budget day estimates of non-Exchequer elements and adjustments, we reckon that the broader measure of the General Government Balance (which is the reference measure used for budgetary comparisons across the EU) is likely to end 2018 as a surplus of around €300-400 million. This would represent a fiscal surplus amounting to a little over 0.1% of GDP.

As early official estimates will only become available in April and these numbers can be prone to revision, it is probably best to emphasise a return to broad balance in the public finances in 2018 downplay rather than overstate the numerical significance of what is only a fractional surplus. However, the broader significance of the turnaround in the Irish public finances through the past ten years is noteworthy.

The achievement of a small surplus implying broad balance in the Irish public finances in 2018 follows ten years of significant deficits.  Indeed, it was the exchequer returns for end 2008 that formally signalled the Irish public finances had moved into deficit as boom turned to bust. The 2008 deficit (which surged to 7% of GDP) followed six years in which a booming economy delivered a succession of strong fiscal surpluses in spite of exceptional budgetary largesse.

Progress in restoring order to Ireland’s public finances over the past ten years is largely the product of a painful and protracted fiscal adjustment as well as a strong recovery in the Irish economy. However, the now likely delivery of a marginal surplus in 2018 is primarily the product of accident rather than design.  An unexpected surplus in 2018 is not the result of a tough fiscal stance of late nor a reflection of stronger than expected domestic economic conditions.

The better than expected exchequer outturn for 2018 is largely the result of an unexpected surge in Corporation taxes which were some € 1880 million higher than envisaged (€ 10,385 million outturn v €8,505 million profiled). In turn, while there may be some element of contribution from healthier operating conditions for companies focussed on the Irish economy, the exceptional performance of the corporation tax heading seems to primarily reflect windfall bounties resulting from the international activities of multinationals located in Ireland rather than current Irish economic conditions or recent fiscal measures introduced in Ireland.

In contrast, taken as a whole, headings other than corporation taxes were slightly below target (€498 million). Revenues from economically sensitive tax heads (income tax, VAT, Excise) were slightly lower than expected in aggregate (€40,894 million v €41,355 million). This might hint that activity growth across the Irish economy as a whole in 2018 that was solid rather than spectacular:

•  The most encouraging aspect is healthy growth in income taxes of 6.2%. While this is marginally below expectations and, as such, indicative of restrained rather than runaway growth in earnings, it mirrors increases of around 3% in both employment and earnings (partly reflecting a rise in hours worked). 
• VAT receipts slightly exceeded matched Budget forecasts and a 7.0% increase would imply healthy growth in consumer spending. However, a notably weaker performance of excise duties(down a substantial 8.6% but partly due to technical reasons related to a switch in tobacco packaging) hints that the pace of increase in consumer spending may have varied across areas of the economy. Overall, spending taxes appear reasonably consistent with a volume increase in consumer spending of around 3% in 2018 and price increases in the region of 1%.     

 
Voted Exchequer spending increased 8.7% overall in 2018, some €810million higher than envisaged at the start of the year but broadly in line with the increased outlays envisaged in the revised figures presented at Budget time last October.  The step-up in spending is largely a reflection of larger than originally planned outlays on health (€654 million), housing (€113 million) and Social protection (€106 million).
  
The 8.7% increase in voted exchequer spending compares to a KBC estimates of a 6.5% increase in the money value of headline Irish GDP in 2018 and is roughly twice the underlying rate of increase in activity in the Irish economy that we estimate for last year.   The Budget arithmetic also benefitted from notably lower interest costs than originally predicted (€5791 million outturn v €6104 million).  

We would draw a couple of lessons from the December exchequer returns:

1. The return a small Government budget surplus in 2018 doesn’t mean that the public finances have been much better managed or are now altogether healthier than has generally been suggested.  Instead, the unexpectedly favourable outturn is largely the result of accident rather than design. More importantly, this further emphasises the extent of volatility and unpredictability in the Irish budget arithmetic. In turn, it means that recent debate as to whether a surplus or deficit should have been targeted misses the point. Instead, managing Ireland’s public finances requires that trends in public spending are sustainable and reasonably predictable (in contrast to surprises of recent years). The particular volatility of taxes as demonstrated in 2018 makes control of public spending altogether more important for economic and budget management.
2. If we have ongoing concerns about the manner in which spending is increasing, we are not overly concerned with the short term impact of such spending on the Irish economy. Indeed, as global concerns are much increased since October when Budget 2019 package announced (reflecting China, Euro area and to a lesser extent US growth worries as well as increased risks around Brexit), a slight boost to the Irish economy from 2019 fiscal stance doesn’t seem unreasonable and may well be welcome particularly in the context of healthy but not white hot increases in economically sensitive tax receipts.
3. The risks to economically sensitive Irish tax receipts from a troubling start by financial markets to 2019 may mean further pleasant surprises on corporation taxes may be needed to ensure this year’s fiscal targets are met. While it is far too early to make any strong judgements, market concerns about US technology earnings suggest some downside risks to such an outcome.        

This non-exhaustive information is based on short-term forecasts for expected developments in the economy and financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalised investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a judgment as of the date of the report and are subject to change without notice.