Makhlouf urges Govt to stick to spending rule in budget

The Governor of the Central Bank has urged the Government to stick to its own rule limiting the overall annual increase in spending to 5% in the upcoming budget.

Gabriel Makhlouf also advised the new Minister for Finance, Jack Chambers, that it will be necessary to strike the right balance to avoid the risks of overheating and damaging the competitiveness of the economy.

The Central Bank boss also said it was time for temporary or non-core spending, put in place to deal with the fallout from the Ukraine war, to be considered permanent for the purposes of the spending rule.

Writing in his traditional annual pre-budget letter to the minister, the Governor noted the Irish economy has rebounded well from external shocks, with little sign of scarring.

He said the economy has now moved to a new phase as activity is expected to be broadly in-line with its medium-term potential.

“These generally favourable conditions provide a good backdrop for attention to turn more decisively towards strengthening that potential,” Mr Makhlouf wrote.

“Budget 2025 and the medium-term direction for fiscal policy that Government must set are key to achieving this.”

Mr Makhlouf said budgetary policy is now in a good position to address capacity constraints in areas like housing and infrastructure while also maintaining a fiscal stance that doesn’t add unnecessarily to overall demand or undermine monetary policy.

He said the budget could also reduce the structural vulnerabilities in the economy that arise from the concentration of the tax base, climate change and an ageing population.

“Success across all of these outcomes will entail trade-offs and require credible choices to be made around tax and expenditure, cognisant also of the significant resources required to at least maintain the existing level of public services,” he said.

“Striking the right balance to avoid the risks of overheating and damaging the competitiveness of the economy is necessary, so that it can deliver sustainable growth in living standards for the community over the longer-term.”

The Governor added that given overall economic conditions at present it would not be appropriate to continue with an expansionary fiscal stance over the next two years.

“Recently published analysis by Central Bank staff illustrates how continuing with so called ‘core’ expenditure growth similar to the recent past without offsetting discretionary changes in taxation would significantly contribute to overheating risks,” he wrote.

“Such a scenario would lead to higher inflation in Ireland than would otherwise be the case, potentially moving contrary to the disinflationary process that is expected to continue gradually in the euro area overall.”

“This would damage Ireland’s competitiveness and long-term prospects for growth in living standards.”

The Central Bank boss also refers to the significant structural vulnerabilities in the public finances, including around the concentration of corporation tax and the ageing population.

“In this context, I welcome the planned creation of the Future Ireland Fund (FIF) and the Infrastructure, Climate and Nature Fund with the use of excess corporation tax receipts,” he said.

But Mr Makhlouf also pointed out that estimates suggest extra age-related demand on the public finances from 2035 are larger than the estimated future drawdowns from the FIF.

Indirectly referencing the temptation for the Government to bump up spending ahead of the general election, the Governor said the 5% spending rule needs to be complied with.

He added that the justification for temporary or non-core spending items to be excluded from the rule is increasingly difficult to maintain as the “extraordinary economic shocks from the pandemic and Russia’s invasion of Ukraine pass and certain related expenditures have become de facto permanent.”

“Accordingly, in order for the net spending rule to achieve its aim of promoting an appropriate fiscal stance and more resilient public finances, all expenditure should be included,” Mr Makhlouf said.

While in relation to tax, the Governor said that over the longer-term, with material uncertainty over the sustainability of current revenue from corporation tax, new revenue-raising measures would help to create a more sustainable tax revenue base and more resilient public finances with which future fiscal challenges can be addressed.

The letter comes just days before the Government publishes its Summer Economic Statement, which will lay out broad parameters for Budget 2025.

On Wednesday the mid-year exchequer returns showed that tax receipts in the first half of the year were stronger than expected and that the State is on course to record a surplus of up to €8bn this year.