Wednesday 24 April 2019

We can't afford to ignore the danger of slide in tax revenues

Government remains optimistic about growth forecasts despite poor first-quarter tax figures

Finance Minister Michael Noonan and Taoiseach Enda Kenny have overseen a partial economic recovery — but there are still dangers to be wary of
Finance Minister Michael Noonan and Taoiseach Enda Kenny have overseen a partial economic recovery — but there are still dangers to be wary of

Dan White

Higher growth forecasts were unveiled last week but, with first-quarter tax revenues coming in below target and the UK having pressed the Brexit button, are these forecasts 'Leprechaun Economics'?

On Monday, Finance Minister Michael Noonan announced that the Department of Finance was increasing its 2017 GDP growth forecast to 4.3pc and its 2018 forecast to 3.7pc.

The Department hasn't been alone in increasing its economic-growth forecasts. The Central Bank recently upped its 2017 GDP growth forecast from 3.3pc to 3.5pc and its 2018 forecast from 3.0pc to 3.2pc while the ESRI raised its forecasts for 2017 GDP growth from 3.5pc to 3.8pc and its 2018 forecast to 3.6pc.

While most of the other forecasters have also raised their economic-growth predictions, the Department of Finance is still by far the most optimistic about the Irish economy's prospects in 2017. How justified is this optimism?

These higher economic-growth forecasts come despite the lower-than-expected tax revenues for the first quarter of 2017, with the total take coming in 2.4pc lower than the budget day forecast. March was particularly disappointing, with monthly tax revenues a massive 7.6pc behind target.

While revenues from all of the main taxes were below target in March, it was the 4.2pc under-performance in income tax and USC revenues - apparently completely at odds with continuing strong job creation - that was of most concern.

The poor March exchequer returns came less than a week after UK Prime Minister Theresa May invoked Article 50, starting the two-year countdown to Brexit.

The UK's decision to leave the EU and the subsequent sharp fall in the value of sterling against the euro has hit Irish exports to the UK and consumer confidence in this country.

The value of Irish goods exports to the UK fell by 3.4pc in 2016.

The weakness of the UK market is acting as a severe drag on overall Irish exports which, when booming IT and pharmaceutical exports are excluded, actually fell by 4.6pc last year. Even when these two categories are included, the total value of Irish exports grew by just 2.4pc in 2016.

Domestically, last June's Brexit referendum result has had an impact on consumer confidence. While consumer confidence levels have since recovered slightly, they are still way lower than the post-crash peak recorded in January 2016.

Just for good measure, with the proportion of our exports going to the US having risen from 16pc in 2002 to 24pc in 2015, Ireland is uniquely vulnerable if US President Donald Trump delivers on his promise of a border adjustment tax.

This proposed tax would encourage US-based companies to use American-sourced inputs by removing the tax-deductibility of imported inputs (eg those from Ireland) while at the same time making US exports tax-exempt.

So are the latest batch of improved Irish economic growth forecasts for real or are we dealing with, to quote Nobel Prize-winning economist Paul Krugman, the latest manifestation of the "Leprechaun Economics" phenomenon? In other words, will this growth prove to be merely a statistical chimera or will it translate into higher earnings, consumer spending and tax revenues?

"There are two core fundamentals when looking at the Irish economy; the pace of job creation and the amount that consumers are spending," says Fergal O'Brien, director of policy at employers' body Ibec. "Job creation has continued very strongly into 2017. We are confident that the job creation numbers will feed through into consumer spending."

The latest CSO numbers certainly point to continuing strong job creation. The unemployment rate fell to just 6.4pc last month, down from 8.3pc in March 2016. If sustained, this means that we will come close to matching the 65,000 new jobs created in 2016 - the Department of Finance reckons that the Irish economy is currently creating 1,000 new jobs a week.

Which, of course, begs the question: If new job creation is so strong then why are income tax and USC revenues coming in so far below target?

A Department of Finance spokesperson points out that while the first-quarter exchequer returns and the March monthly figures were below target, tax revenue was still above the figure collected for the same period in 2016, with the total tax take up by 3.5pc in the first quarter.

In other words, tax revenues are still rising, but not by as much as the Department of Finance had previously predicted.

The spokesperson says that the Department's economic growth forecasts and tax-revenue projections are "prudent", despite the first-quarter hiccup.

However, the Department concedes that there has been an "anomaly" in first-quarter income tax and USC revenues. So what's going on?

"PAYE and PRSI revenues are tracking the increase in employment. Other income taxes, mainly related to pensions, are not. USC seems to be the main factor," says a Department spokesperson.

Matters are complicated by the fact that USC is a relatively new tax. This means that the Department of Finance has less experience than it does with more established taxes in tracking USC revenues and determining the factors that influence them. It is conducting an investigation to see what has caused the wobble in USC revenues and expects to have the result within a few weeks.

"We are not overly concerned just yet," he says.

However, even if the dip in tax revenues turns out to be no more than short-term blip, it might be a good idea to heed the warning. With the UK economy now slowing rapidly following the once-off boost it received from the post-referendum collapse in sterling, the going is going to get even tougher for indigenous exporters and retailers.

O'Brien expects the Irish economy to begin to feel the impact of this UK slowdown in the second half of the year.

So is the recovery in the Irish economy about to be snuffed out by a combination of Brexit and Trumponomics? While O'Brien predicts greater volatility as a result of these two factors he remains broadly optimistic about our prospects.

"The first-quarter returns came as a surprise. From everything we can see wage growth is pretty strong. These tax receipts, particularly income tax, should bounce back in the second quarter."

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