In this weeks blog, NERI Co-director, Dr Tom McDonnell gives the NERI's response to Budget 2021.
Budget 2021 was a firefighting budget against the twin threats of Covid and Brexit. It was designed to preserve as much of the economy’s productive capacity as possible by enabling a menu of wage subsidies, business supports and contingent funds that trigger as we move up and down through cycles of lockdown. The wage subsidies and business supports are welcome and the overall package was reasonably well targeted in terms of preserving that productive capacity. Many of these supports will need to operate in some form until we have a widely available vaccine.
On the other hand, the decision not to commit to retaining the Pandemic Unemployment Payment until we have a vaccine is likely to weaken the recovery and increase poverty. The lack of increase in the core social welfare rates is similarly problematic Incomes policy should be moving in concert with fiscal and monetary policy. The modest 1% increase in the value of the national minimum wage was also disappointing. Even so, the setting up of the new living wage commission signifies a recognition of the problem of low pay and high cost of living and is an important policy innovation.
Some of the economic supports are poorly designed. The two most obvious of these are (A) the cut in the VAT rate which will mainly benefit the businesses that have the largest sales and therefore need it least and (B) the continuation of the help-to-buy scheme that will simply add to house prices and de facto function as a subsidy from the State to households and businesses engaged in selling houses. The VAT cut would have been better designed as a subsidy to help businesses pay for fixed costs such insurance or rent. The tax break for house buyers would have been much better allocated as a straight-up increase in the capital budget for public house-building.
The budget’s scale and the overall expansionary fiscal stance were broadly appropriate. However, the increased allocation of just €600 million compared to the 2020 total for public capital investment was disappointing and lacking in ambition. There is no better time to increase public capital investment than when interest rates are low and when unemployment is high. Research from the IMF and others shows that the economic benefits to public investment are very high in the current context, particularly green investments such as green electricity, efficient buildings and public transport. A missed opportunity. An important caveat is the lag between allocating funds for investment and the project start date. This means investment is not an immediate panacea. A second concern is the capacity of the construction sector and the labour supply to actually absorb the higher level of investment. As such, focusing on increasing apprenticeships in 2021 and then on investment in 2022-23 may well be the optimum strategy. Hopefully the National Economic Plan in November will show sufficient ambition and clarity.
Unfortunately, the budget shows no obvious vision for dealing with medium-term well-being issues. The Republic of Ireland will continue to be a very low spender on public childcare and early years. The country will also continue to be a low spender on per pupil education and on public R&D. Class sizes will remain amongst the highest in Europe. The cost of childcare will remain amongst the highest in Europe. The housing supply problem will persist. Of course, not every structural weakness can be resolved in a single budget.
The ‘green’ decisions are welcome with a needed reform to VRT and an increase in support for retrofitting. An important issue is that retrofitting remains an option that is realistically only viable for higher-income households. In addition, the carbon tax increase, which I welcome, will need to be complemented by just transition options in the form of better public transport options, better electric car charging availability in rural areas, and commensurate increases in the incomes of poorer households.
A deficit in the order of €20 to €21 billion is obviously not sustainable long term. However, some of the deficit relates to once-off health and contingency measures. In addition, much of the deficit will decline if the economy is able to generate sustained employment growth in 2022 and beyond. Finally, interest rates are extremely low and we have the ability to lock-in low interest rates for at least a decade. Debt interest is likely to fall in the next two years. Even so, it is clear that the revenue base of the State needs to be broadened in order to pay for the increases in recurring spending and in order to fund needed reforms in areas like childcare spending and education spending. This will need to be honestly debated in the months to come. As such, the formation of the Commission on Taxation and Welfare is a welcome development.
The economic context will remain very challenging in 2021. Modified domestic demand is likely to be smaller at the end of 2021 than it was at the start of 2020. Even so, this budget will help protect the economy in 2021 and enable it to bounce back once a vaccine is widely available as consumer confidence returns and households start to tap into their accumulated savings. Budget 2022 will need to set out what we want the future economy to look like.