The ESRI has warned that any reduction in windfall levels of corporation tax will have a significant impact on the public finances, which could require the Government to implement austerity policies.
Because of this danger, it advises that the windfall portion of the corporation tax take should be set aside to counter any shocks to the economy in the future.
In its latest quarterly report on the economy, the think-tank has forecast that the economy – as measured by GDP – will grow by 5.8% this year before moderating to an increase of 3.3% next year.
The main drag on growth next year will be continuing fallout from ongoing trade disputes between the US and China and the US and the EU.
When combined with Brexit, there has been a sharp reduction in investment by businesses in the UK which has fed into a reduction of imports of machinery into Ireland. This is reflected in a slide in business confidence here.
The ESRI expects the current low levels of unemployment will continue.
As a result, it expects wages to rise by an average 4% next year. This will feed into inflation which it expects to increase to 1.2%.
It noted that a weak sterling exchange rate due to Brexit has kept down the price of imported goods.
On the property market, the ESRI believes parts of the market in Dublin have reached the limits of affordability.
This has resulted in prices either stagnating or falling.
It also noted that compared to house prices across the EU, prices here are relatively high and said the focus must be on increasing supply.
It also noted there is a clear divergence between rental levels in Dublin and other urban areas and the rest of the country.
The ESRI also modelled the impact on the public finances of a reduction in corporation tax.
It took two scenarios, a “moderate” €2 billion reduction and a “sharp” €6 billion drop.
This is the range outlined in a paper by the Department of Finance which could be described as temporary either due to windfall gains or future changes to international tax rules.
In the moderate scenario, the hit to the economy in the first year would be a reduction of €8 billion in GDP.
But under the sharp scenario, GDP would reduce by €26 billion.
This would have knock-on effects for borrowing costs and would require the Government to close the gap in the public finances by introducing austerity policies.
The ESRI recommends that “windfall” amounts of corporation tax should not be used to fund current spending and should be set aside to guard against any shocks to the economy in the future.
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