Managing the Public Finances in a Full-Employment Economy

The Government’s fiscal response to COVID-19, cost of living pressures and humanitarian support for Ukraine resulted in an increase in government spending of €35 billion between 2020 and 2022. Despite this exceptional rise in expenditure, the headline budget balance returned to surplus in 2022, driven by windfall corporation tax revenue. If this excess corporation tax is excluded, the budget remained in deficit last year. The current macroeconomic environment – characterised by an economy at full employment and with high inflation – presents fresh challenges for fiscal policy. The analysis indicates that discretionary government spending increases or tax cuts above current plans would add to demand and inflation when the economy is already at full capacity. Moreover, the public finances face looming constraints over the medium term due to the need to increase public spending to address the long-term costs of ageing and climate change. Saving windfall taxes today would reduce – albeit not eliminate – the extent of future tax increases needed to fund these new demands on the public finances. Introducing measures to broaden the tax base could help to ease inflationary pressures while public capital spending is being ramped up and at the same time enhance the resilience of the public finances in the face of known future challenges.