Economic Letter: Irish Government debt in the event of a disorderly Brexit or a fall in corporation tax receipts

• Government debt in 2018 was around four times higher than in 2008 and the level of debt remains high by historic and euro area norms.
• A disorderly Brexit, or a loss of corporation tax revenue accompanied by an international slowdown, would result in a material increase in government debt.
• In an uncertain international environment, reducing the level of public debt can help to improve the capacity of the public finances to withstand negative shocks.

An Economic Letter by Dr Thomas Conefrey, Rónán Hickey and Graeme Walsh published today examines the exposure of the public finances to potential adverse shocks. The paper finds that there has been a significant improvement in the State’s fiscal position since 2013. This has mainly been driven by strong economic growth, low interest rates and once-off factors. Underlying improvements in the public finances have played a smaller role in debt reduction. The level of debt remains high, at over 100 per cent of national income in 2018.

Starting from a position of high debt increases the vulnerability of the public finances to future negative economic shocks. The scenario analysis estimates that a disorderly Brexit, or a loss of corporation tax revenue that is accompanied by a slowdown in the international economy, would result in a material increase in the government debt above current central projections.

In a disorderly Brexit scenario, the research estimates that the debt-income ratio would stabilise at a higher level out to 2023 before starting to decline thereafter. As a result, by 2025 the debt-to-income ratio would increase by around 17 percentage points, with nominal debt approximately €22 billion higher than the baseline.

The second case considers a scenario where there is a permanent €3 billion reduction in Corporation Tax revenues from 2019, combined with a temporary three-year slowdown in the international economy. In this scenario, the General Government debt-to-income ratio would be around 10 percentage points higher than in the baseline by the middle of the next decade.  

If either scenario materialised, the persistence of a debt-to-income ratio of greater than 90 per cent well into the middle of the next decade would increase the vulnerability of the public finances to further shocks. There would also be an additional direct burden on the economy owing to the cost of financing a higher level of debt.

The Economic Letter concludes that in an environment of elevated risks, reducing the level of public debt can help to improve the capacity of the public finances to withstand negative shocks.

Notes:

• The views presented in Economic Letters are those of the authors and do not necessarily represent the official views of the Central Bank of Ireland.