How things have changed.

Last week Irish government 10-year bond yields traded close to 2.8pc, up from borrowing costs close to zero right up until the outbreak of the war in Ukraine and before natural gas prices surged, pushing up CPI inflation and forcing the ECB to raise interest rates.

Irish bond yields over the past 12 months have now increased at their sharpest pace since 2011. At face value, this could be taken as cause for alarm.

However, the context couldn’t be more different. Ireland’s economy and public finances have been unusually resilient, during the Covid-19 pandemic and through the recent cost-of-living crisis.

What has gone unnoticed this time around is that Irish government borrowing costs are now amongst the lowest in Europe.

In September,the National Treasury Management Agency announced that it would not issue any further debt in 2022, given the buoyant state of public finances. Since then, and as it became apparent Ireland would run a substantial budget surplus in 2022, Irish 10-year bond yields have traded below Austria, Belgium, Finland and in recent months France.

In the past week, the spread on Irish 10-year bonds against triple-A rated Netherlands fell to just 0.1pc. Beyond the Netherlands, the only euro area country with lower borrowing costs than Ireland is Germany.

​

Is that confidence in Ireland justified?

IMF forecasts published last week projected that Irish GDP would grow by 5.6pc in 2023 and the general government balance would be in surplus by €7bn, or 1.3pc of GDP.

If anything, that now looks too conservative. We now know tax revenues grew by 15pc in the first three months of 2023, again well ahead of expectations.

On April 18, the Department of Finance will publish its revised Stability Programme projections. These could see the official forecast for the budget surplus pushed up towards €10bn. Our last Davy forecast was for a surplus of €9bn, a little above the Central Bank’s €8bn.

Once again, the story is that corporate tax revenues are showing little sign of slowing from the explosive growth seen in the past few years. Budget 2023 had assumed corporation taxes would grow by only 8pc in 2023 but in the first three months they rose 71pc to €3.2bn.

The dangers of becoming overly reliant on this source of revenue are now well known. Just ten companies accounted for 55pc of corporate tax revenues in 2021. Hence, the €23bn corporate tax take must be vulnerable to conditions in the ICT, pharmaceutical and medical-technology sectors.

However, bigger picture is that corporate taxes are still benefitting from global tax reforms from the OECD. Specifically, the deadline in 2020 to locate intellectual property assets in onshore locations, close to substantive business operations, rather than in the likes of the Cayman Islands and Bermuda.

The impact of this rule change is evident in the investment by companies operating in Ireland in research and development (largely IP assets) which surged from €41bn in 2019 to €139bn in 2019 and €112bn in 2020. The generous capital allowances for this expenditure are now depreciating and so the positive impact of the OECD BEPS rule change is still being felt.

Ireland is now set to implement Pillar II of the OECD’s latest round of corporate tax reforms – the minimum 15pc effective rate for firms with revenues exceeding €750m. This move has too often been discussed in negative terms, the focus being on the possible threat to Ireland.

This doesn’t seem credible given the UK, our main competitor for FDI, has decided to raise its corporate tax rate to 25pc. Rather, the move to implement the 15pc effective rate will in the first instance push corporate tax revenues higher still.

There is a risk of becoming overly fixated on scenarios where the corporate tax base suddenly shrinks. Ireland also needs to plan for a future in which the economy, multinational sector and corporate tax revenues continue to perform.

​

Can budget surpluses be ring-fenced from political pressure?

In March, the Irish Fiscal Advisory Council (IFAC) proposed a new pension fund utilising the budget surplus to invest and help meet the cost of the aging population. IFAC also suggested PRSI rates may need to rise by 3.5pc if the state pension age is to remain at 66.

From a dour economist’s point of view one advantage is that the surplus will be saved, rather than funding lavish giveaways at Budget time. This is especially pertinent now given the overheating pressures that are becoming increasingly evident in the Irish economy and to avoid the mistakes of the past when fiscal policy helped inflate the Celtic Tiger boom.

The obvious example is Norway – which from the mid-1990s decided to invest oil revenues exclusively in foreign assets. This ensured the domestic economy didn’t become overly reliant on them, but also helping to fund higher government spending.

Speaking at an IFAC conference in late March, former central bank chief Svein Gjedrem described the extensive legislation that was required to ensure the fund was protected from raids by political parties and interest groups.

One striking observation was that as the fund grew and was perceived to be a success, it became taboo to countenance any interference with it.

​

Could Ireland follow suit?

Speaking after March’s buoyant exchequer returns, Finance Minister Michael McGrath said he will bring a proposal to cabinet for a new longer-term fund to invest corporate tax revenues.

No detail has been revealed on the size of an exchequer contribution. In Budget 2023 the Department of Finance had estimated windfall corporate tax revenues would be €10bn, around 45pc of the then-expected company tax haul.

It seems ambitious to believe cabinet would sign off on such as large contribution.

After all, there is also an election to be won and Budget 2024 may be the last before it is fought.

Will politics trump economics? Irish politicians should bear in mind investor confidence and favourable borrowing costs can be lost easily.

​Conall Mac Coille is chief economist at Davy