Joint research programme on the macroeconomy, taxation and banking

Macroeconomics

The joint research programme between the Department of Finance, the Revenue Commissioners and the ESRI on The Macroeconomy, Taxation and Banking began in January 2015 with the objective of undertaking research on a range of macroeconomic and taxation issues in Ireland. The programme was initially launched by the Director of the ESRI and the Secretary-General of the Department of Finance for a three-year period and has been renewed annually since then.

The research programme is an innovative initiative that builds on the ESRI’s proven economic research capability and the Department’s commitment to enhance its capacity for evidence-based policy analysis. To maximise the benefits of the different areas expertise of all the involved institutions and ensure close linkage between the research and policy objectives, many of the projects have involved collaboration between economists from the ESRI, the Department and the Revenue Commissioners.

Examples of the range of topics investigated by the research programme include:

Impact of COVID-19

As a result of the dramatic change in economic circumstances coming from the COVID-19 pandemic, research examining the economic implications of the pandemic became a major focus of the joint research programme since 2020. Using the ESRI’s structural macro-model COSMO, a range of alternative scenarios for the Irish economy were investigated to help quantify the initial macro-economic impact of the public health shock. This was developed further in 2021 to take into account developments in both the economy and in public health restrictions. Although the pandemic has a considerable negative impact on output in the short run, in each of the scenarios there is a return to growth over the medium term.

In addition to research on the macro-economic impacts of COVID-19, work was also undertaken on the impact of the pandemic on small and medium enterprises (SMEs). This research estimated the scale of the revenue losses and liquidity shortfalls for the SME sector. It was then expanded to analyse the extent to which the pandemic might have longer-run implications for SME finances and the role of policy interventions in mitigating the economic impacts of the pandemic on this sector.

Impact of Brexit

One of the first completed projects as part of the programme was a comprehensive assessment of possible implications for the Irish economy of a UK exit from the European Union, which was prepared as a risk assessment in 2015 prior to the referendum result. Following the referendum decision in favour of Brexit, more in-depth work on the potential effects on the Irish economy became a key focus of the research programme. A major aspect of this involved the use of the ESRI’s COSMO macroeconomic model to examine a range of Brexit scenarios and the channels through which they could impact the Irish economy. This work formed the baseline for how the effects of Brexit have been incorporated into forecasts for the path of Irish GDP. At a more disaggregated level, other work on the potential impact of Brexit focused on transport connections between Ireland and the UK, specifically with regard to the role of the UK as a land-bridge to other trading partners. With the COVID-19 pandemic having a major impact on the Irish economy, work was also undertaken to examine the extent to which COVID-19 might interact with Brexit, particularly in the event of no trade deal being agreed. This found that the sector-level exposure was quite different for each shock with those most impacted by COVID-19 at the lower end of the risk profile from Brexit and vice versa. Following the end of the Brexit transition period, the initial impact on Irish and EU trade links with the UK were examined. This showed sharp declines in imports from Great Britain and increased trade with Northern Ireland as customs checks were introduced.

Fuel and carbon taxes

Reflecting the importance of carbon pricing in achieving targets on tackling climate change, this research aims to create a better understanding of how different carbon tax rates can be expected to impact both the economy and the level of CO2 emissions. This involves the development of an Energy Social Accounting Matrix which makes it possible to evaluate the emission reduction associated with specific carbon tax policies. The explicit modelling of sectorial inter-linkages makes it possible to investigate the wider economic impacts of a specific shock or policy through the different transmission channels in the economy and distributional impacts of policies. Work in this area included the estimation of direct and indirect impacts of the carbon tax itself and also how distributional impacts could be offset by different uses of the resulting revenue. The report on The economic and distributional impacts of an increased carbon tax with different revenue recycling schemes by Kelly de Bruin, Eoin Monaghan and Aykut Mert Yakut which was undertaken as part of the joint research programme in 2019 was awarded the 2020 Miriam Hederman-O’Brien prize by the Foundation for Fiscal Studies. Further work on the economic impacts of climate transition extended the modelling of carbon tax to also include other policy targets on electric vehicles and domestic retrofitting.

Another topic undertaken as part of the research programme examined how the differential prices of motoring fuels between Ireland and Northern Ireland as well as exchange rate variations can create an incentive to purchase motoring fuels across the Border.

SME investment and financing

Work on the investment patterns and financing requirements of small and medium enterprises is an important focus of this programme. This topic analyses detailed information on investment activity at firm level to provide a comprehensive profile of SME investment patterns in Ireland and how this investment activity is financed. It also examines reasons why firms may not have invested and, in particular, the roles of uncertainty and credit access. Providing insight into these questions will ensure a better understanding of the investment activity of Irish SMEs as well as provide evidence to support the development of targeted policy initiatives around investment and investment financing.

Sensitivity of taxes to economic activity

A number of different research papers examined aspects of the sensitivity of major Irish taxation aggregates to underlying economic activity. These included the sensitivity of overall tax revenues to different measures of output and more detailed analysis of the different levels of responsiveness to income tax, USC and VAT rates depending on household income levels and taxpayer type. A comparison of tax elasticities in Ireland relative to other OECD countries and an analysis of the so-called “deadweight loss” of taxation (also referred to as the excess burden of taxation) arising from potential spillover effects of taxes on relative prices. This strand of research also used an analytical approach to estimate the relationship between a firm’s corporation tax liabilities and their taxable income. This work found a baseline estimate for the aggregate tax revenue elasticity is 1.3 with this figure displaying a slight upward trend over time.

Linked research examine the relationship between the Irish fiscal mix and trends in economic growth, comparing the patterns to EU averages. The results showed that taxes that distort economic incentives and/or increase non-wage costs are significantly lower in Ireland compared to the EU average and to most individual European countries. Conversely, relatively less distorting taxes (such as taxes on consumption) are significantly higher in Ireland, although since 2008 the Irish consumption tax indicator converged towards the EU average. The research also found that the Irish tax structure is positively linked to GDP growth as business investment and hours worked tend to be negatively correlated with distorting taxes (e.g. labour and capital taxes) which are relatively lower in Ireland than in other EU countries.

Multinationals, taxation and productivity spillovers

As the attraction of FDI has been a cornerstone of Irish industrial and economic policy for many years, understanding the factors that affect investment decisions of multinationals is an important area for research. A number of aspects of the role and effects of corporate tax policy on the attractiveness of Ireland and other European countries to foreign direct investment were therefore examined, including the extent to which corporate tax policy impacts on the location choice of FDI in Ireland and other EU countries and how would changes in corporate tax policy would affect Ireland’s attractiveness to FDI. This research stream examines the role and effects of corporate tax policy on the attractiveness of Ireland and other European countries to foreign direct investment. A further stream of research under this heading examines whether, and to what extent, the productivity performance of indigenous firms is linked to spillovers from foreign affiliates operating in Ireland. This updated previous work on intra-industry spillovers and extended the research by examining if spillovers are more likely to occur through supply chain linkages.

Household wealth distributions

The research under this heading examined the composition of household assets and liabilities to estimate the potential impact of a tax on household wealth in Ireland under a wide range of assumptions on how such a tax might be designed. The scenarios used were based on models of existing taxes on household wealth across Europe and a number of hypothetical tax designs structured to illustrate how the results are affected by varying qualifying thresholds or asset exemptions. Further work examined the role of inheritance and gifts in determining the distribution of household wealth.

Mortgage arrears

This topic aims to provide analysis of the Irish mortgage market and implications for financial stability by designing a micro-econometric stress-testing model which links mortgage arrears at the household level to the equity and affordability channels which drive arrears. This allows us to understand how shocks such as changes in the ECB policy rate will impact mortgage arrears. The research also explores the differences across households to see whether pockets of vulnerabilities are evident.

Other topics

Along with those outlined above the research programme has examined links between labour’s share of national income and sector-level productivity distributions, the exposure of Ireland to US tariff policy and fiscal multipliers.