Pay hikes will mean spending cuts, warns fiscal watchdog

The State’s fiscal watchdog says there is growing evidence of a potential slowdown in the Irish economy, and has warned that public sector pay increases will have to be funded by cuts elsewhere.

The Irish Fiscal Advisory Council (Ifac) said, while the economy continues to grow at a solid rate, recent data on domestic demand, output and retail sales pointed to a gradual "loss of momentum".

Asked whether it would be a mistake to increase public sector pay in 2017, council chairman Prof John McHale declined to offer a view but said it was important to “recognise the full implications of moving away from Lansdowne Road”.

“The resources for 2017 have already been committed - the dreaded fiscal space - it’s been fully allocated. If you’re going to have more spending such as in public sector pay then you’re going to have to cut back spending in other areas affecting services or have higher taxes, which is very hard to do in the short term, so the likelihood is to cut spending in other areas.”

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He said projections indicated there would be “more fiscal space” after 2019.

"We're not talking about endless austerity but we're still in the process of adjusting down to that target getting down to a budget balance and during that period we do face difficult constraints and therefore choices," he told RTÉ's Morning Ireland.

The council suggested the Government's growth forecasts were far from assured and may need to be revised downward, especially in light of the uncertainty presented by Brexit. The Department of Finance is anticipating a 3.5 per cent expansion in gross domestic product in 2017 and an average of 3 per cent for the three years after that.

However, the council warned that even a 0.5 percentage point lag from these projections would keep the public finances in deficit until at least 2021, several years beyond what had originally been targeted.

The council’s latest economic assessment is the last under the stewardship of Prof McHale, an economist based at NUI Galway.

The council also noted that the Government’s recent deviations from the EU’s budgetary framework had left the public finances more exposed to shocks such as a “hard Brexit” or a downturn in the world economy.

Spending benchmark

The Government will breach the EU’s spending benchmark by about €200 million next year because of an additional EU budget contribution necessitated by an unprecedented jump in Irish GDP last year.

This follows a breach of about €500 million this year linked to spending overruns in health and justice.

Prof McHale said the European Commission had taken a benign view of these "slippages" and therefore Ireland had avoided sanctions. However, he said the EU's budgetary framework, established in the wake of the financial crisis, was there to protect Ireland and "shouldn't be seen it as something that's been imposed on us by Brussels".

In its report, the council also noted that an extra €1 billion in corporation tax revenue, which may or may not recur into the future, had already been tied into additional Government spending.

“Using unexpected tax revenue for difficult-to-reverse spending increases goes against the spirit of the new budgetary framework and is especially risky when the source of the additional revenue is corporation tax,” it said.

The council also believes the Government has significantly underestimated the cost of maintaining the existing level of public services in the face of natural demographic forces.

The Government estimates it has €10.5 billion in so-called fiscal space over the next five years but the council suggested the State would eat up €4.2 billion of this just to “stand still” or retain the existing level of services before any additional spending can be committed.

In 2018, it also noted, €700 million would be required to meet the carry-over cost of tax cuts and expenditure increases introduced in Budget 2017, effectively absorbing half the fiscal space available for 2018.

In its report, the council said the lack of a supply response to the excess demand in the property market had seen residential and commercial property prices escalating.

“These both have negative implications for competitiveness, with compensating upward pressure on wages likely,” it said. Conversely, a stronger supply response, while necessary to keep prices and rents down, ran the risk of overheating the economy, it said.