Government should set a benchmark for any permanent increases in spending

Spending increases should be front-loaded to deal with Covid crisis

Economic recovery will  be aided by a possible consumer boom. With restrictions on spending and heightened caution, household savings are rising rapidly. Photograph:  Dara Mac Dónaill

Economic recovery will be aided by a possible consumer boom. With restrictions on spending and heightened caution, household savings are rising rapidly. Photograph: Dara Mac Dónaill

 

The publication of the Programme for Government (PfG) comes at a time of heightened uncertainty. It would have been good if the programme had contained more detail on the design and cost of the proposals in it but the post-election negotiation phase is not the place for costings to arise. They should be available to everyone before the election.

The programme could set out a benchmark for the aggregate amount of permanent increases in policy spending (including tax changes) the Government intends to introduce. On this, the programme is also silent and it is not clear that the tax and spending proposals in it are compatible with each other.

The first concern for the new Government will be ongoing crisis management. The borrowing implications of the emergency measures that have been introduced because of Covid-19 should not be a worry. Or you worry about it but do what is necessary anyway.

We do not need to put in place long-term funding for emergency measures as, by definition, they are temporary. We can borrow very cheaply to fund them, at least for now. And it should be the Government that does this borrowing. The debt will never be repaid so the main worry is the interest cost. Over time, the debt will reduce relative to national income.

Permanent changes to government spending do need long-term funding. While borrowing at the current low rates to fund long-term spending programmes may seem attractive it would not be sensible to rely on borrowing as a permanent source of funding.

The deficit is not entirely under the control of government. It depends on the state of the economy and developments in tax revenues

Governments can borrow, and should when circumstances require, but a stable tax base is a more sustainable basis for long-run spending programmes. Those who favour an expansion of the role of government should also be in favour of ensuring that expansion is funded on a sustainable basis.

The actions of the European Central Bank are ensuring the public health crisis does not become a public finance crisis, even as governments run huge deficits. Some of the programmes rolled out by the ECB explicitly have “pandemic” in their title. They are not designed to be long term.

If new spending programmes in areas like housing and health are considered important enough to be included in the PfG they need to be funded on a sustainable basis. In the near term, this will involve borrowing but the deficit will need to come down. Part of the reason we can borrow at such low rates is that market participants believe a large component of the deficit is temporary.

The recovery will do most of the heavy lifting as tax revenues rise and the call on emergency measures reduces. We are already seeing this as sectors of the economy reopen.

Deficit

The programme includes the intention “to return to a broadly balanced budget”. While reducing the deficit is necessary that does not mean explicitly targeting a particular outcome is the best way to set budgetary policy.

The deficit is not entirely under the control of government. It depends on the state of the economy and developments in tax revenues, with particular focus here on corporation tax.

Also, we do not know if a balanced budget is the appropriate target for 2024. A slower than hoped for recovery would mean that a deficit might still be required in 2024 to support incomes and economic activity. Or maybe the surge in corporation tax will see these receipts double over the next five years as they have over the past five. Adopting a “when I have it, I spend it” approach to such windfalls would not be prudent.

Back in December, the Minister for Finance Paschal Donohoe gave a keynote speech to the Institute for International and Economic Affairs. The centrepiece was the intention to set fiscal policy to achieve a budget surplus of 1 per cent of GDP in 2022. This target has now been rightfully binned but it was not appropriate to set it in the first place.

Setting a medium-term envelope for permanent spending increasing in line with the potential growth rate of the economy would be a much better way to set budgetary policy. It is in the control of government and can be partially adapted to suit economic conditions.

The Government should probably focus the additional increases in 2021 and 2022 on investment as households will drive consumption

In normal times, these increases could be spread evenly over the period to fund public sector pay increases, increases in social welfare rates, the increased costs due to demographics with maybe some room for new spending initiatives, though without tax increases this will be limited.

We could consider the new Government to have a fixed envelope for permanent spending increases for the period 2021 to 2024. Introducing more of these spending increases in 2021 and 2022 will help the economy recover.

This recovery will also be aided by a possible consumer boom. With restrictions on spending and heightened caution, household savings are rising rapidly.

The Government should probably focus the additional increases in 2021 and 2022 on investment as households will drive consumption. As the recovery takes hold there will be less need for this pace of spending increases in 2023 and 2024.

This does not mean austerity to reduce the deficit – it is a profile of spending increases that sees more happen sooner in response to economic conditions.

The failure to run sufficiently large surpluses in the run-up to the crisis, as the strong employment growth and surging corporation tax receipts would have warranted, means the underlying or structural deficit that will be revealed once the crisis period is over will be larger than it might otherwise have been. The implication of past spending overrruns is that the future spending envelope that a sensible medium-term expenditure framework would allow is reduced.

Putting the objective of a “return to a broadly balanced budget” into the PfG is a nod to prudent budgetary management. However, it would be much better if it was framed in terms of outcomes under the government’s control such as the amount of spending increases, net of tax changes, it intends to introduce. This happens when new coalition governments are negotiated in some EU countries including the Netherlands. We would benefit if the same happened here.

Seamus Coffey is a lecturer in economics, University College Cork

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