Is the Government going for broke again?

Budgetary watchdog stops just short of accusation that recovery is being squandered

  Minister for Finance Paschal Donohoe: adamant that   Government spending will only rise by 4 per cent in 2019. Photograph:  Nick Bradshaw

Minister for Finance Paschal Donohoe: adamant that Government spending will only rise by 4 per cent in 2019. Photograph: Nick Bradshaw

 

At the height of the financial crisis in 2009, the State was spending €23 billion more than it was taking in by way of taxes and other income. That amounted to 14 per cent of gross domestic product (GDP).

The tide had gone out on several property-related tax headings leaving a hole in the Government’s finances while the banking system had effectively collapsed under the weight of excessive lending into a now defunct property market.

The following year the cost of this collapse, underwritten by the infamous bank guarantee, was heaped onto the Government’s ledger, sending the budget deficit to €54 billion or 32 per cent of GDP, off the charts in EU terms.

The State was now on the brink of financial ruin. An international bailout and a four-year exile from the bond markets followed. This was pure crash-and-burn economics.

Ten years on, the budgetary arithmetic has been transformed. The Government is projected to run a budget deficit of €195 million this year, equating to just 0.1 per cent of GDP. It might even generate a surplus if buoyant corporation tax receipts continue to exceed expectations.

The transformation is the result of an extraordinarily severe austerity project, one that removed upwards of €30 billion from the economy via tax hikes and spending cuts. Greece has become impoverished attempting a similar adjustment.

This is what makes the Irish Fiscal Advisory Council’s stark warning to Government this week about the public finances all the more surprising.

In its hardest-hitting assessment to date, the State’s budgetary watchdog rebuked the Government for “repeatedly” breaching its own budgetary targets; allowing public spending to advance at an unsustainable rate; and presenting unrealistic spending targets for 2020 and beyond.

“Repeated failures to prevent unbudgeted spending increases have left the public finances more exposed to adverse shocks, with the budget balance in deficit rather than surplus,” it said.

Council chairman Seamus Coffey said there were “worrying echoes” of the 2000s when a cyclical expansion in tax revenues funded a significant increase in public spending. He all but accused the current Government of squandering the recovery.

At the heart of the watchdog’s criticism is Government spending. It zeroed in on the €4.5 billion spending hike allowed for in Budget 2019, noting that this was well beyond the €3.5 billion it had judged appropriate and which the Government had itself signalled in its summer economic statement just four months previously.

As with other years, much of the increase, injected into the process at the last minute, has been linked to budgetary overruns in health, a perennial feature of the budgetary landscape.

Different starting point

Minister for Finance Paschal Donohoe defends the Government’s position by insisting that Government spending will only rise by 4 per cent in 2019. But that’s from a different starting point than the Government had previously signalled – one that includes another last-minute, unplanned €1.1 billion spend in 2018.

If this is excluded, spending is rising by 6.5 per cent. The fiscal council claims this is unsustainable and out of line with the long-run growth trajectory of the Irish economy, typically put at 3 per cent before inflation. And there are likely to be further increases in the health spend next year, while the 2019 Christmas bonus payment to welfare recipients has yet to be factored in, both of which could push the spending dial further.

The watchdog also makes the point that the Government’s future spending estimates, particularly in the area of health are simply not credible, not only on the basis of recent precedent but also with the cost of medical treatments rising globally.

Over the past two years, health spending has risen by €2 billion to €17 billion, but the Government estimates that it will only rise by a further €400 million by 2021. This implies a major structural adjustment in health over the next two years. But there is no evidence that such a strategy is in place.

The Government is under no obligation to heed the watchdog’s advice and typically ignores it, but the criticism has injected heat into the debate and sharpened the focus around the Government’s budgetary numbers. It also comes on the back of a warning last week from the Organisation for Economic Co-operation and Development (OECD) that another possible boom-and-bust cycle may be developing in the Irish economy.

Taoiseach Leo Varadkar responded to the criticism by saying the Government could not turn a “blind eye” to pressing needs in housing and health.

Donohoe also maintained that, unlike one of his predecessors as minister for finance Charlie McCreevy, when he had it, he did not spend it, playing up the Government’s fiscal probity.

The Government’s standard response to criticism of its budgetary policy has been that spending is prudent and necessary to improve public services. The watchdog insists it is not its role to be prescriptive on where spending should go, only that it should funded sustainably.

Irish Fiscal Advisory Council chairman Seamus Coffey: he said there were “worrying echoes” of the 2000s in the Government’s latest budgets. Photograph: Dara Mac Dónaill
Irish Fiscal Advisory Council chairman Seamus Coffey: he said there were “worrying echoes” of the 2000s in the Government’s latest budgets. Photograph: Dara Mac Dónaill

Tax bonanza

For now at least, the current tax bonanza can paper over the cracks in the budgetary policy, but how long will this last? The fiscal council’s point is that spending hikes are easily deployed but less easily reversed.

“Failures to prevent unplanned spending increases has meant long-lasting increases in spending that are difficult to reverse and that represent a repeat of policy mistakes of the past,” the watchdog said in its report.

There is a natural downturn in the cycle coming – on top of whatever Brexit delivers.

The Bank of England’s disorderly Brexit forecasts, which suggest the UK could suffer a worse shock than the 2008 financial crisis, must have sent shivers through the Department of Finance here, not least when you consider that a 1 per cent contraction in UK GDP typically has a corresponding drag on Irish GDP of between 0.3 and 0.8 of a percentage point.

Defending the Government’s position, Varadkar noted the fiscal council’s claim that the budget was not prudent differed from the European Commission’s assessment delivered only a week ago, which found that the budget was compliant with the EU’s stability and growth pact. He also said the Government’s spending was modest compared to the constant demands of left-wing members of the Opposition for increased spending.

The row neatly encapsulates an age-old divide between economists, who believe budgetary policy should be used to cool a heating economy, and politicians, who are beholden to political pressures usually to cut taxes and beef up spending.

Counter-cycle budgetary policies – saving when times are good and spending when times are bad – are a difficult sell politically, not least when a substantial part of the electorate have yet to feel the uplift.

Having originally targeted a budget surplus in 2018, the Government is still running budget deficits despite having one of the highest debt burdens in the OECD. It is now not expected to achieve a surplus until 2020.

Economic goals

KBC Bank economist Austin Hughes believes the emphasis on running a budget surplus is perhaps misplaced. “A budget surplus is, in itself, a good thing but, in terms of economic goals, it shouldn’t be seen as the only thing,” he says.

“It may not be necessary for economic stability and history shows it certainly isn’t a sufficient condition in itself,” Hughes adds, noting that Ireland ran substantial budget surpluses in 10 of the 11 years between 1997 and 2007 but “that didn’t reflect a stable fiscal setting or provide much protection from the crisis”.

“It may be more useful to consider the road we are travelling rather than the point we are at,” says Hughes.

“Of the EU 28, only Greece has gone through a larger fiscal turnaround since the crisis. Ireland has made enormous progress since 2008/09 when the budget deficit was about three times the EU norm to the point in 2017 where it was about one-third of the EU average.”

“We should look to ensure this continues and also try and make the road we are on a little less bumpy by avoiding major budget surprises,” he says.

Hughes says the Government’s annual trick of producing large last-minute rabbits out of magically appearing hats has the opposite effect, focusing attention on specific giveaways and clawbacks rather than on assessing whether the overall thrust of the budget is expedient.

It also flies in the face of what Donohoe says he wants to get away from, namely a focus on the “fiscal space”.

Perhaps the biggest criticism levelled at the Government by economists is that its budgetary policy doesn’t seem to be part of an overall plan or strategy. The Department of Finance seems to scramble together enough money at the end of each year to cover various departmental overruns while kicking the can down the road for the next year.

“The budget out-turn is merely a statement of the fiscal arithmetic whereas the policy that underlies it seems to be entirely haphazard,” Hughes says. “The arithmetic balances because the economy is strong and everything is fine at the moment, but the arithmetic is not being made balance by policy that takes into account both the short-term dynamics of the economy and its longer-term needs.”

Structural deficit

Goodbody economist Dermot O’Leary agrees with the fiscal council’s criticism. “The medium-term objective of a structural deficit of no more than 0.5 per cent of GDP will be breached in 2018 and will not be met in 2019 either,” he says.

“This is in breach of EU rules, although only to a small extent,” O’Leary says, noting the 2018 breach is due to in-year spending increases. “This has been a feature since 2015, with tax revenue windfalls being used to fund these increases,” he adds.

“For 2019, spending is forecast to be €2.3 billion higher than the level set out in the stability programme update in April of this year, due both to extra spending this year and a larger than expected increase announced in Budget 2019,” he says.

There is, of course, the spirit of the EU’s fiscal rules, which the Government here complies with, and the letter of the fiscal rules, which the Government frequently flouts.

Without getting into the nitty-gritty of structural balances and expenditure benchmarks, the EU’s rules stipulate that Government spending should not increase over and above long-term potential of the economy. But the long-term potential of the Irish economy is virtually unknowable. And technically you should be able to raise spending on foot of bigger tax revenue: the problem is that many people believe the corporation tax windfall is precisely that.

Merrion Capital economist Alan McQuaid also agrees with the watchdog’s critique, suggesting the Government should have targeted a surplus in Budget 2019.

“The economy is growing strongly enough as it is without the need for further stimulus,” he says. “There are so many potential headwinds as regards the Irish economy over the next few years: Brexit; global trade wars and a slowing world economy, that we should be playing it safe and putting as much money away as possible to cope with the next downturn, especially given that both government and household debt remain elevated despite the economic recovery,” McQuaid points out.

Poring over the minutiae of the Government’s budgetary numbers might seem like a dry exercise but facing down the challenges of health and housing, surely the most pressing crises facing the State, in the absence of stable public finances is next to impossible.

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