We at the Fiscal Advisory Council are concerned at the Government’s spending plans

When I joined the Irish Fiscal Advisory Council in 2019, one headline labelled me a “deficit-friendly economist”. This has since provided amusement to me and my council colleagues.

The reality is that, despite being called the dismal science, economists don’t simply view deficits as bad and surpluses as good. It depends on various economic factors, as I explained in a 2017 article that earned me this label.

The sustainability of public finances, for example, depends on a country’s growth rate and interest costs. Countries with high growth and low interest costs can sustain larger deficits, while those with lower growth and higher interest costs must balance their budgets or even aim for a surplus to prevent a mounting debt burden. Thus, economists’ stance on deficits depends on economic conditions.

The same is true if we think about another macroeconomic objective of fiscal policy – stabilising the economy. Economists often label good fiscal policy as broadly “counter-cyclical”. That is, support should be provided during weak economic periods and removed when the economy is running hot.

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For instance, the council supported the large fiscal supports, more than €30 billion, during Covid. Although there was certainly scope for better targeting, the spending and tax reliefs provided essential supports to businesses and workers during the pandemic.

However, providing support to the economy when it needs it relies on showing restraint in better times. Currently, Ireland faces capacity constraints in most sectors due to historically low unemployment and high, though falling, inflation of goods and services. Consequently, stimulating the economy further in a broad sense is unnecessary. Nonetheless, the Government may feel that some households and sectors warrant additional fiscal support. To limit the total stimulus provided, the onus is on the Government to make choices.

One choice a government must first make each year is whether it wants to maintain the status quo. Does it want to increase spending just to maintain the value of existing spending (“the cost of standing still”) – allowing for a larger population, people ageing, and prices rising? Similarly, does it want to adjust tax bands and credits to ensure that tax rates don’t increase just because people got higher wages and salaries?

A second choice for a government is whether it wants to introduce new spending initiatives, or adjust taxes in other ways. This includes ramping up capital spending as the Government’s National Development Plan intends. The council has generally supported such a ramp-up, to help deliver better public services and to facilitate the climate transition.

To help guide the choices while ensuring the overall approach is sensible, governments typically adopt a fiscal framework that includes rules. Such rules can make government plans more predictable, more consistent, and ultimately more sustainable. To the extent that they are followed, the rules can promote fiscal credibility and ensure fiscal policy is able to respond when it is most needed (as was the case during Covid).

In Ireland, the “national spending rule” plays this role. By committing to having no more than the 5 per cent net growth in core spending allowed under the rule overall, the Government achieves several things. As it is a net rule, the Government can give itself extra space for additional spending, by increasing taxes.

The basis of the 5 per cent limit is a combination of medium-term economic growth (3 per cent) and inflation (2 per cent). The national spending rule also helps stabilise the economy. When inflation is high, the costs of maintaining spending in real terms is higher. If the Government chooses to cover these costs, it will have fewer resources available elsewhere.

At these times of high inflation, the 5 per cent limit automatically binds more and this pushes the Government to make the tough choices. When inflation is low, typically in periods when the economy could do with more support, the same 5 per cent limit in the spending rule affords the Government more space, by virtue of the lower costs associated with standing still, and choices become easier.

This will be the third year the Government increases spending by more than the 5 per cent limit suggested by the rule. Unexpectedly high inflation was a good reason for going beyond this temporarily, but doing more now risks adding to that very problem.

More worryingly, the Government now plans to go beyond the rule in 2024 with close to a 6 per cent increase in net terms, and to breach it again in 2025 and 2026. Each violation of the rule gets built into the level for future years, further deviating from earlier plans.

This shift in direction indicated by the Summer Economic Statement raises concerns for the council. Failure to make difficult choices now may result in even more challenging decisions in the future.

The windfall corporation taxes currently benefiting the State should not change this approach. While Ireland is fortunate to receive these funds, they are concentrated among a small number of multinationals in just a few sectors. Relying on this revenue to fund permanent domestic spending poses serious risks, as they can disappear rapidly, like property taxes during the financial crisis. We don’t want to repeat mistakes of the past.

Could the excess corporation tax be used for one-off measures? One-offs are useful supports that can give rise to fewer concerns about sustainability. The countercyclical logic is why the council tends to worry. One-offs don’t avoid inflationary impacts. A large package of one-off measures that causes inflation to linger at high levels risks exacerbating the pervasive effects of inflation. If replicated across Europe, it may necessitate higher interest rates for longer. And one-off capital spending is unlikely to generate good value for money when the construction sector is so constrained.

Instead, the excess corporation tax should be saved and allocated to address the costs associated with an ageing population. Our analysis indicates that by 2035, and particularly by 2045, the additional healthcare and pension expenses will strain public finances significantly. By building substantial savings over time, the government can generate yearly investment returns to help fund these future costs. This approach will free future governments from limited choices and reduce the reliance on risky funds.

Prof Michael McMahon is acting chairperson of the Irish Fiscal Advisory Council as well as a professor of macroeconomics at the University of Oxford and senior research fellow of St Hugh’s College