The publication of a parsimonious Book of Estimates for 2003 and the pace of the slow down in Irish economic activity have provoked a rather lop-sided debate on the ideal level of Government spending, writes Colin Hunt.
Given the emergence of some spare capacity in the economy, the relative health of the Exchequer and the need for policy stimulus, the Government is supposedly now presented with a perfect opportunity to borrow and spend.
The governmental largesse of the past three years, when rampant expenditure growth coexisted harmoniously with radical taxation reform, created an impression that Ireland had permanently entered some sort of fiscal Utopia. In this fantasy land, budgetary expansion was a cost-free exercise in economic management where resources were unlimited and increased spending was financed out of thin air.
This impression, which led directly to the dramatic deterioration in the state of the public finances since 2000, was of course accommodated only by the extraordinary growth rates of the boom years. Once economic activity returned to normal settings, the new budgetary reality was exposed as a mirage which evaporated along with an apparently impregnable Exchequer surplus.
There is one general lesson to be drawn from the experience of the past three years: Government spending increases in excess of nominal economic growth always lead to either higher tax burdens or a deteriorating budgetary balance. There is no escaping the beautiful simplicity of mathematics.
Ireland's economic success of the past 15 years has been driven primarily by a fiscal transformation which was characterised by a reduced role for Government spending in the economy and a lighter taxation burden. Since 1987, Government spending as a proportion of Gross Domestic Product has fallen from nearly 50 to 30 per cent.
Now that Ireland's income convergence process is complete, nominal growth is unlikely to stray above 7 per cent in the years ahead. Any increases in Government spending above this level will inevitably lead to higher borrowing and/or increased levels of taxation. Of course, the advocates of higher Government spending will argue that no long-term damage will be inflicted on the economy by what is politely described as a temporary budget deficit.
"Temporary budget deficit" is nothing more than a fiscal oxymoron. It took us 25 years to escape the deathly grip of the Exchequer's last "temporary" dip into the red. Higher Government spending levels and the tolerance of structural budget deficits, once sanctioned, become nigh on impossible to reverse.
In the absence of a bout of abnormally buoyant growth, excessive spending will lead to a vicious cycle of higher borrowing, higher taxes and lower growth. In essence, a continuation of the spending practices of the 2000-02 period, when spending growth frequently topped 20 per cent, will lead to an impairment of Ireland's structural efficiency and reduced growth rates over the medium term.
The 2 per cent increase in spending for 2003 announced in the Book of Estimates should be regarded as the opening gambit in a process which will end on Wednesday with the publication of the Budget. Additional spending measures announced on that day are likely to bring expenditure growth for 2003 closer to our medium-term 7 per cent growth target. If these targets, in marked contrast to the overshooting experience of the past three years, are attained, Budget 2003 will have succeeded in consolidating the existing tax regime and in bringing the fiscal rot of the 2000-02 period to an end.
If it could be proven conclusively that higher Government spending led to improved public services, fiscal purists (or should that be puritans) might have a fight on their hands. However, there is no evidence that this is indeed the case. Over the course of the past five years, Government consumption has increased by 48 per cent in real, inflation-adjusted terms.
In particular, unprecedented resources have been provided for the health services where expenditure has more than doubled. Can anyone claim that public services are 48 per cent better?
AT THE very least, there is a perception that this is not the case and some would argue that the quality of public service provision has actually deteriorated. If having indulged in a spending spree of gargantuan proportions you have nothing to show for it, surely logic dictates that you stop spending. Even if there was an economic case for higher spending, responsible policymaking would demand that a full audit of past expenditure be conducted before additional resources be made available for public services. If spending doesn't help, why spend more?
The argument in favour of higher Government spending is not only naïve: It would make scant difference, in the absence of public sector reform, to the provision of public services. If heeded, the call for an excessive spending increase would be inimical to Ireland's budgetary stability and would lead to a reversal of the economic gains of the past 15 years. Prudent fiscal policy is at the very core of responsible economic management. Heed the calls for higher spending and short-term solutions at your peril.
Colin Hunt is research director at Goodbody Stockbrokers