John McHale: Coalition spending strays from prudent path

After the harrowing crisis years, the Irish economy is now experiencing an impressive recovery. Real GDP growth is forecast to reach 6.2 percent this year and unemployment has fallen below 9 per cent. As economic conditions improve, it is timely to remember our collective tendency to make budgetary mistakes during good times that have helped set the stage for the crises that followed. Prudent policy is a necessary ingredient of sustainable growth in incomes and employment in a fragile global economy - all the more so given the crisis legacy of high debt.

As part of its mandate under the Fiscal Responsibility Act, the Irish Fiscal Advisory Council is required to publicly assess whether the fiscal stance adopted by Government is conducive to prudent economic and budgetary management. It must also assess compliance with fiscal rules and endorse, as appropriate, the macroeconomic forecasts underlying the budget.

In our Pre-Budget Statement published in September, the Council was broadly supportive of a €1.5 billion package of spending increases and tax cuts planned for 2016. This was considered to be appropriate given the stage in the economic cycle and high debt level, and also consistent with national and European fiscal rules.

In the days before Budget 2016, the Government announced its intention to have a large and unexpected increase in spending for 2015. Compared to its Spring projections, this amounts to an additional €1.5 billion in spending this year, providing unnecessary stimulus to an already fast-growing economy and reflecting a missed opportunity to further lower the deficit and debt.

More worryingly, the spending increase is funded by better-than-expected revenues in the recovery, largely from corporation tax. This has echoes of the last boom, when property-related revenues funded large increases in spending. Indeed, spending this year will be four percent higher than planned a year ago, a larger upward adjustment to plans than occurred in any year during the property boom.

In each of our previous Fiscal Assessment Reports, the Council assessed that the Government was following a prudent fiscal stance. This year’s surge in Government spending is a deviation from this prudent path.

More positively, the Government has signalled its intention to follow the requirements of the European Stability and Growth Pact (SGP) and the national Budgetary Rule from 2016, which would return it to a prudent path.

It might seem counter intuitive to say the fiscal stance is imprudent when Ireland’s headline budget deficit - the extent by which Government expenditure excess revenue - continues to fall? But when you strip out the effects such as economic growth and the lower cost of borrowing the underlying deficit – or structural primary deficit – has actually worsened as a result of the decision to increase spending this year.

In the Spring Economic Statement this structural deficit was projected to improve by 0.7 percent of GDP in 2015; it is now projected to deteriorate by 0.2 percent of GDP. This swing of almost a full percentage point of GDP represents a sizable - and unexpected - loosening of the fiscal stance for this year.

As noted, the Government has indicated its intention to meet the requirements of the fiscal rules. Ireland will get its headline budget deficit below the traget of three percent of GDP this year and should exit the "corrective arm" of the SGP. It would then enter the "preventive arm" in 2016 in which stipulates that any increase in spending has to be linked to increased revenues, this is called the Expenditure Benchmark.

The Government’s spending projection for 2016 just meets the Expenditure Benchmark but leaves no margin for overruns. However, overruns have been a recurrent issue for health spending over the last number of years.

The Government’s own system of multi-year expenditure ceilings has also been ineffective, with continuous upward revisions to the ceilings. There is therefore a danger of falling foul of this rule next year unless spending is better managed.

The Council has also expressed concern about the absence of well-anchored medium term budgetary projections to underpin the planning process. The current spending projections imply a fall in non-interest spending of 5 percent of GDP between 2015 and 2021. This primarily reflects the assumption that spending will not rise in line with inflation, implying significant falls in real expenditure. It is important that realistic assumptions about underlying spending pressures are incorporated into the projections to support the planning process, not least in regard to decisions about tax cuts.

However it finally reports, the Banking Inquiry has helped us understand the causes of the crisis and has also highlighted the major institutional changes put in place to prevent old mistakes being repeated. The new national and European budgetary framework is a core part of the new infrastructure. But it is a fragile construction. Respect for the framework-both letter and spirit - will give us the best chance of following a truly countercyclical budgetary policy and securing sustainable growth in incomes and employment.

John McHale is Chair of the Irish Fiscal Advisory Council. He is also Established Professor of Economics and Director of the Whitaker Institute for Innovation and Societal Change at NUI Galway. The latest Fiscal Assessment Report can be downloaded at fiscalcouncil.ie