Friday 28 October 2016

Fiscal watchdog rightly damns Government budget strategy

Published 07/06/2015 | 02:30

Michael Noonan and Brendan Howlin are facing criticisms from the Irish Fiscal Advisory Council over their handling of the public finances
Michael Noonan and Brendan Howlin are facing criticisms from the Irish Fiscal Advisory Council over their handling of the public finances

The most damning critique by any organisation or entity of the current government's economic management since it took office - it was a sentence that describes Thursday's report by the independent watchdog tasked with overseeing the Government's handling of the public finances.

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It raises very serious questions about both Michael Noonan at the Department of Finance and Brendan Howlin in its sister department, Expenditure and Public Sector Reform.

The criticisms made last week are very different from past spats between the Irish Fiscal Advisory Council (IFAC) and the Government. The IFAC has on a number of previous occasions differed with the Government as to the most prudent course of budgetary action. Its general view has been to reduce the deficit and debt as quickly possible. The Government did not take that advice.

But this was not an issue of being right or wrong. Rather, it was a judgement call on the pace of the adjustment.

The watchdog's latest assessment is very different, and much more serious. That is because it finds the Government to be in breach - and quite flagrant breach in some cases - of many of the rules designed to prevent yet another period of boom followed by austerity.

This is much more serious than merely making a call for more prudence. It should be a wake-up call for all those who believe that Ireland is out of the woods into which it wandered early in the last decade, when the bubble began inflating.

There is very good reason for the council's extensive and multifaceted criticisms. Consider first the fiscal context.

This year the Government intends to spend €1,000 more for every man, woman and child in the country than it takes in. It plans to narrow this gap very slowly, balancing its books only in 2019, which, it might usefully be noted, will be well into the second half of the parliamentary term.

Not bringing the public finances to surplus from deficit more quickly increases the risk of two very bad things happening - a return to austerity and national bankruptcy.

Deficits widen very quickly when economies slow or go into recession. If a government is already in deficit when a downturn hits, it is under greater pressure to worsen the slump by tightening policy to prevent the deficit exploding.

With the economy now expanding solidly the Government is boosting it further, having started to stimulate in the last budget. But if the economy slows, it will have to go into reverse and reintroduce austerity. If it had used the stronger revenue growth to narrow the deficit now, it would have built up a buffer for a slump. The bigger the buffer, the less austerity that would be needed in the event of a downturn.

Nobody in the Government has even articulated this basic fact. It is abundantly clear that we are already back to "pro-cyclical" fiscal policy, despite the endless promises from the political class that lessons had been learned.

Nor has the second risk - of outright bankruptcy - gone away. Currently the national debt exceeds 100pc of GDP, making it one of the highest not only in Europe, but in the world. That leaves little room for manoeuvre if the recovery does not go according to plan. It is very easy to envisage circumstances in which Ireland's debt dynamics turn very nasty, very quickly.

That is the general context. Now consider the IFAC's findings.

On the Government's tax and spending plans for 2016, IFAC says that they are "not in line with the requirements of the domestic Budgetary Rule or the Preventive Arm of the Stability and Growth Pact".

In other words, the Government is breaking its own rules and the rulebook for euro area countries, something which raises the possibility of a clash with Brussels.

Very specifically on spending, the council says that the Government's plan for 2016 "goes against the letter and spirit of the rule". And the rule is as clear as it is sensible.

If highly indebted governments want to increase spending, they are obliged to raise new taxes. That explicitly does not mean using extra revenue that comes in as a result of stronger economic growth, known as "tax buoyancy". Revenues generated in this way must be put into deficit and debt reduction. The Government is blatantly in breach of the expenditure benchmark rule.

The council is hardly less scathing about the projections after 2016. And it is not hard to see why. Those plans involve lower cash spending, excluding the costs of servicing the national debt, out to the end of the decade. The council dryly states that this will be "very challenging to achieve while maintaining current services and meeting demands for increases in public services due to demographic and other pressures".

A sleight of hand that the two Merrion Street ministers have used to give themselves more wiggle room to spend more, is their de facto abandonment of longer term expenditure ceilings aimed at anchoring the entire budgetary process. The use of such ceilings, long considered best practice in public finances management, "is not working effectively because the Government has consistently made adjustments to the ceilings. This undermines its value as an expenditure planning and control tool" the council concludes.

On the revenue side, the IFAC finds that the Government has masked its unrealistic projections by failing to set out in detail where it believes future cash flows will come from.

At its broadest, prudent management of the public finances involves risk assessment. The single greatest criticism of how Ireland's system of government functioned during the bubble was the dismissal of warnings that anything could possibly go wrong. There has certainly been change within the system regarding risk assessment, but the council raises serious questions about how deep the change has been.

A year ago in response to the council's concerns, Michael Noonan said that a statement on the overall balance of risks "can be provided in future". But Budget 2015 failed to include such a statement. When the council raised the matter again in November, Noonan radically changed tack - saying such an assessment was not needed, citing as a reason the "often self-fulfilling nature of annotating such risks". This echoes the "don't talk down the economy" argument used by the cheerleaders during the bubble against anyone who raised concerns about the sustainability of it all.

Quite rightly, the council dismisses this, bluntly stating that it "does not accept these reasons for not providing an assessment of the balance of risks".

Thursday's report highlights in great detail how the system is lurching back to short termism and risk blindness. The council has done a very great service in highlighting just how quickly and seriously that has happened. In the future nobody will be able to say there were no warnings.

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