Saturday 15 December 2018

Alarm bells should ring over our spending spree amid budget deficit

Ireland’s public debt level is still too high.
Ireland’s public debt level is still too high.

Conall Mac Coille

The recent publication of the June exchequer returns was heralded in some quarters as showing the public finances are in rude health, with the Government planning a cautious approach to October's Budget.

This is a skewed perception of Ireland's fiscal position.

The reality is that public spending is now growing rapidly, funded by buoyant tax revenues, but with only modest progress towards achieving a budget surplus.

This poses risks, especially with the economy facing the threat of Brexit, protectionism in global trade and with corporate tax revenues still heavily reliant on the multinational sector.

Of course, June's exchequer returns showed buoyant tax revenues.

The key tax headings were all up sharply on 2017: incomes taxes by 8pc; value added taxes by 2.8pc; and corporation taxes 15pc. This reflects Ireland's strong economic performance.

Once again corporation taxes were the stand-out performer - but remain reliant on a small number of multinational sector companies, exposed to developments in the IT and pharmaceutical sectors. Global tax reforms still pose risks. This is a potentially unstable platform from which to launch rapid spending increases.

Gross voted current expenditure was up sharply by 6pc and is now €68m over budget. Not surprisingly the perennially over-spending Department of Health was the chief culprit.

Current spending on health is already €168m over budget, up 9pc on the first half of 2017, adding to concerns spending discipline is being eroded.

Indeed, the Government's own Summer Economic Statement almost reads as a critique of budgetary policy.

Comparable small European economies with low unemployment rates are now running budget surpluses, including the Czech Republic (1.6pc of GDP), Denmark (1.0pc), Luxembourg (1.5pc), Malta (3.9pc), Netherlands (1.1pc), Slovenia (0.0pc) and Sweden (1.3pc).

Ireland is clearly lagging behind on this front.

Furthermore, the government debt/GDP ratio among these EU countries averaged 45pc in 2017. Irish Government debt is still close to €200bn, or 100pc of national income.

The headline debt/GDP ratio is expected to be 66pc in 2018 but that is flattered by the many problems that are distorting Ireland's GDP measure.

What is clear is that Ireland's public debt level is still too high and there is a case for budget surpluses to run it down more aggressively.

No doubt debt servicing costs will rise as the ECB ends its quantitative easing programme and slowly begins to raise official interest rates.

However, the date at which Ireland is expected to achieve a budget surplus has been pushed back in recent budgets, originally expected to be achieved in 2018, but now only expected in 2020.

Of course, Ireland has made enormous progress in reducing its budget deficit, from €11bn in 2013 to €1.5bn in 2016. However, the purse strings have been loosened since then.

Total spending is now expected to equal €62bn in 2018, 15pc higher than originally envisaged. The strategy since 2016 has been to make consistent but modest improvements in the deficit.

The growth in spending can be traced back to the general election and 'confidence and supply' agreement between Fine Gael and Fianna Fail.

The agreement committed to maintain at least a 2:1 ratio of spending increases over tax cuts in the Budgets for 2017 onwards. This 'four legs good, two legs bad' approach to managing the public finances is long on ideology, but short on ensuring value for money for tax-payers. Notably, Budget 2018 included a €5 per week increase in social welfare benefits, such as jobseekers benefit and the basic state pension - but with smaller gains through tax cuts for those on the average wage.

The narrative that voters expressed a preference for spending over tax cuts seems questionable given the extent of support for parties advocating the unrealistic goal of eliminating the USC. In any case, the actual ratio of spending increases to tax cuts since the 2016 election has been far higher.

Despite rapid growth in the Irish economy, Budget 2018 was forced to raise revenue in net terms, including a higher 6pc rate of stamp duty on commercial property.

Unfortunately, the EU fiscal rules that Ireland signed up to under the Fiscal Compact treaty will do little to maintain fiscal discipline. Remarkably, they would allow a budget giveaway of €4.5bn in 2018. Once again, there is now a danger that EU fiscal rules, inappropriately set for Ireland, will provide political cover for overly exuberant public spending.

The Summer Economic Statement indicates the Government plans to pursue a similar strategy out to 2021, gradually moving into a budget surplus, but with the bulk of additional revenues allocated to further spending increases.

Specifically, as the National Development Plan is rolled out, capital expenditure is set to almost double, from €4.6bn in 2017 to €8.6bn by 2021.

The case for higher public capital expenditure is compelling - especially given the lack of investment over the past decade and emerging infrastructural bottlenecks.

However, it remains to be seen whether the political system will allow funds to be prioritised towards Cork, Galway, Limerick and Waterford.

The intention is to help facilitate growth in these areas and diversify population and economic growth away from the capital.

This may be a laudable goal, however as we raise spending we should be conscious that Ireland is now lagging behind its European peers, by still running a budget deficit.

Conall Mac Coille is chief economist at Davy. Brendan Keenan is away.

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