Saturday 25 May 2019

Brendan Keenan: Simple approach best way to decide future budget aims

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Brendan Keenan

Brendan Keenan

A retired Department of Finance official once paraphrased the old Schleswig-Holstein joke to me this way: "Only three people understood the national accounts; a secretary-general who has gone to the central bank, an assistant secretary who is deceased, and myself - and I've forgotten all about it."

Perhaps he should refresh his memory. If anything, things seem even more complicated now. The published Budget is intended for the vast bulk of us who don't really understand the government books, but there seems to be an added confusion as to what exactly is the purpose of the whole exercise.

The first problem was well illustrated by a recent spat between Finance Minister Paschal Donohoe and Fianna Fáil spokesman Michael McGrath.

This concerned the little matter of €800m and how it was to be accounted for in those accounts. The money covers the estimated costs of the growing population and agreements on public sector pay.

Mr McGrath felt there had been a change of procedure. The Minister said there hadn't - sort of. For those who wish to see an example of the difficulty with national accounts, I recommend Mr Donohoe's explanation to the Budget Oversight Committee.

Fianna Fáil detected murky pre-election politics, designed to show that their plans would not fit into the budgetary framework and perhaps precipitate a general election - but all that may be a bit premature.

The opinion poll showing a near 50/50 split over the Government's game of chicken with Britain on the Border question - not to mention the communications fiasco over the CervicalCheck issue - may change the electoral calculations enough to alter the Budget plans themselves. That is one thing we do know the national finances are for: making governments popular.

This often runs counter to the other purposes pressed upon them. That is part of the second problem; what should be the objectives? There are far too many to be convincing, as could be seen in the new report from the IMF.

Given its timing, most attention fell on the call for restraint on spending and tax cuts in the October Budget for fear of overheating the economy. After the events of 2008, that has become the most fashionable purpose of fiscal policy: to smooth out the ups and downs of the economic cycle.

Despite its apparent simplicity, this is something of a "counsel of perfection". Even accepting the undoubted fact that Irish governments have a particularly bad record, the concept of denying spending demands and curbing tax cuts, because things are going well, is not easy to understand - and even harder to sell.

Nor is it ever quite clear how much leeway there is for governments to ease recessions on the downside with extra borrowing. Bodies like the IMF and the EU authorities rarely go beyond allowing "automatic stabilisers" - which mainly means not trying to claw back increased spending on social welfare.

The IMF's own suggestion was for a small surplus next year and a medium-term aim of reducing debt to 50pc of GDP. That would be below the eurozone's ideal limits but, more realistically, would equate to 75pc of Ireland's national income (GNI*).

One objective leads to the other of course, but the debt target may be a more politically practical policy. One can then ask the question as to whether the 0.3pc reduction in the debt ratio planned for next year is adequate in an economy expected to grow by 4pc; and whether the 87pc target for 2021 after another three years of good growth is sufficiently ambitious?

The answers are a matter of political choice, but it is easier to identify the political stance represented by those choices than to figure out to what extent the economy is being overheated or excessively cooled.

In the meantime, we can compare the figures from last month's Stability Programme with the forthcoming Summer Statement and then with the budget itself to assess Mr Donohoe's final choices.

Although there is no precise medium-term debt target one can infer Government policy from the figures. Whether the Government actually does so itself is another matter, but the stability programme shows growth (GDP) averaging 3.4pc over the next three years, while the debt ratio falls by 2.4pc a year.

Using debt targets does not remove the economic stability quandary. The ratio ought to fall faster when the economy is growing above trend and more slowly when it is not.

A figure of 3.4pc would be above most people's opinion of long-term trend growth and, even if achieved, at the current rate of progress it will take until the end of the next decade to reach the 50pc ratio.

Given the ups and downs that are likely to occur over such a period, it will probably take longer. Unless, of course, there is a return of the debtors' friend, inflation. Whether it does or not, applying more specific targets to the country's indebtedness might be more useful than mucking about with surpluses and deficits in response to economic performance.

At present this is officially done with a calculation that seeks to incorporate how much the economy is operating above or below potential, so as to get the underlying (structural) deficit. It is supposed not to go below 0.5pc of GDP; a target which is meant to be finally achieved in next year's budget. But no one really believes in the calculation and the Department of Finance thinks the target may have been achieved already.

It is all pretty unimpressive and confusing. There is yet another objective that gets little attention but might point to a better way of doing things. This is the 'expenditure benchmark', which is meant to align increases in government spending before interest payments with growth in the economy.

It is hard to disagree with the EU commission's view that this provides a better picture of the budgetary position, but it too ran into trouble over the distortions caused by multinational activities and the resulting difficulty in assessing "normal" growth in the Irish economy.

Yet, when all is said and done the national accounts are about spending - the role of government, the size of the state, and the choices which must be made. An acceptance that spending should not grow faster than independent economic forecasts (or be paid for with new taxes if it does) would open the way to a clearer picture of what all this complexity is supposed to be about.

The benchmark would have to be simpler than the present inscrutable formula, but research suggests that, combined with debt targets not that different from the present system, but more precise, it could provide fiscal stability in a way that could be clearly monitored reasonably well understood.

It would switch attention to how money should be spent, rather than how much. Recent budgets have been safe enough, but the political discourse points to an inherently unstable and risky approach. Of all the targets and measures in use, simple or obscure, the now dominant 'fiscal space', with its emphasis on residual tax revenue, may well be the worst.

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