Saturday 25 May 2019

Budget to reveal extent of 'hidden space' priorities

The Government has more freedom of action in Budget 2018 than voters believe - but there's a catch

Taoiseach Leo Varadkar (right) and Minister for Public Expenditure Paschal Donohoe
Taoiseach Leo Varadkar (right) and Minister for Public Expenditure Paschal Donohoe
Dan O'Brien

Dan O'Brien

Over the next week there will be a lot of talk about how budgetary rules - both EU and national - prevent the Government from doing this and doing that. Let's start this pre-Budget column by setting out some facts.

Neither set of rules puts any limit on public spending increases, provided those increases are funded by tax increases. Equally, the Government can cut taxes as much as it wants, provided it reduces spending in line with the cost.

'To govern is to choose' goes the old saw. The rules oblige governments to make choices, instead of allowing them to hoodwink voters with tax cuts and/or spending increases paid for with borrowed money which they, and their children, will have to service and repay.

Nor do these rules prevent shifting the emphasis of spending or taxation. Earlier in the year the Taoiseach described the freedom to shift priorities as the "hidden fiscal space".

The latter point is particularly important in the context of capital spending - the money spent on roads, hospitals, schools and public housing. The latest Department of Finance documents show capital spending will account for only 7pc of general Government expenditure this year. Put another way, the capital budget could be increased by 50pc if recurrent spending was trimmed by just a few percentage points.

Tuesday's Budget may not reveal very much, but it will show how much, if any, of the 'hidden' fiscal space Government has decided to use. If the Government followed the advice of the majority of economists, it would confine itself to the hidden space alone, rather than using limited leeway for unfunded spending increases and tax cuts.

The reason most dismal scientists advise against stimulating the economy in Budget 2018 is, ultimately, to lessen the likelihood of resorting to austerity when the next slowdown occurs. That, in turn, is because the Government still has not balanced its books, 10 years after tumbling into the red.

If you are spending more than you are taking in the good times, it does not take much of a slowdown to cause the public finances to move into the danger zone. That risk is much greater when you already have a massive accumulated debt burden.

This was underscored on Friday when the Central Statistics Office published its full set of public finances figures for 2016.

At the end of last year, the Government owed €201bn. When the Government's cash on hand is deducted from that gross figure, the state had a debt of €176bn. Despite the economy being in recovery mode since 2012, the debt pile has risen by €24bn over four years and continues to rise.

To put that into less mind-boggling terms, it amounts to a debt burden of €37,000 for every person currently at work in the economy.

The Government's Budget 2018 sums are predicated on the economy growing strongly next year. Most economists who try to forecast how activity will evolve agree. The budgetary watchdog - the Fiscal Advisory Council - has given the mandarins' economic projections its stamp of approval.

This is perfectly reasonable. Ireland's main export markets are, collectively, growing at the fastest clip in a decade. Foreign investment continues to flow into the country. And there are more than a few indigenous sectors that are expanding nicely. But growth is not guaranteed.

Two weeks ago this column noted two worrying recent developments.

Figures published in mid-September showed the widest measure of consumer spending contracted in the April-June period. A week later another set of numbers showed employment growth had slowed sharply in the same period.

As suggested two weeks ago, this could well have been a temporary softening of the recovery: such lulls are common enough. But two more timely indicators published last week give further cause for concern.

On Tuesday, the CSO's estimate of the monthly unemployment rate was published. Just over 6pc of the labour force was jobless in September - a rate that has remained unchanged since June, after falling almost uninterruptedly for five years. This suggests the near-halting of jobs growth in the second quarter of the year may not have been a one-off blip.

Last week's second worrying indicator was from the nation's factories.

Though Ireland is now largely a services-based economy, manufacturing still matters a lot. In August, the "traditional" industry sector produced less than in any month in almost three years and the recent trend has been downwards. The figures are adjusted for seasonality, so the summer holiday slowdown does not explain away the slump.

These new, additional concerns were partly offset by the latest Government tax and spend figures.

Last week the September numbers were published, giving the full picture for the third quarter of the year. They showed that the widest available measures of revenues - which importantly includes the large sums paid in social insurance (PRSI) - perked up a bit over the summer. They certainly didn't flag.

Over the first nine months of the year, all the Government's main sources of cash undershot the Department of Finance's projection, if only by a little, with one exception - the ever-topical corporation tax.

Last week's surprise announcement by the European Commission that it was taking the Irish Government to court generated lots of coverage. Brussels resorted to the action because of the Government's tardiness in getting Apple to put billions of euro into an escrow account to cover underpayments of tax it claims were in breach of competition laws. But the announcement means very little. The cash will be lodged before the case is decided by the judges.

Martin Shanahan, the boss of the IDA, said last week the decision of the Commission in August last to find against Ireland and Apple has had no impact on Ireland's attractiveness as an investment location.

The threats to Ireland's corporation tax regime from various European angles are exaggerated in both likelihood and impact.

A bigger and less-discussed threat is the volatility of these revenues and the impact a decline could have on the future fiscal space.

In the first nine months of this year, corporation tax receipts were up by half a billion euro on the same period in 2016. The increase was a third more again than the Department of Finance had projected. Revenues are on course to top €8bn for the full year. Underestimating this source of revenue has become par for the course in recent years. In 2015 alone corporation tax receipts jumped by 50pc.

What has happened to this windfall?

The Government has spent the lot and locked-in future spending commitments on the assumption that the cash keeps flowing. Given that this source of revenue is among the most volatile - it halved from peak to trough during the recession - this was not wise.

If those revenues were to unwind in the future, for whatever reason, a big hole would be blown in the public finances.

Sunday Independent

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