Friday 23 August 2019

Alarm bells are sounding - yet the Government is spending like crazy

Taoiseach Enda Kenny and Public Expenditure Minister Paschal Donohoe during the annual recital by the Department of the Taoiseach staff choir. Photo: Collins
Taoiseach Enda Kenny and Public Expenditure Minister Paschal Donohoe during the annual recital by the Department of the Taoiseach staff choir. Photo: Collins
Richard Curran

Richard Curran

The economic landscape is going to look very different in three years' time. And when it does, we will be able to point to 2016 as the year when things really began to turn.

It might not seem obvious now, given that the economy will grow at the fastest rate in the eurozone this year. Unemployment continues to fall and our exports remain very solid.

But we have been hit with a three-punch combination in 2016 and the damage hasn't yet been seen.

Brexit, the election of Donald Trump in the US and renewed questions about Italy's future in the euro all spell bad news for our economy.

None of them are of the Government's making. Yet, the problems they throw up are likely to be compounded by decisions made in Government Buildings and Leinster House, from public sector pay, water charges and the housing crisis, to expenditure increases and complacency about our tax revenues.

The Irish economic recovery has been truly astonishing. We have gone from running a budget deficit of 32pc in 2010 to less than 1pc in 2017. The real turnaround happened in the last three years when we were reaping the benefits of the pain taken in the austerity years, while also getting incredibly lucky on three fronts.

Our recovery enjoyed triple tailwinds of a cheap euro to help exporters, low oil prices which helped everybody and low interest rates which kept borrowing costs down. The State has also benefited enormously from being able to borrow cheap sovereign debt on the bond market.

But things are beginning to shift. With Brexit, the euro has risen in value against sterling, one of our most important export markets. Oil prices have remained relatively low but are now starting to tick upwards.

Interest rates remain low but as they start to go up in the US, we may see change closer to home.

Uncertainty about the nature and timing of the British withdrawal from the EU will be a drag on our economic performance. Thousands of jobs, mainly in indigenous firms, are under threat from a hard Brexit.

The uncertainty could go on for years, with the British ambassador to the EU warning in recent days that a new UK/EU trade deal could take a decade to negotiate.

If anything, the pending Trump presidency is an even greater mystery. His determination to boost the American economy could even play in our favour. But it all depends on how he does it and what sort of longer-term damage he does to the exchequer of the largest economy in the world.

If he slashes US corporation taxes to 15pc, there is an argument that says Ireland should benefit through the increased investment that richer American companies might make.

However, it all depends on how he cuts corporation tax. The suggestion is that cuts will only be available for companies that export from the US and do not import goods produced abroad to the US.

This would be a new corporate tax system not simply based on a percentage of profits but based on the origin of the product and the investment flows that surround it.

In other words, US corporations would be financially incentivised to reduce foreign investment and make more at home. This could undermine the flow of future US inward investment to Ireland.

Separately, the EU is yet again pushing for a harmonised corporate tax position based on where products are sold and not where the company behind them is registered. Economists have warned that such a move would seriously erode our corporation tax base, which is expected to bring in €7bn this year.

Then there is Italy. Italian banks have not dealt adequately with their legacy bad loans and high cost base.

Monte dei Paschi di Siena (MPS), the country's third biggest bank, is trying to raise around €5bn in new capital from private investors. Unicredit wants to raise €13bn.

If MPS fails, it goes under or is bailed out by the Italian government. Under new EU rules, a government bailout must see bondholders burned on part of their investment. Billions of its bonds are held by ordinary Italian investors who would lose a lot of money.

Junior bondholders could lose 80pc to 90pc of their investment in a forced state bailout. Italy is not far away from electing a government that wants out of the euro. It may come to that unless the country can politically push through massive reform. But it failed at the first hurdle when the electorate rejected reforms in a referendum earlier this month.

As the third largest economy in the eurozone, Italy is too big for a bailout.

Economic alarm bells are going off all over the place - in London, Brussels, Rome and Washington. So what is our Government doing? Well it is abolishing water charges, spending like crazy, awarding public sector pay increases to anyone who threatens to strike and finding new ways to subsidise its way through the housing crisis.

It runs the risk of squandering the potential gains of years of austerity through new spending commitments before even getting its hands on the money.

The Fiscal Advisory Council crystallised it very well in recent weeks when it re-visited the so-called "fiscal space" in the years ahead. It said half of the money available for spending increases or tax cuts in 2018 has already been used up by the full-year effects of last October's Budget.

Any increase in spending on public sector pay next year, for example, would have to be paid for by increased taxes or cuts in other areas of spending.

Nobody will pay a cent for water, other than businesses and group schemes, despite the billions needed to upgrade the network. First-time buyers will land €15,000 in free money from the State, irrespective of their wealth or income, as a way of getting around Central Bank mortgage rules that have now been changed anyway.

Exchequer figures for November were well ahead of target in several categories. Much of it was corporation tax and self-assessed income tax based on earnings made in 2015. Vat is a useful real-time barometer of spending and confidence and it was the only tax category behind target.

The Government needs to change tack and stop trying to buy its way out of tough political problems. Unfortunately, Dáil arithmetic makes that look impossible. This has been the year of living dangerously. We will need to be lucky to escape the consequences.

Irish Independent

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