Monday 14 October 2019

Dan O'Brien: 'People don't want prudent spending, they want to push budget to the limit'

Austerity is more likely than stimulus if Brexit causes a slump. Proliferating warnings have made that crystal clear, writes Dan O'Brien

'Another less discussed development that could blow a €5bn hole in the public finances is a common or garden cyclical fall in profits. Companies' earnings are much more volatile than individuals' earnings. When an economy takes even a mild downturn, profits evaporate'
'Another less discussed development that could blow a €5bn hole in the public finances is a common or garden cyclical fall in profits. Companies' earnings are much more volatile than individuals' earnings. When an economy takes even a mild downturn, profits evaporate'

It's not rocket science. If the Government has no petrol in its budgetary tank, it won't have the wherewithal to hit the accelerator in the event of a slowdown in the economy.

Worse still, if a slump happens the State may have to put the brakes on its many activities in order to avoid losing control of its finances. When the State, which is by far the largest single actor in the economy, pulls in its horns at the same time as the rest of the economy is slowing, the result is an amplified downturn. That is as plain as the nose on your non-economist's face.

Nor does it take an economist to understand that the Government has been putting the accelerator to the floor as hard as it can for the past half-decade. Year after year, the Government has ignored its previous spending ceilings and ramped up expenditure, as the accompanying graphic of spending plans set out in each of the past four budgets shows. All of this happened at a time when the Irish economy was clocking one of the fastest rates of growth in the developed world and didn't need further stimulation.

Click here to view full-size graphic
Click here to view full-size graphic

When the sun shines, make hay. The Government has not made hay. There has been no significant reduction in the stock of over €200bn in debt. Last year, the Government managed to take in more than it spent by the merest smidgen, and that was only because companies handed over far more in taxes on their profits than the mandarins and their economist minions in the Department of Finance had expected.

The massive increase in profit tax revenue - up from €4bn in 2013 to more than €10bn last year - is a much-discussed phenomenon. There is, quite rightly, lots of talk about the risks of these revenues going into reverse. This could happen for not one, but a number of reasons.

This column over the years has often made the point that concerns in Ireland that the "EU was coming for our corporation tax rate" were much overstated. That remains the case. What has changed, however, is a wider global push to shut down tax avoidance opportunities for multinational companies.

Ireland has a veto when tax matters are discussed at EU level. It does not have a veto in wider global forums. Some form of worldwide agreement is likely in the next couple of years. That would almost certainly mean multinationals booking less profits in this jurisdiction. That, in turn, would lead to lower revenues, not higher ones as the Government is banking on.

Another less discussed development that could blow a €5bn hole in the public finances is a common or garden cyclical fall in profits. Companies' earnings are much more volatile than individuals' earnings. When an economy takes even a mild downturn, profits evaporate. The total wage bill in an economy also tends to fall (as unemployment ticks up) but not by as much as profits. That means that taxes on personal incomes tend to be much less volatile than taxes on corporate. The same is true for most of the other taxes that fill governments' coffers.

The current administration has imprudently ignored this, and the other risks to profit taxes in its medium budgetary strategy. It is currently basing its future budget arithmetic on profit tax revenues rising in each of the next four years. The latest projections put revenues reaching €11.7bn in 2023, €1.7bn above this year's target.

Another unexpected fillip to the public finances in recent years has got scant attention. A scarcely believable decline in the cost of government borrowing, to rates never before experienced in financial history, has meant the amounts paid out on debt servicing have shrunk.

Half a decade ago Merrion Street's number-crunchers expected interest payments on the national debt to cost the taxpayer €31.5bn in the 2015-18 period. The bill turned out to be €7.5bn less than that. If one goes back further, the savings have been even bigger. In the 2012 budget, the official expectation was that debt servicing would rise above €10bn annually. Instead, it is now coming in at just half that figure.

Where have these savings and the windfall revenues from profit taxes gone? Straight out the door of the Department of Public Expenditure is the depressing answer.

The repeated failure of the public health system to stay within budget and cost overruns on big capital projects are two reasons why spending keeps breaking though the ceilings set each year.

The Government giving in to public sector pay demands is another. Budget 2015 foresaw the public pay and pensions bill, as measured in the EU-standardised way, reaching €18.9bn last year. Because of cave-in after cave-in, the figure came in at €22.2bn, a €3.3bn difference in one year alone. That the public pay bill has risen twice as fast as non-pay spending in recent years tells its own story about the Government's priorities.

Despite the much better than anticipated fiscal developments discussed above and stronger economic growth, the Government's books are now actually in worse shape than was anticipated in the 2015 budget by some measures.

Back then, the plan was to run a budget surplus (an excess of revenues over spending) of around €700m last year. In the event, it turned out to be just a fraction of that, €46m. This has happened at a time when, as the Department of Finance has itself highlighted, the Irish state remains among the most indebted in the world on a per person basis.

All of this raises questions about what the public wants. With the fiscal watchdog barking ever louder about budgetary risks and last week's ESRI report on economic prospects raising similar issues, the public is aware that the economics profession is worried.

Few people are unaware of how difficult the post-2008 years were. Many others will know that the recent crash was not the first time bad economic management has caused misery.

The prudent thing to do to avoid another bout of austerity would be to run a hefty budget surplus now so that there is fuel in the tank to boost the economy in the event of a shock (or at least to avoid amplifying the downturn with an enforced austerity if there is a slump).

That would involve slowing the rate of spending growth and/or raising more money in taxes. Neither the Government nor the non-government parties and groupings is suggesting such a course. If anything, the opposition wants to push the fiscal envelope even further.

Politicians usually have a good sense of what their voters and potential voters want. That no party is advocating running a bigger surplus so that there is less risk of having to return to austerity suggests that they don't think real prudence is a vote winner. Perhaps voters are happy to run the risks of pushing existing budgetary rules to the limit and beyond. Make the most of the party and endure the hangover - if it comes to that - may be how we want our economy to be managed.

Sunday Independent

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