Yahoo – it’s Fiscal Space time again!
So the economy is growing like topsy, the taxes are rolling in, the deficit and the government debt are falling rapidly, as is unemployment. What could possibly go wrong?
Well plenty, says the Fiscal Council – from Brexit, to a changed corporate tax regime in America, to simple lower growth, all of which could severely knock what is still a rather delicate set of government accounts. (They are too polite to mention the ever present risk of dumb-ass politicians making stupid budget choices, so we won’t either).
That’s why it is urging the Government to use its budget plans to make the public finances better able to stand up in the face of an economic downturn. That way, there aren’t as many tax rises and spending cuts needed to withstand a crisis. Resilience, they call it.
So how do the new Government’s economic and budget plans stack up? Well, because of the long delay in getting a Government, the Spring Economic Statement had no new policy commitments, while the Programme for Government had no budget costings, so it is hard to say.
The Fiscal Council wants to see a new medium term budget framework that shows both no policy change projections, and projections that take account of the Programme for Government. It also wants to see how the programme will be paid for.
That would be a lot of extra work for the Merrion Street Mandarins – but the Fiscal Council thinks it would really help us -and most especially politicians – better understand the budget implications of policy decisions. This is important at any time, but is all the more so now, when a raft of budget rules come into play for the first time.
The new Government is committed to sticking to the budget rules – both domestic and EU. According to its assessment of the Spring Economic Statement the current plans will miss the deficit adjustment requirement by a small margin, unless tax receipts over-perform in the way Corporation Tax did last year.
They are not too worried about this down in IFAC towers, as last year’s big over-performance in reducing the structural deficit makes this year’s target harder to hit (at least without a helping hand from tax over-performance – and so far, so good on that front).
Corporation Tax issues
The council raises a few interesting questions about Corporation Tax, revisiting the scene of a blazing row with the Government over the funding of a big increase in supplementary spending on the eve of the budget last October.
It questions the Department of Finance’s assumption that Corporation Tax will be down compared to last year, wondering why the SPU does not take account of the big surge in Corporation Tax receipts in the last quarter of 2015, and carry that over into this years forecast.
It had previously expressed its concerns about using a pretty volatile tax head like corporation tax – which ebbs and flows with the fortunes of individual companies – to fund permanent spending increases like health or pensions.
It has gone further this time, drawing attention to the dependence of that tax head on just ten companies, which between them paid over more than 40% of the total Corporate Tax take last year. Between them these ten firms accounted for 6% of the Government’s total tax revenues last year.
So if two of them have a bad year (or go bust entirely – it happens), then we have a pretty sizeable hole in our budget. To put it in context, these ten firms paid around €2.7 billion in Corporation tax last year – the projected Fiscal Space for budget 2017 is €900m. So beware of the vulnerability.
Rainy day fund
IFAC has drawn attention in this report to a proposal by one of its members, UCC economist Seamus Coffey, for a rainy day fund that would see the Government tucking away roughly half of the annual corporate tax take for, er, a rainy day.
Such a fund would have two advantages. Firstly it could be used as a counter cyclical reserve, to be available for spending in a downturn (rather than cutting spending and jacking up taxes, as we have traditionally done – the so-called pro-cyclical policy that makes recessions worse, but is often unavoidable as the Government has no money in the piggy bank, and no capacity for borrowing).
Secondly, a rainy day fund could come in handy to protect budget surpluses from politics. In good times, when there is actually some money to set aside, it is hard for governments to run significant budget surpluses for a sustained period, because there is never any shortage of projects to spend money on.
Just running a surplus (or even putting the money into debt reduction) is politically hard. Putting the money into a rainy day fund makes it politically easier to justify not loosening spending discipline in the good times, because of the promise of money to spend in the bad times (when its really , really needed).
Right now we are in the economic good times. It might not feel that way in the nerve endings of the average wallet, but viewed from the eyrie of the Fiscal Council, it is the good times, and a further surge may be coming over the horizon, driven by the urgent need to ramp up housing output.
That, along with the already strong growth, could mop up a lot of the excess labour and lead to the emergence of hotspots in the economy, increasing the risks of overheating.
IFAC stress there is no sign of overheating now, but we are getting rather close to the point where overheating pressures could start to emerge.
Then the Government will face the unenviable task of having to contemplate taking some money out of the economy to ease the overheating risk. This would be much easier accomplished by setting up a rainy day fund, with its promise of some payback in the inevitable downturn, rather than by hiking taxes.
Not that politicians are likely to be rushing to talk about the possibility of taking money out of the economy. More the opposite. Indeed their problem now is reconciling the commitments made in the Programme for Government, with the estimate of available Fiscal Space – the money available to pay for the promises.
Even if the range has gone up from €8.6 billion to somewhere in the €10-12 billion range (and we will get a fresh estimate from the Government in the next couple of weeks), the Fiscal Council says there is less to it than meets the eye.
The main reason is inflation, not something we hear much about these days, but nevertheless the Department of Finance has gone to the trouble of making an inflation forecast over the period covered by the Spring Economic Statement.
But in accordance with long standing practice, it does not index spending commitments to those inflation forecasts in the Spring Economic Statement. IFAC thinks this is wrong (and cites an EU directive on budget forecasting in support of its view).
It applied the Department’s inflation forecast to the numbers and found that cost of living increases to current spending programmes would eat up €6 billion of the available fiscal space.
That about half of it gone before any new programmes are introduced, just to keep real spending at its current value. They call it a “stand-still” expenditure forecast.
This report may provide the people formerly known as the Social Partners with some extra food for thought when they meet the Government at the end of the month for an economic dialogue, where the main course will be the soon-to-be-published “Summer Economic Statement”, setting out more detail on the fiscal space for budget 2017, and the batting order for Programme for Government tax and spending plans.