Oireachtas Joint and Select Committees

Tuesday, 11 June 2019

Committee on Budgetary Oversight

Fiscal Assessment Report: Irish Fiscal Advisory Council

Mr. Seamus Coffey:

I thank the Chair and members of the committee for inviting us to meet them and for the opportunity to discuss our latest fiscal assessment report. As the Chairman outlined, joining me today are council members, Mr Sebastian Barnes, Mr. Michael Tutty and Professor Michael McMahon, the latter being our newest council member. I wish to put on the record of the committee our recognition of the positive contribution made by Dr. Íde Kearney during her four years as a member of the Irish Fiscal Advisory Council. Also joining me are Mr. Eddie Casey, chief economist and head of the secretariat, as well as members of the council's secretariat, Mr. Niall Conroy, Ms Friederike Vogler and Mr. Killian Carroll. We continue to value these engagements.

The council's latest report, published today, covers all aspects of our mandate, as set out in the Fiscal Responsibility Acts 2012 and 2013. It is important to note that the council's mandate does not cover commenting on the choice of individual tax measures or spending items or priorities, but rather to comment on the overall fiscal stance.

The domestic economy has shown continuing strong growth since about 2013. It has recovered from a deep crisis and is now operating near capacity. That is most visible in the labour market with the unemployment rate falling to about 4.5%. The percentage of the population employed in prime age groups, those aged between 25 and 54, was above its pre-crisis peak at the end of last year. Efforts up until 2015 to turn around a large budget deficit were successful. The Government's debt ratios are on a downward path, creditworthiness has improved and the budget balance appears to be close to a balanced position when the effects of the cycle are accounted for.

However, the outlook for the economy is unusually uncertain. On the one hand, the domestic economy could continue to outperform. It could significantly overheat if housing construction expands at a faster pace than is expected or if migration flows and credit growth rates follow more typical patterns for a mature phase of an expansion in the economy. On the other hand, there are severe downside risks.

A disorderly Brexit poses profound risks to the economy and public finances, as do changes to the international tax environment, an escalation of protectionist measures, the onset of a cyclical downturn in major trading partners and adverse financial developments, including those possibly arising from Italy.

Since 2015, there has been little progress to improve Ireland's budget balance, excluding interest costs, and Ireland's net debt ratio remains the fifth highest in the OECD when measured appropriately. Reflecting this, creditworthiness is still vulnerable to rapid changes. Government spending growth has accelerated in recent years and the Government has also allowed a pattern of spending drift to take hold. Annual non-interest spending rose by €2.4 billion in 2017; €5.2 billion in 2018 and budget 2019 sets out plans for a rise of €4.5 billion this year. The pace of spending growth has risen from 4.5% in 2015 to 6.7% in 2018. Spending increases within the year, over and above what was originally budgeted for, have also contributed to a faster than planned pace of expansion. For 2019, there is more evidence of this. In October, the Department estimated that gross voted spending would be approximately €1 billion higher than planned for the year. As it turned out, it was closer to €1.3 billion higher than planned, with additional spending increases occurring in the final months of the year. The overruns are evident even more so in the general data published by the CSO. The council's critical assessment last November, for example, was based on a 2018 general Government expenditure increase that was €500 million lower than shown by the eventual CSO outturn data published in April when one-offs are excluded. On this basis, a within-year spending revision of €1.9 billion is evident for 2018 compared with the stability programme update, SPU, 2018 estimates. The additional €300 million overrun appears to have been driven by anticipated underspends in non-health areas not having materialised - these were factored into the budget day Estimates for 2018 - and higher than estimated social payments, including health service, housing assistance and other social protection schemes.

The council has adopted a new principles-based approach the aim of which is to make the assessment of the fiscal rules simpler and more robust, including using the Department of Finance alternative measures of the cycle. On this basis, the objective of a structural balance of no worse than -0.5% of GDP was achieved in 2018 as the structural balance was estimated to be +0.2% of GDP. However, there was a significant deterioration in the structural balance in 2018 and Government spending breached the limit for the spending rule in 2018. This reinforces the council’s view that the net spending increases in recent years have not been conducive to prudent economic and budgetary management. The lack of progress comes against a backdrop of significant favourable factors. The economy has experienced a continued cyclical upswing, meaning lower unemployment related payments and higher tax revenues, while corporation tax has surged. Both of these factors are likely to prove temporary.

The council’s report shows that between €3 billion and €6 billion of the €10.4 billion corporate tax receipts received in 2018 could be considered excess. In other words, beyond what would be projected based on the economy’s underlying performance and based on historical or international norms. Unlike typical revenue windfalls, these gains could persist for a number of years before reversals could be expected. They also represent a net injection to the economy given that foreign-owned multinational enterprises contribute four fifths of corporation tax receipts. As much of the improvement in Government revenues in recent years may be cyclical or temporary, this suggests that the structural position - looking through these effects - has deteriorated.

The council assesses that the Government should be cautious, reflecting the risks associated with a hard Brexit, the reliance on corporation tax, possibilities of overheating and the rapid rise in spending between 2017 and 2019. For this year, the Government should stick to its existing plans as contained in SPU 2019. This means that no additional within-year increases, including the payment of a Christmas bonus for weekly social welfare recipients, should be introduced without offsetting measures. Further slippages, which imply a looser fiscal stance and contribute to overheating pressures, should be avoided. To stem the increasing reliance on corporation tax receipts, any additional unexpected receipts should be allocated to a prudence account during the year and then to the rainy day fund or elsewhere.

For 2020, the Government should stick to its plans as set out in SPU 2019. This would imply some €2.8 billion of budgetary measures for 2020, including amounts already earmarked for increases in public investment, public sector pay, provision to cater for demographic changes and for assumed tax cuts in 2020.

This approach would mean minimal new tax and spending measures on budget day. If further discretionary measures are to be introduced beyond SPU 2019 plans, the Government should introduce additional revenue-raising measures or scale back planned spending increases and tax cuts to preserve overall sustainability. A smaller expansion than the €2.8 billion would also be desirable, again, recognising the severe risks now faced. This could include not using the €600 million that is currently set aside for assumed tax cuts and unallocated spending increases.

The Government's budgetary plans for later years lack credibility. Specifically, the medium-term spending forecasts are based on technical assumptions that appear unrealistic as they do not reflect either likely future policies or the future cost of meeting existing commitments. The projections imply an implausible slowdown in spending growth, which leads to increasing surpluses in later years. For example, gross voted expenditure is assumed, as a technical assumption, to grow at 2.5% per annum over the period 2020-23. The spending growth forecasts for the later years would also be insufficient to cover the council's estimates of the standstill scenario of maintaining current public services levels and income supports, given demographic and price pressures.

The Government needs a credible strategy for the medium term. A better approach to budgetary planning could be built around four key elements. First, the Government's debt ratio target should be revisited. It should be lower to reflect Ireland's volatile growth rates, should be restated as a percentage of modified GNI*, should be clarified as either a ceiling or target and should have clear staging posts. Second, a clear statement of the sustainable growth rate at which net policy spending can grow is needed. This could be informed by the Department's alternative estimates of potential output but any approach should try to correct for the risks of pro-cyclical bias present in such estimates. Third, departmental three-year expenditure ceilings should be reframed around this medium-term growth rate and forecasts should be more realistic. The current ceilings are evidently not working. A better approach would see more realistic spending plans set out in advance and a strengthening of subsequent spending controls and monitoring. Fourth, a budgetary position less reliant on corporation tax receipts should be an overarching principle guiding fiscal policy in coming years. Using a prudence account, as the council suggests, could help to achieve this.

I thank the committee for providing us with the opportunity to attend this meeting. We look forward to taking questions and hearing the views of members.