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EU requirement that states produce and stick to a five-year spending plan is a welcome restraint

New fiscal rules will make it much harder for finance ministers to spend recklessly

Minister for Finance Michael McGrath and Minister for Public Expenditure Paschal Donohoe have overseen enormous increases in State spending that have been enabled by windfall corporate tax receipts. Photograph: Barry Cronin for The Irish Times.

Conall MacCoille
Mon May 13 2024 - 05:45

After last month’s Stability Programme Update (SPU) from the Department of Finance, the focus was understandably on the headline figures, specifically the €8.6 billion budget surplus expected in 2024. Crucially, the department still judges weak corporate taxes in early 2024 to be a temporary issue rather than a pernicious trend. However, the SPU also sounded a warning that the current 15 per cent pace of growth in public expenditure is unsustainable, with a substantial overshoot in health already evident.

But it’s what the SPU says about the next generation of EU fiscal rules and their implications for Ireland that should perhaps have received more attention. Within the rules, the Maastricht Treaty debt and deficit reference values of 60 per cent and 3 per cent of GDP respectively remain in place, which Ireland comfortably adheres to. However, the Government will now need to publish a medium-term fiscal plan, the first due by September 20th.

The main innovation of the revised rules is their focus on net expenditure – in other words, public spending excluding debt interest, unemployment benefits and after any revenue-raising measures. Member states, including Ireland, must commit to a five-year path for net expenditure that will be monitored by the EU via annual progress reports.

The intention is that member states will not be able to alter the path of net expenditure once it has been agreed with the EU council, unless a new Government takes office. This will certainly be a very different vista for the next Irish government.

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The theatre of October’s budget day will certainly be transformed if any spending increase announced by the minister of finance must be met by a corresponding tax rise

As the Department of Finance puts it in the SPU, the new rules will require a careful examination of the macroeconomic environment and a credible path for public expenditure, a “sea change” in how budgetary policy is formulated in Ireland.

Is Ireland ready? The theatre of October’s budget day will certainly be transformed if any spending increase announced by the minister of finance must be met by a corresponding tax rise. It is unclear what action, if any, the EU council might take if Ireland inevitably deviates from its five-year plan.

Setting out a credible five-year path for public expenditure is an ambitious target. Currently, social welfare benefits and income tax bands and credits are not explicitly indexed to consumer price inflation. Also, demand for public services is determined by population growth, which has consistently exceeded official projections due to inward migration.

The Covid-19 pandemic, Ukraine war and associated migration, and energy price hikes have also contributed to enormous increases in public expenditure. For example, the €121 billion target for public spending in 2024 was originally envisaged at just €102 billion five years ago in the October 2019 budget.

In their December assessment of Budget 2024, entitled The Government needs a Serious Fiscal Framework, the Irish Fiscal Advisory Council (IFAC) was unusually trenchant in its criticism, highlighting that the Government is set to repeatedly breach its own 5 per cent rule for expenditure growth and arguing fiscal gimmickry had been employed to flatter the numbers.

[ Budget watchdog accuses Coalition of ‘fiscal gimmickry’ while warning about its €6.6bn overspend ]

IFAC also believed the “standstill” costs of providing public services were far higher than in the Budget 2024 projections, most notably in the health allocation.

That said, the over-arching reality is that Ireland will be one of only a handful of OECD countries to run a budget surplus this year. The new Future Ireland Fund (FIF) and Infrastructure, Climate and Nature Fund (ICNF) are significant and welcome steps forward – ring-fenced outside the exchequer, effectively banking windfall corporate tax receipts. Hence, contributions to these funds will not be available to finance higher public spending or tax cuts in October’s budget for 2025.

[ What was behind budget watchdog’s extraordinary broadside against the Government? ]

The UK’s experience with fiscal planning is also telling. The UK Treasury’s Spending Review sets out departmental allocations for three years, supplemented by the Office for Budgetary Responsibility’s (OBR) five-year projections. Some Conservatives have seen the OBR’s seemingly arcane and uncertain judgments on productivity growth, investment and labour participation as playing too strong a role in the process, or even anti-democratic.

... more difficult times lie ahead. Growing bottlenecks and capacity pressure in the labour and housing markets should serve to slow growth, and corporate taxes will not grow as aggressively in the next five years

Yet the OBR’s projections have merely reflected the reality of lacklustre economic performance post-Brexit. As the private sector has languished, the burden of providing public services to the still-growing British population has grown. Hence, tax and public spending are now expected to rise to their highest level since the 1940s (expressed as a proportion of GDP), an outcome far removed from the Singapore-on-Thames envisaged by many Brexiteers.

Very often the debate in Ireland is focused on the size of any giveaway on budget day, but less so on the appropriate size of the State, or how to fund it. The unexpected windfall of corporate taxes has played a role, with the Irish tax take now at 30 per cent of gross national income, the highest level this century. This has helped fund rapid increases in public expenditure while avoiding difficult questions on personal taxation.

However, more difficult times lie ahead. Growing bottlenecks and capacity pressure in the labour and housing markets should serve to slow growth, and corporate taxes will not grow as aggressively in the next five years.

Hence, the next government will need to think more carefully how to fund the many competing demands for public spending – the ageing population, healthcare, infrastructure, and climate change. In this context, that the next generation of EU fiscal rules place a greater onus on member states, including Ireland, to set out credible medium-term fiscal plans is surely welcome.

Conall MacCoille is chief economist at Bank of Ireland

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