Fiscal council’s critique of Coalition budgetary policy: An expert view

The Irish Fiscal Advisory Council (Ifac) this week delivered what can only be described as a stinging attack on Government budgetary policy. The fiscal watchdog claimed the State's financial forecasts – its projections for spending and tax – lacked "credibility" and failed to take account of future policy commitments.

It described the financial planning as “piecemeal”. It also claimed that the Government wasn’t providing realistic guidance to the public and therefore increasing the risk of things going wrong.

“There are clear risks to the forecasts: spending is very likely to grow at a faster pace than is shown, and the overreliance on corporation tax to fund ongoing spending looks set to continue,” the council warned.

For Fine Gael and Fianna Fáil – who like to see themselves as fiscally responsible and who typically paint the opposition as fiscally irresponsible – the rebuke will hurt.

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The council has – for some time – been critical of the Government’s longer-term budget forecasts, arguing that they fail to incorporate factors like the ageing population.

That said, the criticism was more trenchant this time and comes at a critical juncture for the Government. As the economy turns and the pandemic abates, the focus will switch from Covid-19 containment and supports to the Government’s depleted budgetary position and the State’s worrying debt dynamics.

The possible scarring effects of the crisis – up to 100,000 people are expected to be left unemployed – and a potential decline in corporation tax receipts add to the challenge. We break Ifac’s criticism into four key areas – longer-term budgeting; health spending; corporation tax receipts; and the phasing out of Covid supports – and ask the experts what they think.

Longer-term budgeting

A long-standing issue for Ifac is that the budgetary process here is too narrow in its focus – concentrating as it does solely on the year ahead. The council wants the Government to sign up to more “credible” multi-year budgets, ones that will serve as some form of anchor.

Ifac’s chief criticism is that the Government’s medium-term forecasts are published purely on a “technical basis” that assume a 3.5 per cent per annum increase in spending. The council argues that even the cost of maintaining the same level of public services – “the stand still costs” – will exceed this estimate.

A better model, in its view, would be to base these forecasts off a combination of estimates, which include the stand still costs and policy commitments laid out in the Programme for Government.

"The current outlook is still very uncertain and, in such circumstances, explicitly 'technical' assumptions seem to me to be preferable to Hail Mary outlines of still very unclear economic and political influences on the scale and shape of public spending in a post-pandemic world," KBC Bank Ireland economist Austin Hughes says.

“It seems far more credible to me to emphasise that the longer-term outlook could be very different to that envisaged today. More generally, while I appreciate the specific mandate of Ifac as well as the tone of its pronouncements through last year, I continue to despair at the perception that the only purpose of Irish public policy and economic advice is to ensure a persistent surplus in the public finances.

"In circumstances where the Irish Government can borrow for 10 years at around 0.25 per cent, there should be a priority on identifying projects that generate an economic and social return that enhances the future ability to service and repay such borrowings," Hughes adds.

Goodbody economist Dermot O’Leary agrees with Ifac on the need for better medium-term planning but believes the Government should be given “some slack” given the extraordinary fiscal decisions it has had to make over the past 12 months.

“Ifac is correct on this, of course, but we are sure that the Government won’t argue that the benefits of laying out these medium-term forecasts are reduced due to the heightened uncertainties triggered by the Covid crisis,” O’Leary says.

"There will come a time, in the near future, that the focus of the Department of Finance will move back towards more boring issues like long-term budgeting forecasts. To have Ifac there to remind them of this is not a bad thing."

Health spending

Ifac’s criticism of Government budgetary policy in recent years has zeroed in on the perennial overruns in health. Healthcare spending has been rising at an average rate of 7 per cent a year – at least that was the case prior to Covid. But the Government’s current multi-year forecasts for health assume only minimal increases for the years ahead – just €200 million or 1 per cent rises are factored in for 2022 and 2023. Ifac claims this is unrealistic. In its report, it also makes the point that the cost of implementing Sláintecare’s health reforms – estimated at €1.2 billion in 2021 – was only disclosed in May, seven months after the budget, while estimates beyond 2021 have not been provided.

Both the Economic and Social Research Institute (ESRI) and the International Monetary Fund (IMF) have in recent weeks suggested the Government needed to find ways to generate more tax to fund spending in areas such as health.

"An aging population, commitments to future spending increases, and potential declines in both corporation and motor tax receipts made the need for significant future tax rises likely even before the pandemic," the ESRI's Barra Roantree said in a recent report. "Increases in broad-based taxes on incomes, consumption and property may therefore be needed in the years ahead."

Peter Vale, tax partner at Grant Thornton Ireland, however, warns that our income tax rates are already relatively high, with little scope to increase further. "A broadening of the tax base may be considered, which would see more people within the tax net, albeit paying a small amount of tax," Vale says.

“While politically sensitive, an increase in property taxes may also be considered, given that our property-related taxes are currently at the lower end of the scale in a global context.”

Corporation tax

The perennial bulge in health spending has – in recent years – been paid for by excess corporation tax receipts, Ifac noted. What happens if this business tax bounty ends? While the Government has factored in a €2 billion decline in receipts by 2025 from the proposed changes to the global system being drawn up by the OECD, the council warns the changes being considered could have a bigger impact. A scenario considered in its latest report shows how just five firms exiting Ireland could result in €3 billion of lost receipts. Vale says the global tax landscape is uncertain and predicting the impact of OECD reforms on Ireland's tax receipts is next to impossible.

“ It seems inevitable that we will see further global tax changes, and that these will have an adverse impact on Ireland and on our receipts,” he says.

"That said, Ireland will still remain the most compelling location in Europe in which to do business from a tax perspective, albeit not as attractive as it was. There are also other factors which could see Ireland's corporation tax receipts increase in the future – for example, the expiry of IP-related tax allowances. How this will all balance out is almost impossible to call. It could well be a €2 billion impact, or it could be €3 billion, or it could be a number far removed from that," Vale says.

Goodbody’s O’Leary agrees, noting that there is a margin of error around the forecasts. “Ifac’s analysis is essentially a ‘what-if’ scenario. The OECD has provided governments with information on the impact of Pillar I reforms so one would have to think that the Department of Finance should have a very good handle on the potential impact of various tax changes in the coming years,” he says.

Phasing out of Covid supports

The removal of supports stands as a key reckoning point in the not-too-distant future and while Minister for Finance Paschal Donohoe has pledged repeatedly that there will be no cliff-edge scenario, he has also stated he wants to keep Ireland in the middle of the pack in terms of the deficit.

In its report, Ifac said the scale of the financial supports for workers and businesses was unprecedented but also “prudent and necessary” to support the economy. “The budgetary costs were high, but it was possible to introduce substantial supports without jeopardising fiscal sustainability,” it said.

Fergal O’Brien, of employers’ group Ibec, agrees with Ifac on the necessity of the supports and on the need not to remove them too swiftly.

“As the economy reopens fully, many businesses will be challenged by reduced margins due to higher costs of doing business and variable demand trends and the stock of debt accumulated as a result of the crisis,” O’Brien says.

“It is therefore vital that Government supports are continued for this transition period in order to preserve as many firms and jobs as possible.”

KBC’s Hughes makes the point that the supports and their gradual removal need to foster recovery.

“ I think the arguments in respect of the speed of scaling back of Covid supports should initially be couched in terms of the economy rather than the public finances,” he says.

“ The argument for tapering is to ensure there are no disincentives to re-opening businesses and returning to work – there is some debate in the US as to whether recent fiscal measures have slowed the pace of recovery in jobs.

“On economic and health grounds, the pace at which Covid supports are reduced should foster recovery. That means it is better at least temporarily to err on the side of excessive generosity – possibly allowing payments at a reduced rate continue in the early stages of the re-opening,” Hughes says.

The above responses – while accepting Ifac’s call for better medium-term budgeting – seem to suggest that the Government, as O’Leary says, should be cut some slack given the uncertain circumstances of the past year. They also suggest that the Government’s budgetary strategy – whether it runs a deficit or a surplus – needs to be viewed in the context of other challenges and risk factors.