Next Government may have €2.5bn more to play with

A new Irish Government has yet to be formed post-election but EU fiscal rules have not gone away and to that end the Department of Finance has just published its annual Stability Programme Update (SPU) which has to be submitted to the European Commission  by the end of April. The SPU sets out medium term fiscal and debt projections based on updated economic forecasts. The publication would also normally provide a detailed breakdown of the monies available to the government of the day given the constraints imposed by Brussels in order for Ireland to comply with the Stability and Growth Pact. However, in this case, there is no detailed breakdown of the ‘Fiscal Space’ available to the incoming administration, although it is possible to arrive at some broad conclusions given other published information. On that basis it seems there may be more Space available than previously envisaged, as much as  €0.5bn annually over the next five years.

Irish GDP growth emerged at 7.8% in 2015, well above any earlier forecasts, which has prompted a rise in the consensus estimate for the current year. Consequently it is not a surprise that the SPU has also revised up the official  growth forecast for 2016, to 4.9%, from the initial 4.3% underpinning the  Budget. That has not resulted in any change to forecast tax receipts, although other minor revisions mean that the General Government deficit is now expected to be marginally lower that previously projected, at 1.1% of GDP instead of 1.2%.

The EU rules impose limits on the growth of government expenditure (net of certain adjustments like unemployment benefits, debt interest and capital spending) with that limit depending on  the economy’s potential growth rate averaged over a decade. A key development in the SPU  is that Ireland’s potential growth of late is now estimated to be much higher than previously thought. In 2015, for example, potential growth was estimated at 3.4% but is now put at 4.4%, with a figure of 5% now seen for both 2016 and 2017. In addition , Irish Government expenditure  in 2015 has been revised up by €1.5bn (reflecting a reclassification of State transactions with AIB ) which therefore raises the expenditure  benchmark. These two changes mean that spending can now rise by  a greater amount while still complying with the fiscal rules.

In the 2016 Budget, for example, the Government was limited to a €1.2bn increase in spending (net of any tax change) and this Fiscal Space was fully realized. It now appears that the figure could have been higher, perhaps €1.7bn.  In 2017, the gross Fiscal Space  available was estimated  at €1.3bn but  may well be above that given these new figures, at €1.7bn or €0.9bn  in net terms when allowing for  known demographic pressures on spending  and  other existing  expenditure commitments. This net Fiscal Space figure compares with the €0.5bn previously published.

Further out in time, the higher GDP growth figure will boost the Fiscal Space , as will the EU decision to allow Ireland to aim for a small budget deficit (0.5% of GDP) rather than the budget balance target previously agreed. The  result is that the  net Fiscal Space available over the five years from 2017 to 2021 may be around €11bn , rather than the €8.5bn previously published by Finance. How those resources are allocated will be up to the new government, although one should note that they make no allowance for any broad based increases in public sector pay and may underestimate the pressures on the Health budget.  Of course the government also has the option to eliminate the deficit completely and to run down  the national debt at a faster clip, by choosing not to utilize all the available Fiscal Space, but that appears unlikely given the present political backdrop.

 

Euro Fiscal Rules to the fore in Irish Medium Term Outlook

The Irish Government has just published the annual Stability Programme Update, incorporating macro-economic projections out to 2020 and  a forecast of the fiscal position over that period. The figures indicate that this  Administration has the scope to deliver some further modest tax reductions in the 2016 Budget, and no doubt that will  garner the most column inches, but a key feature of the text is the degree to which EU fiscal rules will remain a constraint for Irish Budgetary policy.

The near term economic and fiscal outlook certainly looks brighter than it appeared in last year’s Update, or indeed at the presentation of the 2015 Budget (in October last year). Tax receipts are running well ahead of target and the Department of Finance now expects a €1bn overshoot, which appears conservative. Non-tax receipts have also surprised to the upside , thanks to a higher Central Bank surplus, and debt interest is now expected to be substantially lower than initially forecast. Capital receipts are also likely to be well ahead of the Budget projection, with the result that the Exchequer deficit ( the cash sum that  it needs to  borrow ) is now forecast at  €3.5bn instead of the initial €6.5bn. The impact on  the  General Government deficit is not as large ( some of the unplanned capital receipts are excluded ) and that is now expected to come in at €4.6bn, or  some 2.3% of GDP , against a Budget target of 2.7%.

Surprisingly, perhaps, the Department has resisted the temptation to  materially revise its previous growth forecasts; real GDP in 2015 is now projected to increase by 4% instead of 3.9%, with 2016 now 0.4 percentage points higher, at 3.6%, but growth in each of the next two years is now expected to be 0.2 percentage points lower. Nominal GDP is forecast to rise strongly this year, up 6.9%, but by 2018 is only 1% higher than previously envisaged.

In the past greater tax buoyancy often resulted in higher exchequer spending and/or tax reductions ( ‘if I have it I’ll spend it’, to quote Charlie McCreevy) but Ireland’s membership of the euro imposes fiscal constraints. One, under the corrective arm of the Stability and Growth Pact,  was the requirement to reduce the  fiscal deficit to under 3% of GDP. That achieved, Ireland has now to adhere to the Preventive arm, and this imposes two constraints over the next few years.

The first is that Ireland has to move to a structural budget balance ( the actual balance adjusted for the economic cycle). According to the EU Ireland is now operating around full capacity ( a strange assumption, in truth ) so none of the actual  deficit forecast for 2015 is deemed cyclical. Hence the structural deficit is projected at 2.6% and under the rules Ireland has to reduce that by at least 0.5% of GDP each year.

A second rule, designed to complement the first, limits the  amount the government can spend. Certain items are excluded from the requirement, such as debt interest, capital spending and some unemployment benefits , which in Ireland’s case means  that €66bn falls under the with the limit, from a grand total of €73bn. The former can only grow in line with the potential growth rate of the economy or in Ireland’s case at a lower rate in order to ensure that the structural deficit declines. That potential growth rate is in turn calculated periodically by the EU, and it appeared that the existing  formula would leave the Government with little room to manoeuvre  in the 2016 Budget ( with little ‘fiscal space’ in economic jargon) . However, the EU has now been persuaded to update potential growth estimates on an annual basis and although spending is still constrained the permitted rate of  spending growth in Ireland has increased, to 1.6%, and it  now appears that the Government has around €1.3bn in terms of ‘fiscal space’, or around €1bn more than envisaged a few months ago, Those additional resources , according to the Minister for Finance, will be used to increase spending by around €0.6bn in 2016 while also reducing taxation by a similar amount.

One issue is that the structural deficit is only projected to decline by 0.4 percentage points in 2016 ,to 2.2%, which may cause problems for the EU. Further out, the Update projects that tax receipts will rise slightly faster than GDP and that the structural deficit  will decline by 1% per annum in both 2017 and 2018 , before moving to surplus in the following year. Yet  that outcome is achieved by assuming  unchanged  current spending in nominal terms, which is clearly incompatible with any real increase  if inflation is anything above zero.  The implication is that any Irish government, of whatever political hue, will continue to face significant fiscal constraints over the medium term, and the limited resources available will intensify the debate about  the efficacy of tax cuts as against  spending increases.