Government Fiscal projections beg some questions

As pointed out in a recent Blog (‘Next Government may have €2.5bn more to play with’) the European Commission has revised up its estimate of Ireland’s longer term potential growth rate and as a result the Government has more fiscal room to manoeuvre than previously envisaged. The ‘Summer Economic Statement’ projects spending and taxation figures out to 2021, based on these new assumptions, and as such helps to clarify and quantify some of the budgetary options open to the Administration, although begging other questions about the effective Fiscal Space available.

For 2016,  tax and PRSI revenue is now expected to be €1bn ahead of target, with about half of that earmarked for higher spending, largely on health. Consequently , the fiscal deficit is now projected at 0.9% of GDP instead of 1.1%.

A lot of media coverage has focused on the outlook for the 2017 Budget. That is predicated on 4.2% GDP growth following 5% this year, which feeds into revenue projections, and under the Expenditure benchmark the Government could increase spending  (net of any tax changes) by up to  €1.7bn, or 2.5%,  and thereby keep the structural budget deficit on a downward path. Of course the option is always there to increase spending by less than the stated sum, which would reduce the deficit and therefore the national debt at a faster pace, which some would argue for, given that the economy is operating above capacity.

The €1.7bn fiscal space is likely to be used, nonetheless,  and Finance estimate that demographic pressures and existing public sector pay commitments will swallow up an additional €0.7bn, leaving a net €1bn for the Minister to utilize. The Statement indicates that two-thirds of this will go on increased current spending, with the balance used to fund tax reductions, a split set to continue out to 2021.

On the published figures the gross fiscal space over the next five years is projected at €14bn, with a net figure of €11bn. However, the €3bn gap makes no allowance for any general rise in public sector pay or  the indexation of the tax system  and may also substantially underestimate the demographic pressures on areas such as education and health, particularly the latter if the recent past is anything to go by.  As a result gross voted current spending actually falls substantially relative to GDP ( to under 20%) which appears unrealistic and inconsistent with a pledge to devote far more resources to the provision of public services.

Public Capital spending has plummeted in recent years and the Statement makes great play with the need to significantly increase resources devoted to infrastructure and housing. Yet, by 2021, gross capital spending is still only 2.7% of GDP, against 2.1% this year. In fairness, the EU’s fiscal rules are a constraint in that capital spending in the aggregate is not excluded from the Expenditure benchmark, but it is clear that public sector investment will still be taking a very low share of GDP by international standards ,and the planned increases are certainly  not transformative.

Economics is about choice  and this Statement highlights that while the new Government may  have a little more flexibility than thought it will still be faced with difficult decisions as to how to allocate the fiscal space between taxation and spending, and indeed how much is used to expand the volume of public services and how much in higher pay for those delivering the services.