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Fiscal Council issues warning over Government’s budget plans

Fiscal Council issues warning over Government’s budget plans

The Government will have just €600 million to either increase spending or reduce taxes in October’s budget once existing commitments are taken into account, the State’s independent finance watchdog says.

According to the Irish Fiscal Advisory Council (IFAC), if the Government sticks to its plans, a total of €2.8bn in additional measures could be included in the budget, although €2.2bn of those are already accounted for.

IFAC chairman Seamus Coffey said public finances are experiencing a temporary surge in growth as the economy recovers from the financial crash and this is combined with an unexpected surge in corporation tax revenue.

He warned, however, that Ireland has one of the highest reliances on corporation tax across the OECD and there is a potential for this to evaporate and “cause a hole to open up in the public finances”.

Speaking on RTÉ’s Morning Ireland, Mr Coffey said if this was to coincide with another external risk, such as Brexit, it could result in increased taxes and reduced spending.

He said there were currently significant over runs in health and there appear to be problems in estimating the cost of large capital projects.

He added that the budget constraints are not been adhered to and these unplanned increases are also leaving the country unnecessarily vulnerable to the inevitable downturn and external shocks that the country faces.

Following the warning from the IFAC Chairperson, Fianna Fáil’s spokesperson on Finance Michael McGrath said the criticism of the Government’s medium-term spending plans was stinging, adding that one does not need to be clairvoyant to see the Government’s forecasts were not credible.

“They’re not based on a realistic assessment of the real needs of the economy and public services,” Mr McGrath told RTÉ’s Morning Ireland.

Asked whether Fianna Fáil should intervene more if they were really concerned, Mr McGrath said they were doing that, and that they were holding the government to account.

He added that Fianna Fáil have repeatedly asked for longer budget forecasts from the minister, as they have not seen forecasts for the next 10-15 years.

In its latest Fiscal Assessment Report published this morning, IFAC says that while it is now operating near capacity, the outlook facing the economy is unusually uncertain.

It says Government forecasts, which are based on an orderly Brexit, are balanced between potential overheating on one side and an “exceptional adverse shock” from a harder than assumed UK exit from the EU on the other.

It also points to possible changes to international tax arrangements, as well as increased protectionism, downturns in the economies of Ireland’s trading partners and other potential adverse financial developments.

IFAC says Ireland’s net debt ratio remains the fifth highest in the OECD, making our creditworthiness vulnerable to rapid changes, and it claims little progress has been made on this issue since 2015.

In fact, data suggests the structural budgetary position has worsened in recent years, IFAC claims, because although the economy has been performing strongly and corporation tax receipts have been increasing, the budget balance has not improved in the last four years.

In this regard the council points the finger in part at the Government for allowing spending to drift in recent years, with expenditure growth rising from 4.5% in 2015 to 6.7% last year.

This led, IFAC says, to net spending last year breaching rules put in place after the financial crisis, that aim to keep expenditure under control.

It also levels heavy criticism at the Government’s medium-term spending plans from 2021 onwards, saying they are not credible as the spending forecasts that underpin the budgetary projections are not accurate.

“The Government’s Medium-Term Expenditure Framework is not working,” the report states.

“Repeated, procyclical revisions to expenditure ceilings look set to continue. This risks repeating the mistakes of the past, with revisions to expenditure ceilings now of a similar magnitude to those immediately prior to the crisis.”

The body warns corporation tax levels are now “a long way from conventional levels and from what the underlying performance of the economy would imply.”

In fact, it says, between €3 billion and €6 billion of the €10.4 billion of tax taken in by companies last year could be considered beyond what would be projected for an economy performing like Ireland’s is right now.

As a result, it cautions that while these benefits could last for several years, reversals could also be expected, unlike other revenue windfalls.

It also says the Government needs to make a “credible commitment” to not use corporation tax revenue for spending increases that last for the long term.

It suggests a way of mitigating against the risk would be to set up a so-called “Prudence Account”, into which extra revenue above that which was forecast from corporation tax during each fiscal year would be set aside.

That money could then be put into the rainy-day fund, or given to the National Treasury Management Agency to reduce debt at the end of the year, it claims.

On Brexit, the IFAC warns that a disorderly exit of the UK from the EU poses “profound risks” to the public finances and could lead to increases in the state’s debt ratio.

In such an event, it says, the Government might be forced to reduce spending or hike taxes to stop an indefinite spike in the debt ratio caused by an opening up of a budgetary deficit.

Overall the council says the Government should keep to its existing plans for this year as sketched out in the economic forecasts published in the Stability Programme Update 2019 in April.

In particular, it cautions that the Government should not get involved in increasing spending during the remainder of the year, unless it takes steps to cut expenditure elsewhere or increase revenue.

It says the Government’s plans for 2019 indicated that the fiscal position would grow along the same trajectory as the potential of the economy and inflation.

But it says last year the Government went further than expected, allowing spending to rise by €1.3 billion, over and above the €3.2 billion that had been originally planned for.

Much of that extra outlay went on health due to further overruns in its budget, extra spending that IFAC had previously been critical of.

The council says extra spending and tax measures announced in Budget 2019 were a further €300 million above what had been anticipated.

It says all these rises have contributed to a faster-than-planned pace of expansion and possible overheating of the Irish economy.

Next year, the organisation says, budgetary caution must be exercised by the Government given the risks posed by Brexit, corporation tax, potential overheating and the faster than planned growth in spending in recent years.

It says if the Government sticks to its plans, €2.8 billion in additional measures could be included in the budget.

However, it says that when pre-existing commitments such as increases in public investment, public sector pay, provision to cater for demographic changes and for assumed tax cuts are taken out of this total, the actual amount available to the Minister for Finance will be around €600 million.

As a result, only minimal new tax and spending measures will be possible on budget day, with any further spending or tax cuts funded from additional revenue-raising measures.

It adds that it would be better though if not all that €2.8 billion fiscal space was used, given the potential challenges facing the economy.

Revenue estimates that a 1% reduction in the higher 40% rate of income tax would cost €340 million.

Reacting to the report, Fianna Fáil spokesperson on Public Expenditure and Reform Barry Cowen said it is critical that the warnings and conclusions from IFAC are taken on board by the Government.

“Despite what the Government want us to believe the country is sailing very close to the wind when it comes to the State’s finances,” he said.

“There is a serious lack of credibility when it comes to expenditure ceilings as they are almost always ignored.”

“The €645 million in supplementary funding in the Department of Health last year and the overspending on capital projects such as the Children’s Hospital and the National Broadband Plan is having a direct impact on Ireland’s fiscal position, which means there is very little room for manoeuvre in the years ahead.”

“Fine Gael claims that it can be trusted with the State’s finances but when all is said and done this is a complete fallacy and this report backs that up.”

However, in a statement ahead of the report’s publication, the Department of Finance said the European Commission, as gatekeeper for the fiscal rules, assessed the Irish budgets to be compliant with the fiscal rules.

It also said IFAC had endorsed its forecasts.

The department also said the Minister would publish a report shortly outlining how reliance on corporation tax can be reduced.

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