Committee on Budgetary Oversight debate -
Tuesday, 6 Dec 2016

EU Directorate-General Economic and Financial Affairs: Discussion

Chairman

I welcome Mr. Carlos Martínez Mongay, director of economies of the member states II at the Directorate-General Economic and Financial Affairs, and Mr. Stefan Kuhnert, deputy director of unit at the Directorate-General Economic and Financial Affairs, to discuss the EU Commission's opinion on Ireland's draft budget for 2017 and the EU Commission's annual growth survey.

Before we begin, I remind witnesses and members to turn off their mobile phones as they interfere with the recording and broadcasting of the meeting. I bring to the attention of the witnesses that they are protected by absolute privilege in respect of their evidence to the committee. If they are directed by the committee to cease giving evidence on a particular matter and they continue to do so, they are entitled thereafter only to a qualified privilege in respect of their evidence. Witnesses are directed that only evidence connected with the subject matter of these proceedings is to be given and they are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any persons or entity by name or in such a way as to make him, her or it identifiable. Members of the committee are reminded of the long-standing parliamentary practice to the effect that members should not comment on, criticise or make charges against a person outside the Houses or an official by name in such a way as to make him or her identifiable.

I invite Mr. Martínez Mongay to make his opening statement.

Mr. Carlos Martínez Mongay

I thank the Vice Chairman. It is an honour to have been invited to appear before this committee. I consider this an ideal moment to be here because, as members know, a few weeks ago on 16 November the Commission adopted the autumn package that launches the economic policy co-ordination cycle for 2017. In addition, only a few days previous to that, on 9 November, the Commission released the autumn forecast. It is, therefore, a good occasion to discuss issues related with the main policy messages of the Commission to the EU and the euro area, as aggregate entities, and especially for Ireland. I have learned that the recent reform of the budgetary process in Ireland gives the Parliament a more prominent role in the formation and scrutiny of budgetary proposals. This is an important development which will enhance transparency and ownership of the fiscal framework in Ireland. It also gives more sense to my presence before the committee to discuss a broad range of issues linked to economic policies in the euro area and Ireland, including budgetary policies.

I will start by briefly introducing the autumn package where the Commission presents, every year, the economic and social priorities for the European Union in the year ahead. The package starts the 2017 cycle of economic governance, the European semester, and assesses the euro area member states' draft budgetary plans for 2017. The package builds on the Commission's 2016 autumn forecast that was released on 9 November. The core document, where the Commission's sets those priorities, is the annual growth survey. This year, the Commission calls on member states to redouble their efforts along the virtuous triangle of economic policy; re-launching investment, pursuing structural reforms and ensuring responsible fiscal policies.

Emphasis is placed on the need to stimulate more inclusive growth and to strengthen competitiveness, innovation and productivity.

The annual growth survey signals that Europe is experiencing a fragile but relatively resilient and job-intensive recovery. Its GDP is now higher than before the crisis. Unemployment is decreasing and investment is growing again. However, there is no room for complacency. Some of the tailwinds that have supported the recovery so far are fading. The legacies of the crisis, notably the social impact, through high unemployment as well as high levels of public and private debt, and the share of non-performing loans, are still far reaching.

Similar to last year, the policy guidance in the annual growth survey is accompanied by the recommendations on economic policy of the euro area, which are also part of the autumn package. The fiscal part of the recommendations reflect the main conclusions of a new communication on the euro area's fiscal stance.

I wish to say a few words on the communication. The communication starts by recognising that, albeit resilient, the economic recovery is weak and inflation remains well below the 2% target. In that context, the Commission is calling for a moderately expansionary fiscal stance for the euro area. It is what the document calls a positive fiscal stance. The positive fiscal stance refers to both the supportive, that is, expansionary, direction that fiscal policy should take overall and to the quality - I put the emphasis on that - of the composition of the adjustment in terms of repartition of efforts across countries and of the types of expenditure or tax cuts, or both, behind it. The findings of this communication are reflected in the fiscal aspects of the recommendations on the economic policy of the euro area that also refer to productivity, labour markets, banking union and they also depend on economic and monetary union.

Another document which is part of the package is the alert mechanism report, AMR, which is also an integral tool of the European semester, which aims to prevent or address macroeconomic imbalances. The goal is to promote the smooth functioning of the economies of the member states and to prompt the right policy responses within the so-called macroeconomic imbalances procedure. Based on the analysis in the AMR, the Commission has concluded that in this European semester cycle, 13 countries, including Ireland, will be covered by an in-depth review because imbalances were identified in the analysis presented in the report on the basis of the agreed scoreboard.

In the previous European semester cycle, imbalances were identified for Ireland in the financial sector, private and public sector debt, and high external liabilities. The current alert mechanism report highlights similar issues. Therefore, the Commission considers it would be useful to examine further the persistence of imbalances or their unwinding. The Commission will present the conclusions of the in-depth reviews as part of its annual country reports in early 2017.

The analysis and opinion contained in the autumn package are based on the main findings of the Commission's 2016 autumn forecast. I would summarise the main messages for Ireland as following. Irish GDP growth surged in 2015, mainly driven by the operations of some multinationals, with little impact on the domestic economy, but underlying economic activity also grew strongly by 4% to 5%. Domestic demand is projected to expand at robust rates, although risks have increased, also due to the UK referendum. Employment growth and the continued recovery of wages are forecast to support private consumption over the forecast horizon. The unemployment rate is expected to fall to 7.6 % in 2018, thanks to continued job creation and despite sizeable population growth. The contribution of net exports to GDP growth is forecast to be negative this year but to recover in line with global trade over the forecast horizon. The structural deficit is expected to remain broadly stable in 2016 and to improve gradually by 2018. The debt-to-GDP ratio is projected to decline to 71.9 % in 2018, contingent on robust GDP growth and primary budget surpluses of more than 1.5 % of GDP per year in 2016 and 2017.

If I can have another minute, I wish to say a few words on the Commission's opinion on the draft budgetary plan of Ireland, which is currently under the preventative arm and subject to the transitional debt rule. The Commission has concluded that the budgetary plans for Ireland are broadly compliant with the provisions of the Stability and Growth Pact, SGP.

It should be borne in mind that the Commission recalls that the Government's decision to use a large part of volatile, and therefore still uncertain, corporate tax intakes to allocate additional expenditure in 2016 is not in line with Council recommendations of July, in the context of the European semester, which ask Ireland to use windfall gains from better than expected economic and financial conditions to accelerate the deficit and debt reduction.

After putting on the table this large variety of issues in terms of Ireland and the EU, I will stop here and am ready for a fruitful discussion. I thank the committee for its invitation and for the attention of members.

Deputy Dara Calleary

I have a number of questions. I welcome the delegation from the Commission. However, I find a contradiction at the heart of the presentation. Mr. Martínez Mongay spoke of the need to have a moderately expansionary fiscal stance and he said the Commission wants this to happen, yet when we introduced a budget that is expansionary, it was criticised because we did not put the gains we have made into debt reduction. We were not allowed to have any fiscal expansion.

Mr. Martínez Mongay spoke about the social impact of the crisis and many of the expenditure aspects of the budget are directed towards addressing that impact. The Commission invited the authorities to take necessary measures to ensure compliance with the SGP. Mr. Martínez Mongay also spoke about the high level of debt, yet he ignored the role the Commission had as a member of the troika in setting that debt by not giving us any leeway around bondholders and bank debt in particular. Our hands were tied in terms of expansionary fiscal measures that the Commission otherwise called for. Could he address the contradiction?

The presentation made by Mr. Martínez Mongay is very like the budget presented by the Government in that it is a Brexit-free zone.

He spoke about positive tail winds, but the decision by Britain to exit the European Union is a gale on our doorstep. What impact does Mr. Martínez Mongay believe this will have in 2017 and what short-term impact does he believe it will have on our figures? Is the Commission willing to assist us in dealing with this impact, given that we are the only country on the front line of this major happening?

In September, the President of the Commission, Mr. Juncker, spoke about the need for capital expansion and the need to be flexible about the rules on capital expenditure. We have major capital deficits in this country, which will be addressed during a capital review in 2017. Will Mr. Martínez Mongay put meat on the President's proposals on relaxing the rules for capital expenditure in particular?

Mr. Carlos Martínez Mongay

I thank Deputy Calleary for his questions. I will try to address the so-called contradiction. I remind the Deputy the Commission communication refers to the fiscal policy stance in the euro area. The Commission began by analysing the economic cycle in the euro area. It sees aggregate growth in the euro area as resilient but still low. It also sees that inflation clearly remains below 2% and that monetary policy in the euro area has already reached the zero lower bound. Nominal interest rates are zero, which means there is not much room for manoeuvre in monetary policy.

At the same time, the Commission sees aggregate domestic demand in the euro area as still weak. On this basis, the Commission considers the fiscal policy stance in the euro area should be positive, which means in those member states with room for expansion in fiscal policy it should be expansionary and positive. In considering the fiscal policy stance of other member states, the Commission also considers the composition of the adjustment, which is the distribution of the adjustment in various countries, so that countries with fiscal policy space which have reached the medium-term objective and have low levels of debt have room to extend fiscal policy, but countries which have not yet achieved the medium-term objective and have high levels of debt, and countries still in excessive deficit, should be broadly compliant. This is the case for Ireland. Countries in the corrective arm should continue to consolidate. Where the level of deficit in public finances remains unaffected, the Commission advocates for less extortionate taxes, broadening tax bases and increasing the relative weight of investment. This is what the Commission communication states.

With regard to Ireland, the Commission considers Ireland's budgetary plans are broadly compliant. There are some risks, as the expenditure benchmark may not be fully in line with our recommendations, but Ireland is broadly compliant. We must take into account the growth rates for Ireland and the euro area are very different. For Ireland, we project growth at 3.6% a year and 3.5% the year after. For the euro area, the projection is still 1.5%. With regard to the cyclical position of the country, without entering into a discussion on calculating the output gap, there is consensus the output gap for Ireland is already positive. This means there are risks in principle of over hitting it, which means Ireland does not need to put in place expansionary fiscal policies. In my view, there is no contradiction because we state what the fiscal policy stance of the euro area should be, but we also differentiate between the respective cyclical positions of countries. In this sense, I would not say there are contradictions.

With regard to flexibility, the Commission published a communication in January 2015, and the Council adopted a commonly agreed position on flexibility and clarified the rules under which there could be some flexibility in investment which is equivalent to structural reform. We use the structural reform clause of the Stability and Growth Pact to allow for temporary deviations from the adjustments to the medium-term objective to invest more or enhance investment. The Council stated this clause would apply only to countries with negative growth or a very large negative output gap. These are the conditions and the Council allows for some deviation. I can go through the details if the committee wishes, but I would not like to cover all of the issues in this reply.

With regard to what we predict for next year, the entire euro area has been affected by the tail winds. Of course next year the tail winds may disappear, and therefore we must prepare our economies to be more resilient and ready to adjust to the new conditions. We can deal with other issues later.

Deputy Dara Calleary

I asked specifically about the impact of Brexit on our fiscal plans. Will Mr. Martínez Mongay go into more detail on what Mr. Juncker referred to regarding room for capital projects in particular?

Mr. Carlos Martínez Mongay

The answer on Brexit must be long because we must take into account that today we do not know much about it. All we know is there was a referendum in which the people of the UK voted to leave the EU. We also know that after the referendum there was a serious depreciation of the pound. There was also quite a strong initial temporary impact on the stock markets but they recovered.

The only stocks on which this had a more permanent impact were those in the banking sector, and that was not only in this country but also in the UK. It impacted on almost every type of bank almost everywhere in Italy because it was a factor from the beginning of the year. Apart from that, the stock markets have recovered completely and the impact on risk premium, in particular for this country, was almost non-existent. What has remained after the referendum is a weaker pound.

Brexit is another process. We do not know the structure of the relationships that will exist between the UK and the EU after Britain exits the negotiations because the negotiations have not started. There are no negotiating positions until Article 50 is activated, which lies only in the hands of the UK Government or authorities. I do not know if that is something that has to be decided internally in the context of the UK authorities. It is up to the UK to activate Article 50, and until it is activated, the UK is an EU member state and nothing changes except that we know now that the pound is weaker. We know that perhaps there will be some impact in terms of confidence in the currency, which will affect mainly investment in the UK, but we have incorporated that in forecasts concerning the UK. There are some issues linked mainly to the weaker pound that could favour exports from the UK to the rest of the euro area and make exports from the euro area to the UK more expensive. Such effects are not yet visible but we have incorporated them in the autumn forecast. I would like to make clear that we have not incorporated any impact of Brexit simply because we do not know when the Article 50 will be activated. We do not know how long the negotiations will last. We know they will have to conclude within two years at most following the activation of Article 50. We do not know what the structure of the relationships between the UK and the rest of the EU will be after Brexit. Therefore, we do not know whether we will move to having a Norwegian model or to the World Trade Organization, WTO, rules.

Chairman

There was also the question regarding Mr. Juncker's comments.

Deputy Dara Calleary

Brexit is happening for us now. We cannot wait for Article 50 because we export €13.6 billion worth of products to the UK. In the first six months of 2017, which we are discussing here, many contracts which were negotiated in the first six months of 2016 will be renegotiated on the basis of the new relationship with sterling. That is impacting on our food and manufacturing industries. Approximately 40% of our exports are to the UK market. There are concerns about jobs, and the taxes that accrue from them are essential to our fiscal position in 2017. Many issues will directly hit us in 2017. What is the Commission's position on that? What work has it done to assist or encourage the Irish Government to prepare for that better than it has?

Mr. Carlos Martínez Mongay

We are aware the UK market is important for Irish exporters, especially for its agrifood sector. We have taken into account the possible impacts of a weaker pound in our forecasts concerning Ireland. However, there is also the strength of domestic demand in Ireland together with the fact that it depends on the UK but now its markets in the euro area as a whole and in the rest of world are more important than the UK market. Therefore, if we have, as we set out in our forecasts, an expanding global economy in terms of global trade, Ireland will benefit. There will be some sectoral impacts, but as a whole, we see a recovery in Irish exports compared with 2016.

Chairman

There was also the question regarding Mr. Juncker's comments.

Mr. Carlos Martínez Mongay

On the issue of flexibility, I did not go into the details but in the Commission's proposal and in the commonly agreed position by the Council, there is a clear reference to two elements. The first one is the Structural Funds and the second one is the contribution to the European fund for strategic investment in terms of capital. Those contributions are not out of the pack because they affect the level of expenditures but they are considered one-offs, which means they do not feature in the calculations of the structural balance.

Deputy Seán Barrett

Mr. Martínez Mongay spoke about the weakness of the pound but what about the weakness of the euro? He has not commented on the disaster that has happened in Italy, one of the largest member states, and the general sense that the euro is under serious threat. We are talking as if the euro is very strong and the only weakness is sterling, but I am surprised no comment has been made about the current situation, namely, the state of matters in Italy and the general lack of confidence in the euro that is creeping in. There does not seem to be anybody, in European terms, making any effort to improve morale in terms of enhancing confidence in our currency. I find this quite extraordinary.

Mr. Carlos Martínez Mongay

I apologise in that I might not have explained the position well enough. In explaining that the Commission is proposing an expansionary fiscal policy stance, I said the reasons for that are that growth is low, inflation has not picked up and domestic demand is weak. Those are the reasons the Commission is proposing that those member states with high current account surpluses should provide support to improve domestic demand. I am not saying that everything is perfect in Europe and the only weaknesses are on the side of the pound. The Commission has clearly recognised that growth and activity in the euro area is weak. This is the reason the Commission has adopted the communication on an expansionary fiscal stance for the euro area.

Deputy Pearse Doherty

I want to discuss the Commission's expansionary fiscal stance. People in this State would have read the headlines, namely, that the Commission has done a turnaround, austerity is over and now it is all about expansion, which will affect this country. Regarding the Commission's statement on an expansionary fiscal stance two weeks ago, will Mr. Martínez Mongay confirm that it will have no impact on Ireland's stance, that we will still have the same amount of fiscal space next year, that this will be the total amount, and that the Commission's position does not allow us to go beyond that?

Mr. Carlos Martínez Mongay

As I said, in this communication, the Commission distinguishes between three types of countries. The first type is countries that have reached the medium-term objective or have overachieved the medium-term objective, implying also that their debt levels are low. In the communication and in its proposal for a recommendation for economic policies in the euro area, the Commission recommends that these countries should use the fiscal space to support aggregate domestic demand. For countries which have not yet reached the medium-term objective, the Commission says that these countries should be broadly compliant, which is the case for Ireland. For the countries that are still in the corrective, which means that they still have an excessive deficit, such as France, Spain and Portugal, the Commission says that they should first reduce the excessive deficit. That is what the Commission communication says. There is another aspect which-----

Deputy Pearse Doherty

I just wish to clarify this point and I would like the witness to make it clear. With regard to Ireland, which is in the middle, having not met the medium-term objective and being in the preventative programme, the Commission statement does not allow us to increase the fiscal space available to us. Is the Commission recommending that we use the fiscal space available to us in next year's budget?

Mr. Carlos Martínez Mongay

The Commission is saying that the budgetary plans for 2017 in Ireland are broadly compliant with the Stability and Growth Pact. This is what the Commission is saying. In this communication on the fiscal stance, the Commission has said that those countries should be broadly compliant. This is what the Commission is saying.

Deputy Pearse Doherty

So the Commission is encouraging countries to go expansionary, but not Ireland.

Mr. Carlos Martínez Mongay

Exactly.

Deputy Pearse Doherty

That is exactly the point I wanted to make. The witness responded to one of my colleague's questions and he stated that Ireland should not have an expansionary fiscal policy because there are indications that the country could be overheating. The witness spoke about the output gap. Is it his view that we should not have an expansionary policy or is it that we should use the fiscal space, which obviously is an expansionary policy?

Mr. Carlos Martínez Mongay

The view of the Commission is that the budgetary plans presented by Ireland concerning 2017, and therefore the projected budget, are broadly compliant with the Stability and Growth Pact. That is the position of the Commission. If the committee allows it, I would like to refer to an aspect of this communication that is perhaps even more important in the case of Ireland. It is about the composition of the adjustment and the quality of public finances. In those cases in which there is no need for an expansionary fiscal policy simply because the country is growing above potential, the Commission is saying that the country has to, on the one hand, reduce possible distortional effects of taxation which cast an impact on potential growth. On the other hand, the country should enhance the composition of expenditures to make this composition more growth-friendly. We should invest in more physical infrastructure and human knowledge capital. That is what the Commission is also recommending for countries like Ireland in which growth is already above potential. The idea is to increase potential but not to go for a cyclical expansion because the cycle of the cyclical position is already-----

Deputy Pearse Doherty

The witness can correct me if I have picked him up the wrong way. We know that the budget 2017 assessment is broadly complaint in the view of the Commission. When we look deeper into that, the Commission's view is that the country is showing indications of overheating. However, that does not necessarily mean that the country stops spending. What it does mean is that it needs to spend in different ways. Instead of cyclical year-on-year increases in expenditure or tax cuts, what should happen is investment in the long term, for example, capital investment in roads, housing, health centres and hospitals. Is that what the Commission is saying?

Mr. Carlos Martínez Mongay

The Commission recommends financing in such a way that fiscal sustainabilities ensue. We have not-----

Deputy Pearse Doherty

Within the fiscal space, yes.

Mr. Carlos Martínez Mongay

But there is no fiscal space. The debt is still high.

Deputy Pearse Doherty

Yes.

Mr. Carlos Martínez Mongay

Exactly.

Mr. Stefan Kuhnert

I want to draw the committee's attention to the annexe of the communication to which Mr. Martínez referred, which I think is very useful reading. It is precisely not only about the stabilisation needs and whether the output gap is positive and at risk of overheating, but also about the consolidation need that member states have. For instance, Ireland, given its high level of public debt, has a consolidation need. If we look at the countries at which this recommendation was directed, Germany, the Netherlands and Luxembourg, they are countries that, according to the Commission's assessment, have a negative output gap at the moment and no fiscal consolidation need. We were really looking into both dimensions when we made this recommendation. Given the high level of public debt that remains, Ireland still has a consolidation need.

Deputy Pearse Doherty

I understand that.

Mr. Stefan Kuhnert

That is the logic.

Deputy Pearse Doherty

The headline is that the Commission is recommending expansionary policies, but that does not affect Ireland because the Commission is saying that Ireland has a high level of public debt and that there are signs of the country overheating. What the Commission is basically saying is to use the expenditure available to deal with that issue, which is investing in the long term rather than tax cuts or short-term expenditure.

Mr. Carlos Martínez Mongay

I also believe that it is important not to be too reliant on taxes, tax bases and tax revenues that can be volatile.

Deputy Pearse Doherty

I am going to come to that because it has been stated very clearly by the Commission, and indeed by most other external agencies, including our own Irish Fiscal Advisory Council. Before we move on from the type of expenditure that we should have, I am sure the Commission is looking beyond the economic data, or maybe it is not. We have huge challenges in this State. There has been an investment drought here both in the private and public sector for the past decade. Our capital investment has gone from about €10 billion down to €4 billion. There are serious cracks now starting to appear. They are going to become more and more obvious and visible. We are going to see massive congestion in our infrastructure and roads, particularly around Dublin city and elsewhere, within the next short period. Our population is continually increasing. While we went through a terrible period of migration, we are going to see it reverse very quickly.

In my view, the fiscal rules are going to be changed because they are unworkable and because we know that countries are breaking them willy-nilly, to the point that the Germans are calling for the Commission to be sacked and for the role to be given over to another agency of Europe, but we will leave that to one side. Let us forget about budget 2017. Budget 2018 for this country has a fiscal space of about €600 million. We have a crisis in terms of housing, health and a serious problem in infrastructure. I appreciate the fact we have a high level of debt that has only reduced because the economy has improved. However, the volume of debt is continually increasing. At a time when the country can borrow at the lowest it will ever likely be able to borrow at, is it not nearly criminal that we are not investing in the long-term health of our nation by borrowing at this time, building the infrastructure, and making sure that we have houses that can house the homeless and those on waiting lists? How does the Commission in any way rectify that or allow for it to happen at this point?

Mr. Carlos Martínez Mongay

The fact that interest rates are low today does not mean that they will be low in the future.

Interest rates will probably be higher in future and the current burden of debt will increase. If debt is already high, increasing it may increase the country's vulnerability. To address this, a government uses the idea of a rainy day fund. It uses extraordinary revenues to reduce debt levels and vulnerability to, for example, volatility in international markets. The situation is far from stable for some countries. For Ireland, the impacts of risk premia in recent months have been almost zero. Other countries, however, have been vulnerable and others can become so. What is a stable situation can become unstable in, for example, two years.

I wish to refer to an important issue. We must consider the revenue side. We have to ensure an adequate composition of expenditure and a tax base that is broad enough to be stable. The narrower our tax base, the more unstable our revenues. Our debts and interest rates increase and our revenue base decreases. That is not new to this or other countries.

Deputy Pearse Doherty

I wanted to get to that point. My final question is on volatility in the tax base, with a particular focus on corporation tax, which Mr. Martínez Mongay mentioned. He has met Professor John McHale and our Minister, so these conversations are being had by the Commission, the Irish Fiscal Advisory Council, IFAC, and the Department of Finance. This is not a new issue. We have an above average percentage of corporation tax receipts. Ours is approximately 15% whereas the European average is approximately 10%. There has been a major surge in recent years. The Department and Revenue officials tell us that it is permanent. We have a significant concentration, in that ten companies pay 40% of all corporation tax. That figure increased from 20% just over ten years ago.

Mr. Martínez Mongay has a bird's eye view across Europe. Does any other country have such a concentration of taxation receipts in the hands of so few? He, the IMF and IFAC have stated that there is a vulnerability from our corporation tax receipts. Is that vulnerability related to their level or their concentration? Where does our vulnerability rank?

Mr. Carlos Martínez Mongay

Consider the developments in GDP. To what did 2015 revision of GDP lead and by whom was it driven? It was driven by this small number of multinationals that book a series of operations, including intangible assets, in Ireland. The gross value added, including profits, that they booked in Ireland increased by 20% or more. Decisions of multinationals are driven by global production factors, but these factors can change and multinationals can move. In this case, these extraordinary revenues could be used to create a rainy day fund and reduce the debt and deficit.

The November budgetary data that were released yesterday drew my attention. All revenue targets seemed to have been achieved, but mainly because of corporate taxes. Consider VAT. Usually, it is a more stable base, but its revenue target was underachieved.

Deputy Pearse Doherty

Yes.

Mr. Carlos Martínez Mongay

Our policy recommendation is to try to reform the tax system in such a way that revenues rely on stable tax bases while revenues from unstable or not-so-stable tax bases should be considered as windfalls and used to reduce debt and deficit levels.

Deputy Pearse Doherty

May I ask about that? I mentioned how we would make capital investment. Given that capital investment does not commit itself each year, would it not be appropriate to use those increases in corporation tax by investing in capital? Doing that would break the European rules, however.

Mr. Carlos Martínez Mongay

There is the idea that investment is a one-off, but public investments are not one-offs. They are relatively stable. The projects are one-offs. To build a bridge, one needs two or three years, but the level of public investment is not a one-off. There is a minimum of public investment in Ireland. It is reaching 2% of GDP again. The total level is a permanent expenditure and is not a one-off. Therefore, we should not use windfalls to finance public investment.

Chairman

Are there EU member states paying down substantial debts? The instruction from the Commission is to use windfall taxes to pay down debt.

Mr. Carlos Martínez Mongay

Member states' debt developments depend on annual budgetary policies. In Spain, for example, GDP is growing quickly, but its deficit is high and, therefore, debt is not being reduced. This is not because of whether countries have windfalls. There are a number of reasons. There is a new Government in Spain and it is still reverting the situation. It is in the process of consolidating public finances. I would not like to refer to a specific country, but what happens depends on the extent to which the deficit trajectory is downward and the denominator is rising.

Chairman

Spain is in a similar space to Ireland. Surely it flies in the face of the perceived economic wisdom of years to advocate the paying down of debt when interest rates are so low that money can be acquired so cheaply by member states. Excluding London, which will be excluded from the EU anyway shortly, Dublin is the most expensive city in the EU in which to rent a home. When this identifiable and significant bottleneck exists in our economy, we should be in a position as a member state to prioritise it for public and private investment and there should be significantly more leeway than there is under the rules to allow us to tackle the problem.

Mr. Carlos Martínez Mongay

In the case of the housing sector, the important point is to overcome all the barriers concerning supply.

Chairman

We, as a State, can borrow money cheaper than we have ever been able to or will ever be able to borrow it in the future. We could then make a significant impact on that problem but we cannot do it because we are in a strait jacket.

Mr. Carlos Martínez Mongay

I do not think so. On the one hand, the State has to find stable revenue sources which is important. On the other, even if today the State borrows money at low interest rates, in the future when interest rates go up, the State's debt will also balloon. The burden of the debt will depend on the future interest rates. The higher the debt, the higher the interest payments will be in the future. One does not borrow all the debt for, say, 20 years or 50 years. A small fraction of the debt is at a long-term rate but the rest of the debt has to be refinanced in the short term.

Deputy Thomas P. Broughan

I welcome our colleagues from the Commission. We have been following events in Italy closely for the past several years, as well as events in Greece and Spain. Does Mr. Carlos Martínez Mongay accept European monetary policy is completely inappropriate for certain member states? Could it be inappropriate in 2017 for Ireland?

Mr. Carlos Martínez Mongay

The single monetary policy is only one for the euro area. The key question is not so much whether monetary policy is adequate or not for a specific country. The question is whether monetary policy is adequate for the euro area.

Deputy Thomas P. Broughan

What, however, if that monetary policy, which may suit the Benelux and Germany best, is destroying the industrial base of Italy, the second industrial power in Europe, as Italian politicians have been saying, or destroying large tranches of Greece's economy in the process? Are the alert mechanism reports picking this up? Will those reports include Brexit and its uncertainty? It will affect Ireland more than other country and it should come into the imbalance scorecard. Other states, such as Portugal, Greece and Italy, have specific circumstances which should give them more leeway in the fiscal rules.

Mr. Carlos Martínez Mongay

There are many issues mixed up here. On the one hand, when we talk about monetary policy and the diminishing industrial base, we are talking about two different matters. One is about monetary policy which is about a commodity. It is the right policy. I would not like to comment on monetary policy because the European Central Bank is fully independent. The other problem the Deputy is referring to is, perhaps, an issue of competitiveness. It is to what extent productivity in certain countries is too low compared to the level of wages. Accordingly, these countries are losing competitiveness and, in turn, are losing certain industrial activities in which labour costs are important. This is totally different from the monetary policy stance.

Concerning the leeway in the current circumstances, for countries in which GDP growth is not strong, the monetary policy is most adequate for them simply because growth is low and, therefore, monetary policy is accommodated. The problem is not with monetary policy but, for some countries, the need to enact the structural reforms which enhance productivity and, therefore, allow for high living standards.

There is uncertainty around Brexit. We do not even know when Article 50 will be activated, how it will be activated and how the negotiating process will work.

Deputy Thomas P. Broughan

That does not matter to this economy because it is the uncertainty that has been created for our agricultural exports and across a whole range of our economic performance. This uncertainty is a significant factor for us which is already impacting on us.

Mr. Carlos Martínez Mongay

At the same time, when one talks about uncertainty, depending on the final result there can be some reallocation of some activities from the UK and to the UK. We do not know what will happen. I do not believe this is a question of investing more and even less a question of increasing public debt. It is a question of being resilient and being ready for structural adjustments. It is a question more of enhancing the structural resilience of the economy. In certain countries where growth is low but debt is high, fiscal stimulus will not do the job.

Deputy Stephen S. Donnelly

I thank the delegation for its time.

Last year, the convergence margin was applied because it was deemed Ireland had not hit one of its targets for budgetary correction. The economic logic was that the economy was overheating and, therefore, one cannot buck all of the real correction and one has to overcorrect. Due to the fact that logic was applied, we missed our target which meant a convergence margin was applied which shrank our fiscal space considerably. The argument from all the economists this committee met was that Ireland's economy is not actually overheating. We are at nearly 8% unemployment and there is still potential growth. It was explained to the committee that the calculation was based on a ten-year rolling average of unemployment. As Ireland's unemployment through the crash had been so high, if one applied a ten-year rolling average, it looks like Ireland is at full employment or, indeed, past full employment at 8%. Clearly, it is not. No economist would suggest Ireland's economy is overheating based on an unemployment rate of 8%.

Accordingly, we found ourselves heavily penalised because the accuracy of a rule which no one would defend was applied to Ireland. Does the Commission have a view on that? When we put it to the Irish authorities, the answer was that is the rule and we have to use the ten-year rolling average unemployment and, as such, we are deemed to be overheating. Accordingly, we are deemed to have missed our target and the fiscal space has been contracted significantly by applying the convergence margin. When the rules, to which we have signed up, are not lined up with reality, should the Commission still insist on applying them?

The Commission should still insist on applying them.

I will ask my questions one at a time.

Chairman

That is fine.

Mr. Carlos Martínez Mongay

There are several questions here as I see it. One concerns the way in which we calculate the output graph and potential output. This is based on a commonly agreed methodology. There is a technical group within the EFC which is chaired by Mr. McCarthy, an Irish official. We apply the same methodology to all of the countries in order to have an analysis of the cyclical positions which is comparable across all countries. We use the production method and we have a way to calculate the multifactoral productivity and capital stock. This is very complex, technically speaking but at the same time, the methodology is very transparent. All countries can see exactly how the calculations are made. This is the way we measure the cyclical position of the different countries. In the case of Ireland in particular the calculations were made on the basis of the budgetary plans one year ago. At that time, we did not know about the revision that took place concerning 2015 and the various adjustments that had to be made. Last year we saw the output gap closing very quickly. This year we still have very high output gaps. In some cases, the output gaps are positive. In the case of Ireland, the output gap will start to close in 2018 or later.

This methodology also allows us to calculate the structural balances, that is, the parts of developments in the balance which are not due to the cyclical evolutions, that is, due to the fact that if one grows faster, one has more taxes, less unemployment and therefore, less expenditure. These cyclical fluctuations or impacts on the budget are netted out from our calculations of the structural balance which are made on the basis, in turn, of our calculations of the output gap and potential GDP.

This is one indicator that we use in order to determine to what extent the fiscal stance in the country is appropriate, taking into account the debt levels and the distance towards the medium-term objective, MTO. We have used another indicator which is the expenditure benchmark. This is related to the ten year average of potential growth. We never use these two indicators in a totally mechanical way. We make what we call a nominal assessment in order to understand better the underlying factors concerning the changes in the structural balance and the structural expenditure. That is, the expenditures net of discretionary tax changes. We never use this in an automatic or mechanical way. We always look at all of these factors. We examine the cyclical position of the economy, the distance with respect to what we have defined as the MTO which ensures that there is enough room in front of cyclical fluctuations. We also look at expenditures net of expenditure finance through EU funds and net of cyclical expenditures, for instance, of unemployment and net of interest payments and discretionary changes in tax revenues and how these have evolved compared to potential growth - not potential growth for one year but over a number of years.

Finally, this is why our assessments may change although we have to take into account that the benchmarks are frozen either in 2015 or 2016. We even reduce the possibility of more cyclical or annual fluctuations. I do not think that it is a question of saying that we have this indicator and then we change completely. We have a rather stable analysis.

Deputy Stephen S. Donnelly

I have a follow up question but Mr. Martínez Mongay does not need to explain why. Does Mr. Martínez Mongay stand over the view of the Commission that the Irish economy is currently overheating?

Mr. Carlos Martínez Mongay

What we say in the case of Ireland is that the output gap is positive. Therefore, in the case of an expansionary policy, there could be risks of overheating but we are not saying that it is overheating.

Deputy Stephen S. Donnelly

The witnesses have identified Ireland's debt level and in that context, I am very interested in the question posed by the Chairman. I am not sure it was answered in terms of whether any EU country is actually paying down debt. The answer given related to ratios. I am interested in finding out if any country is actually reducing the euro amount of debt.

One element of Ireland's debt is the promissory notes which arose out of a deal that was done between the Irish State, the Irish Central Bank and the European Central Bank. Approximately €20 billion remains to be paid. At an EU level, that is a small amount but scaled up for Mr. Martínez Mongay's country, Spain, it would be about €170 billion or scaled up for Germany it would be about €400 billion. Given the size of Ireland's economy, a €20 billion debt is very significant. The debt was incurred at the insistence of Mr. Jean Claude Trichet, who told our Minister for Finance that a bomb would go off in Dublin if he considered burden sharing with private sector investors in private banks. I believe it to be odious debt, legally and therefore, challengeable. This promissory note debt is attached solely and exclusively to two dead banks, namely Anglo Irish Bank and Irish Nationwide, in which the State had no stake or guarantee in place. The State was essentially forced, in the face of a very serious threat by the then President of the ECB, Mr. Jean Claude Trichet, to pay this money down. The State wrote an I.O.U which was then subsequently turned into these promissory notes. Does the Commission believe, in the spirit of reducing debt and in the spirit of social fairness, that Ireland has a case to make to have this debt reduced? Would the Commission be sympathetic to the argument that a €20 billion is still a serious amount of debt that would, if it were in Germany, amount to €400 billion? It is an IOU against two dead banks that have been prosecuted for illegal behaviour and for which the State had provided no guarantees. The State was essentially forced to bail them out by Mr. Trichet. Is there a case to be made that the Commission would support? Is there a case for burden sharing or - if one were a monetary purist, as many of the German authorities are - setting it at 0% for 200 years? In the latter instance, inflation would essentially get rid of it but we would not have to tear it up.

Mr. Carlos Martínez Mongay

First of all, I would not like to comment on any decision taken years ago. Furthermore, I do not think the situation was exactly as the Deputy has described. I would not like to comment and of course, I cannot anticipate what the Commission might say on this matter.

All I know is that we measure the total amount of debt in nominal terms, that is, the ratio of debt to the nominal GDP, according to the treaty and on the basis of EUROSTAT data.

Deputy Stephen S. Donnelly

I appreciate that.

Mr. Carlos Martínez Mongay

Therefore, this is not a question of distinguishing between promissory notes and total debt. For us, what counts is the total debt according to the treaty definition.

Deputy Stephen S. Donnelly

Does Mr. Martínez Mongay believe, as the Commission's DG for European economies, that as part of Ireland's economic management of our debt we should pursue this?

Mr. Carlos Martínez Mongay

What I can tell the Deputy, in response to his question, is whether countries are repaying their debts. It is clear that all the countries are doing so, rolling it over. No country is in default, so-----

Deputy Stephen S. Donnelly

I think the Chairman asked a different question, that is, whether any country is reducing its total quantum of debt?

Mr. Carlos Martínez Mongay

I think some countries are reducing the total amount of debt. On examining the nominal data, I see that there are countries reducing the ratio of the debt to GDP very quickly - some more quickly than others. This ratio is our main concern in analysing sustainability.

Deputy Stephen S. Donnelly

I appreciate that Mr. Martínez Mongay will not comment on the promissory notes but I wish to comment on the point he has just made, after which I will move on to my final question. Mr. Martínez Mongay holds a very senior position within the Commission and now that we have moved to the European semester, he and his team have an influence on our budget. With respect, if he comes before the Irish Parliament and states that we should pay down the debt, he should probably know whether any other country in Europe is doing so.

Mr. Carlos Martínez Mongay

All the countries are repaying the debt in the sense that they are able to repay it as soon as it must be paid. In examining debt sustainability, we examine the relative weight of nominal debt compared to GDP. In some cases the nominal debt decreases faster or, in other words, increases by less than the nominal deficit, so-----

Deputy Stephen S. Donnelly

I understand that but, with respect-----

Mr. Carlos Martínez Mongay

Perhaps I do not understand the Deputy's question.

Deputy Stephen S. Donnelly

I will put it again. Mr. Martínez Mongay has stated categorically to the committee that we should use windfall taxes to pay down debt. This has nothing to do with a ratio; this is about a total quantum of debt owed. The Chairman asked whether any other country in Europe is doing this, and my understanding of Mr. Martínez Mongay's answer is that he does not know.

Mr. Stefan Kuhnert

I cannot tell whether any country is doing this actively. What I know for sure is that the recommendation to use potential windfall gains to reduce public debt is given to some member states.

Deputy Stephen S. Donnelly

I understand that. I am making the simple point that the recommendation to do this is a very big call to make because we are in the middle of a housing crisis, a homelessness crisis and a child poverty crisis and we are still recovering. Therefore, all I am saying is that before Mr. Martínez Mongay comes to Ireland and states that we should potentially use several billion euro to pay down the debt, he should know whether any other country is doing so.

Mr. Stefan Kuhnert

A more important consideration is whether there is a rationale to ask for this. These recommendations are directed at countries which have elevated levels of public debt such that there is a risk to fiscal sustainability. This is why the recommendation was given.

Mr. Carlos Martínez Mongay

To put it differently, these exceptional, extraordinary revenues should not be used to finance expenditure, but to reduce the deficit. By reducing the deficit, one reduces the increase in debt.

Deputy Stephen S. Donnelly

I have a final question. There is an apparent contradiction in the advice given. I ask the witnesses to provide some advice in this regard. On one hand, Mr. Martinez-Mongay states that Ireland should not expand fiscally, while, on the other, he has identified major investment shortcomings in research and development, transport, housing, general capital infrastructure and so forth, a point on which I agree with him. How does he think Ireland should solve this problem if he recommends that we stay steady fiscally but states that we need serious investment. What is the Commission's view on how to meet both these requirements?

Mr. Carlos Martínez Mongay

On the one hand, as I said, we can act on the composition of expenditures, that is, transferring resources from current expenditures to capital expenditures. This is one possibility. Another possibility, as I said, is to broaden the tax bases, which will bring more future, even current, revenues. If revenues are increased, there is the possibility to increase expenditures without affecting the deficit.

Chairman

Does Deputy O'Connell have a question?

Deputy Kate O'Connell

No.

Chairman

I wish to return briefly to the notion of exceptional revenues regarding the tax receipts this year. The Revenue Commissioners believe that these revenues, these receipts, were not exceptional and that changes made in particular to the Irish corporation tax system a few years ago and improvement in the economic activity of the country would mean that these receipts would come in regardless. We have seen evidence from the Revenue Commissioners in this regard, and they have spoken elsewhere about the matter. I also refer to the fact that since the budget, the Exchequer return figures from last week, with which the witnesses are no doubt familiar, show that income tax receipts are almost €1 billion ahead of schedule, VAT is €500 million ahead of schedule and corporation tax is €500 million ahead of schedule. Does this not put paid to the witnesses' argument that this was an exceptional once-off increase in revenues? Rather, as the year has progressed, income tax in particular has performed much more strongly. It is not a once-off windfall tax. Is it not, therefore, the case that the criticism of the budget is not well founded at this juncture?

Mr. Carlos Martínez Mongay

We are not saying that all the increases recorded in tax revenues are exceptional. We refer to the fact that tax revenues in some cases are growing exceptionally because part of the tax bases which are not very stable are growing exceptionally. We must distinguish between permanent increases in taxes, cyclical increases in taxes and exceptional increases in taxes. This implies a very detailed and rigorous analysis of the developments in the tax bases and tax rates and, therefore, the ability in this case to identify which taxes or which tax bases are more volatile. The more volatile tax bases are associated with the production of the most volatile tax revenues. As a result, some of them can be exceptional. Our recommendation is, once these exceptional revenues have been identified, to allocate in order to reduce the deficit and, therefore, the debt.

Chairman

The evidence we received from the Revenue Commissioners showed that such exceptional revenues did not arise. This question was raised by a number of members of the committee in the context of corporation tax in particular. The Revenue Commissioners did not figure that the increases in receipts under that heading were unreliable. They figured that the increases would continue for the foreseeable future.

Mr. Carlos Martínez Mongay

When I look at certain tax bases, I see that increasing those tax bases is recent and is related to some decisions taken by a few companies, which can be reverted. This is what we see. Therefore, we call for prudence when using these tax bases.

Chairman

I thank Mr. Martínez Mongay and Mr. Kuhnert for their evidence and answering questions.

The select committee adjourned at 6.40 p.m. until 5 p.m. on Tuesday, 13 December 2016.