On behalf of the IFAC, I thank the committee for the opportunity to discuss our recent fiscal assessment report. Joining me today are council members, Dr. Martina Lawless, Mr. Michael Tutty and Mr. Sebastian Barnes. Mr. Eddie Casey, Ms Kate Ivory, Ms Ainhoa Osés Arranz and Mr. Kevin Timoney from the IFAC secretariat are also present.
The IFAC’s work is enriched by its interactions with the committee and we continue to value these engagements. We hope we can continue to interact meaningfully with elected representatives and I would also like to acknowledge the ongoing interaction between the secretariat and the Oireachtas staff to support these meetings. The IFAC published its 13th fiscal assessment report on 29 November. The report covers all aspects of the IFAC’s mandate, as set out in the Fiscal Responsibility Acts 2012 and 2013. This includes: an assessment of the appropriateness of the broad fiscal stance set out by the Government; an assessment of the macroeconomic and budgetary forecasts in budget 2018 incorporating the IFAC’s endorsement function of those forecasts; and an assessment of compliance with both Irish and EU fiscal rules. The IFAC welcomes the fiscal stance adopted by the Government in budget 2018 for next year and assesses it as conducive to prudent economic and budgetary management. There are two key positives to draw from the budgetary stance.
First, budget 2018 demonstrated how limits imposed by the rules can be flexible to the priorities a government may have. In budget 2018, a number of revenue-raising measures, estimated as yielding €830 million for 2018, were introduced in addition to €500 million in revenues raised through non-indexation of the tax system. These revenue-raising measures enabled corresponding increases in government spending over and above the increases that were already allowed under the rules.
The discretion for a government to use tax policy changes is an essential feature to understand. The rules set a limit for the pace at which non-interest spending can increase sustainably. That limit is based on an estimate of how fast revenue growth can be expected to rise on average when the economy is performing at its long-run potential. However, those limits are set before any tax policy changes are considered. Tax policies that increase revenue in a sustainable manner, that is, in a way that can be expected to last over the long run, allow a government to grow spending at a faster pace than the initial limits set by the rules. Correspondingly, tax cuts constrain the pace at which spending may grow.
A second positive that the IFAC noted in budget 2018 was that it also saw the Government follow through on its earlier plans. Those plans, which were to keep net spending and tax plans within the available gross fiscal space for 2018 of around €1.7 billion, had been set out in the Department of Finance’s summer economic statement 2017. The IFAC’s subsequent pre-budget 2018 statement recommended these plans be adhered to.
Budget 2018, therefore, avoided a repeat of the within-year spending increases visible in recent years, which followed surprise gains to the public finances. Such surprise gains included increases in volatile corporation tax receipts and lower-than-expected interest costs. The IFAC had advised against using these gains to fund permanent expenditure increases, given uncertainties about their sustainability. As the IFAC has noted on numerous occasions, corporation tax receipts are the most volatile of the main tax heads. They are prone to very large forecast errors, they are exposed to a number of risks and they are highly concentrated with close to €2 in €5 of corporation tax receipts attributable to just ten companies. Risks include potential reversals in receipts due to changes in global tax policies, and various company-specific factors that might see their taxable profits decline or decisions to relocate take place.
In 2018, the Government is expected to meet a key target under the fiscal rules. This target, known as the medium-term objective, MTO, is for a structural deficit of 0.5% of GDP. The IFAC has often noted that there are a number of shortcomings to the methodology used to estimate the structural deficit, primarily the adjustments that correct for the effects of the economic cycle. However, the IFAC, using its own estimates of the cyclical position of the economy and a broader economic assessment, assesses that the budgetary position is now likely to be close to balance in structural terms.
A key challenge over the coming years is to ensure that the underlying budgetary position is not allowed to deteriorate excessively again. If this were to happen, another painful correction of the public finances might ultimately be required. This could happen if temporary or cyclical revenues were not recognised as such and instead were used to fund long-lasting expansions in government spending or a narrowing of the tax base, as has often happened in the past.
Looking beyond 2018, the budget plans allow for a gradual pace of debt reduction, moderate increases in current expenditure, and a ramping up of public investment to rates that are among the highest in the EU, while also complying with the requirements of the fiscal rules. With strong growth rates forecast and low effective interest rates on government debt, this should facilitate a steady pace of debt reduction from ratios that are still among the highest in the OECD. At present we have the fourth highest net debt to GNI* ratio and fifth highest net debt to government revenue ratio.
The plans also allow for the services and supports to be maintained allowing for demographic and price pressures, while also expanding public investment from its recent low levels. The IFAC’s illustrative estimate of the cost of providing today’s level of public services over the forecast horizon to 2021 implies that the spending increases currently budgeted for in budget 2018 over 2019-2021 would fully accommodate demographic pressures and the cost of maintaining real public services and benefits. By 2021, public investment is planned to rise to ratios that, across a number of measures, would be higher than that of EU peers.
However, risks remain. We do not see significant evidence of overheating in the economy at present, although there is a risk that the economy may experience overheating should a rapid, albeit necessary, response from the construction sector to persistent supply shortfalls arise which is not offset by countercyclical measures elsewhere. Improvements in the public finances in such circumstances might primarily reflect cyclical or transient developments. There are also a number of downside risks. Although a hard Brexit is the central scenario envisaged in budget 2018, the impact of Brexit is highly uncertain, as is the timing of its economic effects. These effects could be more negative, more persistent and more upfront than currently forecast. An additional risk is posed by potential future tax changes to tax arrangements among Ireland’s trading partners. Important domestic risks relate to the housing market and the highly concentrated production base.
Recognising these challenges, the IFAC makes a number of recommendations. In particular, it recommends that the Government adopt an approach that sets out a credible plan for the medium term. This should include a firmer commitment to use the expenditure benchmark as an anchor for fiscal policy even when the MTO is met and a strengthening of the proposed design of the rainy day fund. The fund could serve as a useful countercyclical tool to ensure more sustainable growth and prudent management of the public finances. However, the current proposal is not adequate to achieve the necessary countercyclical effects and is small in size. Achieving these goals within the EU fiscal rules is a difficult challenge and remains to be fully addressed. The IFAC also calls for a development of the Department’s toolkit for assessing the cyclical position of the economy beyond the EU's commonly agreed methodology and, finally, adhering to a target for public investment spending over the medium term.
These measures should help to alleviate known measurement issues and prevent an excessively expansionary fiscal stance from being followed as in previous cyclical upswings. They would also allow the Government to reduce high debt levels and help avoid the need for a correction in the future.
I thank the committee for giving us with the opportunity to attend. We look forward to taking questions and hearing the views of members.