Thank you very much. I thank the committee for inviting the Irish Fiscal Advisory Council here to discuss the EU fiscal rules. The council's mandate is to assess and endorse the Government's macroeconomic forecasts, to assess its budgetary projections and compliance with domestic fiscal rules and to provide an overview of the overall fiscal stance.
The council has not undertaken a formal assessment of the proposed changes to the EU fiscal framework.
However, the Council takes a close interest in these reforms. As members of the informal network of EU Independent Fiscal Institutions, we have participated in a number of contributions to this debate. These are available publicly on the network's website.
Fiscal rules, frameworks and institutions provide useful guidance in setting fiscal policy. They help ensure sound economic management of the economy and public finances and help to improve the focus on the medium term. In the EU context, fiscal rules have a special role in ensuring individual countries do not put the wider euro area at risk, as we experienced in 2010. Designing fiscal rules for countries in the euro area is a challenging task given the diversity of different economic situations and different traditions and institutions among the member states. Since the Stability and Growth Pact was put in place in 1997, there have been three regimes. The original pact focused on the 3% deficit and 60% of GDP debt ceiling. The amended pact of 2005 focused on a target for the structural balance adjusted for the economic cycle. In 2011 the six-pack of reforms aimed to reinforce this approach. For the past three years, with Covid and the energy crisis, exceptional circumstances in terms of the pact have prevailed and normal operation of the rules has been suspended. However, this is set to end this year.
The Stability and Growth Pact has been widely criticised on two grounds. The first ground is that the rules are seen as overly complex and not always delivering sound advice and the second is that compliance and enforcement of the rules has been inadequate. Against this background, on 26 April the Commission published detailed legislative proposals to reform the EU fiscal rules to build on the mandate agreed by Ministers at the ECOFIN meeting in March. These reforms aim to simplify the framework, strengthen the medium-term focus and increase compliance by improving national ownership.
These reforms are a major change in direction, although many familiar features will remain. Much of the existing framework based on the structural balance and the one-twentieth debt rule would disappear. In simple terms, the new framework would have three steps. The first is that the Commission would propose a four-year reference adjustment path for spending. This reference path is designed to put the debt ratio on a downward path over the following ten years after the initial four-year reference period. The top-left chart in slide 2 shows a hypothetical example where the dotted line is the baseline for debt. The Commission would then propose a trajectory that would put debt on a downward trajectory over a ten-year period after the adjustment has taken place. This will be translated into a spending path, as can be seen in the bottom-left corner. Thus, for this country, spending would initially have to grow more slowly than the economy to help increase the fiscal balance. Then, over the ten-year period, it could grow in line with it. In its most recent proposals, the Commission has also introduced a number of safeguards. These can be seen on the right of the slide. They are some additional conditions around the deficit, the amount of adjustment countries will need to be doing, around backloading and so forth. The Commission will come back to this trajectory. I return to the first slide. As a second stage, each member state will then propose its own national trajectory for spending, which could differ from the Commission's proposal. This would need to be approved at EU level. The third step is that this spending path would be monitored and enforced both at EU level and by national fiscal councils. There is a three-step procedure anchored in the objective of getting debt down.
Broadly speaking, this regime would apply to countries with deficits greater than 3% and debt ratios above 60% of GDP. The potential advantages of this regime are that, on the one hand, it allows for a more tailored design of fiscal requirements through a richer process to set the adjustment path than we have had in the past. On the other hand, it gives a simpler operational target based on spending that should be easier to enforce. Furthermore, the whole approach has a much stronger medium-term focus than the traditional year-by-year assessments we have had up to now in the Stability and Growth Pact. However, there remain important open questions. The Commission has yet to publish simulations of the spending paths, so we do not ultimately know what these will imply for fiscal policy in each member state nor how robust or sensitive to the assumptions the underlying calculations are. How far this regime increases national ownership and compliance remains to be seen. Much will depend on the degree of political support and the willingness to enforce this system among EU member states.
The proposals would also significantly strengthen the role of national independent fiscal institutions, IFIs, as shown in slide 3. The Commission notes they "have proven their [capacity] to foster fiscal discipline and strengthen the credibility of Member States' public finances". IFIs would be given a range of new tasks, building on their existing activities and there would be EU requirements on countries to strengthen their capacity. In slide 3 we have indicated new or modified roles with bold font. These roles are particularly around producing or endorsing medium-term macroeconomic and budgetary forecasts, producing debt sustainability analysis and a number of other things.
What does this mean for Ireland? Given the use of GDP, Ireland will most likely be classified as a low-debt country. The debt ratio was 45% of GDP at the end of 2022. However, on a more appropriate GNI* basis, Ireland would have a debt ratio around 83% and therefore would have been considered a high-debt country. Despite this, the fiscal trajectory is relatively benign given the surpluses projected and this would likely imply no real changes in policy. Due to the use of GDP and the relatively benign position, Ireland will most likely not face very intensive scrutiny under the new framework. Ireland’s unusual circumstances mean it has historically been largely compliant with the EU rules outside of the banking crisis, though largely as these rules have been insufficiently demanding. Compliance has been helped by the surges in corporation tax receipts. In this new world of the reformed pact, the domestic Irish framework will therefore need to play a critical role to ensure the economy and the public finances are kept on a stable path given the EU framework will ultimately be less binding. In short, the domestic framework should be the first line of defence, with the EU rules providing a backup. This would help ensure Ireland has the fiscal rules it needs and that work for its economy.
The Government’s national spending rule, introduced in summer 2021, is a sensible framework and has helped steer the public finances through the energy crisis. It is similar in spirit to the national fiscal trajectory at EU level. This should be reinforced by enshrining the national spending rule in law, so it is more specific and harder to ignore. This would help ensure Governments current and future only increase net spending in way that is sustainable and not in a way that relies on exceptional and potentially unreliable revenues. Given the huge inflows of corporation tax from a small number of foreign multinationals and Ireland’s now historically low unemployment rates, saving a large part of corporation tax receipts is necessary to avoid overheating the economy. The National Pensions Reserve Fund should be redeveloped. One option would be to make it a pensions reserve fund that would save incoming revenues and help to put the pension system on a more sustainable footing. The council welcomes the reports put out by the Government around that this morning.
For the Irish Fiscal Council, the proposed range of tasks in the Commission proposals broadly fits with our existing tasks, but would be extended in some ways. This would require some additional resources.
Given the proposed changes at EU level, the Fiscal Responsibility Act 2012 would need to be overhauled to reflect the new requirements and remove some of what would by then have become legacy requirements. This would be an important opportunity to strengthen the domestic budgetary framework by including the national spending rule and a new pensions reserve fund or similar arrangement. Overall, the main gain to Ireland from these reforms should be in making the euro area more stable and reducing debt in other countries with riskier levels of debt. However, it comes with opportunities to strengthen our own budgetary arrangements to manage what are likely to be more complicated times in the years ahead.
