Fiscal Assessment Report, November 2019

Summary Assessment

The Government based Budget 2020 on a disorderly Brexit scenario. This was appropriate, given the uncertainties and risks involved. For the macroeconomic forecasts, two scenarios were considered: a “deal scenario” and a “disorderly Brexit”. However, only one budgetary scenario was published, which was for a disorderly Brexit, and this envisaged €1.2 billion of disorderly Brexit contingent spending, some of which would be temporary and some long-lasting.

Developments since the budget suggest that a disorderly Brexit scenario is now less likely in the near term. Yet the macroeconomic outlook remains unusually uncertain. Even if the UK agrees a withdrawal agreement and a trade deal with the EU, this may be less favourable than free trade agreements previously envisaged. Strong growth in the domestic economy has continued, risking overheating in the near term. Adverse risks include the possibility of a global slowdown, further trade tensions, increased financial vulnerabilities, or changes to the international tax environment. While the Budget 2020 disorderly Brexit scenario does result in an economic slowdown, there are strong downside risks to this assessment. Downturns typically have severe impacts on the domestic economy including significant falls in consumer spending, investment, wages, and employment.

Ireland’s government debt burden is the sixth highest in OECD economies. This is when assessed as a share of an appropriate measure of national income like GNI* and allowing for certain liquid assets held by the government. At end-2018, Ireland’s net debt burden was equivalent to 90 per cent of GNI*. Only France, Portugal, Italy, Japan and Greece have higher net debt burdens in the OECD.

Budget 2020 projects a budget surplus for 2019 and a return to deficit in 2020, even without disorderly Brexit-related spending. The position would have been more favourable if the Government had not allowed spending to drift upwards in recent years. The pattern of within-year spending increases—beyond what was budgeted for—risks repeating mistakes of the past. New analysis in this report shows that three quarters of the upward spending revisions since Budget 2017 are due to current spending. Many of these increases are long-lasting in nature. This report also shows that recent health overruns have been largely driven by hospitals, where current spending—such as wages—dominates overall spending. Repeated overruns in the health budget, averaging around €500 million annually in recent years, are undermining the sustainability of the public finances and health spending needs to be properly managed.

In recent years, large tailwinds have not been used to improve the budget balance. Yearly tailwinds have risen to an estimated €10–14 billion. Yet the deficit has only improved by €3 billion between 2015 and 2018. The tailwinds include surges in corporation tax, the reduced interest bill, as well as higher revenues and lower unemployment-related costs associated with the economic cycle.

The Government has become increasingly reliant on the surge in corporation tax receipts to fund spending. Corporation taxes are forecast to account for more than €10 billion of tax revenue, almost one-in-every-five euro of tax collected by the Exchequer. A large portion of this corporation tax is “excess”, in other words, beyond what would be projected based on the economy’s underlying performance and based on historical or international norms. The excess is estimated to contribute €2–6 billion to the Government’s yearly revenues (1–3 percentage points of modified GNI*). The reliance on these volatile receipts leaves the government vulnerable to changes to the global tax environment, including the OECD’s Base Erosion and Profit Shifting (BEPS) initiative. It also increases exposure to firm- and industry-specific factors, given that half of receipts are accounted for by only ten corporate groups.

A prudent policy for Budget 2020 would have seen the Government stick to its plans for 2019 and 2020 as set out in the April Stability Programme. These allowed for substantial increases in net policy spending, but at a pace below sustainable revenue growth. Such prudence was needed given the risks associated with a potential disorderly Brexit, the reliance on corporation tax, possibilities of overheating, and the rapid rise in spending between 2017 and 2019. There was a case for even more caution with Budget 2020 owing to the risks associated with Brexit and a worsening external outlook.

For 2019, the Government did not stick to its plans and is again likely to rely on unexpected corporation tax receipts to fund spending overruns. Overruns in 2019 are forecast to be €0.7 billion. This includes €0.3 billion in health spending and the Christmas Bonus. If health spending goes beyond its forecast €0.3 billion overrun or if social welfare spending is revised upwards to reflect higher-than-expected payments in 2018, this could worsen the upward revisions to spending for the year. The health overrun comes despite an extra €1.1 billion being allocated by the Government in last year’s budget (an increase of 6.6 per cent). With the overrun, the health spending increase is likely to be more than 9 per cent.

The structural budget balance based on the Department of Finance’s measure has deteriorated in recent years. It is now forecast to just meet the minimum requirement set out in the fiscal rules for 2019. However, the position is flattered by excess corporation tax receipts, which may prove unsustainable.

For 2020, the Government adopted the welcome approach of offsetting overruns from 2019 in its Budget 2020 package. The Government opted to incorporate overruns in 2019 in its budget package for 2020 and to introduce offsetting measures elsewhere on the Exchequer side. Steps like this are in line with the Council’s advice in recent years. The approach helps to prevent budgetary measures from drifting up with each spending overrun. Thanks to this approach, the Government broadly stuck to its 2020 plans on an Exchequer basis. It will require spending to be tightly controlled in 2020 to deliver this plan.

However, upward revisions to spending outside of the Exchequer—where more transparency is needed—mean general government spending is forecast to expand more rapidly than previously planned. This includes planned spending by local government and by housing bodies, which should be fully incorporated in budgetary plans. Budget 2020 implies a net policy spending increase in 2020 of €4.6 billion overall in general government terms: this is €2.1 billion higher than the Government planned in April. Within this, Brexit-related costs of about €1 billion are expected to arise only in a no-deal scenario. However, a further €0.9 billion of higher spending arises outside of the Exchequer, including in local government and Approved Housing Bodies. This is a concern as these increases impact the economy just as much as central government spending and they should be considered in budget planning. To improve budgetary planning and oversight, the Department needs to publish more information and comprehensive projections in budgetary publications on a general government basis. This should include a comprehensive “walk” of all items from Exchequer to general government data in gross terms. Currently, this is only done on a net basis.

The overall nominal increase in spending (net of new tax measures) planned for 2020, excluding Brexit measures, is now 4.4 per cent. This compares to the 3.1 per cent growth rate set out in April and is right at the limit of what could be considered sustainable for 2020. The spending revisions in other areas of the general government have taken the Budget away from the original approach of increasing spending by less than a measure of sustainable revenue growth. This would have accounted for the uncertainties facing the Irish economy by keeping budgetary increases below this benchmark. Instead, Budget 2020 plans remove the safety margin. This narrows the scope for budgetary policy to cushion adverse shocks without raising concerns of fiscal sustainability. It also adds to activity in an already fast-growing economy.

The Government included a disorderly Brexit contingency in Budget 2020 and suspended the first annual payments to be made to the Rainy Day Fund in 2019 and 2020. A spending contingency was allocated for sectoral supports and other measures in a disorderly Brexit scenario. While temporary measures to address a severe short-term shock can be accommodated, permanent effects should be viewed within the overall budgetary package. If the contingency were to arise, it is important that the temporary measures do not lead to long-lasting levels of higher net spending. There is a case for suspending Rainy Day Fund payments in the event of a disorderly scenario, but the case for suspending payments without the risk materialising is less convincing.

For the medium term (2021–2024), the Budget 2020 projections suggest a return to a surplus in 2021, which gradually rises to 1.3 per cent of GNI*. The Government’s medium-term spending forecasts are more realistic than they have been recently. Yet, they still rely on arbitrary technical assumptions for spending rather than Government plans or assessments of demographic and inflationary pressures, and they do not include any public sector pay agreement beyond 2020.

The Government should set a course for a prudent fiscal policy that ensures its net policy spending growth does not exceed sustainable growth in its revenues. This should tackle the economic and budgetary risks associated with reliance of government revenues on excess corporation tax receipts. Successive governments have managed to bring a large deficit to balance and to put debt ratios on a downward path following the crisis. But progress has slowed since 2015 and a clear plan is needed for the medium term to limit the risk that hard-won gains might give way to a need for forced austerity yet again. The Government should develop and implement the proposals set out in the Department’s “Fiscal Vulnerabilities Scoping Paper” to reinforce its budgetary framework. Three sets of reforms—which go beyond what the Department proposes—are needed. The Government needs to: (1) use the rainy day fund and a prudence account to save temporary receipts, including saving unexpected corporation tax receipts so that they cannot be used to finance overruns in other areas; (2) use sustainable growth rates informed by alternative estimates of potential output to guide net policy spending growth and to aid in producing more realistic medium-term forecasts; and (3) establish meaningful debt ratio targets.