Pre-Budget 2018 Statement

Key Messages

Substantial progress has been made in moving the public finances to a safer position with a likely return to a budget balance in 2018, but risks remain. With the government’s budget returning to balance, debt ratios on a downward trajectory and near-term interest and growth prospects relatively favourable, Ireland is in a good position to move the public finances to a safer position. The favourable short-term macroeconomic outlook means that there is no need for cyclical stimulus at this time, while risks of overheating could materialise in future years. Debt levels still remain very high, which leaves Ireland vulnerable to adverse shocks such as those from a harder-than-expected Brexit impact. On the basis that GNI* is a more appropriate measure of national income for Ireland than GDP, this suggests that Ireland’s net debt burden ranks as the fourth highest in the OECD. Progress in moving the public finances to a safer position slowed in in recent years following the introduction of within-year spending increases.

The Council assesses that it would be conducive to prudent economic and budgetary management for Budget 2018 to stick to existing spending and tax plans within the available gross fiscal space for 2018 of around €1.7 billion. The Department’s latest estimates show some €1.7 billion available for tax and spending changes in 2018 if the fiscal rules are fully met. This estimate of €1.7 billion is based on the required 0.6 percentage point of GDP improvement in the structural balance as Ireland moves to its medium-term budgetary objective. However, the cost of previously announced measures, as well as the yet-to-be approved public sector pay agreement (Public Service Stability Agreement 2018–2020), reduces the scope for new initiatives in Budget 2018 to approximately €½ billion. If additional priorities are to be addressed, these should be funded by additional tax increases or through re-allocations of existing spending. Any unexpected increases in tax revenues or lower interest costs should not be used to fund permanent budgetary measures.

Additional in-year spending measures for 2017 would not be advisable. Considering that the rules already risk being breached this year, a further relaxation of the stance for 2017 would not be appropriate. Within-year expenditure increases, like those in 2015 and 2016, would result in a much more expansionary stance than originally planned, unless they are offset by corresponding expenditure savings or new revenue measures elsewhere. Insufficiently ambitious budget plans combined with a number of within-year increases in expenditure contributed to limited compliance with the fiscal rules. This is visible in a lack of progress in improving the primary balance during 2016 and 2017, despite favourable economic conditions. Had unexpected corporation tax receipts and interest savings been used for deficit reduction, rather than for within-year spending increases in 2015 and 2016, the budget would have been in balance roughly two years earlier than is now projected.

The Government should commit to adhering to all elements of the fiscal framework, including the Expenditure Benchmark, even if the medium-term objective for a structural deficit of 0.5 per cent of GDP is exceeded. Once the objective for a structural deficit of 0.5 per cent of GDP is passed—as may happen next year under current plans—the other pillar of the rules, the Expenditure Benchmark, ceases to apply as strictly. However, continuing to adhere to this spending rule would help to avoid the boom-bust cycles that have proved costly in the past. The Expenditure Benchmark is designed to ensure that spending growth does not follow a procyclical pattern and is meant to be consistent with the structural balance rule, though differences in its calculation compared with the structural balance rule provide some safeguards around measurement issues. If current growth projections are realised this would imply small budget surpluses in the coming years.

The Rainy Day Fund could make a useful contribution to more sustainable growth and to prudent management of the public finances, but details of how it is to operate should be published. It is not clear how the design of the Rainy Day Fund will ensure that it is truly countercyclical, given that allocations set out so far are fixed and appear to end in 2021 rather than responding to cyclical developments. How the fund is intended to operate in tandem with the fiscal rules should be clarified, particularly so that support can be provided to the economy in a downturn. Recognising these issues and the limited information that is currently available in relation to how the Rainy Day Fund is intended to operate, the Council urges the Government to publish a detailed proposal on the Rainy Day Fund before or as part of Budget 2018.

Public investment looks set to ramp up quite rapidly, while still complying with the fiscal rules. Following high levels of investment pre-crisis, the consolidation of the public finances saw public investment levels approximately halved. However, government plans show Exchequer capital spending set to ramp up again from €4.2 billion in 2016 to €7.8 billion in 2021, with some of these allocated resources still available to commit to new initiatives. As a share of either government spending or revenues, this would imply public investment in Ireland moving from relatively low levels to among the highest in the EU. The investment increase would be achieved while complying with the fiscal rules in future years. The recent experience in Ireland has seen a procyclical pattern to spending, and this has been a pronounced feature of public investment spending in particular. Adhering to all elements of the fiscal framework would help to prevent forced cuts in areas like investment spending in future downturns, and would help to smooth out spending on investment projects over future cycles.