The experts have been queuing up over the past week to tell the Government – and the wider political system – to be careful, very careful, about spending more money in the budget.
First up was the Governor of the Central Bank, Philip Lane, who told the Oireachtas Finance Committee that the State should be prepared to increase taxes to help prevent overheating in the economy.
Ok, so he didn’t actually say increase taxes – but he did urge the politicians to plan to run a budget surplus in coming years, not simply balance the books.
He said that this did not conflict with spending plans – it’s just that increase in spending needed increases in revenue to keep the budget neutral, and protect the resilience of the public finances from the next downturn.
Hence the need to run a surplus – money that is not committed to budget spending but which is used to reduce debt – or go into a rainy day fund (however that is defined). Either way, the idea is to toughen up the State’s defences against the consequences of a reversal in the current good economic fortune.
And that’s the thing about upswings – they are always followed by a downswing. Knowing that, it makes sense to avoid setting up a situation where the Government has to cut spending and raise taxes when the economy goes into a downswing. That only makes a bad situation worse. As we know from what happened here ten years ago. The next few budgets will tell is whether or not we learned any lessons from that time.
Then came the IMF, in their annual Article 4 financial health check. They were more explicit – the Government should not cut taxes in the budget. The IMF argue that large increases in spending – including justifiable increase in capital spending – against the backdrop of very high levels of economic growth risk overheating the economy. Cutting taxes as well would amount to throwing petrol on the fire.
And if you burn all your fuel in the good times, you have nothing left for warmth when the chill winds of recession begin to blow.
And then came Seamus Coffey, the chairman of the Fiscal Advisory Council and author of a report for the Department of Finance on Corporation Tax. He warned the Finance Committee that the current high level of corporate tax receipts cannot be taken for granted. Indeed he said a fall in corporate tax receipts was inevitable – and it won’t have to be the result of changes to tax regimes here or elsewhere, it will be just part of the business cycle or general health of firms.
The Corporation Tax take has doubled in the past four years – an extraordinary rate of growth. It is now about 15% of Government revenues – double the EU average, another extraordinary figure. And despite this the government is still running a deficit, and plans to run a deficit next year also. OK, its only 0.1% of GDP – but still, if the government needs to borrow money at a time of very strong GDP growth, very strong employment growth, and a healthy international trade backdrop, what does that say about the underlying strength of the public finances?
How would we cope? More directly, given the inevitability of recession – how will we cope? If all the unexpected growth of corporate tax revenue has been committed to spending – which it pretty much has been – how will that spending be maintained when corporate tax receipts fall? Prof Coffey pointed out that corporate tax receipts are very volatile: even though aggregate receipts continue to climb, that masks a big variation from year to year in the composition of the reciepts. And just as the corporate changes of 2015 led to the "Leprechaun Economics" growth of 26% of GDP in a single year - a result that was utterly unexpected – so too could another unexpected change in circumstances see a huge negative swing in GDP and its related (and tax paying) real activity.
The fact that ten companies, mainly US owned, pay 40% of the corporation tax means a big chunk of this money is dependent on how well these ten firms trade. All else being equal, a bad year for Apple means a bigger budget deficit. Gaining budget space to ensure that is not the case is therefore important.
Which brings us to Wednesday’s chippy questioning of the Minster for Finance Paschal Donohoe by opposition counterparts Michael McGrath and Pearse Doherty about our old friend, the fiscal space. They wanted to know how much uncommitted money the Government has available to fund additional spending and tax cuts in the autumn budget plan for next year. They accept that the Government does not have to spend every available cent. But it is the last budget in a three budget supply and confidence deal with Fianna Fáil. So the old pre-election spending urge may apply.....
Trying to figure out the available fiscal space (understood in Ireland as spending money, but it doesn’t have to be ), is a head-wrecking task at the best of times, and nowadays the Government doesn't want us to think about fiscal space at all, hence its banishment from its former dwelling place in the tables at the back of the budget book.
However, using the last published estimate of €3.2bn of fiscal space for 2019 (a figure which will change when the European Commission produces its latest economic forecasts), it looks like about €1.8nn has been committed in spending increases for next year. Adding in other commitments, leaves a rough figure of €600m.
Using the pre-agreed formula of a three-to-one ratio of spending rises to tax cuts, it looks like this may be the rough size of a tax cut - should the Government and Fianna Fáil agree to use it for tax reduction.
But that would be to ignore all of the advice above. And it may run counter to the Government's own stated aims. In a note to the budget oversight committee this weekend, the Department of Finance says "it is imperative that the pro-cyclical mistakes of the past are avoided. with the economy now very close to full employment, it is crucial that budgetary policy does not add to overheating pressures".
The Government will produce a summer economic statement, set for early July, though it could come by late June. In it the Government will attempt to promote the idea of a budget (or fiscal) stance. This, it says will determine the parameters of the budget in October. It says its guiding objective will be "steady and sustainable increases in living standards, not a return to the boom and bust of the past".
A key test of that objective will be whether the Government and Fianna Fáil go for tax cuts, or resists the urge to spend every cent of fiscal space during what are, by any measure, the economic good times.