EU pact ‘failed to predict Irish fallout’

GOVERNOR of the Central Bank Patrick Honohan said last night the EU’s stability and growth pact, which sets out the budgetary guidelines for EU member states, failed to identify the excessive impact a slowdown in economic activity would have on the flow of taxes to the state’s coffers.

Addressing the Institute of Certified Public Accountants in Dublin last night, Mr Honohan said while the pact offered broad guidelines on how governments should manage their budgets, it was not equipped to identify what would happen when the Irish economy fell out of bed after the property boom ended.

While there was some relaxation in Government policy during the last two years of the boom, the real problem was that the pact failed to identify the inherent flaw in the economy, which had been its over-reliance on certain forms of taxation.

The real issue was “the policies that had delivered steady surpluses suddenly stopped delivering”.

The direct cause was the failure of property prices, which had stopped rising at the end of 2006. As a result capital gains were down as property transactions slowed dramatically and construction contracted.

“But my point is that as an indicator of the sustainability into the future of the public finances, the SGP rules were not adequate.

“A country could run a surplus for years and yet the structure of its tax receipts and spending rules could leave it vulnerable to a sudden crippling turnaround in the deficit and a rapid accumulation of debt,” he said.

While most tax systems tend to fare better in such conditions, the impact on tax returns after the property bubble burst “was exceptionally high in Ireland,” he said.

Of course tax revenues have slumped, and expenditure has soared in all of the countries affected by the global downturn of 2008-9, but most have not been as badly impacted as we have, he said.

Ireland ran a balanced budget on average for two decades before the collapse of 2008.

“It satisfied the deficit criterion of the Stability and Growth Pact of the European Monetary System before it was invented,” he said.

Over the period deficits became smaller and “turned into surpluses in the early years of the new millennium”.

On the banking crisis, Professor Honohan said a strong feeling exists “that I should challenge the accounting profession for not having looked sufficiently far beyond the balance sheet date in providing their audit opinion; arguably, in a rapidly deteriorating environment, accountants should at least have been more concerned with post-balance sheet events concerns, and more fundamentally could have done better in seeing the need for expected losses and the amplitude of the potential property price movements in assessing the going concern assumption.”