Fiscal rules add extra dimension to election

Imagine you were lucky enough to win €10,000 on a scratch card.

Before cracking open the champagne, a glance at the small print reveals that you could not actually spend all of this unexpected windfall. 

Instead, the rules state that you must take the more prudent course of paying down part of your low-interest tracker mortgage.

This is, in effect, the equivalent of what Finance Minister Michael Noonan is dealing with as he prepares for Budget 2016 five weeks away.

Minister Noonan’s unexpected windfall has come in the form of much better than expected tax revenues. 

In the year to the end of August, tax revenues were some €1.4 billion ahead of target, and could well be €2bn higher than expected by the end of the year.

In years gone by, this would have afforded the government of the day the luxury of loosening the purse strings by offering tax cuts and spending increases for the following year.

One still hears suggestions that the positive Exchequer returns “increases pressure on the Minister to offer further Budget give-aways”. This is no longer the case.

European fiscal rules, strengthened over recent years, severely hamstring governments in setting their policies on spending and tax from one year to the next.

Some forget that we were the only country to have a referendum on this issue in July 2012, with 60% of the Irish electorate signing up to it. The consequences of this decision will only really be felt for the first time in 2016. 

This is because budgets in the 2011-2015 period were first determined by the Troika programme and then by the requirement to reduce the budget deficit to 3% of GDP. That particular target will be reached this year.

In the jargon, Ireland is moving from the “corrective” arm of the Stability and Growth Pact to the “preventive” arm.

A key aspect of this is the “expenditure benchmark”, which dictates that spending growth must not exceed a rate that is largely determined by the medium-term potential growth in the economy, not by its “cyclical” fluctuations. 

The Irish Fiscal Advisory Council (IFAC) estimates that this amounts to just a 1% increase in spending in 2016, equivalent to €1bn. Crucially, the rule also states that any policies that reduce taxes will reduce this allowable expenditure further.

There are important implications for both the public and the government of this fiscal straitjacket. Even though the economy has already returned to its pre-crisis level of output, we should not expect the automatic reversal of some of the painful fiscal measures of recent years. 

Secondly, the government cannot cynically buy the next election and instead must operate within fairly strict constraints.

Some will complain that the rules are an infringement on our sovereign right to set our own policies. 

The rules are far from perfect, especially in relation to the way in which they can stymie important capital investment, but overall should be seen as a very helpful tool to prudently manage the public finances, something that Irish governments have spectacularly failed to do on two occasions in the past 30 years.

It is essential that the election promises are viewed in the context of the constraints mentioned here. 

It is also important that proposals are independently costed. Doing this will make it easier than ever for the electorate to make our own mind up on the competing proposals that we will be hearing about over the coming months.

Fiscal rules are not the most exhilarating topic to be discussed on the doorstep, but their presence adds a new dimension to the upcoming election campaign.

Dermot O’Leary is chief economist at Goodbody Stockbrokers


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