In a recent speech, Minister for Finance Paschal Donohoe put forward a logical argument in favour of sound economic and budgetary management – but the suggested policies that follow these warnings must go beyond words.

Periodic speeches from a minister warning of the dangers of inappropriate fiscal policy are all well and good, but it’s time we did something credible about this.

The general thrust of the position set out to the Institute of International and European Affairs is to be welcomed.

It could be said that 1976 was the last time the fiscal stance was appropriate from both the budgetary and economic perspectives at the same time.

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Following the first oil price crisis in the early 1970s, it was decided to plan for a current budget deficit to support incomes and economic activity. This appropriate response contributed to an economic recovery and for 1976 and 1977, measures were introduced to reduce the budget deficit. This prudent approach was thrown off track by the general election campaign of 1977 and it is hard to identify a time since when the fiscal stance was appropriate from all perspectives.

We have had ill-timed fiscal expansions of tax cuts and expenditure increases that were unnecessary from an economic perspective and, on occasion, funded from a narrow and vulnerable tax base. Inevitably, unsustainable booms were followed by fiscal contractions.

That a minister for finance needs to set out the rationale for sound economic and budgetary management when we are still in such close proximity to the catastrophic consequences of the most recent episode of getting it wrong illustrates that either our memories are short, or we are not willing to accept budgetary decisions have broader implications outside of the sphere of what is in it for us as individuals.

Alternatively, because we hear a minister for finance talking about fiscal buffers, debt reduction and budget surpluses, it could be that we assume the principles of sound economic and budgetary management have made a welcome return to the Irish policymaking arena.

However, achieving the desired outcome needs more than good intent and using the right words.

An effective fiscal framework needs to be built around commitments that are credible, appropriate and, if necessary, backed up by legislative provisions. An assessment of the minister’s speech shows that it falls short in this regard.

In his speech, he set out two proposals. The first is a target for Government debt as a share of the modified measure of national income, GNI*, as produced by the Central Statistics Office. This is to be welcomed, given the well-understood problems when using gross domestic product as a measure of Irish income – though the target identified for 2025 is little different to the fiscal forecasts set out by the Government in its Stability Programme Update last April.

A debt target is not new. In 2016, then minister for finance, Michael Noonan, announced a target to reduce Government debt as a share of GDP to 45pc.

There were problems with the benchmark, but this announcement was never backed up by formal commitments and has been largely forgotten.

The second proposal set out by the minister is the intention to run a surplus of 1pc of GDP in 2022. While the intention to run a surplus might be laudable, we do not know whether it will be delivered on, or indeed whether it would be appropriate to do so.

Figures suggesting a surplus of 1pc of GDP are not new. Indeed, if we go back four years to Budget 2016, we can see in the accompanying documents that a budget surplus of 1pc of GDP was pencilled in for 2019.

There will not be a budget surplus of that magnitude this year. And, since 2016, we have seen further unexpected surges in corporation tax receipts, the continued strong performance of the economy and a reduction in debt interest costs – all of which could have contributed to a greater improvement in the budget balance.

Meanwhile, this latest announcement for a surplus of 1pc of GDP, but to be delivered in 2022, is exactly what was in the Government’s own forecasts as published last April.

A major issue with the proposed target using the headline balance is that we do not know if it will be appropriate and, even if it is, a new target will subsequently have to be set.

It could happen, for example, that further unexpected surges in corporation tax ease the achievement of this target in 2022 and mean unnecessary fiscal stimulus is provided to an overheating economy.

On the other hand, an external shock could result in a slowdown, meaning running such a surplus would be inappropriate, given the need to support incomes and economic activity.

Is there an approach to fiscal policy that can accommodate these divergent scenarios?

Possibly. The increased use of fiscal resources should be limited to the medium-term real potential growth rate of the economy, plus inflation.

Such a provision is already part of our fiscal framework through the expenditure benchmark set out in an EU regulation, but this is subservient to the medium-term objective of a balanced budget in structural terms which, while theoretically attractive, is beset by significant measurement problems. Reliance on estimates of the structural balance in a single year or pro-cyclical estimates of potential growth can result in inappropriate parameters for fiscal policy.

Estimating potential growth rates is not straightforward, but around 3pc per annum is not likely to be wholly inappropriate for Ireland, and is in line with the long-run historical performance of the economy.

Over the period 2002 to 2018, the annual real change in net policy spending actually averaged just under 3pc per annum but, within that, there was a period with unsustainable increases averaging 9pc a year, which was followed by a period of austerity, where painful real reductions averaging 6pc per annum were introduced.

This pro-cyclical fiscal stance added fuel to a booming economy and saw massive budget cuts introduced just at the time when the economy and household incomes needed support.

Over the past five years, real net policy spending will have increased by an average of 4.5pc a year. This is above the rate that could be considered sustainable and was particularly true for 2018, when the increase exceeded 6pc.

Some of this might be considered ‘bounce-back’ from the era of austerity, but it adds to the yo-yoing of Ireland’s fiscal stance since the late 1970s.

If the spending increases from 2002 to 2018 were maintained at 3pc each year, plus an allowance for inflation, it would still have been possible for general Government primary spending to rise from the €43bn it was in 2002 to the €77bn out-turn recorded for 2018, but it would have been done in a much more stable and sustainable fashion.

Intuitively, a stable real growth rate of policy spending might not seem counter-cyclical, but it is, and it would be a huge improvement on the pro-cyclical pattern that has blighted fiscal policy for years.

Maintaining the real growth rate of net policy spending in line with an average rate while the economy grows faster means Government spending acts as a drag on overall growth, and allows fiscal buffers to be built up, as revenue growth should exceed spending growth.

Those buffers can be used when the economy inevitably slows. And if the economy is growing at low rates or contracting, then real net policy spending growing at a faster rate will pull up the overall growth rate.

This does not mean a government’s hands are tied on the rate at which it can change nominal spending, or the level of spending it wants to achieve. If there are further spending priorities, the capacity to increase spending can be expanded with tax rises that provide sustainable revenue streams. Any spending rule should assess the net impact incorporating both spending and tax changes.

A legislative commitment to limit the increases in net policy spending to the medium-term growth rate of the economy, plus inflation, would be far better than an informal target to deliver a particular budget balance in a particular year.

It is possible that the EU’s fiscal framework will move in this direction over the coming years, with a number of proposals in the works to increase the importance of the expenditure benchmark relative to the structural balance rule.

But such changes are not guaranteed to happen, nor do we have to wait until they do.

Seamus Coffey is a lecturer in economics at UCC and chairperson of the Irish Fiscal Advisory Council

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