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What is the ‘fiscal space’ and why does it matter?

It’s a phrase you’ll be hearing a lot from the political parties in the coming months.

OVER THE NEXT few weeks you’ll be hearing a lot of politicians and commentators talking about something called the ‘fiscal space’.

The general election campaign is likely to be dominated by the phrase and it’s already been the subject of claim and counter-claim from political parties and economists.

In recent days you might have heard people talking about how much of a fiscal space there is and what should be done with it.

To be clear, the fiscal space is not an actual thing:

Nor is it an episode of Star Trek:

spock shatner Source: Wikimedia Commons

So what on earth is the fiscal space? 

Put simply, it’s the amount of money the next government will have available to spend over and above what it is already spending on public services like health, welfare, education and so on.

The theory, and the hope, is that strong economic growth will bring more money into government coffers through extra tax revenue as a result of more people working and therefore more taxes being paid.

All going well, after the State pays for guards, teachers, nurses and everything else there will be some money left over, which can be used to cut taxes and/or increase spending on public services.

So how much fiscal space is there? 

Ireland Financial Crisis Source: AP/Press Association Images

Here’s where the debate begins. Presently, the government is estimating a fiscal space of around €12 billion over the next five years. But this is based on the assumption that the economy will grow at around 3% every year in this period, as the Department of Finance projects it will.

That’s a big assumption given economic forecasts can, as we’ve seen in the past, be badly wrong. It’s also assuming there are no domestic or world economic events which plunge us back into the sort of mess we were in six years ago.

The €12 billion figure is arrived at when you include the €8.6 billion in extra revenue the Department of Finance says this 3% annual growth will create.

As well as this, by not doing something called ‘tax indexation’ it will free up around €2 billion. Tax indexation is essentially adjusting tax bands in response to inflation, which is the rate at which the price of goods and services rises.

In addition, the government hopes that European authorities will allow a small adjustment in the EU’s fiscal rules so it can run a deficit (the gap between what the State brings in and what it spends) of around 0.5% of gross domestic product. This will give the government an extra €1.4 billion.

Add them altogether and you get your €12 billion of a fiscal space.

So what’s the issue? 

While the government’s figures give the next administration some €12 billion to play with, its own budget watchdog, the Irish Fiscal Advisory Council, is far more cautious. Last week, IFAC head John McHale said that the fiscal space could be only €3.2 billion over the next give years.

25/11/2015 Fiscal Assessment Reports John McHale

He said the government figures don’t put aside enough money to account for pressures on public spending and adjustments for inflation. Examples of such pressures would be a spike in health spending, which we’ve seen happen over the past few years with the need for supplementary budgets.

“We actually think that there is a need for a further allowance for demographics and also if you were to maintain the existing level of public services and benefits, really the free fiscal space drops quite sharply to about €3.2billion. So there is a real question about affordability,” McHale told RTÉ’s Morning Ireland last week.

Even if the EU allows a small change in the rules, that would only allow a fiscal space of around €5 billion. Far less than the government estimates.

Again, it’s worth coming back to the point that while the Department of Finance figures are the official figures they could be wrong, very wrong. Particularly if the economy does not grow as healthily as it is predicting over the coming years.

What are the political parties saying? 

Most parties agree that the fiscal space is somewhere in the region of between €9 billion and €12 billion. With that being the case, the debate is over how to spend that money.

Fine Gael is arguing that 70% of the money should go on investment in public service with 30% used for tax reductions, including the planned abolition of the Universal Social Charge.

23/1/2016.78th Fine Gael Ard Fheis Michael Noonan Source: Sam Boal/RollingNews.ie

Labour is arguing for 75% of the money to be spent on public services with the balance on tax reductions, including plans to abolish USC for people earning up to €72,000 over give years.

Fianna Fáil, which thinks the fiscal space is somewhat less than €12 billion and around €9.5 billion, is arguing for a 60-40 split between spending increases and tax cuts.

We’ve yet to hear the detail from Sinn Féin but given its previous pre-Budget submissions, and costly commitment to overhaul the health service, you can take it that it will use the vast majority of the fiscal space to spend on public services.

Similarly, the Social Democrats are proposing to use all of the available fiscal space to increase public spending, including establishing an Irish NHS.

Did I hear something about a ‘rainy day fund’? 

Yes. Last week Finance Minister Michael Noonan proposed the idea of Ireland having a contingency fund to act as a buffer for any shocks in the economy. This would amount to around €2.5 billion over five years which would be held back in case there are any unforeseen events or spending pressures.

24/11/2015 Credit Union Bills Michael McGrath Source: Photocall Ireland

However, Fianna Fáil questioned where Noonan is plucking this idea from. Finance spokesperson Michael McGrath said that given Fine Gael’s pledge to abolish USC as part of a 70-30 split of spending increases and tax cuts, Noonan’s party would need a fiscal space of between €16 billion and €17 billion to meet all of its pre-election commitments.

“This is simply impossible,” McGrath said. “Fine Gael need to accept that it cannot do all of these measures and explain clearly which proposals they will not go ahead with.”

Labour is also putting forward the idea of some sort of rainy day fund, but sources have pointed out that the money kept aside might be needed to pay down Ireland’s considerable national debt which is around €200 billion.

Is it just me, or is all this pre-election spending talk worryingly familiar? 

Indeed, before 2011, general elections were all about how the parties were going to spend loads more money, be it through greater investment in public services or juicy tax cuts.

You might think they’d be a bit more cautious about all these nice promises given the economic catastrophe from which we are now only starting to emerge.

CHARLIE MC CREEVY GENERAL ELECTION CAMPAIGN 2002 These lads loved to spend money back in the good old days. Source: Leon Farrell/Photocall Ireland

The government is insisting that it’s being responsible and prudent. The opposition parties are, of course, disagreeing while at the same time making their own pledges around spending.

The government argues that this time things are different because of the EU fiscal rules, which we voted into the Constitution in 2012. Ministers are at pains to insist the days of “boom and bust” are over.

Taoiseach Enda Kenny said that the detail of Fine Gael’s plans will be outlined in the party’s long-term economic plan, which will be published with its manifesto in the coming weeks. Other parties are promising similar detail.

But all the detail in the world can’t make up for the fact that everything they will promise is based on the economy growing very strongly over the next five years.

If it happens, then great. But it’s a big ‘if’.

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