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Why the government is set to break its own budget rules for the second year in-a-row

Paul O’Donoghue looks at why government is going against advice from serious entities.

WHEN I SAY ‘spending rules’, you say ‘breached’!

Spending rules! Breached!

So it has gone for the government for the last two years in-a-row. 

Serious bodies such as the Central Bank and Irish Fiscal Advisory Council (IFAC) issue serious warnings about the serious consequences of spending too much public money.

The government listens, nods, and says: ‘Yeah, thanks, but no thanks.’

The rule in question is one which would limit increases in state spending to a maximum of 5% a year.

The figure of 5% was chosen because the economy was expected to grow by about 5% annually for the next few years. So by keeping spending in line with growth, theoretically the government avoids getting too loose with state funds during good times.

This year, it is expected the spending increase will come in at more than 6%. While that may not sound like much, that 1% is equal to an extra €1 billion which will have to be spent every year for the foreseeable future.

This will likely go to areas such as welfare increases and tax cuts, measures which can’t be easily undone.

The main worry from the likes of IFAC is that doing this will fuel inflation. They argue, with the Irish economy at full employment and consumer demand still high, there is no need to keep spending big.

If anything, they are pushing for the opposite. To ease off on spending to help drop demand and slow down inflation.

So, why is the government going against this advice?

Summer Statement

It lays out its reasoning in a bit more detail in the Summer Economic Statement, published earlier this week.

First off, it argued that the extra money has provided “enhanced social protection supports” as well as more public service staff.

It also said it has helped with “the rollout of key government strategies” in relation to areas like housing and healthcare, which are of huge concern to both the public and politicians who want to stay in office.

However, these are constant issues which will crop up every year, and so don’t quite explain why the government is breaking the spending rules again.

In a statement to The Journal, it indicated that its main justification is because of the effects of inflation.

“[The 5% rule] was taking into account an assumed inflation rate of around 2%,” the Department of Finance said.

“Last year, in the context of a radically different inflationary environment, the parameters were temporarily adapted for Budget 2023.

“Given that inflation is expected to remain above 2 per cent next year, the government is also adjusting its fiscal parameters for Budget 2024.”

Some more detail on the reasoning is laid out in the Summer Economic Statement.

It essentially argues that higher spending is needed to provide support for people struggling with the cost of living, such as the energy subsidies rolled out last year.

“The measures introduced sought to strike a balance between targeted supports to those struggling most in society while avoiding actions that would fuel inflationary pressures,” it said.

This sounds pretty reasonable. But critics say there are two big issues.

The first is around the sustainability of corporate tax. About €12 billion in corporate tax this year is a ‘windfall’ – which is to say, it’s not something which policymakers can be sure will last.

Without this, the state would have recorded a deficit last year, and the public finances would be in a much shakier place.

The worry is that the reliance on corporate tax now is similar to a modern-day equivalent to the importance of stamp duty during the Celtic Tiger, which left a massive hole in the state’s balance sheets after the housing collapse.

But the bigger concern from entities like IFAC is around inflation.

Full employment

Michael McMahon, the organisation’s acting chair, said the government’s decision to keep spending could actually be harmful in the long run if it causes inflation to linger.

“Unemployment is at historic lows, and it’s not a sensible time to be adding extra demand to the economy,” he told The Journal.

“If you were to give everyone an extra €1,000, particularly if that money is generated from multinationals with activities outside of Ireland who are booking taxes here, we create extra demand without extra supply. Think of it like houses, what happens if you give all house buyers an extra €10,000 – prices go up.”

However, the Department of Finance argued the extra €1 billion in spending is needed.

“This balances improvements in public services and investment in critical infrastructure while ensuring that budgetary policy does not become part of the inflation problem,” it said in its statement to The Journal.

But bodies such as IFAC and the Central Bank are not so sure. As well as feeding inflation, they also argue that higher spending basically undoes the work the European Central Bank is trying to do by raising interest rates.

The point of raising interest rates is to make borrowing more expensive, causing people to spend less money and leading to a reduction in prices.

But if the government is giving people extra money at the same time as interest rates are rising, the two can interfere with each other.

“While inflation is high, the European Central Bank will keep raising interest rates,” McMahon said. 

“If the authorities in Ireland and other countries counter hikes with more spending, we’ll end up with even higher interest rates.”

Voters versus Think Tanks

No matter which way it’s sliced, the government faces a delicate balancing act. 

Resisting calls for increased spending will prove almost impossible with corporate taxes flowing in at the same time as a massive chunk of the population is grappling with a cost of living crisis.

At the same time, the higher spending risks undoing counteracting interest rate hikes and overheating the economy.

But with think tanks on one side, and voters on the other, only one winner looks likely.

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