ECONOMICS: If all goes well, the Republic's budget deficit will stabilise at 1 per cent of Gross Domestic Product over ther period 2003-2008, says the International Monetary Fund
The IMF's latest report on the Irish economy made the headlines last week. The media focus was firmly on the directors' expressions of concern about the state of the public finances and their implied rebuke to the Irish Government. However, there was little attention paid to the analysis that underpinned the directors' assessment, which was published in a separate "Selected Issues" report. This was a pity because that analysis was concise, cogent and carried out from a disinterested standpoint.
In its "Selected Issues" report, the IMF constructed a number of medium-term scenarios for the Irish public finances. In the baseline case, the IMF economists essentially adjusted the Government's own medium-term forecasts, published at the time of the last budget, to reflect recent developments, such as the emerging shortfall in tax receipts. The critical assumptions on which this scenario is based, therefore, are (i) that economic growth will soon reaccelerate to annual rates in the range 5-6 per cent, with corresponding positive effects on tax revenue, and (ii) that the growth of Government spending will decelerate to a rate less than half of that recorded in recent years. It is also assumed that tax cuts will be very modest.
On this basis, the budget deficit is projected to stabilise at about 1 per cent of GDP over the period 2003-2007. No great harm there, one might conclude, particularly as the IMF's baseline projections also see the ratio of Government debt to GDP - the ultimate barometer of the sustainability or otherwise of the budgetary position - continuing to decline. However, the trajectory for the deficit is arguably in breach of, and is certainly at the limit of, what is allowed by the EU's Stability and Growth Pact (SGP). The SGP requires budget deficits to be kept close to balance or in surplus over the medium term.
The point here is that, even assuming a generous measure of fair wind and action to sharply brake the growth in spending, the budgetary position is set to evolve in a way that is just about within the thresholds of acceptability. Clearly, if less benign (more realistic?) assumptions are used, these thresholds are breached. The IMF analysed two such situations: one in which pressures on spending are not successfully withstood; the other in which tax receipts respond less buoyantly to accelerating economic growth than the Department of Finance estimates of tax elasticity would suggest. In each of these scenarios, the budget deficit is projected to approach the SGP limit of 3 per cent of GDP by the end of the forecast period and the debt-GDP ratio starts to rise again.
It is worth pointing out that the less benign scenarios explored by the IMF are nowhere near as bad as it could plausibly get. For example, it is possible that a failure by Government to rein in spending growth could occur in tandem with low tax elasticity. In such circumstances, the incipient budget deficit would head towards 6per cent of GDP, requiring a correspondingly large and painful fiscal correction to shift it back to balance.
Another, and perhaps more pertinent example of how the IMF scenario-building exercise is not nearly as gloomy as it might have been, is that the economy is assumed to be growing at a 5-6 clip by next year. A less sanguine view of growth prospects inevitably converts into a rather more fraught view of the public finances.
Of course, there is a point of view that dismisses all the current talk of fiscal crisis as so much nonsense. According to this viewpoint, the solution to such budgetary difficulties as are in prospect over the next couple of years is obvious to all but those who are ideologically blinded to it. That solution is to raise taxes. After all, the argument goes, the tax burden has fallen sharply over the past decade or so. At the same time, there is a popular clamour for more and better public services.
The higher tax solution to the emerging fiscal difficulties needs to be heard and vigorously debated. There is no purpose served by simply pretending that the option doesn't exist or by characterising those who favour it as some sort of pink lunatic fringe. That said, those who argue for higher taxes need to deal with some fundamental objections. The most important of these is that there can be no justification for a situation where higher taxes merely serve to fuel waste and inefficiency in the public sector or add another layer of feathers to already well-feathered nests. And, several years of double-digit growth in public spending, provide ample grounds for suspecting that waste, inefficiency and generously feathered nests have become more rather than less prevalent.
This links back to the recommendation, made by the IMF last week and made by several domestic commentators, including Gerry Boyle and myself in this newspaper a couple of months ago, that the Government adopt a formal medium-term fiscal framework. Such a framework would include an overall budget constraint, multi-annual spending limits and the application of rigorous value-for-money criteria along with clearly defined outputs to all spending programmes.
An approach along these lines offers the only equitable, rational and transparent means of maintaining fiscal balance while at the same time improving the range and quality of public services at acceptable tax rates.
