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Tom Ferris is a Consultant Economist specialising in Better Regulation.
He was formerly the Department of Transport’s Senior Economist.

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The words “fiscal space” have recently entered Ireland’s lexicon. We will hear a lot more about it during this general election campaign. What exactly is a “fiscal space”? Put simply, it is the ‘spare’ funds available to government for additional expenditure and/or tax reductions, while meeting its day-to-day expenditures under the new EU fiscal rules. This blog looks behind the fiscal space figures and the differences between the estimates produced by the Department of Finance and the Irish Fiscal Advisory Council.

What is “Fiscal Space”?

Fiscal space is a relatively new term in Ireland, referring as it does to the flexibility of a government in its spending choices. It was given traction over ten years ago by Peter S. Heller of the IMF in a paper entitled ‘Understanding Fiscal Space’

It is now being used to measure the extra resources available to government, after on-going expenditures have been met and current taxes raised. The Department of Finance produced a very useful information note on fiscal space on 1 February. It points out that

“Fiscal space is defined as the projected amount of resources available to the Government for additional expenditure and/or tax reductions, while ensuring compliance with the fiscal rules, specifically the so-called Expenditure Benchmark. Policy decisions on how to allocate these resources are, of course, a matter for the next Government”. [ii]

Fiscal Space in context

Fiscal space needs to be put in the context of total government finances. This was done in a table produced as part of Budget 2016; a summary of which is reproduced in Table 1. It shows that the fiscal space ranges between €8.6bn and €12.7bn. The differences are determined by what assumptions are made in the calculations; it depends on:

  • Whether one includes (or excludes) discretionary revenue measures of €1.8bn, and
  • Whether one takes into account (or not) other anticipated expenditure of €4.3bn, including those in relation to demographics, public capital plan and the Lansdowne Road Agreement.

Regardless of which fiscal space one picks from the foregoing table, it is necessary to see what share such figures represent of overall government expenditure. For the years 2017 to 2021, each of the fiscal space estimates represent only a small percentage of total general government expenditure (ranging from 1.2% to 3.7%). In other words, unless radical changes are made in existing public expenditures by future governments, there will only be a limited amount of flexibility in increasing public expenditure further and reducing taxation further.

                                   Table 1: Fiscal Space, Budget 2016
 
Category

      Years 2017 – 2021€ billions % of Govt. Exp.
General Government Expenditure*345.9100.0%Gross Fiscal Space10.93.2%Discretionary revenue measures1.80.5%Adjusted Fiscal Space12.73.7%Other adjustments **4.31.2%Net Fiscal Space8.62.5%
* “Corrected expenditure aggregate net of discretionary revenue measures”** Takes account of anticipated expenditure, including those in relation to demographics, public capital plan and Lansdowne Road Agreement.Source: Table A8 of Budget 2016

What does the IFAC say?

On 29 January, Professor John McHale of the Irish Fiscal Advisory Council (IFAC) was more pessimistic than the Department of Finance about the scope for significant fiscal space in the years ahead. He suggested that the figure might to only around €3.2bn. Specifically he said that

“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 €3.2bn”.[iii]

 

So there is a big difference between the two estimates; with IFAC at a low of €3.2bn and the Department of Finance with estimates of between €8.6bn and €12.7bn. The information note issued by the Department of Finance addresses the difference between the Department’s figures and those of the IFAC. It points out that the IFAC estimates

“…assume that various forms of social benefits (unemployment benefits, old age pension, child benefit payments, etc.) are indexed to the rate of inflation. Their numbers are also based on the assumption of public sector pay increases beyond 2018. Any such increases in expenditure are a matter for the Government of the day and require a policy decision as part of the annual budgetary cycle. To include these measures in the fiscal space by the Department of Finance would be an assumption on future policy decisions, which are a matter for the next Government”.

 

Is the Fiscal Space helpful?

Fiscal Space can be of help in the course of the debates taking place during this general election campaign. The important question to ask of any political party that uses fiscal space figures is what are your assumptions? Are you including discretionary revenue, measures already in the pipeline, and are you taking into account other anticipated expenditures, including those in relation to demographics, public investment and taxation reductions? It is only with answers to these questions, that you can be assured that additional public funds will in fact be available, without any ‘double-counting’ of public funds.

Notes


[i] https://www.imf.org/external/pubs/ft/pdp/2005/pdp04.pdf

[ii] http://www.finance.gov.ie/sites/default/files/Information%20Note%20on%20Fiscal%20Space%202017%20fin.pdf

[iii] http://www.rte.ie/news/election-2016/2016/0201/764419-a-brief-guide-to-fiscal-space/

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