John Walsh: Here come the latest French and German attempts to control Ireland’s budget

The familiar rhythm of the pre-budgetary cycle is well underway. The government floats spending increases and tax cuts, while the fiscal watchdogs advise against these measures.

The Central Bank, the Irish Fiscal Advisory Council and the Economic and Social Research Institute (ESRI) were out with the same message during the week. The government should not breach its own 5 per cent of GDP spending rule as this will stoke inflationary pressures at a time when the cost-of-living crisis is already biting.

Finance Ministers Michael McGrath and Paschal Donohoe signalled in their Summer Economic Statement that it plans a €6.4bn package in the budget, which is considerably above the 5 per cent cap.

The main risk stemming from increased spending is that is it baked into the annual framework but pegged to transitory revenues. The Central Bank reduced its growth outlook for the economy on the back of lower exports in the pharmaceuticals and semi-conductor sectors.

The comparisons between 2007/8 and now have been made on these pages and elsewhere over the past few months. Back then, at the height of the Celtic Tiger, the government ramped up spending based on buoyant tax revenues from the property market. When construction activity collapsed, tax revenues shrank, and the government had to put a hand-brake on spending.

Ireland has one of the healthiest fiscal positions among OECD countries based on surging corporate tax receipts. If there is any threat to corporate tax revenues, the consequences for the economy would be similar to the fiscal belt-tightening from 2008 onwards.

While 2007/08 is an obvious and valid comparison, it is also worth considering what happened in 2015/16. In the middle of the last decade there were legitimate fears that the EU would unravel. The sovereign debt crisis had pushed the eurozone to breaking point and a migration crisis was lapping the bloc’s borders.

Solidarity was in short supply among member states amid mutual recriminations about fiscal responsibility and migration policy.

The Leave side in the Brexit referendum orchestrated a highly effective campaign that focused on the imminent demise of the euro and the EU. Indeed, when Britain left the EU there was a shrill delirium among Brexiteers about who would be the next to leave. Ireland was cited as an obvious candidate because of the close ties between the two countries.

Underestimated the resolve

But the UK underestimated the resolve of the EU to chart a way through its seemingly intractable woes. Reforms that had been initiated in the aftermath of the global economic crisis were accelerated and often enhanced. The Covid pandemic added to the integrationist impetus.

The EU is unrecognisable now compared to the entity that existed a decade ago. New budgetary rules were suspended amid the cost of living crisis, but overall there will be much greater co-ordinated between member states.

There is a banking union, which backbones the resilience of the financial system. There is an EU rescue fund that will help countries that get into trouble in the future. Perhaps most importantly, the European Commission crossed a previous red line to issue mutual debt to support member states ravaged by the pandemic.

The institutional underpinning of the EU is now sufficiently robust to ensure that it doesn’t lurch from one economic crisis to another. But there are new challenges emerging that pose potentially existential risks for Ireland.

There is another migration crisis at the EU’s borders. A series of ad-hoc measures were put in place over 2015/16, but a more durable solution is needed on this occasion to ensure migration does not add even more ballast for incipient far-right movements throughout the bloc.

Once again reform is at the heart of the EU agenda. A paper commissioned by the French and German governments was released during the week and could have far-reaching consequences.

The starting point of this paper is that the current institutional architecture of the EU is too unwieldy and unable to deal with future enlargement, therefore, radical restructuring is needed. It proposes that the number of EU commissioners and MEPs are reduced, the EU budget is greatly enhanced and the national veto is removed.

Trenchant opposition

The national veto has enabled the Irish government to maintain the corporate tax regime, despite trenchant opposition from other member states over the past few decades.

The Franco-German paper acknowledges that these proposals are moot unless the national veto is removed.

To circumvent this impasse, it proposes a multi-layered EU. The inner circle would be a coalition of willing member states, who would opt for much closer political and economic integration, including the removal of national vetos; the second tier would be based on how the EU operates at present; the third tier would be for associate members; and the fourth tier would be a political community. The last tier could solve the Brexit dilemma as it would bring the UK back into the EU’s orbit, but without any formal re-entry process.

It is important to note, this is just a paper that hasn’t yet been put to member states at any official level. But if it points to the direction of travel, then Ireland’s future membership could become freighted with risks.

There has always been a deep tension at the heart of Irish economic policy: on the one hand, it relies on being a core EU member state, but its corporate tax policy is depicted as inimical to EU values by many other core member states.

If this multi-speed EU were to proceed, Ireland could not become a member of the inner circle and maintain its tax competitiveness. Without fiscal levers, such as the corporate tax rate, the hit to the economy would be very destabilising, but the costs of not being part of an EU core could also be potentially significant.

Last week, it emerged that Ireland was fending off attempts by Brussels to seize a greater slice of corporate tax profits to replenish the EU budgets. These pressures will intensify in the years to come.

The time-frame for the accession of new Baltic member states is 2030 and the Franco-German paper wants the reforms introduced before the end of the decade.

If Sinn Fein led by Mary Lou McDonald forms the next government, then potentially it faces years of high-stakes negotiations with the EU. This will be quite a dilemma for a party that has traditionally been Eurosceptic, although its position is evolving. However, its most cherished goal of a united Ireland cannot happen without EU support, which makes its position even more complicated.

Overall though, if the Franco-German proposals come to pass, then pre-budget horse-trading will have a much different tone in the future and it certainly won’t be about what to do with corporate tax surpluses.