Budget 2010: the pain and the gain

The ESRI's TIM CALLAN, CLAIRE KEANEand JOHN WALSHassess how Budget measures affect households

THE SITUATION with the public finances confronted Budget 2010 with the challenge of an adjustment package on an unprecedented scale.

How did the package chosen spread the burden of adjustment across income groups, family types and sectors of the economy?

The scale and complexity of the Budget 2010 package mean that it will take more time than usual to analyse.

Here we present early estimates of the impact of Budget 2010 based on Switch, the ESRI tax benefit model. They are subject to revision, but provide the best indicator at this early stage of overall distributional impact.

This goes beyond the usual “example families” to look at how tax, welfare and pay changes affect a large-scale, nationally representative sample of households – the CSO’s Survey on Income and Living Standards, uprated and adjusted to represent the 2010 situation.

We look first at the impact of the tax and social welfare package, which is the usual focus of attention at budget time. Then we consider the impact of the public sector pay cuts.

Finally, we turn to some broader concerns about how perceptions of which groups are at highest risk of poverty – on a variety of measures – tend to be slow to change. Better allocation of scarce resources can be achieved if the impact of recent trends is recognised.

As in past years, we assess the impact of policy against a “distributionally neutral” baseline – eg, one in which all incomes, whether of employees, those who are retired or are unemployed, rise or fall by the same percentage.

This is achieved by indexing or uprating existing policy for 2009 in line with an expected fall in average wages in 2010 of about 2½ per cent.

Average incomes for the poorest one-fifth of the population could fall by more than 2 per cent, as against a baseline where all incomes fall by 2½ per cent. It seems that much of this relates to cuts affecting two very specific groups.

The first is the young unemployed, for whom payment rates have been reduced. Here, the complication is that this is to affect new applicants, so the scale of the impact is difficult to gauge.

The second group is parents of young children affected by the ending of the early childcare supplement. In this case we have allowed, however, for a value to be placed on the pre-school places to be offered under the replacement scheme. Thus, the impact of the change involves a shift from lower levels of support to all under-fives, to a higher, in-kind level of support in respect of children who take up places under the new scheme.

Other income groups will see a fall in their incomes compared with last year, but not as much as would arise from the implementation of a “neutral” budget, where nominal welfare rates, tax bands and tax credits would all be reduced. Relative to this benchmark, they would see gains of about half of 1 per cent.

These results contrast with those for last year’s budget, which saw gains for those on the lowest incomes and losses which were greatest in proportionate terms for those on the highest incomes.

In future work, we will examine more closely the impact of the current Budget and the combined impact of budgets 2009 and 2010.

While cuts in public sector pay have been announced as part of the Budget, it would be misleading to treat them as on a par with tax and welfare changes. From the perspective of those affected, each involves a loss in take-home pay.

But the appropriate comparison for public sector pay and employment is private sector pay and employment.

Both public and private sector face challenges in maintaining jobs. Our expectation is that private sector wages will fall, but by much less than the cut in public sector pay. On the other hand, along with this, private sector workers have higher risks of unemployment, risks which have become a reality for many.

A cogent argument can be made that, with Ireland now in the euro zone and inflation low or negative in many countries, nominal reductions in labour costs are needed to sustain employment in both public and private sectors.

A flat percentage pay cut would have maximum impact on those with incomes so low that they do not pay tax, but the graduated structure of the pay cuts works against this tendency so that disposable income tends to fall by more for those who are in higher income groups.

For many years, pensioners have been thought of as a group especially vulnerable to poverty. Poverty, though, however measured, has fallen sharply among the elderly in recent years, a trend driven largely by increases in the State pension. While pensioners were at a higher-than-average risk of poverty at the turn of the century, recent figures from the CSO’s Survey of Income and Living Conditions show that they are now at lower risk of income poverty than the rest of the population.

They are also at lower risk of “consistent poverty”, the target of official policy, measured by income and indicators of deprivation. The rationale offered in the Budget for excluding pensioners from the general cut in welfare rates was that they obtained less benefit from falling prices than the rest of the population.

The reason for this is that most pensioners own their homes outright. This gives them an income advantage over those who pay rent and mortgages.

Taken together, these considerations suggest that policies which reduce, or do not increase, the gap between pension payment rates and those of other welfare recipients are more likely to be effective in reducing poverty.

A key element of the public service pension package has been that pensions are based on the salary of those currently serving in the relevant grade (“pay parity”). Over recent years, this has resulted in substantial growth in cost of public service pensions.

Now public service pay rates are being reduced. There is a strong case that public service pensioners who have benefited from the “up” side of pay parity should also share in the downturn.

The Government’s position on this is not clear from the Budget but perhaps the White Paper on pensions may soon clarify this.

A final thought on fairness – not in the sense of high versus low incomes, but in terms of “equal treatment of equals”.

In the last year, banking institutions have had to obtain emergency assistance from the State. Given the size of the State’s investment in the banks and the scale of Nama, it seems strange that there have been pay increases in the banks during the past year.

This contrasts with the cuts in public sector pay and the fact that private sector firms facing severe financial difficulties would plead “inability to pay”. It appears that the banks’ “ability to pay” is effectively underpinned by the State.