Full consolidation of €3.1bn in budget will risk prolonging domestic recession
Delivering massive shock to economy already on the floor is risky
A combination of slowing growth or recession in many of our European trading partners together with the overhang of private household debt and continuing fiscal austerity measures means that the domestic economy has little or no space to recover.
Consumer expenditure, investment and public consumption are stagnating or declining, as indicated by trends since mid-2012. Measures to increase personal income tax (through withdrawal of the PRSI tax credit earlier this year) as well as increased local property taxes and other charges may be partly linked to the fall in personal consumption in the first quarter of this year.
Paradoxically, more austerity risks prolonging recession with an adverse impact on the Government deficit as spending related to unemployment and associated income support measures and health spending exceed planned levels.
Over the coming two months, the Government will need to carefully assess the balance of risk in relation to the size, composition and timing of fiscal consolidation over the coming two budgets. A prudent course of action would be to cut some slack in the scale of consolidation to allow more breathing space.
The very risk of lower growth cited by those arguing for maximum consolidation “just in case” may very well be fulfilled if a €3 billion shock is administered to an economy on the floor. However, fiscal easing is not sufficient, of itself, to generate sufficient recovery. It needs to be complemented by an accelerated programme of investment, building on those decisions already taken or signalled in relation to the National Pension Reserve Fund.
If an accelerated programme of European, private and public investment were brought forward over the coming two years, together with a smaller consolidation effort in the region of €2 billion in 2014 and €1 billion in 2015 (instead of €3.1 billion and €2 billion respectively), there is a good prospect that Government could attain its deficit target of 3 per cent in 2015 (as projected recently by the Nevin Economic Research Institute in its Quarterly Economic Observer).
Pressing on the brakes as the car is skidding off forecast growth may worsen the skid. Each €1 billion of tax increases or spending cuts lowers growth in GDP by up to 0.5 per cent per annum based on Department of Finance estimates.
Much of the progress towards lower deficits has been slow, painful and economically disruptive. A quicker way towards deficit reduction is through investment and fiscal correction that causes the least damage to domestic consumption.
However, such a course of action would require difficult and possibly unpalatable political choices to raise the low average levels of effective corporate, employer and high-income taxation.
The Government has more than one way of reaching its stated fiscal targets. Risking prolonged recession through an adjustment of €3 billion this autumn is not the most prudent or economically sound way to proceed at this time of heightened uncertainty.
Dr Tom Healy is director of the Nevin Economic Research Institute.