The right cuts in spending will not hit recovery

 

OPINION:Deflation should be reflected in reduced pay in the public sector but there are many other innovative ways for the Government to save money, writes RICHARD TOL.

BUDGET CUTS are an opportunity for government reform. The Government should withdraw from areas it has no business in. Deflation-indexed public pay would save money without inflicting too much pain.

It had been long known that, in theory, the Irish tax receipts were vulnerable to meltdown. Now we have clear proof. If public spending is not cut, public borrowing will rise – and taxes will have to go up in the future.

There are two parts to the plan for the recovery of the Irish economy.

First, the governments of China and United States nurse the world economy back to health.

Second, growing exports reinvigorate the Irish economy.

The first part is not in real doubt. The second part requires that Ireland maintain its low taxes. Therefore, spending has to be cut. I here work with a cut of €2 billion from a €64 billion budget.

Spending in 2009 has to be cut while keeping in mind that further cuts will be needed in 2010, and most likely in 2011 as well.

Public spending has to be cut in such a way that the eventual economic recovery is not endangered. Therefore, spending cuts are not a shaving exercise, taking 1/32 of everything. We need to use the cut in spending as an opportunity to reform government. Protecting the vulnerable would be nice, but protecting those that will get us out of this mess is paramount.

President John F Kennedy used to say that you need to repair the roof when the sun is shining. We did not, so we now have to fix the roof in the rain.

In past years incidental tax receipts (stamp duty, capital gains tax) have been used to expand government structurally, particularly in the form of more civil servants at higher pay. This was a mistake, and it has to be reversed.

Wages are typically indexed on consumer price level. As we expect that inflation will be a negative 3 per cent this year, the public pay bill can decrease by 3 per cent. As the 2009 Budget foresees a 3 per cent increase, this measure saves 6 per cent of the public pay bill. This amounts to €1.2 billion.

This pay cut should apply to every civil servant. Unexpected nominal wage cuts are hard on anyone, regardless of salary. The lower paid benefit disproportionally from deflation. Income differences provide an incentive to work and study hard for a promotion. Furthermore, the best civil servants have alternative options for employment. A brain drain from the Civil Service is the last thing we need.

The Government gives some €2.2 billion per year to quasi-government organisations (including the Economic and Social Research Institute), and €11.8 billion to the regional bodies of the Health Service Executive.

The same pay cut should be applied there. If we assume that wages are three-quarters of this budget (a half for the HSE), another €500 million is saved.

Some of these quasi-government bodies serve the public interest at arm’s length from the Government. Others serve a private interest. The Irish taxpayer, for instance, supports the marketing of food.

Indeed, farming, fishing, forestry and entertainment receive a whole range of government-financed services – at a cost of €700 million per year plus €400 million in capital spending – that companies in other industries pay for themselves.

Over a period of 10 years, such bodies need to be transformed to fee-based co-operatives. For 2009, they should get 10 per cent of their budget from the communities they serve. This would save the exchequer €100 million.

The Government does not only inappropriately support private companies, it also owns them. It is a bad investment strategy to have large holdings in a few companies. It also distorts competition.

Aer Lingus is seen as a national champion, but Ryanair is the more impressive company. Aer Lingus cannot survive as an independent company. It is unlikely that another airline will make an offer that beats Ryanair’s.

The threat of new entrants provides sufficient competitive pressure. The Government should, therefore, sell its stake in Aer Lingus, and it can probably get some €250 million for that.

The Government also holds significant stakes in other companies, such as the ESB, CIÉ, and An Post, each providing services that private companies can do just as well if not better. The Government regularly uses its powers as a shareholder to make up for its failures as a regulator.

The energy companies should be sold in 2010, perhaps bringing in as much as €4.4 billion. Transport and communication require new regulation before these companies can be sold for some €800 million in 2011. In 2012 the banks can, hopefully, be sold again.

In 2010 carbon emission permits should be auctioned, but the rules allow only 10 per cent. This would bring in €24 million. A tax of €12 per tonne of carbon-dioxide equivalent would yield some €500 million in 2010.

In 2009 the Government can auction its CDM (clean development mechanism) access rights (as allowed in the carbon trading system of Kyoto), and the unused ones from 2008. It can also abolish the various subsidies for clean energy (roughly €60 million) as sufficient incentives are provided by the proposed carbon tax.

Because the economy is down, emissions are also down. And because emissions are down all over Europe, the price of carbon permits has fallen considerably.

The Government had reserved €50 million to offset the difference between our Kyoto targets and the actual emissions. It now seems that €10 million is enough.

Unused CDM access rights are a nice example of Government waste. In this case the Government does not seem to realise that it owns a valuable asset.

Everyone has their favourite story about civil servants wasting money. Unfortunately, potential savings are hard to quantify and harder to realise without imposing a crippling system of checks and audits.

There are probably too many meetings, seminars, workshops, and conferences; and attendance at international meetings is often unnecessarily large.

Most departments can cut their 2009 travel and “incidentals” budget by 10 to 20 per cent – but not all. Cutting these budgets by 20 per cent would bring about €20 million. This illustrates that reducing Government waste, however necessary, cannot be the solution.

Decentralisation is one reason why civil servants travel so much. Decentralisation is a daft idea in a small country with a predominant city. There is €72 million reserved for decentralisation. All should be cut.

The Government plans to invest some €8.2 billion in 2009. This is needed to prepare for the recovery and for an orderly winding down of the building sector.

However, these investment plans were developed in a time in which the Government was competing in a tight market. Now the Government is the only significant buyer. Renegotiation should easily save €200 million of the capital budget.

If deflation allows for a reduction of nominal wages of civil servants, then benefits can go down too. However, the 2009 budget underestimated the number of people claiming unemployment benefits so it would be wrong to count a benefit cut as a saving.

Other benefits can be cut, too. Between 30 and 40 per cent of people who receive a fuel allowance do not need it. This allowance is not means-tested. Even those who had their home insulated at the expense of the taxpayer continue to receive a fuel allowance. Taking the benefit from those who do not need it would save €100 million.

The table accompanying this article summarises the proposed budget measures. For 2009, extra revenue is limited to €250 million, but €2,300 million can be cut from spending (with a rebound effect on income taxes). For 2010 and 2011, more revenue can be raised from privatisation and a carbon tax. The table has a total of €12 billion; perhaps a property tax can close the gap to €15 billion. The 2009 spending cuts should be maintained, so that, hopefully, the income levy can be abolished and the VAT increase reversed by 2012.

The proposed measures are painful and unpopular. With the right measures, the pain will be short-lived. Without measures, or with the wrong ones, the pain will only grow.

  • Dr Richard Tol is research professor at the Economic and Social Research Institute. He is also professor of the economics of climate change at the Institute for Environmental Studies, Vrije Universiteit in Amsterdam, and adjunct professor at the department of engineering and public policy, Carnegie Mellon University in Pittsburgh. Further contributions in this series will come from Rossa White, chief economist with Davy Research; Paul Sweeney, economic adviser to the Irish Congress of Trade Unions; and Danny McCoy, director of policy at Ibec, the employers’ body