Budget decisions framed by strong economic recovery and looming election
Opinion: ‘For the second time in less than three decades, Ireland has successfully implemented a programme of fiscal corrections that has restored order to the public finances’
‘It’s clear from recent election results and other signals of public dissatisfaction that the political cost of continuing to hike taxes and cut spending would have been enormous.’ Above, Minister for Finance, Michael Noonan, arriving at the Department of Finance, ahead of the announcement of Budget 2015. Photograph: Dara Mac Dónaill / The Irish Times
The measures announced in Budget 2015 were shaped in large part by two considerations. First, the strong recovery in the Irish economy has given the Government room to loosen the purse strings, while still bringing the budget deficit to below 3 per cent of GDP as required under EU rules.
By aiming for a deficit of 2.7 per cent of GDP next year, the Government, on the face of it, has not allowed itself much margin for error.
Had the Government introduced a neutral budget, with none of yesterday’s tax cuts or spending increases, the projected deficit would have been 2.4 per cent.
By relaxing fiscal policy, the Government has decided not to buy insurance against potential adverse economic shocks next year that could knock the budgetary arithmetic off track.
This decision is not without risks, especially given the precarious state of the euro area economy.
On the other hand, the Government can reasonably argue that the baseline growth forecasts underpinning Budget 2015 are relatively conservative. The Department of Finance’s forecast for GDP growth next year of 3.9 per cent, for example, is well below the 5.3 per cent figure pencilled in by the ESRI.
Moreover, the Government has consistently underestimated the amount of tax receipts generated by a given increase in GDP. If that trend continues, the Government may hit its target for tax revenues in 2015, even if the economy were to underperform.
The Government can also legitimately point to the anticipated moderate decline in the public debt next year to 109 per cent of GDP from 111 per cent this year.
On the basis of the department’s projections for growth, the budget deficit and interest rates in the years ahead, Ireland’s debt ratio is now firmly on a downward path.
That said, the Government might have aimed for a budget deficit below 2 per cent of GDP had it not been for a second consideration: a general election is looming within the next 18 months.
It is worth noting that all of the political Opposition parties favoured relaxing budgetary policy. Politicians don’t have the luxury of being able to ignore political realities.
An economist, being in a position to downplay political considerations, might point to the undesirable narrowing of the tax base resulting from both the increase in the entry point to the universal social charge and the introduction of the income tax relief relating to water charges.
One of the biggest achievements of budgetary policy over the past six years has been the reversal of the disastrous hollowing out of the tax base that happened during the bubble years.
It is worth recalling that by 2008, more than one-third of workers paid no income tax at all and the tax code was riddled with tax credits and allowances that distorted economic behaviour and rendered the tax system unfit for purpose.
High quality water
Similarly, the claim that the cut of 1 per cent in the top rate of income tax to 40 per cent and the widening of the standard rate tax band are the most effective ways to make work pay and create more jobs is not particularly convincing.
With the unemployment rate still above 11 per cent, there are hardly many vacancies for jobs paying more than €32,800 that will only be filled if people are incentivised to take them up through tax cuts.
For sure, the extra money in workers’ pockets as a result of the tax changes announced yesterday will give some boost to consumer spending next year. But to the extent that heavily indebted households use the extra money to pay down personal debt or save for a rainy day, the effect of such tax changes on spending will be muted.
Moreover, the propensity of Irish households to use additional disposable income to buy foreign-made consumer goods will dilute the benefits to the domestic economy.
As former US treasury secretary Larry Summers remarked last week, a greater emphasis on public investment spending would recognise “that in a time of economic shortfall and inadequate public investment, there is for once a free lunch – a way for governments to strengthen both the economy and their own financial positions”.
None of this is to deny the achievements of the past six years of budgetary policy, which have allowed this Government to bring an end to a very difficult period of fiscal consolidation.
For the second time in less than three decades, Ireland has successfully implemented a programme of fiscal corrections that has restored order to the public finances. Claims from some quarters along the lines that “You can’t tax or cut your way out of a deficit” have been proven to be bogus.
A longer-term perspective on budgetary policy is now needed to ensure that at some time in the future a third such programme will not be required.
Prof Alan Ahearne is head of economics at National University of Ireland, Galway