John FitzGerald: ‘neutral’ budget seems right for 2016

Between the mid-1970s and 2007 the budget for the coming year was presented to the Dáil in December, immediately before the new financial year started.

In 2008 a decision was taken to move it forward to October to fit in with the EU budgetary calendar. However, it proved a very bad year to make this move – September 2008 saw the closure of Lehman’s, the eruption of our own banking crisis, and the bank guarantee. Unemployment rocketed, tax revenue fell, and a huge hole opened up in the public finances.

The budget introduced in October 2008 didn’t tackle the scale of the problems, and two further budgets had to be introduced in early 2009.

Thankfully ,the pace of deterioration in 2008 was highly unusual. Under more normal circumstances, the economy evolves sufficiently slowly so that the information available at the end of September, on which the budget is based, is a good guide to the end-year outturn.

This year the available information suggests that the budgetary outturn will be well ahead of earlier government expectations, with a deficit of 2 per cent of GDP or less. Even with the uncertainty about China, the momentum in the Irish economy means that fairly rapid growth is likely to continue into 2016. This is the basis on which to assess what the budgetary strategy should be for 2016.

As has been the practice in recent years, the Department of Finance will probably err on the side of caution in choosing the economic forecast that will underpin the budget. However, whatever about caution in the economic forecasts, there are a lot of pressures on the Government to be generous in Budget 2016, with tax cuts and expenditure increases being widely canvassed. However, as the Fiscal Council has argued, given the continuing high level of debt, prudence is still appropriate.

With the economy growing, tax revenue is also rising rapidly and expenditure on welfare is falling as the numbers of unemployed decline. The accelerated growth in the economy, and the fact that the current account of the balance of payments is broadly in balance, suggests it would be inappropriate to provide a stimulus to the economy. With unemployment still high, and low inflation, a “neutral” budgetary stance seems the right choice for 2016. While it may be easy to recommend a neutral budget, it is a more complex task to translate this into actual budgetary measures.

Unchanged

A policy of economic neutrality means keeping the average rate of tax broadly unchanged. With some inflation, albeit very low, this would imply raising flat-rate excise taxes by the rate of inflation, and raising income tax credits and bands in line with rising wage rates. Although wage growth remains low, this inflation-proofing suggests spending a few hundred million on what are referred to in the budget as “reductions” in income tax or the universal social charge (USC).

Similarly on the expenditure side, neutrality would imply raising welfare rates in line with the rate of inflation and also raising public sector pay rates in line with private sector pay rates.

Once again this would translate into what the budget terms an increase in expenditure of a few hundred million.

When these tax and expenditure measures are taken together, a neutral budget in economic terms would actually translate into a budget that “gave away” around €1 billion.

As the Government appears to be currently planning measures costing between €1.2- €1.5 billion, this would not be very different from the neutral budget that I would consider appropriate.

On the assumption of continuing growth in the economy this would also imply that government borrowing would fall below 1 per cent of GDP next year.

The growth in the economy is producing other desirable changes in the economy which will further reduce the government debt this year and next.

As a consequence of the banking collapse, the taxpayer ended up spending around €65 billion on propping up the banks. However, as a result of the economic turnaround and the banks returning to financial health, the State is beginning to see some of this huge sum returning.

Already the government accounts show receipts this year of €2.1 billion from Bank of Ireland and PTSB. Between now and next summer, the public finances should see a repayment by AIB of between €2 billion and €4 billion. That is before factoring in any proceeds from selling any more of the State's ordinary shares in the banks. Because of accounting conventions, most, if not all, of these receipts will not be considered as reducing government borrowing. However, they will all serve to reduce the national debt.

Repayments

With the prospect of a low level of borrowing next year, combined with expected repayments from the banks and a run down in the continuing very high level of cash reserves, the gross debt to GDP ratio is likely to fall from around 100 per cent of GDP at the end of this year to below 90 per cent of GDP next year (see graph, left).

Looking beyond 2016, extreme caution is necessary. A benign scenario could see the State move into surplus in 2017, a gradual move to full employment, and a further large reduction in the debt arising from the sale of the State’s stake in the banks.

However, there are many dangers on the horizon which could puncture the recovery, leaving the economy still very exposed due to its indebtedness. In particular, an economic slowdown, especially if accompanied by a big rise in interest rates, would have a severe impact on the still indebted Irish economy.