Plan for next year lacking a sense of urgency

ANALYSIS:By putting the emphasis on tax rather than spending, Government risks dissipating its gains, writes JIM O'LEARY.

IT WAS always unrealistic to think that yesterday’s supplementary Budget would make huge inroads into the emerging budget deficit for 2009. Given that more than three months of the year had already elapsed, that the package of measures had to be put together in a handful of weeks, and that it represented the fourth attempt to get this year’s budgetary arithmetic right, it was always going to be something of a stop-gap.

In the event, the size of the additional fiscal adjustment announced, which amounting to 2 per cent of GDP, seems reasonable. It should be seen in the context of the cumulative adjustment to the 2009 deficit that has been effected to date, which is not far short of 5 per cent of GDP. Hopefully, the Minister’s statement that it marks the end of the process for 2009 will prove correct: neither good policy design nor the Government’s credibility, not to mention the sanity of the public, will be well served if another frenetic burst of emergency action is required in the months ahead.

Given that yesterday’s exercise was in the nature of a stop-gap at least as far as the 2009 deficit was concerned, it’s real significance lay in the opportunity it afforded the Government to lay out a credible and coherent strategy for restoring order to the public finances over the medium term. There are several dimensions to this. Amongst the most important are: the overall pace and phasing of adjustment; and how it is envisaged that the adjustment will be distributed between and within the revenue and expenditure aggregates.

As far as pace and phasing are concerned, the documentation published yesterday includes projections of the main budgetary aggregates out to 2013 together with the economic forecasts on which they are based. The economic forecasts are credible, although it would be hard to argue that they err on the pessimistic side, which I think would be a useful feature of such forecasts.

After a near-8 per cent fall in GDP this year (a sharp downward revision from the official forecast of a 4 per cent decline, published in January), the economy is seen contracting by a further 3 per cent in 2010 before embarking on a very respectable recovery and growing at an annual average rate of 3.6 per cent in the 2011-2013 period. The unemployment forecasts make for depressing reading: the rate peaks at 15.5 per cent in 2010 and declines to just under 12 per cent by 2013.

The budgetary projections evince a surprising lack of urgency in the matter of reducing the deficit. While borrowing is projected to fall to the magic threshold of 3 per cent of GDP by 2013, it is projected to remain stuck at its forecast 2009 level of 10.75 per cent of GDP in 2010. As a consequence, the debt-GDP ratio is projected to increase from 59 per cent at the end of this year to 73 per cent at the end of next, and interest payments on the debt, which will amount to the equivalent of 2.2 per cent of GDP this year, are expected to rise to 3.1 per cent of GDP in 2010. Even the structural balance, which was to have become the focus of the consolidation effort (has it?), is projected to decline by a remarkably small amount next year: to 7.5 per cent, from this year’s 8.2 per cent. The arguments for front-loading the reduction of the large structural deficit that will remain after this year’s effort have, it seems, been set aside. This is one of the most remarkable aspects of the budgetary arithmetic published yesterday. It suggests that much of the considerable energy and momentum behind this year’s consolidation efforts is about to be dissipated.

The measures announced yesterday will generate additional revenue of €1.8 billion in 2009 and result in a further reduction of €1.5 billion in public spending, suggesting a 55:45 bias towards tax increases. Actually, the true bias towards tax increases is much more pronounced than this, at about 2:1, since the revenue-raising measures will generate a full-year yield of just under €3.6 billion while the full-year effect of the spending cuts is estimated at €1.8 billion. This is disappointing, even if not entirely unexpected. Moreover, more than three-quarters of the extra revenues being raised will come from earned income: the changes to the income levy, the health levy and PRSI will generate €2.8 billion in a full year. The consequence will be very considerable increases in marginal tax rates: for some categories of taxpayer marginal rates are set to rise by as much as 7 percentage points, and will have risen by more than that when account is taken of the measures introduced last October. In the short run, this might not have a deleterious effect on competitiveness, but longer term one would worry on this account.

Looking ahead to 2010 and beyond, the Government has supplied somewhat more information than previously about its plans for further consolidation: it has provided a breakdown of the adjustment packages scheduled for 2010 and 2011 between taxation, current spending and capital spending. On a full-year basis, tax increases are projected to comprise more than half the adjustment in 2010 and a little less than half the following year. Reductions in current expenditure are projected to comprise less than one third of the total adjustment effort in both years; cuts in capital spending make up the balance. It should be pointed out that the reductions here are reductions relative to a “no policy change” scenario. There are no absolute reductions in current spending envisaged: in gross terms current spending increases each year out to 2013.

Again, in looking at the profile of spending adjustments, one is inclined to the conclusion that some of this year’s momentum will be lost. €1.5 billion (a little over 2 per cent) adjustment in current spending in 2010, while by no means trivial, seems like a modest return on the efforts of Colm McCarthy’s expenditure review, and would be significantly less than the adjustment that has been made this year.