Spending growth and weak receipts erode surpluses

Have no doubt about it, the end- September Exchequer returns make very unpleasant reading. The once-substantial budget surplus is being eroded rapidly as a result of burgeoning growth in spending and, in particular, a marked weakening in the growth rate of tax revenue.

Net voted current spending rose by 19 per cent to end September, broadly in line with the 21 per cent increase provided in the Revised Book of Estimates. Net voted capital spending is also projected to rise by 21 per cent this year. On the other side of the balance sheet, tax receipts were forecast to rise by 12.5 per cent this year. However, growth in tax revenue has decelerated sharply since the start of 2001 with receipts up by just 2.2 per cent year on year at end September.

Of greatest concern is the rate at which tax receipts are losing momentum. At mid-year tax receipts were up by 5.3 per cent year on year. In the third quarter tax receipts were actually 4.5 per cent lower than the corresponding period of 2000. These are very worrying trends. The downswing in the global economy seems to be hitting both employment and earnings hard depressing income tax receipts. Meanwhile, the sharp drop in new car sales this year, as well as the lingering effects of foot-and-mouth on tourism earnings and the global downturn is dampening consumer spending and thus indirect tax receipts.

The Department of Finance expects tax receipts to undershoot the target by £1.5 billion (€1.9 billion). However, the Department seems to be continuing to err on the side of optimism. If its revised forecast for a £1.5 billion undershoot is to be realised, it requires tax receipts to grow by 15 per cent over the final three months of the year. This seems unrealistic given the sharp slowdown in the economy.

Even if tax receipts pick up some momentum and grow by 5 per cent between now and December, they will still only rise by 3 per cent for the year resulting in an undershoot of £2 billion. It is clear from these projections that there is going to be a very large undershoot of the Budget surplus target. The target of £2.54 billion for this year is slightly higher than the £2.4 billion surplus recorded last year. At end September 2001, the surplus stood at £2.3 billion, significantly below the £2.9 billion surplus at the same stage last year.

Furthermore, if one excludes some £300 million of extra capital receipts that have accrued to the Exchequer year to date, but which were not included in the original Budget arithmetic, then the underlying surplus at end September is £2 billion, some £0.9 billion below the 2000 level.

Overall, assuming that tax revenues grow at 5 per cent over the balance of the year, the Budget surplus would undershoot target by £1.7 billion, allowing for the extra £300 million in capital receipts. This would result in a Budget surplus of £800 million for the year.

Furthermore, the Department of Finance has already forecast that the Budget surplus will decline by £800 million next year, partly because of the high carry-over costs in 2002 of the tax cuts and spending increases implemented this year. The Department forecasts are based on a relatively strong rise of 6.3 per cent in GDP in 2002, which now looks overly optimistic.

Hence, having fallen sharply in 2001, it looks like the once-enormous Budget surplus will vanish completely in 2002, with the Budget probably moving back into deficit.

Oliver Mangan is chief bond economist at AIB Group Treasury