Today's budget needs to show that the Government is in control

OPINION:The scale of this year's cumulative fiscal correction is likely to be about 5 per cent of GDP, writes JIM O'LEARY

THE EMERGING budgetary position is probably worse than is commonly supposed. My calculations point to a budget deficit this year, before allowing for the effect of today’s measures, of about €24 billion. I’ve arrived at that figure by taking the Government’s €17 billion forecast of early January and adding to it a €5-6 billion tax shortfall and a spending overrun of €1-2 billion. I reckon the resultant deficit would be close to 15 per cent of GDP.

Remember, while most attention has been on the burgeoning numerator in this ratio, the denominator has been falling at the same time. My expectation now is that nominal GDP this year will be about €160 billion, comprising a 10 per cent volume fall and a 2 per cent fall in the price level.

The first question that arises is by how much should Brian Lenihan seek to reduce this year’s deficit today? In answering it he must have regard to the enormous size of the problem, but also to the fact that he has already taken two runs at it. The measures contained in his budget last October had the effect of reducing the 2009 deficit by some €3 billion and the February measures caused a further reduction of around €1.5 billion.

Without these earlier interventions the deficit would be heading for 18 per cent of GDP. So, an adjustment of almost 3 per cent of GDP has already been implemented. Today’s adjustment package, which looks like amounting to some 2 per cent of GDP, must be seen in this context.

In any event, today’s exercise is probably best regarded as a stop-gap. Granted, it is important to make an appreciable dent in this year’s deficit, but it is much more important to publish a credible and coherent plan to restore balance to the public finances over the medium-term. That means setting out in as much detail as possible a strategy for eliminating the structural component of the deficit by 2013.

That strategy should be based on a set of economic forecasts that err on the side of pessimism. It should also be front-loaded: the plan should be to eliminate the greater part of the outstanding structural deficit in 2010.

Today’s event cannot just be about the public finances though; it must be about the wider economy. It must be infused with a clear recognition of the kind of economy this is: a small, open economy in which long-term growth can only be sustained by trading successfully with the rest of the world.

The fiscal consolidation strategy, therefore, must be to the greatest degree possible consistent with protecting and enhancing international competitiveness. That principle has clear implications for the composition of the adjustment package announced today and the much bigger adjustment planned for next year and beyond.

In the first instance this means placing greater reliance on spending cuts than tax increases.

It will be very disappointing if half or more of today’s package comprises revenue-raising measures; it will be even more disappointing if this is the complexion of the adjustments planned for the 2010-2013 period.

Of course, an important aim of policy should be to ensure that expenditure cuts translate as little as possible into reductions in the quality of public services.

High-quality public services, after all, have an important contribution to make to the economy’s competitiveness by making Ireland an attractive place in which to live and work.

For that reason it is vital that a thorough-going programme of public sector reform, designed to greatly enhance efficiency and effectiveness, be pursed in tandem with the fiscal consolidation plan.

Competitiveness-proofing the corrective measures also has implications for the composition of spending cuts and tax increases. It argues for cuts in current rather than in productive capital spending, especially for reductions in rates of pay and in transfer payments. It argues for increases in property and expenditure taxes rather than income tax and, if increases in income tax are deemed necessary, it argues for base-widening measures such as the elimination of ineffective or redundant reliefs, rather than raising marginal tax rates.

One fears, however, that convenience will rule the roost this afternoon and that significant hikes in effective marginal rates of income tax will be announced. If so, one hopes that it might be signalled that they are temporary, pending a more considered restructuring of the tax system in the aftermath of the Commission on Taxation report.

More than anything else, today’s supplementary budget needs to demonstrate that the Government is in control, has a clear strategy and has the capacity to execute tough decisions. As far as communicating the latter point is concerned, it would be no harm if the Minister emphasised the scale of this year’s cumulative fiscal correction – likely to be about 5 per cent of GDP inclusive of today’s measures.

As for the politics of it all, the common view is that harsh fiscal medicine inevitably undermines support for government.

Interestingly, this does not square with the international evidence which suggests that governments are not systematically penalised by their electorates for correcting fiscal imbalances.

Nor does it square with the lessons of our own history.

The evidence from the 1980s is that it was those governments that failed to sort out the fiscal problems of that era that lost support.