Targeting of waste could have averted tax hikes


ECONOMICS:After raising taxes, addressing inefficient spending must be the Government's next step, writes Jim O'Leary

LET'S START with 8 per cent. This is Brian Lenihan's estimate of the percentage of gross domestic product (GDP) that the Budget deficit would have spiralled to next year if the Government had sat on its hands and done nothing. His Budget speech of yesterday marked the culmination of a process that managed to reduce that figure to 6.5 per cent.

The first question is: was this reduction enough? Where does a 6.5 per cent of GDP deficit sit between the risk of appearing too relaxed about the deterioration in the public finances and the risk of adding to the already strong recessionary influences that are at work in the economy?

My judgment is that it sits closer to the first than the second. This is all the more so since the economic forecasts and tax revenue projections on which the Budget is based indicate a relatively optimistic view of the world. It is much easier to envisage receipts falling several billion euro short of forecast again next year than to see them outstrip the target. It is eminently possible therefore that, in the absence of some kind of mini-budget during the course of 2009, the deficit will reach the 8 per cent value that so much energy has been expended on averting.

The reduction in the deficit from 8 per cent to 6.5 per cent occurred in two stages, the first of which was marked by the publication of the White Paper on Receipts and Expenditure last Saturday, and the second of which was the Budget proper.

In money terms, the adjustment amounted to roughly €3 billion net. How was this adjustment accomplished as between cuts in spending and increases in taxation? Well, the contribution of tax increases is clear enough: in net terms the measures announced yesterday had the effect of raising tax receipts by about €1.6 billion, that is €2 billion of increases in gross terms, less about €400 million of "negative buoyancy".

Net reductions in aggregate spending account for roughly another €1.5 billion. How to apportion this between current and capital is not straightforward. What is clear though is that far and away the greater part is accounted for by capital spending. This repeats a familiar pattern and confirms what has long been known, namely that reducing capital budgets is much easier than cutting day-to-day spending.

After yesterday's Budget, current spending is set to increase again in 2009 by all available measures. Of course, part of the reason for the especially chunky increase in the most inclusive measures (6.5-7 per cent) is the sharp projected rise in interest payments on a rapidly growing Government debt. This phenomenon underlines the importance of bringing the deficit back down again as quickly as possible.

Another important contributory factor to the rise in current spending is the growth in the live register, a feature that underlines the need to avoid an unduly restrictive fiscal stance.

The aspect of the Budget that is likely to draw the most hostile reaction will be its heavy reliance on tax increases. One criticism will be that tax hikes are deflationary. Well, as far as their deflationary effect is concerned, I'm not convinced that there is much to choose between tax increases per se and reductions in Government spending. After all, public sector pay and social welfare payments enter into the calculation of household disposable income just as taxes do. A more valid basis for concern about the scale of the tax increases announced has to do with the economy's long-term competitiveness. Here the argument turns on the efficiency of the public sector. There is no doubt that spending cuts that preserve the volume and quality of public services are infinitely preferable to tax hikes. That said, in the short-term it is difficult to effect spending cuts with such surgical precision. The key question then is whether there was enough effort made on this front in the context of yesterday's Budget. One suspects that the answer is no. That being the case, the conclusion must be that at least some (though probably not all) of the tax increases announced could have been averted by a more determined pursuit of waste and inefficiency.

At the end of the day, tax hikes, though unpopular, represent an easy option. Herein lies another danger with the balance struck in yesterday's Budget: the risk that it transmits to the public the signal that, faced with the myriad difficult choices that will be a feature of the next few years, the Government will too readily default to the tax-raising option. If that's the message that's picked up, confidence across the household and business sectors of the economy will be damaged. In this respect, it is important that the Government brings forward credible and comprehensive plans for serious efficiency reforms of the public service as soon as possible.

The Government envisages the problem with the public finances getting worse before it gets better. Hence next year's projected deficit is significantly higher than this year's forecast. But how does the Government see the deficit being eliminated thereafter? This is as important an issue as the shape of the 2009 Budget itself, and addressing it requires the adoption of a credible medium-term fiscal framework that would articulate a realistic set of macroeconomic forecasts and specify a trajectory for the deficit and the main spending and revenue aggregates for the period 2010-2013.

Yesterday's Budget documentation incorporates an exercise that could be represented as such a framework, but it falls somewhat short of what is required. In the first instance, the economic forecasts on which it is based seem rather hopeful: the current recession is seen ending in 2009 (with GDP growth averaging over 3.2 per cent in 2010 and 2011) and unemployment is seen peaking next year at 7.3 per cent. Secondly, the forecast horizon extends only as far as 2011, when the budget deficit (by sheer coincidence!) dips just below the Growth and Stability Pact ceiling.

But, most importantly, a large chunk of the adjustment required to get to that point (amounting to €3.3 billion, or 1.6 per cent of 2011 GDP) is completely unspecified in the sense that it is identified as neither a spending cut nor a tax increase. Instead, in a path-breaking piece of fiscal bureaucratese it is described as a "Cumulative Fiscal Consolidation Objective"! Who said this Budget was bereft of innovation?