Wanted: €4bn from cuts in expenditure and higher taxes

 

ANALYSIS:The emergency budget will raise taxes for sure. But it will also cut spending. In the first of three articles, we examine the options, writes COLM KEENA

IN JANUARY the Government’s estimate for public expenditure in 2009 was €73.71 billion. This was made up of €62.99 billion in gross current or day-to-day expenditure, and €10.72 billion in capital expenditure, including contributions to the National Pensions Reserve Fund (€1.58 billion).

On the other side of the equation were receipts totalling €55.76 billion. Tax receipts were €36.99 billion, with the rest being PRSI payments and other revenues such as fees.

The difference between the two was €17.98 billion. Not counting the pension fund contribution, which can be seen as a simple shifting of money from A to B, the difference between income and expenditure in 2009 was envisaged in January as being 9.5 per cent of Gross Domestic Product (GDP).

These projections were contained in a plan called the Addendum to the Irish Stability Programme Update, submitted to the European Commission. It envisaged that the economy would contract by 4 per cent this year. What has happened since is that the tax receipts for the first two months of the year indicate they will be €2.5 billion to €3 billion less than expected for the year overall, while current expenditure may be €1 billion higher.

This is because the economy is performing even less well than anticipated in January. The Government now believes it may contract by 6 per cent this year. Others believe the contraction will be even greater.

This sort of thing has never happened here before. The contraction is a volume figure, ie, it measures the number of “things” we produce. Prices are expected to fall by 3 per cent or more this year, so the value of the “things” produced is also falling. If the number of “things” produced falls by 6 per cent, the fall in the value of the economy’s produce will be in the region of 9 per cent.

As our GDP contracts, the relative size of the national debt rises. This is the context for the emergency budget the Government is scheduled to introduce next month. The Government and the Department of Finance have indicated they wish to try maintain the deficit of 9.5 per cent indicated to the commission and the international financial markets in the January document. What the markets think of us is important as we need to borrow money to keep the State afloat.

If we try to fill the hole between the January plan and the end of February revision we need to get €4 billion plus from harsh tax increases and harsh expenditure cuts.

That sounds bad but in fact the situation is worse. When you suck €4 billion out of an economy it has a contracting effect. Because the economy shrinks you get less than you targeted. So to get €4 billion you aim for above €4 billion.

This is something the department seems to have overlooked in February when bringing in the public sector pension levy and other measures aimed at raising/saving €2 billion.

The idea is complicated by the fact that people may have already begun cutting back, in anticipation of what is to come, and so when the cuts come the contracting effect may not be as big as it would otherwise be.

Given the scale of the cuts required, the Government may decide not to stick rigidly to the 9.5 per cent deficit target for 2009. Its decision on this matter will affect the size of the budget measures, and the effect on GDP.

The Government’s medium-term plan is to eliminate the need to borrow abroad for day-to-day spending by 2013, a plan that it believed in January would require cumulative cuts of €16 billion, or 8 per cent of GDP, over the period. The situation has since deteriorated and so that figure needs to be revised upwards, probably substantially.

There is one other big picture point that needs to be made. As well as the overall income and expenditure figures that are known, there is a figure in taxes foregone which is less clear.

This arises from various tax relief measures or payments not subjected to tax – pension contributions and profits, mortgage interest relief for landlords, and tax-free child benefit payments are examples. Together they account for a number of billions of euro, depending on how you measure/estimate them.

The January plan envisaged what’s called voted or department-selected capital expenditure of €8.2 billion this year. About €7 billion of this expenditure on roads, etc, is understood to have been contracted for, and withdrawing from it bring costs.

There is no option but to service the national debt, which will cost €4.5 billion plus this year. Other non-optional current expenditure will cost another €2 billion.

What’s left is what the Government is spending on public sector pay, social welfare, and the delivery of services. The breakdown for these last three is about 20:20:15, giving a total of €56.5 billion per the January plan.

Some observers believe full-year cuts of €1.5 billion to €2 billion may be sought from this, while full-year tax-raising measures of €5 billion to €6 billion could be sought on the tax/tax reliefs side. It is the collapse in tax receipts since 2007 that has caused the crisis. The cuts in expenditure will involve capital projects, pay, and services. There is an argument for getting on with it, in preparation for a return to growth, from a much lower base, in three to four years’ time.

Likewise, there is an argument for proceeding with caution so as not to suck too much lifeblood too quickly out of the economy.

There is a new group or commission, “An Bord Snip Nua”, headed by economist Colm McCarthy. It is due to report later this year with suggestions for cuts in public expenditure for the period from 2010. It is likely to concentrate on savings from the non-pay, non-social welfare aspect of public expenditure.

The word nua is a reference to an earlier group set up by former minister for finance Ray MacSharry, who introduced harsh cuts in public expenditure in the late 1980s.

There is an interesting political difference between then and now. In the 1980s the State had a wider tax base and higher rates. The Ahern governments oversaw a reduction in tax that was driven by the political ideas of the Progressive Democrats and former Fianna Fáil minister for finance Charlie McCreevy. They favoured less taxation and fewer public services. Because the economic boom was boosting government revenues year-on-year, taxation could be run down without the consequences for the State’s ability to provide services becoming apparent. As a consequence the policy received little debate.

The next few years will be a grim period in the economic history of the State but could be a good time to at last debate what level of public services people want the State to provide, and how we should pay for them.

Colm Keena is Public Affairs Correspondent.