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Money’s too tight to mention
25 October 2009 By Cliff Taylor
Let battle commence. With Lisbon passed and the Greens on board, the government is now facing into its toughest challenge: agreeing a budget for 2010. Ministers have six weeks to agree away to cut €4 billion from borrowing through increasing taxes or cutting spending.
They are talking tough, but opposition is building, with trade unions planning a day of protest and myriad interest groups trying to make sufficient noise to persuade the government that cutting their particular budget is just too much trouble.
The scary thing is this: the government is currently borrowing about 13 per cent of gross domestic product (GDP). In other words, for every €100 million produced across the economy, the government is borrowing €13 million to bridge the gap between spending and borrowing.
Even if it meets its €4 billion target, this will probably just hold borrowing at around its current level next year, or at best reduce it slightly. Until economic recovery takes some of the pressure off, we are having to run very fast to stand still.
There are two problems with this. The first is that, when you borrow a lot, you quickly build up the level of your debt. In turn, this debt takes more and more of our tax revenues to service. On ESRI estimates, our gross debt as a percentage of GDP will rise from 43 per cent in 2008 to about 75 per cent by the end of next year, with the cost of servicing it doubling from €2 billion last year to €4 billion in 2010.
The second problem is that, because we borrow so much, we are already paying more than pretty much any other EU country to raise borrowings.
Not addressing this may push this cost up further and, if international markets are hit by another bout of nerves, could even make it difficult for us to raise cash.
Unlike our last bout of borrowing in the 1980s, this time other countries are borrowing a lot too (though generally not as much as us), and investors have no shortage of countries to lend to. If they reckon that Ireland is getting into an unsustainable borrowing cycle, they have plenty of other countries looking for their money.
The key things investors will look for are signs of commitment from the government that it is getting to grips with the problem and not heading for a repeat of the 1980s debt spiral. This is according to Ciaran O’Hagan, bond strategist with Société Générale in Paris, who closely monitors the sovereign debt markets.
Any further delay in tackling borrowing will be looked on sceptically, he says, particularly as ‘‘the needed adjustments are far, far larger than anything on the table so far’’, with the government likely to seek to borrow some €25 billion next year to fund the deficit.
The government has committed to the EU that it will reduce borrowing to 3 per cent of GDP in 2013.This involves €4 billion in spending cuts or tax increases this year and the same again in 2011 and 2012. If the economy recovers, boosted by stronger growth internationally, this will do some of the work in subsequent years by boosting tax revenues and taking pressure off the welfare bill. For this year, however, the government has to do all the work itself.
As the debate on this grows, we will be hit by a blizzard of figures. Last week it started, with the government ‘‘letting it be known’’ that it wanted savings of €1.3 billion in the public sector pay bill, a goal it put forward in talks with the trade unions. This is, of course, a negotiating position.
Cuts of €1 billion in public pay may well be the target. However, even getting close to this would be difficult without cutting pay rates, which means Taoiseach Brian Cowen’s intervention this weekend is surprising.
Cowen said he wanted to see whether savings could be achieved by reforms, rather than pay cuts, but it is not clear how this could yield quick savings.
Further tough choices await in other areas. If the €4 billion target is to be achieved, then as well as cutting €1 billion from public pay, a similar amount would have to be cut from three other areas - welfare, capital spending and other government programmes.
The Minister for Finance, Brian Lenihan, has repeatedly opined that taxes have already increased significantly, and that the bulk of the adjustment in Budget 2010 must come through spending cuts - hence the strategy outlined above.
The first question is whether the government sticks with the €4 billion figure. The second is whether Lenihan’s strategy of concentrating most of the fire on cutbacks and relatively little on tax will endure until Budget Day. A tough six weeks lie ahead, and the plan will change - the only question is how significantly.
There will be some tax rises and these will lessen the pressure for cuts a little. A few hundred million will come from carbon taxes. The government has an option, without breaking its commitment to no further ‘new’ taxes, to get a few hundred million more from income taxes, through measures such as increasing the employee PRSI ceiling and reforming pension tax relief, both of which are flagged in the new Programme for Government.
But even if there are concessions to union demands to hit the better-off, the reality is that there is no way of finding €4 billion without cutting spending significantly. This is why the trade unions are calling on the government to delay the adjustment over a longer period - and thus aim to find less than €4 billion this year.
The one tax measure flagged in the Programme for Government, and in the Commission on Taxation report, which could raise €1 billion-plus is a new residential property tax. However this is not seen as a runner this year, given the need to value properties before imposing the tax.
So what measures could we consider as bankers on our way to €4 billion - measures which we can pencil in as sure to happen? The first is a big cut in capital investment spending, the money the government spends on things like roads, railways, environmental projects, school buildings and so on.
Some €1 billion will be saved here, up from the €750 million targeted for savings in this area in the plan submitted to Brussels as part of last April’s budget.
There may be long-term economic costs here, if good projects are shelved. The late-1980s cutbacks were characterised by massive cuts in the capital budget, which left our national infrastructure well behind international standards. Will the latest round of cuts do like wise? Either way, money is needed, and this is the politically easy area to achieve it. So the cuts here will happen.
There seems no doubt, too, that child benefit will be targeted. This will be hugely politically sensitive, but the sums dictate that money must be saved from the welfare budget, and cutting a universal benefit such as child benefit will be less contentious than slashing general welfare benefits, such as the pension or unemployment benefit. The only question is whether it will be taxed, means-tested or cut.
Taxing or means-testing would be more equitable, but also more administratively complex. Either way, the government is likely to aim to save €400 million-plus in this area.
Add in a few hundred million from carbon tax, and the same again from other taxes and charges, and you get to €2 billion - about half of the total required. That will be difficult enough, but it is the second €2 billion which will be the really tricky bit.
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