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Backlash distracts from the scary reality
Sunday, October 26, 2008 By Cliff Taylor
The problem for the government in the budget aftermath is that there is a real risk that the public finances will start to get worse very quickly.

The government’s decision to back down on the over-70s medical cards and the 1 per cent income levy may have been politically essential, but the brouhaha has distracted from what should have been the key message from Budget 2009. Put simply, if economic conditions continue to deteriorate, we will be facing a full-scale public finances crisis.

Even if the relatively optimistic assumptions underlying the budget are broadly met, the government still faces a huge job in trying to keep borrowing from spiralling higher. Either way, many more groups will be following the over70s, the students and the farmers onto the streets over the months ahead. Taxpayers may be among them.

Next year, according to Brian Lenihan’s budget sums, we will have to borrow €4.7 billion to fund current spending - in other words the day-to-day costs of running the country.

When you add in further borrowing to fund state capital investment spending, total borrowing (using the EU general government measure) will be over €12 billion, or around 6.5 per cent of gross domestic product (GDP). Borrowing to fund investment projects is justifiable. Borrowing to pay for day-to-day costs is another matter.

The reason for the rapid turnaround is the extraordinary collapse in property-related tax revenues. Here the real problem for the exchequer is not so much the drop in prices as the lack of activity. Without second-hand houses being sold, stamp duty is not paid; without new homes being build and sold, Vat receipts are hit.

The problem for the government is that there is now a risk that things will start to get worse very quickly. Economic forecasting in the current environment is well nigh impossible.

About all that now seems certain is that we are heading into a period of rising liquidations and company closures and heavy job losses. This looks certain to mean that the final months of 2008 and the early months of 2009 will be pretty grim, with the recession continuing in the sense that the overall level of activity in the economy continues to decline.

Whether things will bottom out inmid-2009 is anyone’s guess at this stage. Lower interest rates will help, as would any kind of a recovery in the US. Yet clearly the potential risks are significant. At home, a continued squeeze on credit looks inevitable and the property sector will remain in the doldrums. Internationally, the environment generally will remain poor. It is difficult to see much that will stimulate growth.

In this environment the budget calculations could quickly come under threat. In terms of the overall economy, the budget figures are based on GDP falling by 1.6per cent this year and just 1 per cent next year, before bouncing back to 2.4 per cent growth in 2010.If you were offered this as an outcome at this stage, you would most assuredly take it.

Even with these assumptions, the budget sums still show the need to find €2.45 billion in higher taxes or lower spending next year and a further €850 million in 2010, or €3.3 billion in total.

When you consider that the 1 per cent levy - before the amendment to exclude low incomes -was designed to raise €815 million, or that the infamous medical card restrictions were intended to save €100 million, the scale of the challenge that lies ahead becomes clear.

There are also some questions about the detail of the tax forecasts. The assumption that an increase in Capital Gains Tax will raise €360 million implies that investors will have significant sums in capital gains to declare. This seems unlikely, given that property prices and equity values have collapsed.

Meanwhile, the assumption that the move in the corporation tax payment arrangements will raise €328 million as a once-off revenue also appears optimistic. This will mainly catch companies with a March year end. The only major corporation in this category is Bank of Ireland, which will hardly be heading for bumper profits in the current environment.

Even the first steps being taken by the government to control spending are proving controversial. It has attempted to control payroll costs by telling departmental managers and those in all state-funded bodies that no allowance has been made in their budget for the 3.1 per cent increase due to come into effect next September.

Seeing as these managers cannot fire permanent staff, they will be forced into recruitment embargoes and the lay-off of temporary positions.

This is one of the controversial issues in the education sector, for example, where there will not be money to take on temporary teaching cover or other temporary and part-time staff who have been filling many of the gaps.

Meanwhile - because public sector payroll costs will continue to rise - departments have had to institute major cuts in non-pay spending to try to make the books balance. And so we have had the controversy about the over-70s medical card, support for farmers, the proposed introduction of third-level fees and so on.

There is more, much more of this to come. The problem for the government is that there is no easy way out. It has done a deal with the trade unions on public sector pay and so is locked into costs in this area.

The signals now are that it may try to cut numbers, with a redundancy programme likely to be signal led next month, when the government responds to a task force report which is itself based on recommendations for reform from the Organisation for Economic Cooperation and Development (OECD).

The potential for controversy here is obvious and it would take time for savings to come through, but if we accept that tax revenues will never recover to where they were, then lower numbers will be needed.

The difficulty with this kind of reorganisation is that it takes time, planning and considerable expertise to achieve reductions in numbers without hitting service levels to the public. There are obvious ways to assist this process - for example by being able to move around civil and public servants more freely from areas of over-supply to where they are needed.

However, with the private sector jobs market looking bleak, public sector workers will not be jumping at redundancy offers. One way to progress might be a much accelerated early retirement scheme. Time will tell how the government addresses this one. Cutting non-pay elements of day-to-day spending is equally difficult, as it tends to hit services to the public directly. Yet there is surely room here for a cull of a whole range of programmes and initiatives. A gain, the key issue is how this will be achieved.

Given the difficulties in cutting current spending, it is a fair bet that there are further restrictions in store for state capital investment spending.

T he government has, bravely, tried to keep spending at a high level in this area, planning to spend over €9 billion of exchequer cash. It is a fair bet that this allocation could be pared substantially further. The key issue will be maintaining investment on the most economically productive programmes.

And then there are taxes. Further hikes are inevitable. Any hope that the carbon tax would be a revenue-neutral levy - with money raised through taxing polluting fuels redistributed through other tax or welfare measures - will be quietly forgotten. Next year’s carbon tax will have to raise a whack of money.

Other significant tax increases will also be necessary, unless the knife is really taken to spending. The risk is that higher taxes further depress growth and spending, prolonging the recession and hitting employment.

Somehow, amid all the post-budget noise, the gravity of the situation facing the public finances has got lost. Unless we get a grip we will be heading back to borrowing figures of 8 to 10 per cent of GDP and a rapidly rising debt burden. This would have a disastrous impact on confidence and business investment of all kids.

The difficulty for the government is that its authority in addressing this situation is now questionable. But if we have marches on the street every time there is a cutback - and row backs here, there and everywhere -we will never get to grips with it and we risk entering a very damaging downward spiral of higher taxes and slow growth.

There is no magic bullet. Opposition noise suggesting that somehow the money can be found by taxing the ‘‘rich’’ is nonsense. There is no easy way out. But the first job for the government is to communicate the gravity of what we are now facing into.

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