Budget 2006 – A Charter to Squander without Adequate Accounting Controls - CPA

Whilst welcoming the social provisions in the Budget in terms of childcare and the elderly the Institute of Certified Public Accountants in Ireland (CPA) expressed disappointment with the proposals to reduce the burdens on small business and to provide value for money for consumers and for taxpayers.

Michael F. Dolan, President of the CPA expressed disappointment that there were no specific measures to introduce controls on public spending. “The huge increase in capital spending equals a charter to squander without adequate accounting controls”, he said.

Budget 2006 will be presented to Dáil Éireann on Wednesday next December 7th, against a backdrop of continued impressive economic growth and positive forecasts until at least the expected consumer splurge on maturity of the Special Savings Accounts (SSIAs) fizzles out after 2007.

In its latest Quarterly Economic Commentary, the Economic and Social Research Institute (ESRI) says that since the publication of the last Commentary in June, the Central Statistics Office (CSO) has produced revised figures for the National Accounts for the years 2002 through 2004. In the case of both 2002 and 2003, the revisions suggest that economic growth was higher than had previously been thought. For 2004, the opposite is the case. The outturn for GDP growth in 2004 has now been put at 4.5 per cent by the CSO, lower than the 5.3 per cent rate reported in the Summer Commentary.

Given the slower pace of economic growth in 2004, the apparent continuation of this slower trend in the first quarter of 2005 and the increasing oil price, the ESRI says that it might have been expected that it would have revised downward its forecast for GDP volume growth in 2005. The actual downward revision is very modest and it is now forecasting a figure of 5.7 per cent (down from 6 per cent in the Summer Commentary).

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The main reason for staying with a largely optimistic view is the increase in employment recorded by the CSO in the Quarterly National Household Survey (Q2). The year-on-year employment increase of 93,000 (5.1 per cent) suggests that the economy is performing extremely well. For 2006, the ESRI's GDP volume forecast is 5 per cent, down from 2005 but still high.

For employment, the ESRI forecasts an average of 1.945 million in 2005, an increase of 80,000 over the 2004 average. It forecasts employment growth to be lower in 2006 (49,000), mainly as a result of a marginal decline in house construction. The unemployment rate is forecast to remain at 4.2 per cent in 2005 and 2006. As regards CPI inflation, its forecast for 2005 is an average rate of 2.3 per cent, rising to 2.5 per cent in 2006.

• The Debt to GDP ratio is expected to remain below 30 per cent

• The current account of the Balance of Payments is projected to record a deficit of 1 per cent of GNP.

• A General Government deficit of at most 1 per cent of GDP and an Exchequer Borrowing Requirement of not more than €2.7 billion are now in prospect

• Almost 13% of the workforce is in the construction sector (more than 17 per cent of the private non-farm workforce). The corresponding proportions for the UK and US are 7 per cent and 5.4 per cent respectively. Economist Jim O'Leary writing in the Irish Times said: Since 2000, total employment in the economy has risen by about 260,000 (16 per cent). Of this, almost 100,000 is due to the public sector. On the other hand, there are 17,000 fewer engaged in agriculture. Private sector non-agricultural employment, therefore, has risen by about 180,000. Of this, the construction sector has contributed 76,000. Thus, more than 42 per cent of the private non-farm employment increase of the past five years is accounted for directly by construction. This is before including rising employment in construction-related activities such as building suppliers, materials manufacturers, estate agents, mortgage brokers, etc. If we allowed for these, we would comfortably account for more than half of the private sector employment gains since 2000, and that's before speaking about multiplier effects.

• Last year 78,000 residential housing units were built in Ireland with 40 percent of demand categorised as second homes. A similar number of housing units will be completed this year but annual completions are expected to fall by at least 25 percent in coming years. By 2010, all major urban areas in the country, will be linked by motorways. 

• Over the last decade, permanent employment in foreign companies supported by the Industrial Development Authority (IDA) grew from 92,000 to 129,000 in 2004, representing an increase of 40%. The number of firms supported by the IDA has increased from 964 to over 1,022 firms in that period.

• Industrial employment has fallen by about 30,000 since 2000.

• 90% of industrial exports are made by foreign owned firms

• Most of the products we manufacture are designed elsewhere

• The bulk of our exports are marketed/sold by organisations based outside Ireland

• Ireland's industrial base relies on 149,654 jobs in 1,273 foreign-owned companies and on 147,895 jobs in 7,390 Irish firms. The service sector, with 240,000 businesses registered for VAT, employs about two-thirds of workers and accounts for 70% of GDP

• The Pharmaceutical Sector is responsible for 40% of Irish exports; Ireland has attracted thirteen of the top fifteen pharmaceutical companies in the world and twenty five of the top fifty.

• About two-thirds of Ireland's top 100 exporters are foreign affiliates, mostly American. 
• There are 165,000 companies operating in Ireland compared to 147,000 ten years ago. The major growth in our economy over recent years has been accompanied by a rise in corporate profits due to increasing export and import markets. This has resulted in a big increase in our corporation tax receipts despite the reduction in the standard rate of corporation tax from 36 per cent in 1997 to 12.5 per cent in 2003. The yield from corporation tax in 1997 was about €2,160 million and this has increased to about €5,330 million in 2004.
• Total payroll costs increased by over 5 per cent between 2003 and 2004 placing Ireland 4^th highest among the 14 countries benchmarked by the National Competitiveness Council in the Annual Competitiveness Report 2005; energy and waste costs which are growing substantially; and Irish private sector services productivity which ranks second last out of ten European countries according to European Competitiveness Index. This has been exacerbated by the appreciation of the euro exchange rate against the US dollar.

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Review of Tax Breaks

Last April, the Minister for Finance, Mr Brian Cowen, T.D., announced the award of two external consultancy contracts for the review of certain property tax incentives as part of the major detailed review of various tax incentives in the context of the 2006 Budget. 

Following a detailed examination of the qualifying tenders by a special Inter-Departmental Group, the successful candidates were Goodbody Economic Consultants in respect of the area-based Urban Renewal, Town Renewal, Rural Renewal and the Living-over-the-shop schemes and Indecon Economic Consultants for the sectoral property tax incentive schemes namely multi-story carparks, park and ride facilities, student accommodation, third-level buildings, hotels, holiday cottages, nursing homes, private hospitals, sports injuries clinics, childcare facilities and refurbishment of rented residential accommodation.

The findings and conclusions to be considered in detail in the context of the 2006 Budget in December.

Related:

2006 Estimates of Receipts and Expenditure White Paper  - pdf file - Published by the Department of Finance on Friday December 2nd.

 November 17, 2005 2006 Estimates

Irish Government spending to increase by 6.6% to €48.5 billion in 2006

Related: October 19, 2005

Limerick developer gets annual personal tax break of €2.8 million from secret National Aquatic Centre funding arrangement

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Update: Tues Oct 18: IMF says Irish economic growth less impressive than expected

IMF headquarters, Washington D.C.

In an assessment published on Monday, the IMF praised Ireland's flexible labour markets, but criticised Irish budgetary policy. It called on the Government to rein in public expenditure and broaden the tax base in the next budget.

This would have adverse consequences for both employment and wealth," the report warns.

However, the effects might not be as bad as in some other countries, because Irish people continue to save at a high level, despite spending so much on mortgage repayments.

This saving means a house-price fall would not necessarily weaken consumption directly," the Washington-based organisation says.

House prices have risen faster in Ireland than any other developed economy, doubling in the last six years, the report finds.

The IMF sees the major outside risks as high oil prices and a sudden correction of US financial deficits.

It expects the economy to perform well in the immediate future, with growth of 4.5 percent a year - although this is lower than the forecasts of some Irish economists.

The IMF issued the following statement on Monday:

On October 5, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Ireland.

Background

Macroeconomic performance in Ireland was extraordinary during the 1990s and has remained impressive in recent years, due in significant measure to good policies. Real GNP growth averaged 4½ percent in 2003-04, reflecting strong domestic demand and healthy net exports. Rapid employment growth was supported by sizable immigration. With the appreciation of the euro since 2002, HICP inflation has fallen to about 2¼ percent. House price appreciation has continued to slow gradually, but house prices remain high on various measures.

Ireland's public finances are strong, but fiscal policy has been procyclical in recent years. Gross public debt is about 30 percent of GDP, among the lowest in the EU; taxes on labor and business income are relatively low; and the general government fiscal position has been either close to balance or in surplus since 1996. However, fiscal policy was expansionary during 2001-02, when economic activity was somewhat higher than potential, and contractionary during 2003-04, when the output gap was negative. The 2005 budget implies considerable fiscal stimulus, at a time when the economy is widely regarded as being close to full employment.

Labor market flexibility is Ireland is good, as reflected in rapid employment growth and low unemployment. This is largely due to reforms of the tax and benefit systems, which has produced one of the lowest tax wedges among industrial countries. However, labor costs are high compared to euro area partners. National wage agreements and public sector benchmarking exercises play important roles in the wage setting process.

Banking system profitability and capitalization are strong, and nonperforming loans are low. However, vulnerabilities exist: credit growth—while slowing—remains high, property-related lending accounts for more than half of the stock of bank lending, and net interest margins have declined as reliance on more expensive wholesale funding has increased. Household debt has risen sharply and amounted to 120 percent of disposable income at end-2004.

The elderly dependency ratio in Ireland will rise considerably over the coming half century, though the increase is back-loaded compared to the rest of the euro area. Incentives to keep older people in the workforce are relatively strong, so that the effective retirement age is one of the highest among industrial countries. The state-funded old-age pension provides a flat share of average earnings, which helps the elderly avoid poverty but provides only a low replacement rate for the majority of workers.

Executive Board Assessment

The Executive Directors commended Ireland's continued impressive economic performance, the result of sound economic policies, including prudent fiscal policy, low taxes on labor and business income, and wage moderation. Directors welcomed the authorities' intention to keep these policies in place, allowing Ireland to maintain its competitiveness and sustain its remarkable performance going forward.

Directors expected economic growth to be strong in the short term, driven by an acceleration of consumption and continued robust business investment, though—with the gradual cooling of the housing market—residential investment will likely decline modestly starting next year. The main risks to the outlook are a further rise in oil prices, an abrupt slowdown in global growth, and a sharp decline in the housing market. While acknowledging uncertainties about supply potential, Directors viewed the economy as now being close to full employment. With inflation projected to rise next year, rapid growth of aggregate demand could give rise to wage pressures, which would undermine external competitiveness, especially as labor costs are already high.

Directors welcomed Ireland's low level of public debt and generally prudent fiscal policy. However, they noted that the 2005 budget is imparting considerable fiscal stimulus, adding to cyclical pressures. With euro area monetary policy very accommodative from Ireland's perspective, fiscal policy needs to help relieve potential overheating. Directors called for prudent budget execution and saving any revenue windfalls in the remainder of 2005, and for underlying fiscal tightening in 2006, in line with the authorities' medium-term fiscal objective of close to balance or surplus. In addition, Directors underscored the importance of building a fiscal cushion in good times, such as now, in the event that downside risks materialize. If aggregate demand were to weaken abruptly, Directors agreed that automatic stabilizers should be allowed to operate fully and that specific measures to prop up the housing market should be avoided.

Regarding the composition of fiscal adjustment, Directors recommended that the growth of current spending be restrained and that the tax base be broadened. Moderating the steep escalation in current spending would limit the risk of inefficiencies. The tax base could be broadened by limiting property-related capital allowances, preserving the nominal ceiling on mortgage interest tax relief, and introducing a property tax.

Directors supported the authorities' objective of improving value for money in the delivery of public services. They suggested that five-year envelopes could be introduced for current spending, that fiscal projections could be extended to five years, that government procurement practices could be strengthened further, and that a focus on quantified performance targets could help motivate efficiency gains. Separately, Directors noted that—to improve fiscal neutrality and reduce the risk of procyclical fiscal policy—it could be desirable to introduce automatic indexation of tax credits and bands, excise duties, and social welfare payments to developments in consumer prices.

While the conduct of fiscal policy in Ireland has been laudable over the years, Directors shared the authorities' view that it would be useful to deepen public understanding of fiscal issues. As pressures to raise spending are longstanding and could increase, an enhanced public debate could help clarify both short- and longer term constraints and requirements. However, many Directors did not see a case in Ireland's circumstances for the creation of a fiscal council to provide third-party assessments.

Directors commended the openness and flexibility of Ireland's labor market, and the low labor tax wedge, which have enabled Ireland to benefit from enhanced intra-EU labor mobility and contributed to faster growth and low unemployment. They underscored that keeping wages in line with productivity is essential to maintaining competitiveness, noting that wages are high relative to those in the euro area. With the slowdown in productivity growth and the entrenchment of low and stable inflation, Directors recommended that wage increases under the forthcoming national wage agreement and the next public sector benchmarking exercise be moderate. In addition, Directors noted that the wage agreement needs to preserve flexibility, given differential productivity developments across firms, and that the next benchmarking exercise should be as transparent as possible, continue to promote verifiable modernization in the public sector, and avoid putting upward pressure on wages elsewhere in the economy.

While recognizing the banking system's strong profitability and capitalization, Directors noted that vulnerabilities exist and therefore welcomed the authorities' efforts to increase awareness of risks. They highlighted, in particular, the need to monitor carefully trends in the housing market, given the high exposure of banks to this market. Directors underscored that continued supervisory efforts are essential to limit excessive risk-taking by lenders and borrowers: stress-testing could be enhanced and conducted more frequently, credit standards could be strengthened, and interim updates to the Financial Stability Report could be prepared. Directors welcomed the FSAP update planned for 2006.

Directors considered Ireland well placed to cope with the fiscal impact of population ageing, given the low debt ratio and the accumulation of reserves in the National Pensions Reserve Fund. Nevertheless, they shared the concern that households are on the whole not saving enough for retirement, and welcomed the authorities' consideration of further policy responses. Directors noted that Ireland's effective retirement age is one of the highest among industrialized countries, and concurred that encouraging longer active participation in the labor force is important. Beyond that, the appropriate role of government in addressing inadequate household saving depends crucially on the tradeoff between the risk of forcing some people to save more than they wish and the risk of some people not saving enough and falling back on the government in the future. In general terms, the solution should be clearly sustainable over the long run and provide the right incentives to work and save.

Directors agreed that strengthening competition in the domestic economy is crucial to maintaining strong productivity growth and external competitiveness. In the banking system, codes of conduct to promote competition could usefully be extended, with the eventual objective of removing the regulation of certain fees. In the non-life insurance sector, greater disclosure of aggregate information on claims histories would be desirable. Better regulation is also needed in retail and professional services to stimulate competition and reduce prices.

Directors encouraged the authorities to continue their efforts to improve the timeliness and reliability of statistics.