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Analysis/Comment Last Updated: Nov 7, 2010 - 7:33:07 AM

Irish Budget 2009 Analysis: Lenihan's "call to patriotic action"
By Michael Hennigan, Founder and Editor of Finfacts
Oct 15, 2008 - 7:26:39 AM

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Source: Davy Research

Irish Budget 2009 Analysis:  Minister for Finance Brian Lenihan said in his speech Tuesday on the Budget, that "it's a call to patriotic action."  Apart from evokingSamuel Johnson's most famous quotation: "Patriotism is the last refuge of the scoundrel," while incompetence is not incompatible with patriotism, it's rich indeed to be lectured about such noble values, by people who used short-term political interest to the detriment of the economy and many thousands of people.

The fallout from the toxic cocktail of self-interest, incompetence, negligence and laziness, has been covered in another article this week.

Click for Finfacts Main Budget 2009 Page

Before moving onto economic analysis, it's interesting to observe how the Green Party has so seamlessly filled the impotent shoes of the near-defunct PDs.

Like so-called "independents" who sell their votes for time security and some baubles to impress constituents, small niche parties, such as the Green Party in its present role, have zero impact on most areas of policy but the priority is to have some crumbs to offer supporters and copperfasten the self-interest of the leadership.

So Green Party leader John Gormley has highlighted what he called "Green Party gains" including: a substantially increased budget for water services; new funding for home energy efficiency and warmer homes scheme; increases in petrol prices; the bicycle initiative; and an increase in motor taxes.

The introduction of the €200 annual charge on second properties, was described by Gormley as a "watershed moment" in local government funding.

Watershed or not, Fianna Fáil will always be happy for their support as long as they stick to "saving the planet" but who saves Ireland?

Environmental group Tarawatch, says spending on the roads programme is inefficient, because the overspends by the National Roads Authority have already reached €16 billion and there is no indication that it is slowing.

Vincent Salafia of TaraWatch said:" Continuing the roads programme at this rate, while reducing spending on public transport, is the height of fiscal irresponsibility, given the current economic climate.

"It is clear the Green party have had zero impact on Government policy, with no –reallocation of funds from roads to public transport, and no significant carbon emission reduction programme whatsoever.

"We will update our complaint to the Comptroller and Auditor General, seeking a review of spending on the roads programme, before funding is allocated, in the wake of the E16 billion overspend by the NRA."

The views of 3 economists:

Pat Mc Ardle, Chief Economist, Ulster Bank commented on the Budget:

The Budget is somewhat disappointing in that, after all the huffing and puffing, the General Government Deficit (GGD) is still 6.5% of GDP, up from a 5.5% deficit in 2008 and a surplus of 0.5% as recently as 2007. Moreover, the economic assumptions on which it is based look optimistic both for 2008 and 2009 and one-quarter of the tax raised comes from once-off cash flow adjustments and is, therefore, temporary. This means that the task facing the Minister next year and the year after is still considerable and, indeed, the Department included further tightening of €2.5 billion in their outline projections for the next Budget. We are not out of the woods yet.

The Government promised to maintain capital spending on vital infrastructure and were true to their word. The medicine was broadly spread and came in the form of higher taxes, cuts in current and (soft) capital spending as well as a deficit higher than expected. This reflected the perceived impossibility of cutting further rather than any desire to accede to the (unrealistic) demands of some economists to blow the Budget and “give the two fingers” to Brussels.

Having said this, the cuts were significant. The Minister ended with a GGD of €12.2 billion. By my reckoning, his opening position was €17.5 billion so the total correction amounted to €5.3 billion. This came in stages. Last July, the Government announced ‘savings’ of €1 billion, split €300mn capital, €700 mn current. Last weekend, the White Paper included further spending cuts of €1.8 billion current and €1 billion capital. Yesterday’s Budget completed the process by adding €250 million to spending – the smallest Budget Day spend in a long time – and raising a net €1.6 billion in taxes. In fact, gross tax receipts for 2009 were increased by €1.9 billion but there was an offset of €0.3 billion in the form of negative buoyancy, i.e. the impact on tax revenue of the Budget Day changes. This is another disturbing feature of the Budget. When the Minister has Budget-Day giveaways he usually claws back more than 30% of them via positive buoyancy. This year, the negative buoyancy is less than 20%, another reason to be sceptical of the tax estimates.

The Budget is slated to be broadly neutral by the official calculations but in reality is contractionary given the size of the adjustments. GNP is forecast to contract by 1% in 2009 but we think it could be twice that. Similarly, we disagree on inflation. Though the Budget added at least three-quarters of a percentage point to the CPI, falling interest rates mean that the 2009 average is likely to be around 1.5% as compared with the Department’s 2.5%. This means that the social welfare rate increases of more than 3% are, in fact, much more generous than they appear. It also means that the draft wage agreement is even more generous than it appeared a few weeks ago, maybe someone will reject it.

The housing measures are limited. This is probably a good thing. In particular, there is no sign of the speculated assistance to first-time buyers via a Government top-up mortgage. The Government have sensibly waited for the market to find a bottom. Meanwhile, Local Authority purchase schemes are being boosted and mortgage interest relief has been extended yet again – will we never learn.

The decision to cut stamp duty on commercial property from 9% to 6% is welcome and does not cost much. Less welcome are the increases in Capital Gains Tax and DIRT. Unlike the income tax levy which is designed to look temporary – UK Income Tax was introduced in 1842 as a temporary measure – they seem to be more permanent. In the absence of indexation, CGT has the potential to be a very nasty tax indeed, at some stage in the distant future when all our recent losses have been used up.

Public sector reform is still an aspiration. The (disappointing) OECD Report is with a task force due to report shortly. Meanwhile the Ministers and top civil servants have taken a pay cut and plan to get rid of 41 QUANGOs with no mention of eliminating the staff involved. Plus, ca change…

The air travel tax pays no heed to efficiency and is a poor substitute for a tax on fuel used – fuel used in aviation as in farming is exempt from duty for reasons that escape me. Meanwhile, action on the Carbon regime awaits the report of the Commission on Taxation next Autumn.

Charlie McCreevy, for once beaten by the Civil Service machine, failed to tax BIK on free car parking spaces. Brian Lenihan is going to have another go – at €200 euro a space. We will watch this one with interest.

Source: Davy Research

Rossa White, economist at Davy Research commented:

Public sector reform kicked to touch; this would have been a better way to yield revenue savings

The government has tried to raise €2bn in extra revenue, as we outline below. But tackling public sector numbers would have been a better way to get the public finances in shape over the medium term. Actual employment reductions are happening in the private sector, with much more to come. The public sector needs to play its part too. We had suggested that a 10% cut in numbers (mainly in administrative rather than front-line areas) would have yielded almost €2bn, albeit that the savings would not come through until 2010 due to redundancy payments. Moreover, such cuts would boost competitiveness in the longer term. But the government has kicked to touch on the issue until November.

Failure to control current spending has been as responsible as vanishing property-related revenue for the deterioration in the public finances. Yet gross voted current expenditure will rise again by 3.6% in 2009, thanks to the rise in the social welfare bill and the public pay bill. Next year, the ratio of current spending (excluding interest payments and contributions to the EU budget) to GNP will reach its highest point since 1986. For 2010 and 2011, the government is pencilling in current spending growth of 2.3% and 1.8% respectively.

Government looks to boost revenue by €2bn or 1.1% of GNP; overall package will hurt consumer spending

We were hoping that taxes would not increase too much. Before the Budget, we reckoned that consumer spending could fall 2.8% next year.

Now the danger is that the contraction in spending could be worse. The total income tax package cuts €1bn, or exactly 1%, from disposable incomes next year. The hit comes from the introduction of a levy on all incomes. This levy is 1% up to €100,000 and 2% on any income over that threshold, costing households €1.2bn. But the standard rate tax band was increased by €1,000 for a single person and €2,000 for a couple. That gives back €200m to households. The increase in the PRSI ceiling by €1,300 has little effect on after-tax incomes.

Fortunately, the government gave back some cash in social transfers. It expects inflation to average 2.5% in 2009. In the event, we think inflation will be less than 1%. It indexed social welfare payments by over 3%. In effect, that boosts real incomes by €400m, limiting the damage caused by the income levy when looking at household incomes in aggregate. Note that unemployment benefit claimants are set to increase by about 80,000 on average next year as employment falls.

Austin Hughes, Chief Economist of IIB Bank commented:

Mr. Lenihan expects a very speedy reversal of the current borrowing difficulties with the Budget deficit seen falling back under the 3% ceiling by 2011.  This seems to be predicated on some combination of further significant pain as well as a substantial economic rebound.  In reality, it is likely to take somewhat longer to restore Ireland’s public figures to rude health unless the economy again surprises with it’s resilience. 

We don’t think government borrowing figures should or can be the cornerstone of Irish economic policy in coming years.  In reality, the target for government borrowing of less than 3% GDP by 2011 is intended to appease Europe.  However, there are many precedents for a notably slower pace of adjustment.  It took Greece 5 years to get borrowing back below 3% and Germany and Italy both took 4 years.  At a time when public deficits and debt are increasingly sharply worldwide, the task for the Irish government in coming years will be to keep the public finances on a sustainable trajectory.  How it does this is what matters.  We think supporting activity and enhancing competitiveness must be the key channels

Taxation Trends Are Worrying

Even though Mr. Lenihan targeted a relatively large government budget deficit of 6.5% of GDP in 2009, he announced a fairly substantial increase in taxation.  As Figure 2 illustrates, today’s tax announcements are markedly different from any in recent memory.  They also imply a painful squeeze on consumer spending power.  While much attention will understandably focus on the income levy, the reality is that a very wide range of goods and services will reflect higher taxation in the coming year.  It’s a fairly long list; the switch to standard rate relief on health expenses, the reduction in relief for pension contributions, the rise in the higher VAT rate, various excise increases, air travel and increased betting taxes, changes in motor taxation and the introduction of charges on non-principal private residences.  These changes mean many consumers will suffer across a wide spectrum. 

Although Mr. Lenihan’s commitment not to increase corporation tax is laudable, the personal tax measures in Budget 2009 as well as changes to payment dates and increases in capital gains tax and deposit interest retention tax will contribute to perceptions of an economy where the burden of taxation is increasing markedly.  The only saving grace in this regard is that poorer economic conditions abroad suggest taxation may be on a rising trend elsewhere in coming years.  So, the damage to competitiveness may not be quite as dramatic.

The approach adopted by the Minister in Budget 2009 creates ample scope for further substantial tax increases in coming years.  Budget forecasts envisage more painful adjustments in next year’s budget with some €2500 million of further unspecified ‘fiscal consolidation’ required to meet next year’s target of a borrowing level of 4.7% of GDP.  We were particularly struck by two of Mr. Lenihan’s comments: ‘the levy will be kept under review in the light of economic conditions’ and ‘if the current economic circumstances deteriorate, it may be necessary

to make some equally difficult tax choices next year’.  These can be combined in a threatening manner.  In these circumstances, it is certainly easier to imagine the income levy being increased rather than reduced or abolished in the next couple of years. 

Mr. Lenihan’s tone and the array of revenue raising initiatives announced in Budget 2009 hark back to the bad old days of the 80’s.  That was a time when taxation policy was effectively treated as a residual that reflected a wide gap between the borrowing level deemed possible and the spending level deemed inevitable.  That approach prompted a serious deterioration in Irish economic conditions.  So, it is to be hoped that any similarities between taxation policy then and now are entirely coincidental and temporary.

Can Spending Be Sustained?

One reason why taxation policy is bearing a significant burden of adjustment at present is the difficulty in delivering a significant adjustment in public spending.  Mr. Lenihan acknowledged that day-to-day public spending had risen by 200% between 1998 and 2008.  OECD data suggest overall Irish government outlays in 2008 will amount to some 38% of GDP.  When account is taken of Ireland’s relatively low defence spending and debt interest payments as well as the effect of comparatively low unemployment and favourable demographics on health and social welfare spending (and also the technical impact of the gap between GDP and GNP), these figures suggest Irish government spending is not out of line with the OECD average of 40.7% of GDP or perhaps even the Euro area average of 46% GDP.  Admittedly, social welfare spending automatically increases as the economy weakens but in light of the pace of spending increases in the past decade there should be scope for adjustments elsewhere.  There is little evidence in Budget 2009 that a significant re-assessment of public spending programmes is underway.  Indeed, as Diagram 3 indicates, day-to-day spending is set to increase as a share of GDP in

the next couple of years.  In addition, increased interest payments on rising government debt mean overall current spending will be on an even poorer trajectory.  Ultimately, an inability to set public spending on a sustainable path implies the risk of notably weaker growth potential for the Irish economy in coming years.

Will The Irish Economy Turn?

The current economic outlook is extremely uncertain and we reckon that both the mechanical impact of Budget 2009 and it’s effect on sentiment will weigh on Irish economic prospects in the coming year.  However, in 1987/88, in 1993/94 and again in 2001/03, tougher Irish budget policy coincided with a significant easing in interest rates.  That could again be the case in 2009.  In addition, signs of an easing in fuel and food prices will offer some prospect of a reversal of the painful increases in these areas in the past couple of years.  In such circumstances, the prospect of a stronger performance by the Irish economy may not be quite as remote as is now feared.  In turn, that might meant that the stance of fiscal policy would not move in a direction that casts a shadow over Ireland’s economic outlook.

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