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Irish Emergency Budget: Government takes 3% of GDP from economy - - at its weakest in a century; Summary of tax, spending and economic forecasts
By Ulster Bank economists Pat McArdle and Lynsey Clemenger
Apr 8, 2009 - 4:38:47 AM
Irish Emergency Budget: Starting on Friday last, the Government began leaking the broad parameters of the Budget package. In the event, its size was €3.3 billion, somewhat below the €3.5 billion leaked but higher than we expected because these figures refer to the impact in 2009 of the measures announced. Their full-year equivalent is over €5 billion or 3% of GDP. That is a lot to take out of an economy which is at its weakest in a century.
The Government estimated the impact on growth at minus one per cent but we think it is at least 1.5%. The result is that the contraction in economic activity will exceed the Government's 8% estimate. We have tentatively revised our pre-Budget estimate from minus 8% to minus 9.5%. The corollary will be pressure on tax receipts though it must be said that the Department's tax figures look cautious enough.
Our main quibble with the Budget is with the split of the burden between tax and spending. In the event, and contrary to the recommendation of practically every economist in the country, they opted for a 55% to 45% split in favour of taxes. It is well established that taxes take a higher toll on the economy, another reason for our caution as regards growth. To make matters worse, the same mistaken policy will continue next year, and it will be 2011 before we get to a situation where spending cuts outweigh tax increases.
The reasons are all-too clear. The Government did not relish another go at public sector pay, about one-third of gross spending. They also went easier than expected on social welfare, another 40% of total spending. Though they did find €300 million – see Appendix below– they have allowed a situation where real social welfare rates have increased by 7%, by accident rather than design, go unchecked.
The consequence was a doubling of the income tax levy, which was expected, and of the health levy, which was not. The result is that households earning €50,000 to €100,000 see their take home pay reduced by 4% to 6%. This will not encourage them to spend more.
The other cause of the huge focus on income and quasi income taxes was the decision to go easy on excises. Only diesel and tobacco were hit. One can see that there are cross-border issues, but why hit diesel, which is cleaner and greener, and not petrol?
The lobby people will be disappointed. There was no car scrappage scheme and little for the construction sector either. Mortgage interest relief was limited to first time buyers for 7 years only – no great surprise given the fall in interest rates. Indeed, it is surprising that it was not abolished for new purchases, given how far both mortgage rates and house prices have fallen.
The new policy of incrementing CGT (Capital Gains Tax) and CAT (Capital Acquisition) rates was continued – a most invidious practice which involves taxation of inflation gains at penal rates in the future.
The pain is set to continue, with another €15 billion due to be extracted from us over the next four years. This is roughly equivalent to 2% of GDP each year. This will surely militate against any early economic recovery. It has to be done but there is a need for a radically different approach with a much greater focus on spending cuts.
One of the more innovative announcements was an early retirement scheme for the public sector – a good deal for those involved because there is no actuarial reduction for the lost years. Unlike the private sector, the Government does not have to provide for this upfront – it seems that it is a contingent liability with a short-term gain in that the pension paid will be less than the salary but the long-term costs are much greater.
Finally, there is a bank scheme whereby the State will buy distressed assets from the banks but, critically, the price arrangements are not disclosed and do not seem to be decided. Depending on the price, there could be a need for even greater capitalisation of the banks. That is why the UK opted for an insurance scheme instead. It looks as though more work is needed on this one.
The Minister ended by announcing the appointment of a retired Bank of England official to help recruit a new chief regulator.
Exchequer and General Government Balances
The Exchequer deficit in 2009 is forecast at €20,350m (14% of GNP). This compares with a deficit of €12,714m in 2008 (8% of GNP). The 2010 forecast is for a deficit of €19,903m (again 14% of GNP).
For the General Government Balance, deficits of 10.75% are forecast for both 2009 and 2010, compared with -6.4% in 2008.
The deficit is expected to fall to the Stability and Growth Pact limit of 3% by 2013, which looks optimistic.
The General Government Debt is forecast at 59% of GDP in 2009, up from 43% in 2008. The ratio is expected to rise to 79% by 2012.
The budget provides for overall savings of €886 million in Gross Current Spending and €576 million in Gross Capital Spending relative to the pre-Budget position. Total saving of €1.5 billion.
Job seeker's allowance for new claimants under 20 years old reduced to €100 per week i.e. halved. Yield is €12m in 2009 and €26m in full year.
Removal of Christmas bonus payment in 2009. Yield of €156m in 2009 and €171m in full year.
Changes to rent supplement eligibility, to yield €50m in 2009 and €78m in full year.
Health and Children
Early Childcare supplement halved to €41.50 per child a month, and will be abolished at end-2009. Yield is €105m in 2009 and €180m in 2010.
Payroll and other Savings
Early retirement scheme introduced in the public sector with no cost.
Other departmental savings yielding €170m in 2009 and €174m in full year.
Reduction in overseas aid to yield €100m in 2009 and in full year.
€300m savings in transport, including a €150m reduction in investment in roads. Also, some deferrals of public transport projects.
€200m savings in areas of Social Housing and Water.
€54m savings in Education and Science, primarily in the Primary and Post-Primary school building programmes.
€100m enterprise stabilisation fund established.
The budget increases tax revenue by €1.8 billion in 2009, mainly increases in the health and income levies.
Income Tax/Health Levy/ PRSI
Income levy rates doubled to 2%, 4% and 6%. Exemption threshold lowered to €15,028. 4% rate to apply to income in excess of €75,036 and 6% in excess of €174,980.
Health levy rates doubled to 4% and 5%, entry point to higher rate at €75,036.
PRSI ceiling raised from €52,000 to €75,036.
Combined yield for these measures is €1,322m in 2009 and €2,786 in full year.
Excise on 20 cigarettes up 25c, and 5c on litre of diesel, yield €102 million in 2009, and €145m in full year .
No increases on alcohol or petrol.
New rates of 25% and 28%, for life assurance policies and investment funds, respectively – to raise €50m in 2009 and €70 million in full year.
Housing Related Taxes
Mortgage interest relief discontinued for any mortgage over 7 years. Yield €96m in 2009, €128m full year.
Restriction in interest relief on rental properties, yield €65m in 2009 and €95 in full year.
Stamp duty exemption for “trade-in” scheme, no cost.
Life Assurance and Non-life Insurance
New levy on life assurance policies of 1%, and levy on non-life insurance policies to be increased from 2% to 3%. Yield of two measures €110m in 2009, and €180m in full year.
Capital Gains Tax rate increased from 22% to 25%, yield of €30m in 2009 and €45m in full year.
Capital Acquisitions Tax rate also increased from 22% to 25%, and thresholds reduced by 20%.
- - Combined yield for these measures is €31m in 2009 and €42m in full year.
Special 20% rate applied to trading profits from developing residential land abolished, income will now be charged at persons' relevant marginal tax rate or the 25% rate of corporation tax. Yield of €20m in 2009, and €70m in full year.
GNP is estimated to fall back further, by -8.0% in 2009, and by - 2.8% in 2010.
Over the medium term, GNP is expected to be positive again in 2011 and 2012, rising by 2.5% and 4.0% respectively.
Consumer spending is forecast to fall by 7.8% in 2009, and by a further 3.7% next year.
The CPI is forecast to fall by 3.9% in 2009, following a rise of 4.1% in 2008. In 2010, inflation is expected to return to modest positive territory, rising by 0.3%. The EU HICP (Harmonised Index of Consumer Prices), the more appropriate measure for euro area comparisons, is also forecast to turn negative, from +3.4% in 2008 to -1.4% in 2009.
Following a modest fall of 0.6% in 2008, employment s expected to fall by 7.8% in 2009. Looking forward to 2010, employment is forecast to fall further, by 4.6%,
Modest positive growth of 0.5% is forecast to resume in 2011.
The unemployment rate is expected to rise from an average of 6.3% in 2008, to 12.6% in 2009, before rising to a significant 15.5% in 2010. By 2013 the rate is expected to fall back to, a still high, 11.8%
Exports fell by 0.4% in 2008, and are estimated to drop by 6.1% in 2009 and 3.1% in 2010, as growth in our trading partners slows.