Budget 2010 - Just The Start.

By Eoin Fahy, Thursday, 10th December 2009 | 0 comments

The €4bn of savings in today's Budget are clearly necessary to begin the process of reducing the deficit.  But unfortunately this is only the beginning of a multi-year process, and we are faced with the prospect of another four or more Budgets as tough as this one before we get even close to budgetary balance.  That said, this was a genuinely encouraging start.

Sometimes it helps to take a step back when looking at a Budget, and move the focus away from whatever politically-sensitive item will feature on Joe Duffy's radio programme tomorrow, towards the "big picture" of assessing just how bad the current fiscal crisis is, and how today's Budget does or doesn't help that situation.

In that context, let's quickly run through the numbers again.  Next year, the government expects to take in €33.4bn in revenue, and to spend €52bn.  That's after the - very welcome - €4bn in savings announced today.  Taxes are expected to fall by €1.5bn, while day-to-day spending - despite the cuts - is expected to rise by €2bn.

A very optimistic forecast for the Irish economy might be that the economy will grow by, say, 3% a year for the next five years, and inflation will average 2%.  All other things being equal, that means that by 2014 the government would be taking in about €41bn in taxes and other revenues.

But government spending next year, even after taking account of today's cuts, will amount to €52bn.  Let's suppose that government spending grew only by 3% per year (again, without serious policy changes this is almost certainly wildly optimistic).  That means that by 2014 (the year by which our deficit must be back down to 3% of GDP, according to the EU), spending would be running at €59bn.  So by 2014, even after all of the cuts and tax increases we have seen in the last three budgets, the gap between spending and revenue would STILL be €18bn.  Or to put it another way, government spending would have to be cut by more than 25% to balance the books, or tax revenues would have to almost double.

We can see that the problems facing us over the next few years are grave.  While EU or IMF emergency support is most definitely not needed in the short--term, we just can't keep borrowing €15-25bn per year for ever.  The cost of interest alone on that extra debt will itself worsen the fiscal balance, and global financial markets - who to date seem to have been impressed with the performance of Brian Lenihan - won't be willing to lend that quantity of money indefinitely. 

So what has this Budget done to address the crisis? 

Well, to be fair, the government said it would tighten policy by €4bn, at the time of the mini-budget in April, and that's exactly what has happened.  So full marks for consistency anyway.

Next, the tax situation.  The very large tax 'increases' in the April Budget were most unwelcome.  Not because they hurt the well off, but because the evidence has been very clear over the years that higher tax RATES do not produce higher tax REVENUES.  Putting up the top marginal rate of tax and levies by nine percent in a few months was always likely to have such a negative effect on economic activity that it would actually collect nothing.  And so it has proved.  The April budget tried to raise taxes by one billion.  But in fact tax revenues fell, not rose, by around €2bn. 

In fairness the government seems to have 'got it' on the tax front, and apparently has realised that while eliminating tax shelters and so on will raise much-needed funds for the Exchequer, raising tax rates will not. So while it did extent the measures that restrict the availability of tax incentives to high earners, it didn't increase marginal tax rates for the vast majority of taxpayers, which is to be welcomed.

There is much more in the Budget than just the tax measures, of course.  There were sizeable reductions in social welfare rates and in public sector pay, particularly for higher earners.  But space and time are pressing.  Suffice to say that in overall terms the government has taken measures that are harsh, but unfortunately seem to be necessary at this time.

The sad reality is that several more budgets that are just as tough as this one are almost certainly on the way, but it does seem that the tough stance adopted in this budget is likely to help, not hurt, social welfare recipients and public sector workers in the long-term.  Not that that will be much consolation to them as they look at smaller pay-packets and social welfare payments in the months and years ahead.

All in all then, this represents a positive step, but a painful one, along what will certainly be a long road to fiscal balance.

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