I have written an article on the debate about the upcoming budget for Business and Finance. It’s hidden behind a paywall, so I’ve attached the full text below the fold.
Issues for the Budget Countdown
The government has begun making preparations for December’s budget. Minister Eamon O’Cuiv’s comment that he couldn’t rule out cuts in pensions tells us that budget kite-flying season is with us again. As with last year, we are likely to see a series of proposals flagged as possibilities in the hope that the public will be immune to them by the time they are revealed on budget day.
This process will eat up plenty of media attention in the coming months. However, there is a bigger picture worth focusing on in relation to the next budget, with three issues in particular deserving attention.
The first issue is the scale of the budgetary measures required. The government has signalled that another €3 billion in adjustments will be delivered in the upcoming budget, with €1 billion of this earmarked for capital spending and €2 billion in current spending.
I noticed Leo Varadkar of Fine Gael saying on TV that he thought this planned adjustment was too large. However, sovereign bond markets have become far more nervous in recent months and a failure to stick with our announced plan for adjustments could very possibly see the Irish government shut out of this market, thus becoming reliant on the EU\IMF stabilisation fund. The price of accessing this fund would almost certainly include a more rapid pace of adjustment than is currently planned. Hopefully this represents a solo run from Deputy Varadkar, as a cross-party consensus on the need for the government to stick to its planned path of fiscal adjustment has been one of the key elements distinguishing Ireland from countries like Greece.
The second issue is the composition of the adjustment in terms of tax and spending measures. Last year’s budget speech signalled that the adjustment would be solely on the expenditure side. To my mind, this would be a mistake.
A major reason Ireland has opened up such a large budget deficit is the collapse in tax revenues from property market sources. The EU projects that Ireland will have a tax to GDP ratio of 34% in 2011 under current policies. This would place us at the very low end relative to other European countries. Maintaining this approach is likely to have very serious consequences in terms of the delivery of public services. The Commission on Taxation has outlined a number of suggestions for expanding our tax base and providing us with more stable sources of revenue. The next budget should start to implement some of these measures.
The final issue deserving attention is the question of stimulus measures. The opposition, perhaps wary of the lack of reward handed out to Fine Gael for its Tallaght Strategy of the late 1980s, has been determined to consistently criticise the government’s budgetary proposals as too negative. Richard Bruton immediately responded to last year’s budget by labelling it draconian, jobless and joyless and the opposition has regularly bemoaned the lack of positive initiatives being taken by the government.
It seems to me that there is an air of unreality about these criticisms. Both Fine Gael and Labour put forward various proposals last year aimed at reducing unemployment. However, both parties also put forward alternative budgets in which the net fiscal adjustment was about €4 billion. The reality is that the overall macroeconomic effect of any of these potential budgets would have been contractionary.
It’s easy to paint a budget that has €5 billion in spending cuts and €1 billion in new spending initiatives as “having stimulus” and a budget with €4 billion in spending cuts and no new initiatives as being “devoid of stimulus”. But even beyond the fact that the overall macroeconomic effect is about the same, there are a number of reasons to be careful about adopting such an approach. Despite the continuous public demand for new initiatives to be seen to be doing something, new and untested spending or subsidy programs are often poorly designed and ineffective. For instance, the job subsidy and enterprise grants that the government has put announced do not appear to be very effective programs.
Constant calls for “positive action” also produce token gestures that do little to help and cost money. For example, in the last budget, Minister Lenihan announced a cut in excise duty on alcohol “to protect exchequer revenue and stem the flow of cross border shopping.” In fact, the budget details showed that this measure, far from protecting exchequer revenue, will cost us €90 million this year.
Similarly, the move to reverse the previous year’s VAT increase of half a percent was motivated by the mistaken idea that the original hike had lead to a flood of cross-border shopping. In truth, the large decline in the pound against the euro was a far more important factor in triggering cross-border shopping. However, this move will cost €167 million a year.
When overall budget targets have to be kept to, these positive measures just need be offset by cuts in existing programs. For instance, without the cuts in excise and VAT rates, one could have avoided the cuts in child benefit, which cost €221 million.
I don’t mean to dismiss the idea that the composition of budget adjustment shouldn’t be looked at carefully in a way that protects as many jobs as possible. However, the debate in the coming months would be more constructive if our politicians admitted that this year’s budget, and others to come, simply will not provide stimulus to the economy.