## The EU Commission’s View of Ireland

Despite the constant references to the IMF in the media, on placards and on posters, the truth is that the Irish bailout deal is largely funded by the European Union and most of the reliable reports about the negotiations have suggested that the terms and conditions of the deal largely represent the preferences of the European Union.

Given that, I’ve been surprised at how little attention has been paid to the European Commission’s Autumn forecasts, released on November 29, the day after the EU-IMF deal was agreed. This post examines these forecasts and what they suggest the Europeans think will happen in Ireland.

Growth

The growth assumptions (see page 9 of this document) underlying this year’s budget come from the government’s four-year plan, published on November 24. They assume real GDP growth of 1.7% in 2011 and 3.2% in 2012 and, more importantly for budgetary projections, nominal GDP growth of 2.5% in 2011 and 4.3% in 2012.

The EU Commission forecast published five days later projects real GDP growth of 0.9% in 2011 and 1.9% in 2012. They project growth in the GDP deflator of 0.4% in 2011 and 0.8% in 2012, so their forecasts for nominal GDP growth are 1.3% in 2011 and 2.7% in 2012, putting them 1.2 percentage points behind the government in 2011 and 1.6 points behind them in 2012.

Budget Deficit

Even if the government’s projected budget deficits came about, the lower level of nominal GDP projected by the Commission would produce a higher deficit as a fraction of GDP but this effect is small. Here’s a spreadsheet I’ve put together with various calculations. It’s not too easy to read but it reports that, on its own (i.e. keeping the government’s deficit forecasts), the lower projected level of nominal GDP in the Commission’s forecast would raise the deficit ratio from the government’s projected 9.4% of GDP for 2011 to 9.5% and from 7.3% in 2012 to 7.5%.

The Commission’s actual forecasts for the deficit ratios for the next two years, however, are 10.3% in 2011 and 9.1% in 2012. Based on my calculations of the Commission’s forecasts for nominal GDP, this implies deficit levels of €16.2 billion in 2011 and €14.9 billion in 2012. These figures are €1.3 billion higher than the government’s assumption in 2011 and €2.6 billion higher in 2012.

The discussion of the Irish forecast on pages 85 to 86 makes it clear that the Commission fully expects the implementation of the adjustment packages of €6 billion in 2011 (though €700 million of this is once-off measures) and €3.6 billion in 2012. This means that the Commission’s higher deficit forecasts are due to their estimates that the weaker economy will mean lower tax revenues and higher welfare spending.

The government projects revenue shares of 35.4% in 2010 and 2011 and 35.8% in 2012. The Commission project revenues shares of 35.1% in 2010, falling to 34.9% in 2011 and 34.7% in 2012.

The government projects an expenditure share of 67.3% this year, with 20.3% of this due to banking costs. The government then project expenditure share of 44.8% in 2011 and 43.1% in 2012. The Commission project expenditure shares of 67.5% in 2010, 45.2% in 2011 and 43.8% in 2012.

It seems clear from these calculations that the Commission do not view the 3% deficit target in 2014 as attainable. If a cumulative adjustment of €8.9 billion over 2011-2012 only succeeds in reducing the underlying deficit from 12.0% to 9.1%, it’s hard to credit how a further €6.2 billion in adjustments will succeed in reducing the deficit to below 3% in the following two years, even if economic growth did turn out to be strong. Indeed, a six percentage point reduction in the deficit over the three years after 2012, thus reaching the 3% deficit in 2015, seems ambitious.

Debt and the Cost of the Banks

One would expect the Commission’s projections for Irish public debt levels to be higher than those of the government over the next two years because of their higher deficit forecasts. However, the higher debt levels in the Commission’s forecasts also appear to reflect the EU’s view on the likely costs related to the banking system.

The Commission are forecasting Debt/GDP ratios of 107% in 2011 and 114.3% in 2012. Based on their nominal GDP forecasts, I calculate that this means debt levels that are higher than those projected in the budget documents by €11.6 billion in 2011 and by €15.5 billion in 2012.

The higher deficit projections will have implied an additional €1.3 billion of debt in 2011 and an additional €3.9 billion in 2012. The remaining €10.3 billion in 2011 and €11.6 billion in 2012, likely reflect the cost of the banking bailout.

The EU-IMF program involved the Irish government committing €17.5 billion in resources from the Pension Reserve Fund and cash balances towards the bank plan. These commitments do not add to the gross government debt. If the Commission are adding an additional €10.3 billion to their forecast for gross government debt in 2011, then this suggests that their estimate of the total cost of the banking package is €27.8 billion. This is already pretty close to the total of €35 billion that has been provided for these purposes. And this is prior to any unveiling of new information on loan losses from the upcoming PCAR stress tests.

Ruling out further costs of bank recapitalisations after 2012, if indeed the deficit is still 9.1% in 2012 and the debt ratio ends that year at 114.3%, it will take a very strong combination of GDP growth and fiscal adjustment to see the debt ratio stabilise at less than 120% in the following years.

## Labour Party Pre-Budget Presentations

Before the snow hit, I gave a pre-budget presentation (pretty similar to my UCD presentation from today, though with some additional material on the banks) at a Labour Party pre-budget event. That presentation and three others are available here. Marie Sherlock from SIPTU and John Martin from OECD gave interesting presentations on labour market and training issues and Michael Collins from TCD gave a presentation on tax breaks.

I did a short pre-budget presentation today at UCD. Here are the slides. One point I emphasised is whether the level of front-loading of adjustment in the four-year plan agreed with the EU and IMF makes sense.

Up until the past few weeks, it was reasonable to argue that a significant front-loading was necessary (if not sufficient) to regain access to the sovereign bond market. However, now that our banking problems and the ECB have caught up with us and access to the sovereign bond market is not an issue for the next few years, I’m struggling to understand the logic for the extent of front-loading in the current plan (€6 bilion in adjustments in 2011, €3.6 billion in 2012, €3.1 billion in 2013 and 2014).

The economy is still in poor shape, so I’m not sure what the current argument is for further undermining it with such a front-loaded adjustment. As I speculated in the talk, perhaps the EU wanted to lock in as much adjustment as possible with the current government because comittments beyond the 2011 budget were most likely going to be open to negotiations with the next government.

## Government Plans €6 Billion Adjustment in 2011

The government have released a ten-page document outlining its plans for the level of adjustment in the upcoming budget and also some details on growth projections and adjustments planned for future years. Here‘s the press statement.

The summary:

The Government has agreed on an adjustment of €6 billion for 2011 and this will reduce the General Government deficit to around 9¼ to 9½% of GDP next year. Taking account of the €15 billion consolidation package, my Department now expects annual average real GDP growth to be 2¾% over the 2011 to 2014 period.

The government have also released a note on the accounting treatment of the promissory notes. The key point:

the terms of the promissory notes will provide that no interest will be chargeable in 2011 and 2012.

I’m guessing these are newly-negotiated terms, though I’m happy to be shown that this is not the case.

In any case, the bottom line is that this €6 billion of adjustment will have slightly more effect on the GGD than the approach I had been recommending. I had been recommending €7 billion but that figure included €1.5 bilion for the promissory note interest, which does not apply now.

There is lots to absorb in this plan but, for now, let me say that I think the govenment have taken the right decision in relation to the size of the planned adjustment. Now we just have to see if they can get it passed.

## Business and Finance Article: Focus on This Budget, Not 2014

Here‘s an article I wrote for Business and Finance on the current budgetary situation (complete with a nice picture of Mrs. Merkel). The article emphasises the importance of getting the upcoming budget right rather than worrying too much about the 3% target for 2014.

## Dail Exchanges on Upcoming Budget

With consensus on the likely size of a four-year adjustment unlikely to emerge (and perhaps not particularly relevant anyway) the key fiscal policy question for now is what the size of the adjustment is going to be in the upcoming budget.

Yesterday’s Fine Gael Dail questioning on this subject was interesting. Deputy Noonan:

Now that we have agreed that 3% in 2014 is the finish of the race, what is the Minister’s starting point on 7 December? Will he go soft? Will the budget deficit be 11%, 11.5% or 10.5% of GDP? Will he go below 10%? He needs to come up with this figure pretty quickly. I will not press him any harder on this; I am simply speculating. I have no information as to his thinking on this but this is an essential piece of information. Unless we know the starting point we do not know where the Minister is going.

I’m pretty sure that Noonan knows that an adjustment of €7 billion would be required to reach the 10% target but hasn’t yet said that he would support it. His lack of enthusiasm for the €15 billion four-year adjustment figure suggests he wouldn’t be too keen.

However, others in Fine Gael are calling for the 10% to be met. Here’s Simon Coveney

My understanding from the briefing from the Department of Finance is that the key requirement from bond markets to allow Ireland to issue bonds is that we will need to bring our deficit below 10% of GDP next year from our current position. No Government speaker, including the Taoiseach and the Minister for Finance, addressed that issue as to what figure will be necessary in the 2011 budget to bring down the deficit to 10% or less of GDP. That is the guideline figure we have been given to issue bonds and raise money in order that we can keep Ireland functioning and keep our economic and political independence in terms of budgetary decision-making.

And here’s a bit of cat-and-mouse play from Damien English

Deputy Coveney is correct in stating that we must bring the deficit down below 10% of GDP next year, and I ask the Government to give us the figure now. Tell us what it is, whether it be €5.5 billion, €6 billion, €5 billion or €4.5 billion, and let us work to that.

Well, Deputy English, it’s not going to be €4.5 billion!

Labour’s participants in this debate seem to have stayed away from this issue. However, on the Vincent Browne show last night, Pat Rabbitte indicated he wouldn’t support more than €4 billion in adjustments. If this is the party line, then it means that Labour are not supporting reaching the 10% target.

## A Discouraging Dail Debate

Yesterday’s Dail debate shows that Fine Gael’s approach to the upcoming budget and four-year plan debates appears to be to emphasise the idea that economic growth may be higher in future years so that €15 billion in cuts will not be needed.  The ESRI’s high growth scenario gets a lot of play in these discussions.

From Enda Kenny’s speech in the Dail:

There are better possible outcomes. For instance, if the ESRI’s updated high-growth scenario of an average growth of 4.5% were to materialise, a smaller package of fiscal measures would be needed to hit the 3% target by 2014.

That is why Fine Gael believes it is necessary, over the coming weeks, to put a relentless focus on the ways to support growth and jobs as the country attempts to repair its public finances. That is why Fine Gael believes that any fiscal plan has to operate in parallel with a credible growth and jobs plan to turn the present downward vicious cycle into an upward virtuous cycle. We have a different approach from the Government. Fine Gael offers real hope that we can rebuild our economy and restore trust in politics and in Government.

This was backed up by Michael Noonan, who was pretty clear about the political costs to the opposition of agreeing to the €15 billion figure:

When the €15 billion is a forecast and when minor adjustments in the growth rate can make such vast variations, would we not be desperate clowns to tie ourselves in to the Minister’s figure, especially when the Taoiseach could not answer Deputy Gilmore this morning when he asked what was factored into the estimate of growth?  …. The key element is the forecast for growth and there is a vast variation between Davy’s forecast, which would take us over €20 billion, and the ESRI high growth forecast, which would bring us down to €9 billion.  The Minister is on the mid point so maybe he is right, but we are not buying in. We need more information.

I’m pretty sure that Fine Gael are aware that the previous budget’s growth projections are now considered to be highly aspirational by the European Commission and that any plan that is agreed will have to be on the basis of lower growth figures than contained in the ESRI’s high growth scenario.

You can call this unfair if you want (and some will—no doubt we’ll have comments here about the need to wear shades due to the brightness of our economic future.) However, that’s the way things are going to work and with the EFSF waiting in the wings to bail us out, the government probably doesn’t have a lot of bargaining power to make the case for a more optimistic scenario.

Indeed, I’m sure even the ESRI don’t believe that their high-growth scenario is the appropriate basis for fiscal planning over the next few years. Recall that the Recovery Scenarios document gingerly raised the question as to “whether a more rapid fiscal adjustment than currently planned would have a more beneficial outcome for the economy.” Note also that, on its own, the news about €1.5 billion per year in promissory note interest would take us to €9 billion even on the basis of the government’s December 2009 calculations.

What this emphasises, I’m afraid, is that the current political situation makes a cross-party consensus on multi-year budgeting essentially impossible. Opposition parties do not want to campaign at the next election on the basis of €15 billion in adjustments and who can blame them?  However, this will gravely undermine the credibility of any four-year plan introduced by the government and will also worry financial markets.

## Puzzling Budgetary Reporting

I’m having trouble making sense of most of the reporting of the budgetary discussions.

Two issues are particularly puzzling. The first is the consistent referencing of the idea that the higher requirement for budgetary adjustment is due to a relatively recent worsening in the forecasts for the Irish economy. (Indeed, a number of government politicians have also made reference to the idea that this worsening stems from a recent downgrading of the outlook for the international economy.)

The second is the dismissal of the €7 billion figure for budgetary adjustment mentioned by Michael Noonan and the lack of reference to the 10% deficit target that had been set for 2011.

## Sticking to 2011 Deficit Goal of 10% Requires €7 Billion Adjustment

Despite all the focus in the past few days on 2014 and European Commission, the key issue facing us right now is the how to convince sovereign bond markets that we are back on a stable fiscal path. Without access to the bond markets, you can be sure that the EU will be imposing the 3% target on us whether we like it or not.

Last December, the government told the EU that our general government deficit would be 11.6% in GDP in 2010 and 10.0% in 2011. So the questions we should now be asking are whether we should still aim to achieve the 10% target and, if not, what are the consequences of missing this target.

Michael Noonan appears to have said yesterday that the Department of Finance briefings called for €7 billion in adjustments. The department is now saying that “Given the current working macroeconomic forecast, indicative deficits were set out for consolidation packages of the order of €3bn, €4.5bn and €7bn.”

Fair enough, they could have set out a no-billion in cuts scenario for all it matters. However, as far as I can see, only the €7 billion scenario sees us meeting the 10% target and this likely explains why Noonan emphasised the €7 billion figure.

This isn’t rocket science. There are four elements to this calculation, none of which are complex or require access to secret figures:

1. Lower GDP: Last year, the government projected that €3 billion in adjustments would get the deficit to 10% of GDP. However, they were projecting GDP in 2011 to be €170 billion. Now, both the Central Bank and the ESRI are projecting GDP in 2011 to be closer to €160 billion. So, hitting the 10% target now requires a deficit of €16 billion rather than €17 billion. Hence, an additional €1 billion in adjustment, bringing the total required adjustment to €4 billion.

2. Promissory Note Interest: The 2009 budget figures did not include the interest on the promissory notes, which appears to be 5% on average. This adds €1.5 billion to next year’s deficit, bringing the total required adjustment to €5.5 billion.

3. Lower Tax Revenues: Tax revenues for 2010 are on target. However, last year’s budget projected a €9 billion increase in nominal GDP in 2011. The Central Bank are currently projecting a €5 billion increase in nominal GDP next year while the ESRI are projecting an increase of only €3.6 billion. Undoubtedly, any credible projection for next year will feature lower tax revenues. In my ongoing calculations (updated here to also include the ESRI’s GDP forecast) I’ve subtracted €1 billion from tax revenues next year. This brings the cumulative adjustment required up to €6.5 billion.

4. GDP Effects of Larger Adjustment: Unfortunately, if additional adjustment of this magnitude is required, then the GDP baseline in the ESRI and CB forecasts are probably too high. Hitting the 10% target will probably require about €7 billion in adjustment.

I’m happy to be corrected about any of these above points but, particularly when one factors in Noonan’s comments, I think it’s reasonable to assume that €7 billion is required to meet the original 10% target.

Is meeting the 10% target really necessary? Might an adjustment of €4 billion to €4.5 billion—perhaps getting us to somewhere between 11.5% and 12% of GDP—be ok if it was accompanied by an impressive-looking four year plan?

It might be but then again it might not. I’d be inclined to recommend assuming the latter. The current EU-agreed plan is already our second plan (there was a previous one in which we reached 3% in 2013). Ripping up this one, so we can start again with a third plan where, after years of cutting, we’ve still only got as far as a 12% deficit next year, doesn’t sound to me like the kind of plan that’s going to work.

So, that’s the debate that needs to be had. Wishful thinking involving only €4 billion in adjustments and still hitting the 10% target just isn’t helpful.

A side-issue in all of this is what exactly the government is (and has been) up to in relation to the budget figures. In relation to point one above, as Philip has pointed out, most of this downward revision in GDP stemmed from the CSO’s annual revision released this summer. Indeed, the Central Bank were projecting nominal GDP in 2011 of €163.7 in July, already over €6 billion short of the original budget projection.  So the government has presumably known the 2011 adjustment requirement was drifting outwards due to this factor for a number of months.

On the second point above, since the government started issuing the magic promissory notes early this year, they will have known about the effect of this on the budget figures for some time.

It seems clear, then, that the government were clinging publicly to a figure of €3 billion in adjustments long after they must have known that this figure wasn’t tenable (e.g. as late as the mid-September Fianna Fail think-in the €3 billion figure was being held to).

Equally, it could be argued that yesterday’s dismissal of Noonan’s comments from, among others, the Taoiseach, also served just to obscure the full scale of the fiscal problem that we face.

Update: I’m not sure if this story pre- or post-dates what I wrote above. It says that “Government sources have firmly ruled out a €7 billion adjustment for 2011.” If so, it looks like they have ruled out meeting their previous target for next year of a deficit of 10% of GDP, though it may be some time before they admit this.

## Promissory Notes: We Need A Powerpoint Presentation!

Okay, here’s a real treat for all our fans of all things promissory-note related. A classic Burton-Lenihan exchange in the Dail today. My favourite bit:

Deputy Joan Burton: We need a PowerPoint presentation on this.

Deputy Brian Lenihan: We do not.

Deputy Jim O’Keeffe: We need lots of money for this.

Full text below the fold.

## Budget Calculation Update: Promissory Note Interest Payments

It was always going to be unlikely that the process of briefings for opposition parties would be kept secret. However, with what appears to be authoritative and pretty detailed information all over today’s Irish Independent, it may just be best if the Department of Finance publicly released the briefing information it provided to the opposition politicians yesterday.

One of the more mysterious aspects of the budgetary finances is the magic promissory notes. By my count, we will have issued about €30 billion of these by the end of the year: About €25 billion to Anglo and about €5 billion to INBS.

In this post earlier today, I pointed out that while the principal payments on these notes didn’t count against the general government deficit (because these will all be registered as part of this year’s deficit) they will still be part of our ongoing financing requirement in the coming years.

I didn’t write earlier about interest payments on these notes (the figures I was writing about were just my guess about the annual principal payments). One reason I didn’t discuss interest payments is that I wasn’t sure there were any: They could just be zero coupon bonds. However, it looks as though they are not. On Prime Time this evening, Joan Burton and government junior minister Billy Kelleher agreed that the annual interest cost of the promissory notes was going to be €1.5 billion. With €30 billion or so in notes issued, it now appears that the notes have an interest rate of 5%.

Now, as far as I know (and I’m happy to be corrected) these promissory note interest payments of €1.5 billion a year will count against the general government deficit.

Here I’ve updated the calculations from my Irish Taxation Institute presentation to incorporate the “if the promissory notes pay 5%” scenario. The bottom line?  If one adjusts last year’s budget projections for (a) New projections from the Central Bank for nominal GDP (b) A projected decline in revenue of €1 billion (c) €1.5 billion in promissory note interest payments, then the starting point for this year’s budget prior to any adjustments would be a deficit of €22.5 billion or 13.9% of GDP.

Note that even if one didn’t factor in negative effects of fiscal adjustments on GDP, then with a Central Bank GDP projection of €162 billion, hitting the original deficit target for 2011 of 10% of GDP would require adjustments of €6.3 billion (162*0.039). Factoring in the contractionary impact of budget cuts on GDP, it would likely take €7 billion in adjustments to get to a 10% target.

As I say, these calculations are based on a 5% interest rate on the promissory notes. My interpretation from Minister Kelleher’s apparent confirmation of Burton’s comments is that this is the correct rate. However, I think it’s time for the government to fully clarify the terms of these notes as soon as possible.

## Talk at Irish Taxation Institute Event

I gave a talk last night at “The Big Tax Debate” organised by the Irish Taxation Institute. Here are the slides.

The opening slides do some calculations of where the government is starting from when preparing the next budget. Taking out the €3 billion in adjustments that had been pencilled in last December, the starting deficit would have been 11.8% of GDP. Adjusting for the lower nominal GDP projected in 2011 by the Central Bank, this rises to 12.4%. Subtracting a billion from tax revenue because nominal GDP growth is projected to be €4 billion less than in the December 2009 budget and the projected deficit becomes 13%.

These figures exclude payments on promissory notes because the full cost of the notes issued so far is getting incorporated into this year’s General Government deficit. However, the payments will be real cash flows and international markets will be aware that they increase our borrowing requirements. So, while one can argue that it may not be appropriate to point to our projected 32% deficit for this year as the correct measure, one can’t also keep excluding the banking-related payments as though we are never paying for the banking crisis. Adding on €2 billion a year for promissory note payments (my guess, based on €30 billion in payments spread over 15 years—no I don’t know what the correct figure is because it hasn’t been released) the underlying deficit rises to 14.2%.

One adjustment I didn’t make was for higher borrowing costs than projected in 2009. In any case, you get the picture. You don’t have to be brought into the Department for secret talks to see that the starting position for the deficit is an extremely serious one and that adjustments of €5 billion are probably the minimum required to establish a credible downward path.

I think this point, that we need to credibly get back to sustainable levels of the deficit in the next year or two, is far more important than the other popular debate about whether we should have a four-year plan or a seven-year plan for getting back to 3%. Colm Keena correctly quotes me in today’s Irish Times as saying that I don’t think anyone believes that we are going to reach a 3% deficit in 2014. That’s been my experience, perhaps others know people who do believe this. Either way, the 3% is an arbitrary figure and when we reach it is not the crucial point.

Of course, if the Commission insists that all our plans end up with 3% in 2014, then that’s the way they will be written. However, what’s far more important is that we can convince people that the deficits for 2011 and 2012 are going to be well below the starting point we’re looking at right now.

Finally, as an aside, Keena also quotes me as saying “On efficiencies in the public service, Prof Whelan said there was no need for any more reports. He believed the Government was not serious about the matter.” I’m pretty sure I didn’t say the latter. In fact, I suspect the government are probably more serious on this matter than those who claim enormous savings can be made from efficiency gains in the public sector. The point I was trying to make was that we should try to get some clarity as to how much, or how little, we can save from public sector efficiency improvements. And then we should implement them.

There has been a lot of reporting about how the cumulative adjustment for the next few years is going to be higher than €7.5 billion and how this was the figure that was announced at the time of the last budget.

I was a bit puzzled by this reporting because I had been under the impression that the figure for cumulative adjustments was €8.5 billion. Here’s why. Here’s the Stability Programme Update released at the time of last year’s budget, which is the document provided to the European Commission to illustrate the details of our multiyear plan.

Click on the document and go to page 19. Table 9 describes €3 billion per year in additional measures to be “delivered” in 2011 and 2012 as being made up of €1 billion per year in capital program adjustments that were “already identified and incorporated into the base” and €2 billion per year of additional adjustments.

For this reason, page 20’s description of the adjustments in future years shows €2 billion in 2011, €2 billion in 2012, €1.5 billion in 2013 and €1 billion in 2014, which adds up to €6.5 billion. However, since Table 9 tells us that an additional €1 billion a year in capital adjustments had been identified and incorporated into the base, I had believed the profile for total adjustments planned was €3 billion in 2011, €3 billion in 2012, €1.5 billion in 2013 and €1 billion in 2014, which adds up to €8.5 billion.

However, it turns out that the baseline for capital spending is a continuation at prevailing levels. Table 10 shows Gross Voted Capital falling from €6.445 billion in 2010 to €5.5 billion in 2011 and staying there afterwards. You can add this €1 billion cut in 2011 to the €6.5 billion identified elsewhere in the table to get to the €7.5 billion.

What about the additional €1 billion of capital spending cuts that Table 9 tells us had been identified and incorporated into the base from 2012 onwards? Apparently, the 2012 element of these “identified cuts” doesn’t exist. (It appears that someone in Finance mixed up their levels and changes.)

So, €7.5 billion is indeed the correct figure. However, those of you who, like me, had thought that the government had been planning €3 billion in adjustments in 2012 haven’t had it right.

## Budget 2010: Welfare Cuts

The idea that social welfare recipients should take cuts is normally considered politically unacceptable. I have mixed feelings about the measures taken today.

On the one hand, when one looks at measures not taken (whatever legal reasons there may be) such as the failure to cut pensions for retired public sector workers (traditionally linked to pay levels which have now been cut) and the failure to freeze public sector increments, as well as measures taken such as the VAT and excise cuts (costing €257 million on a full year basis) and the range of dubious so-called stimulus measures (vouchers for cheap rail travel for senior citizens visiting Ireland from abroad?) one could conclude that these cuts were avoidable.

On the other hand, against a background of significant deflation and with wage rates falling and the potential for serious poverty traps (where people are better off unemployed than in low-paid jobs), one can argue that cuts in unemployment benefits may unfortunately be a necessary part of any policy mix aimed at limiting unemployment over the next few years. (This particular argument does not apply, however, to disability or carer’s allowances). Moreover, with social welfare spending taking up such a large share of total expenditure, it was not realistic to draw a line in the sand and declare it to be off limits.

As an economist, I can manage to hold both sets of opinions at once.

## Budget 2010: Public Sector Pay

The government has cut public sector pay in the budget. A description of these cuts is available on page 27 of this document.

Pay has been cut by 5 percent for low earners gradually rising up to 8 percent for those earning €125,000. The cuts stay at 8 percent between €125,000 and €165,000 and €175,000. Those earning between €175,000 and €200,000 have cuts of 12 percent and those earning over €200,000 have cuts of 15 percent. An Taoiseach Brian Cowen gets a special cut of 20 percent.

Annex A of the document linked to above also described the cumulative cuts for different classes of workers, including public sector workers. To give one example, a public sector worker earning €75,000 in a one-income household with two children over 6 years of age has had a total reduction in net pay since last year’s budget of 18.2%. The comparable figure for a similar couple in the private sector was 5.4%.

I know there are many who will feel that these cuts have been too extreme. More interesting, I guess, is whether those who favoured cuts in public sector pay now think that this is enough or think that the government should come back and cut public pay some more.

## Budget 2010: Stimulus

The budget contains some measures that have been advertised as stimulus. The opposition parties will certainly argue that these measures didn’t go far enough.

I’ll take a contrary attitude here. All the parties put forward plans in which the net fiscal adjustment was about €4 billion so the fact is that all parties are agreed that the overall macroeconomic effect of the budget needed to be contractionary. It’s easy to paint a budget that has €5 billion in spending cuts and €1 billion in new spending initative as “having stimulus” and a budget with €4 billion in spending cuts and no new initatives as being “devoid of stimulus”.

The reality is that, by and large, these two hypothetical budgets will have the same effect. Of course, one can always argue that some types of tax cuts or spending increases are particularly stimulatory and that one can think of a better mix than the government put forward. But, by and large, this is a secondary issue to the principal one related to the overall macroeconomic stance.

My contrary attitude extends to the government’s own limited stimulus measures. The idea that the the half percentage point increase in the VAT rate triggered an huge increases in cross-border shopping was always ridiculous: See two articles from the early days of this blog by current adviser to the Minister for Finance and former blog alum Alan Ahearne (back then blog posts were written in the third person apparently!) and a later crankier post by me.

To my mind, cutting the VAT rate is just a kneejerk response to a wildly inaccurate public perception based on a desire to be seen to be doing something “positive”. Cutting excise duties on alcohol similarly won’t do much to reduce cross-border shopping. I wouldn’t care much if these were measures that didn’t give up much revenue. However, the summary of budget measures shows that these two decisions alone will cost €257 million on a full-year basis. For comparison, the cuts in child benefit will save €220 million.

And, of course, I never liked the scrappage idea. And I still don’t.

## Budget 2010: Stabilising the Public Finances?

Ok, so as with some previous big events such as the Snip Report, it may be best to partition the discussion of the budget into a set of separate threads. I’ll put up a few topics, offering a few of my opinions as I go along.

Let’s start with a big question. Irrespective of one’s opinion of how the adjustments have been achieved, has this set of budgetary measures stopped the rot in the public finances? Will it succeed in stabilising the public finances? My guess is that it will and that, if passed by the Dail (I’m assuming it will) this set of measures will prove to be a key step on the road to fiscal stability. In particular, I would guess that participants in international financial markets will be impressed by the package and that this will help a lot in distinguishing Ireland from Greece, which could prove to be an important issue in the coming months.

The other attitude to this package is what, I suppose, one could term the ICTU approach. This would emphasise that the cuts are likely to further depress the economy and keep us in a downward recessionary spiral. On this point, it’s worth noting that the budget figures concede that the €4 billion in cuts will have a negative effect on tax revenue: Table 8 of the Stability Program Update concedes that the budget day expenditure adjustments of €3.8 billion will reduce tax revenues by €897 million, so the net reduction in the deficit relative to the baseline laid out in the White Paper on Saturday is around €3 billion.

## Labour Budget Submission

The Labour Submission is here

Key points:

Spending
700 million jobs fund for employment subsidies and placement schemes
1.3 billion reduction in pay budget
1.3 billion reduction in capital spending through lower tender prices
900 million reduction in non-pay spending (list given at end of document)
Reinstate Christmas Social Welfare Payment (240 million)

Tax
Third rate of income tax (48 per cent kicking in at 100k for single and 200k for couple)
Abolition of a number of tax expenditures
Carbon Tax