Spending cuts key to restoring public finances

The government now faces a revenue shortfall of over E20bn; its future borrowing capacity is limited, particularly since Standard & Poor’s recent downgrading of the country’s credit rating, and extreme taxation has already proven to be disastrous as a means of creating revenue. Cutting public sector pay and pensions is the unpalatable reality the taoiseach must address
The government now faces a revenue shortfall of over E20bn; its future borrowing capacity is limited, particularly since Standard & Poor’s recent downgrading of the country’s credit rating, and extreme taxation has already proven to be disastrous as a means of creating revenue. Cutting public sector pay and pensions is the unpalatable reality the taoiseach must address

Government must cut public spending now to address the crisis dogging Ireland’s public finances or risk making this recession much, much worse

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20 April 2009 | 0

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By failing to address the key problem in the public finances, the need for drastic spending cuts, the government is both deepening and lengthening the economic downturn.

Until the government grasps the spending crisis things aren’t going to get better any time soon.

At the time of going to press the government had yet to publish its emergency budget. However, even in advance of 7 April it was clear that the government was desperate to avoid dealing with runaway public spending. Before the revenue-raising measures announced on 7 April the government was expecting to raise no more than €32bn in taxes this year. That is about the same as the government received in 2003. However, in 2003 the government spent only €32bn also.

Fast forward six years and the government is planning to spend between €55bn and €56bn in 2009. A gap of more than €20bn between spending and revenue isn’t sustainable for any length of time.

Revenue losses stem from housing boom fall-off

While some of the decline in revenue is cyclical and will recover when economic conditions improve, most of it isn’t. At the peak of the property boom in 2006 the government was collecting an estimated €10bn from property-related taxes such as stamp duty, capital gains tax, VAT on new houses and the income tax paid by the more than 280,000 building workers.
The notion that most or all of this property-related revenue will return, even when the economy recovers, must be considered fanciful. Looking forward it is difficult to see tax revenues bouncing back much above €40bn even when economic conditions improve.

While it would certainly be sensible for the government to borrow the €8bn to €10bn by which the recession has reduced annual tax revenues until the good times roll once again, it is a very different story with the other €10bn to €15bn. This extra revenue, most of it property-related, has gone forever.

So how is the government going to bridge the enormous gap that has opened up between spending and revenue? Ever since the full extent of our economic problems began to become apparent last July, the government has largely relied on a combination of tax increases and borrowing; with disastrous consequences.

Taxing for disaster

Last October’s increase in VAT and excise duties not only failed to provide the government with extra revenue, it actually cut the government’s tax take as tens of thousands of Southern shoppers headed north to shop in Newry, Armagh, Enniskillen and elsewhere in Northern Ireland.

Imposing tax increases on an economy already enduring its worst downturn for almost 80 years is utter lunacy. All this will do is worsen the economic slump.

Meanwhile the borrowing binge (the government will still need to borrow close to €20bn in 2009 despite the measures announced on 7 April) is rapidly destroying Ireland’s reputation in international financial markets. Ratings agency Standard & Poors has already cut Ireland’s credit rating from Triple A to AA+ and warned that further downgrades may be on the way.
Even before the S&P announcement the spread between Irish and German government bonds had widened to almost 300 basis points (3%) and the market in credit default swaps, where bondholders insure against the risk of default by the bond issuer, was rating Irish governments as the most risky in the eurozone.

In other words, the Irish government’s future borrowing capacity is limited, probably much more limited, than most of us realise. The international bond market’s willingness to keep on purchasing fresh Irish government bonds is of a strictly finite variety. Unless the Irish government clearly demonstrates that it has got to grip with our fiscal crisis the money tap could be turned off, and sooner rather than later.

International lenders already wary of lending to Ireland

Indeed that may already have happened. While no-one has been rude enough to come out and say it publicly, there is a strong suspicion in financial circles that much of the €11.5bn which the government has already raised on the international bond markets so far this year has in fact ended up with the ECB.

While the ECB hasn’t purchased any Irish government bonds directly, a large proportion of this year’s new bond issues were taken up by the Irish banks who are widely believed to have then sold them to the ECB. If this is in fact the case then the ECB possesses even more leverage than previously thought should it ever decide to intervene in the internal affairs of the Irish economy.

In the meantime the government seems determined to postpone any politically difficult spending decisions, at least until after the European and local elections in June and the second Lisbon referendum, now likely to be held in either September or October.

Deferring politically tough decisions

The so-called Bord Snip Nua, the committee chaired by UCD economist Colm McCarthy, which is supposed to review public spending, had no significant input into the 7 April fiscal package. The official line is that its recommendations will form part of the 2010 budget to be unveiled next December.

The report of the Commission on Taxation chaired by former Revenue Commissioners boss Frank Daly, which is due to be published in mid-year, has also been used as an excuse to kick politically-awkward decisions into the long grass.
And why is the government so reluctant to get serious about tackling public spending? That’s an easy one; with the public sector pay and pensions bill now running at over €20bn, almost two-fifths of this year’s likely public spending total, any package of public spending cuts that doesn’t address the pay and pensions bill won’t be worth the bother.

Which is why the government, desperate to avoid antagonising the public sector trade unions, will postpone making any unpalatable choices for as long as possible. The fact is that, with private sector wages either frozen or falling, the average public sector salary of more than €49,300 per year is completely over the top and needs to be cut substantially.

Public sector numbers, which have risen by 95,000 since 1997 when the effect of the Aer Lingus and Eircom privatisations are taken into account, also need to be drastically pruned.

Unless and until the government begins to tackle this huge overhead in a meaningful way we will know that it isn’t serious about restoring order to the public finances. Don’t hold your breath.

 

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