January 5th Lunchtime: The Recession Diaries

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Here’s one, of many, New Year resolutions I will undertake: in the future I will not be blase about the deteriorating fiscal situation. I don’t think I have been but several readers have contacted me, suggesting I should work a little bit harder on this issue lest my out-riding Keynesianism becomes so detached it becomes meaningless as a basis for recovery. For there is no doubt – recessions don’ t go on holiday. Over the Christmas season even worse data has came out and none worser than the meltdown in budget numbers.

The Taoiseach has suggested the Exchequer deficit this year could be of the order of €16 billion. This corresponds to the ESRI’s projections. To put this into context, in 2007, the deficit was only €1.6 billion while in 2006 the budget was actually in surplus. What a turnaround.

This has two consequences for any stimulus package based on borrowing. While at the start of this recession we had the benefit of an overall low level of debt (less than 25 percent of our GDP – one of the lowest in the EU and well below the EU-average of 60 percent), that advantage is being quickly whittled away. The National Treasury Management Agency (NTMA) has published it’s 2008 preliminary report showing that our debt level has risen dramatically within a year – up to 41 percent of GDP, or €50 billion. Next year, it will get worse. Using the Government’s now redundant budgetary projections, borrowing will increase by, at least, €18 billion (deficit plus government bond maturing). With the meltdown, it will go higher. By the end of this year, our debt level will be nearly double over that of two years ago. In short, borrowing is out of control.

Another feature of this escalating debt is the rising level of servicing the debt. A year ago, the cost of servicing our debt was only slightly higher than the rates paid by Germany – 0.2 percent more. Today, that gap has widened considerably to 1.3 percent. It may not seem like much but when you are borrowing billions it adds up considerably (nearly €1 billion annually by the end of the year). But that’s even if we get the chance to borrow. Only recently, Germany had severe difficulties selling its debt on world markets. With Ireland burdened by the bank guarantee, never mind a sense that the budget is out of control, we may find ourselves wanting to borrow but few investors willing to lend – and only then at an inflated rate.

Given this, what are the chances that we can borrow our way out of this mess? Limited, to say the least. There is no doubting that given the collapse in the budgetary arithmetic we will have to repair the damage at source. The Government and Fine Gael, backed up by the employers, are already demanding drastic cuts in direct government expenditure. Well, we could abolish the Department of Education and set up hedge schools at the crossroads. Of course, that would only save about half the General Government deficit but actually a lot, lot less (all those teachers queuing in the unemployment lines).

We could slash social welfare rates by half. Didn’t the Free State Minister Patrick Gilligan suggest that ‘people may have to starve’ for the Government to balance its books? Now that’s taking tough decisions. And we wouldn’t have the Combat Poverty Agency giving out because, hey, they don’t exist anymore. Still, this would only reduce the deficit by only a quarter.

Okay, a bit tongue in cheek. The point is that reducing government expenditure will make only minor inroads into the deficit and, when account is taken of the deflationary effects on the economy from such cuts, not much at all. We could resort to general taxation but, again, the deflationary effects may mitigate most of the gain – never mind screwing down people’s living standards even further. We could increase the standard tax rate an incredible 10 percent and that would only represent a third of the deficit. And in the meantime you can say good-by to most of the retail sector for no one would have any money to spend.

Anywhere we turn, we are in a world of pain. But rather than curse the darkness, let’s start lighting some candles. Over the next few weeks I will be canvassing a number of practical approaches to addressing the deficit. Let’s start with one area: tax expenditures. According to the Taoiseach:

‘I’ve said we’ll put all items on the table – that includes all items of expenditure, that full €55 billion that we’re spending which is, as I’ve said, in excess by, next year, €15 billion or €16 billion of what we would take in, and that’s based on present predictions. It is not a sustainable position for us.’

This is disingenuous. The state directly spends €55 billion but it spends a considerable amount in tax expenditure – reliefs, allowances, credits, exemptions. The last year we have information for – 2004 – shows the following:

  • Government current expenditure: €33.8 billion
  • Government tax expenditure: €15.1 billion

Tax expenditure made up 45 percent of current expenditure. But the Revenue Commissioners’ figures for the cost of tax relief doesn’t include all expenditures – there are many which they have no estimates for (e.g. exemption of lump sum retirement payments; reduced tax rate of 10% for authorised unit trust schemes and special investment schemes; relief for various business related expenses such as staff recruitment, rent, legal fees, and other general expenses; etc.).

Not only is tax expenditure rising (the cost of mortgage interest relief has more than doubled in the last three years, now costing nearly €645 million), many of the schemes are highly regressive. Take contributions to annuity contracts and PRSA’s: in 2005, over 66% of the cash subsidy under these schemes went to those earning €100,000 or more; or nearly €250 million. Might this be one of the areas that the Taoiseach will put on the table?

Much of tax expenditure goes on uncontestable reliefs and credits (personal credits, for instance, but these only make up about a fifth of all such reliefs). However, much is clearly contestable – if not the principle of any particular scheme, then the manner of it’s operation and redistribution.

For clearly, there are considerable savings to be made here. And if we were to curtail reliefs to high income groups, we could generate considerably more savings than savaging health and education, while minimising the impact on the economy; high income groups can more easily absorb it and little demand would be withdrawn from the economy.

If the Taoiseach is honest about putting everything on the table, then the first port of call when it comes to ‘controlling expenditure’ would be a line-by-line examination of each and every tax expenditure – ensuring that such monies benefit low and average income groups and benefit the productive sectors of the economy.

Who knows – Brian C. could become the new Robin H.

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