Five things to remember when judging Budget 2010

Today is B-day, the day when the most anticipated and, I don’t think it’s unfair to say, the most dreaded Budget in at least a generation will be unveiled. Taxpayers are dreading higher tax bills, public servants fear more cuts in their pay while those in receipt of public services fear that these will be cut back. No doubt the government itself is not particularly looking forward to the public reaction to its decisions.

The entire gaggle of Irish economists would, I’m sure, be relatively confident in predicting that most households will be in some way worse off after the Budget. However, the Budget must be not only judged on what it does for you, to paraphrase JFK, it must also be judged on what it does for the country and our future. Here are five things to bear in mind when judging how good the Budget is for Ireland Inc:

1. This is only the first step on a long journey back to Exchequer balance. The graph below shows Exchequer expenditure and receipts from 2002 on, including projections given in Budget 2007 for the period 2007-2010. As you can see, expenditure this year has exceeded even boomtime projections, despite all the cuts made, while tax revenues are more than 40% below what the government expected them to be.

2. Spending has to get back in line with what the government can realistically get out of the economy through taxation. Very few people, looking ahead to 2010, would have thought that tax revenues could double in a sustainable way, between 2002 and 2010. Yet the government continues to spend on this basis. This year, Ireland’s government will have the unenviable tag of being the largest in the EU, relative to the economy that it manages. The increase in expenditure by the government has continued into 2009 and gains more impetus as debt servicing grows as an item of expenditure.

3. The longer the adjustment takes, the worse things get. Of all EU countries, Ireland should remember this better than most. Service of the national debt is projected to almost double next year to €4.62bn. In 2008, the figure was less than €2bn. That €3bn is money that has had to come out of public services – if a reasonable chunk of the McCarthy Report were implemented, we would have saved enough to just pay the interest on our new debt, i.e. we’d be running to stand still.

4. Capital spending should not be forgotten in all this. In 2007, the Government spent about four times as much on current expenditure (generally wages for public servants and their suppliers, as well as social welfare) as it did on capital expenditure (essentially infrastructure that pays the country back over a long period). In 2010, it’s projected to be at least 6.5 times as much, as capital expenditure falls from €11bn in 2008 to less than €8bn. In fact, the fall in the red line above in 2010 is due not to cuts in current spending, which will rise next year despite all the government is doing, it is due to a substantial reduction in capital spending. (In particular, it is due to having bought Anglo-Irish Bank in 2009.) The overall rule is that while current spending is certainly important, capital spending is how we lay the foundations for our future. Not investing in the future will have obvious results.

5. The structure of the taxation system is also important. No-one is arguing that we can, let alone should, return to 2006 when stamp duties and capital taxes provided 16% of our revenues, but there is a danger in over-reliance on income taxes, which seems to be the only lever under discussion. Income taxes typically have provided about 30% of the Government’s tax revenues. Next year, they will provide much closer to 40% (actually 37.5%). In absolute terms, the picture is not as alarming. The Government expects to take in €12bn in income tax next year, compared to €11.4bn in 2005. However, the income tax system is incredibly over-reliant on those with high incomes, while two thirds of earners paying hardly anything in tax.

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All the major decisions for today have already been made. In addition, a lot of the focus today will be on public sector pay levels, public service cutbacks, child benefit and income tax rates. For what they’re worth, though, here are three smaller things to look for in Budget 2010:

• A temporary discount in the VAT rate, to counterbalance all the cuts reducing demand in the economy – a 1-year reduction by two percentage points in the top two rates would cost €1bn in a worst-case scenario (i.e. if it had no impact), while if it did indeed bring about a boost in consumer demand (as it has elsewhere), it would start becoming a costless or optimistically a revenue-generating measure.
• A definitive plan for property taxes; while the Minister for Finance shouldn’t be expecting 15% of his tax take to come from property and capital gains, 10% is certainly a more realistic target but one that should not depend on transactions. Announcing a new universal property tax, based on land value, to come in on 1 January 2011, with appropriate discounted tax credits for those who bought at any point between 2001 and 2010, would put in place one of the foundations for a healthy property market and a healthy level of government finances therefrom.
• A reduction in universal tax credits; before considering a third rate of tax on higher earners, or perhaps more realistically alongside such a measure, the Government should reduce the universal tax credits, with a view to getting the typical worker to contribute closer to 10% of his earnings in income tax. This level would make keep the hiring workers very attractive in Ireland but would broaden the tax net.