The latest Exchequer figures are out today, and the headlines talk about tax receipts and government spending down. Scratching the surface, though, most of the falls seem in line with expectations. So where are we? Three months on from the toughest Budget in a generation, it’s time to take stock.
The best place to start is the big picture on Ireland’s government finances. In 2007, gross expenditure by the state was €63bn, while gross receipts were €61bn. This year, expenditure will be €69bn while receipts will be €50bn. The fall in revenue has been driven by tax receipts, which have actually fallen by €16bn and have been offset by other forms of revenue, including levies. The increase in expenditure is accounted for by increased social welfare payments (up €5bn) and debt servicing (up €3bn).
The 2010 deficit, therefore, is estimated to be €19bn. Expressed in relative terms, the deficit is 11% of our national output. Only the UK and Greece have bigger deficits. Ireland’s 2009 deficit – excluding the (one-off?) €4bn ploughed into Anglo – was €21.5bn. So we can see that Budget 2010 was certainly a step in the right direction but we’re not there yet. Not by a long shot.
First, a bit of good news. Figures out last week show that 2009 spending came in €360m less than what the Department of Finance expected at the time of the Budget. Even more encouraging, this was spread across all major areas of expenditure, except social welfare, which is to be expected, given unemployment. All things considered, the overall result was a €300m improvement in the deficit for 2009 – that’s 2% of the way there for free!
Last week, Minister Lenihan announced that he wants to bring about cuts of €3bn in 2011, to further reduce the deficit. The Minister has highlighted two areas of savings: €1bn from capital spending, and €2bn from an as-yet-unspecified mix of spending cuts and tax increases.
Unfortunately, cutting €3bn does not bring about a reduction of €3bn in the deficit. For one thing, “odd” forms of revenue – in particular levies from the banks – are estimated to be particularly high this year. Expecting €3bn from such sources in 2011 – rather than the €4.5bn of this year – undoes some of the good work. Also unhelpful is the logical consequence of large deficits – servicing the national debt. Money spent paying back our growing national debt is likely to rise from €4.6bn to €5.8bn in 2011. The painful truth is that, when looked at in conjunction with other developments in State finances, the Minister’s proposed measures worth €3bn would leave the deficit almost unchanged next year.
What is the plan for the next five years? In December, following Budget 2010, I outlined a scenario for the next five Budgets that would reduce the deficit from €19bn (or 11% of output) back to what the EU has demanded, about €7bn (or about 4% of output). It involved a lot of productivity improvements in the public sector, as well as relying on average growth of 2% from 2011-2015. How does it stack up now?
Put bluntly, after grasping the nettle of public sector pay in Budget 2010, there are now eight further things the Minister for Finance, whoever it may be, needs to do between Budget 2011 and Budget 2015. Three are in relation to taxes, while five are expenditure-related. These are:
- Bring Ireland’s income tax system back into line with our OECD peers, by taxing the average earner 20% of their income, not 2%
- Replace the growing menagerie of levies and social contributions with a single, easy-to-understand and easy-to-apply social solidarity levy (see below)
- Replace stamp duty with a sustainable property tax that promotes investment by homeowners in their property and prevents land hoarding or speculation
- Achieve €2bn in efficiencies on the money spent on Social Welfare and FÁS (currently €22bn)
- Maintain an appropriate level of investment in future-proof infrastructure
- Bring about significant and ongoing annual productivity improvements of 5% in expenditure on health (€3.5bn savings in total)
- Bring about significant and ongoing annual productivity improvements of 5% in expenditure on education (€1.9bn savings in total)
- Bring about significant and ongoing annual productivity improvements of 5% in expenditure on other public services (€2.5bn savings in total)
On the spending side, this involves cutting current expenditure from €55bn to €45bn. In other words, each and every year until 2015, annual savings of €2bn must be found, well above what the Minister has in mind even for Budget 2011. Assuming further pay-cuts are not an option, from an industrial relations point of view, this means that significant productivity improvements will be required.
On the taxation side, there have been few signs that anything will be done about income tax changes or the new property tax. The ‘social solidarity’ levy, however, is likely to be introduced in Budget 2011 and will more than likely be the source of the €1bn in new tax revenue the Government will seek in 2011. What will its introduction mean for average workers?
Currently, there are a variety of health, income and PRSI levies, and cumulatively they mean a total tax rate starting at 4% for someone on €10k rising to about 12% for those on incomes over €75k. (This is entirely separate to income taxes.) To raise an extra €1bn in revenue, the social solidarity tax would have to be structured something similar to the following lines:
- 0% on those earning less than €10k,
- 8% for those on incomes of €10k-€25k,
- 10% for those on €25k-€75k, and
- 13% for those earning more than €75k
The important thing to note is that for most full-time workers, the rate would stay at 10% – exactly what it is now when adding up health and incomes levies and PRSI. In other words, the damage done in the last two years is here to stay but should not get much worse. The reason the State would get €1bn more is that various anomalies at the two ends of the income distribution would be removed.
One important thing to note is the size of this new income source for the government. A consolidated and expanded social solidarity would bring in close to €16bn next year, compared to about €15bn for direct taxes (income tax and corporation tax) and indirect tax (VAT). The graph below shows the business end of Exchequer finances, revenues from direct, indirect and “social solidarity” sources, as well as four key spending areas: social welfare, health, education and debt service. Notice that we will be spending more on debt servicing than we will on education by 2015 – and that’s grasping the nettle. Without large-scale action on the deficit, debt servicing could overtake spending on health by then.
If, in Budget 2011 this December, the Minister were to raise €1bn each from a social solidarity levy and cuts in capital spending, and €2bn from productivity improvements in the public sector, rather than the €1bn currently pencilled in, the good news is that it would almost certainly be the toughest budget in the current crisis. (I will easily forgive readers who could have sworn they’d heard that one before.)
The bad news is that it would more than likely only just win that title. The deficit would have to be reduced by an average of €2.5bn every year each year between 2012 and 2015, in order to get our books back to the kind of imbalance acceptable at EU level.