A month on and on the face of it, Budget 2012 was a bit of a Houdini-style magic trick. How could the Government possibly achieve a correction of between €3.5bn and €4bn in the public finances without changing headline rates of income tax or social welfare? In fact, how could they do it when the single biggest measure in the Budget, the increase in VAT to 23%, would just about break even, according to their own forecasts? The only thing people are really complaining about is a household charge that will at best raise just €150m, a rounding error in the grand scheme of things – and people are only really complaining because it’s such an unfair tax.
Phantom Income, Phantom Jobs?
The problem with a magic trick, though, is ultimately it’s nothing but a bit of sleight of hand and misdirection. And that is what Budget 2012 is, both in receipts and in expenditure. Let’s look at receipts first. When it comes to government revenues, there are effectively six main headings:
- taxes on consumption (in particular VAT and Excise),
- taxes on income (both personal and corporate),
- other taxes (in particular stamp duties)
- social insurance (in particular PRSI)
- other current receipts (that departments receive doing their day-to-day business)
- and then some various other current and capital receipts (e.g. EU transfers, Central Bank income and even interest on our loan to Greece)
The Government has judiciously assumed that most of these are going nowhere next year: even with the higher rate of VAT, consumption tax revenues are only predicted to grow by 1%, as are revenues from other taxes. Social insurance receipts are projected to fall. And yet – out of nowhere – direct taxes are projected to grow by 7% or over €1.3bn to €18.9bn. This is being driven entirely by projections about income tax, which is expected to grow by almost 10% in 2012.
Bear in mind that tax credits were not changed, nor were the headline rates. So how would this stack up – where will this extra €1,250m in income tax come from? This would only stack up in two scenarios. The first is that everyone’s income grows by 10% next year. “Not bloody likely!”, says you, so I think we can rule it out. The second is that employment grows. How many extra jobs would we need for the Government to meet its targets?
Let’s assume that two types of job are created in equal measure: high-skill jobs, where the salary is €60,000 and more tentative new jobs for those with fewer skills or years of experience, where the pay is €30,000. Let’s also assume that the typical job is created in June (a rough way of saying that not every new job will give 12 months of taxes to the Government in 2012). This means that over the six months, the typical high-skill job will generate €7,200 in income tax and about €1,800 in USC. The other job will generate €3,000 in income tax and a further €700 in USC (all figures thanks to HookHead’s tax calculator).
So without any changes to the tax code, and barring unforeseen growth in incomes, for the Government’s figures to stack up, the economy will need to generate an extra 100,000 high-skill jobs and the same number of lower-paying jobs! Economists are often criticised for making heroic assumptions but surely we’re in the ha’penny place when it comes to this. Really does the Government really believe this is going to happen?!
Clearly, it won’t all come down to jobs growth. As last week’s controversy about older people paying their fair share of tax shows, there is some income that is not being taxed fully at the moment and doing so may generate some extra one-off and recurring revenue. But even as the year only starts, the idea that even a hundred thousand new jobs might be created this year seems far-flung. And without that and without any other measures to boost income in any substantial way, it seems pretty clear that the Government’s revenues are going to fall next year, not rise.
Spending: the usual suspects
There is any number of ways of divvying up how the Government spends money. Two key distinctions to understand are current vs. capital (capital leaves an asset, current does not) and voted versus non-voted (non-voted is effectively done outside the Budget, i.e. no element of choice for the Government of the day). My preferred classification has eight main headings:
- Social welfare
- Health (and children)
- Education (and skills)
- All other current expenditure
- All capital expenditure
- Servicing the national debt
- Bank recapitalisation
- Other “non-voted” expenditure (both current and capital)
As the graph below shows, almost three quarters of all expenditure in 2012 will be current: €52bn out of €71bn. (Quick note for those interested in reading through the budget.gov.ie 2012 reports themselves: always work in gross figures even though the Government insists on working in net figures!) The remainder is made up of €4.4bn in capital spending and €15bn in non-voted expenditure, which in 2012 includes €7.5bn on servicing the national debt and €4.4bn on bank recapitalisation.
The Government of the day has no say in non-voted expenditure (at least not without major fuss such as international defaults), so we can set that aside. And as I’ve pointed out before, there really is no more scope for cutting the capital budget. More importantly than that, provided capital spending is done according to proper cost-benefit analysis, deficits due to capital spending do not matter – the deficit that matters is the one on current spending (including national debt repayments).
So when it comes to closing the deficit, we need to get the €66.8bn in non-capital expenditure back down into line revenues of just €51.2bn. Realistically, if we ignore the bank recapitalisation as finite deposit insurance that is added to the national debt, this is about closing to zero over the next five years the gap between current spending of €62.3bn next year and receipts of €51.2bn.
To give you an idea of the scale of the challenge, it is expected that gross expenditure by the Government will be €1.2bn lower in 2012 than what was budgeted for 2011. To give you an idea of the strategy so far, the pie-chart below shows you which of the four areas of expenditure has contributed to these savings. The share of expenditure is shown in brackets in the chart’s legend.
All current expenditure outside the areas of health, education and social welfare constitutes about one sixth of all spending but has made up almost two thirds of the cuts. Clearly, this can’t go on. You could scrap every single one of these departments, from Taoiseach’s right down to Arts & Heritage and you still wouldn’t have cut current spending by enough to balance the books.
So if the country is to avoid bankruptcy, it needs to face up to the harsh reality: spending on the poor (social welfare), the young (education) and the old (health) will have to be reformed. One giant step in that direction would be to make all income from any source – including jobseekers allowance, children’s benefit or the statutory pension – should be taxable. Ironically, given the discussion above, doing this would actually significantly boost income tax receipts, perhaps not by the equivalent of 200,000 news jobs – but it would make sure that those who earn enough anyway pay their fair way. And perhaps even more importantly than that, there would be no welfare trap.