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Budget Analysis ROI

The Minister for Finance certainly faced an unenviable task today.  The idea of trying to take some €4bn, equivalent to 2.5% of GDP, out of an economy contracting at a record pace with the unemployment rate at a near 15-year high must be every politician’s nightmare.

But in fairness to the Minister, he did deliver on the required adjustment.  Well, very nearly.  To be precise about it, today’s Budgetary package actually fell a touch shy of the planned, and much rumoured, €4bn, with the Minister arriving at a headline figure of €4bn by combining pre-Budget savings on Live Register costs (specified in last weekend’s White Paper) of over €200 million with a combination of measures in the Budget itself of about €3.8bn.

The Bigger Picture

But this is a relatively minor point in the big scheme of things.  Indeed, it is worth taking stock of the enormous effort which has already gone into addressing the imbalances in the public finances.  In all, today’s Budget represents the fifth initiative, a process which began in the summer of 2008 with some spending pull-backs at that stage followed by the October Budget in that year. Then in January of this year the Department of Finance unveiled a further update on the fiscal strategy, in turn followed by the public sector pension levy a month later and the Emergency or Supplementary Budget in April.

In total, this series of measures summed to a whopping €8bn in terms of the impact on the 2009 fiscal position.  In other words, had the Minister not taken the steps above, the 2009 deficit would have been of the order of 17% rather than the 11.7% which now looks likely, bad and all as that is.  While one can argue and debate about the piecemeal and at times seemingly ad-hoc nature of the approach at times, the scale of the response is very much deserving of recognition and credit.

Viewed from a macroeconomic perspective, we also regard today’s installment as broadly a development to be welcomed.  In particular, it is very welcome indeed that the overwhelming focus of the €3.8bn savings was on the spending side.  The €1bn cut in the capital spend had been well-leaked.  While such spending can and does provide valuable stimulus to a seriously under-heating economy, the significant decline in the capital requirements of an economy operating so far below trend, combined with large-scale declines in tender prices in the construction sector, makes this decision a reasonable one in the circumstances.

In a relative sense, turning the taps off on capital spending is a straightforward task as it is notoriously difficult to achieve large savings in the typically much more sensitive arena of day-to-day expenditure.  But the Minister grasped this nettle today.  The €1bn reduction in the public sector pay bill was in fact a bit lower than the €1.3bn which had been flagged but has nonetheless generated much anger in union circles.  However, prevailing pay differentials between public and private sectors and the severe adjustment being borne by exposed sectors of the economy (total employment across the economy is down over 8% over the past year, while it is actually up some 3% in government-linked sectors) provide ample justification for today’s move in our view, as undesirable as it is to have to introduce such measures.


Like the capital programme, the cutbacks (of €760 million) in social welfare had been well-signalled.  Cutting unemployment benefits and child benefit is never going to be popular to put it mildly, even if the changes in the former will at the margin help improve incentives to work. The Minister’s intention had been to improve the fairness of the child benefit system by either making it taxable or means-testing it. However, that proved impractical so, for now at least, he has had to resort to the blunt approach of reducing the rates. While it won’t provide much comfort to those affected, the fact that there has been a 6.7% fall in the Consumer Price Index over the past year or so (and a 3.4 fall in the HICP – European Harmonised – measure of prices, which excludes mortgage interest costs) does help to cushion the blow of such initiatives, as the impact in real-terms is correspondingly mitigated.

The Minister also managed to achieve total savings of around €1bn in general day-to-day spending, about 40% of which comes from Health.  The focus here is on efficiencies rather than cutbacks in service levels, with the McCarthy Group recommendations proving helpful guidance no doubt.  The introduction of a prescription charge of 50 cent per item under the medical card scheme is a visible, if contentious, move in this regard.

On the tax side, it was very welcome indeed that the Minister stuck to his guidance and refrained from adding further to the income tax burden having targeted this area aggressively in previous Budgets, especially in April.  The fear of a removal of the PRSI ceiling thus proved misplaced as it turns out, though there was a further restriction of reliefs for very high income earners.


The inevitable carbon tax materialised.  Headlines here included an extra 4.2 and 4.9cents on the price of a litre of petrol and diesel respectively, with the total yield from this area at €250million for next year.  This gave the Minister scope for reductions in other areas, notably a surprise, and welcome, reversal of the previous 0.5% hike in the VAT rate which goes back down to 21% with effect from January.  Excise duties on alcohol were also lowered and should help stem the tide of cash crossing the border, albeit that the exchange rate, clearly beyond the influence of budget policy, will remain a major influence on patterns here. The car lobby will be pleased with a car scrappage scheme even if economists tend to be sceptical about the lasting benefits of such schemes.

There was no provision for additional recapitalisation of the banking system, presumably at least partly reflecting some hope that private resources can be brought into the equation.  But the minister did establish a credit review system to include lending guidelines to banks and an appeals procedure for cases where businesses have an application for credit refused.

The overall thrust of the budget is welcome. It represents another very important contribution to the absolutely necessary process of stabilising the public finances. In particular, the overall emphasis on reducing spending rather than adding further to the burden of income taxation is very much the appropriate one.

Problems Still Loom

It is certainly the case that Budget 2010 distributes an awful lot of pain but the reality is that the scale of the problem is still huge.  For example, the Department of Finance estimates that about three-quarters of the near 12% of GDP deficit for this year and next is ‘structural’ in nature.  In other words, the vast majority of the deficit won’t simply go away even if the economy begins to grow at normal rates again.

This carries the uncomfortable implication that, as painful as everything that has happened to date on fiscal policy has been – including in this latest Budget – there is more to come unfortunately.  In particular, the outline of the plan for the coming years involves a further €3 billion of cuts in next year’s budget, with a further €5bn or so in the subsequent three years.  While this definitely won’t sound like great news, it does actually represent a considerable improvement – of around 3 billion euros on a cumulative basis – compared to what the April Budget had envisaged.

Compared to that version of the plan, it seems that the Department has been able to find material savings in areas including capital spending (helped by lower tender prices), the Live Register and debt servicing costs and higher non-tax revenue including from the charges to the Banks under the Guarantee scheme.  The fact that the planned correction is now to take place out to 2014 rather than 2013 also helps in the lowering of the required annual adjustments.

Reducing The Deficit

So all going to plan the deficit will be down to the much more manageable level of 2.9% in 2014, bringing us back to within the limits set by the Stability and Growth Pact. Of course, how the economy evolves will have a major bearing on the trajectory of our deficit and debt profile in the years ahead.  The Minister envisages a contraction in GDP on average next year of 1.25% (roughly in line with the prevailing consensus) but has a punchy enough set of growth forecasts thereafter, with an average rate of GDP growth in the 2011-2014 period of over 4%.  That kind of scenario is certainly not implausible considering the scope for a rebound from the lowly levels of activity at present.  But it might have been more prudent for him to plan on the basis of something a bit more conservative (our own working assumption is for growth around 3.5% in those years).

In any case, even if the Minister’s scenario comes to pass, there will still be a need for further consolidation in the years ahead.  We note that the actual announcement of the much flagged cut in the public sector pay bill has intensified strains between the public sector unions and the government.  The intention to reform pension arrangements in the public sector also announced today, along with the need for further savings in day to day spending will likely see tension levels between the government and the social partners remain high over the coming year.  The months ahead are likely to provide the sternest test yet of the Social Partnership approach to policy formulation in Ireland.

With thanks to Simon Barry, Ulster Bank economist