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Tuesday, 23rd April 2024
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McCreevy mark II: A new and improved model? Back  
In the Finance Stockbroking Survey 2002 Colin Hunt was voted ‘Best Economist’. Finance invited him to examine the economic outlook for Ireland in the aftermath of Budget 2003.
The Minister for Finance’s sixth budget stands in marked contrast to the look, feel and impact of his previous fiscal efforts. Perhaps, it was inevitable that this would be so given the change in the prevailing economic environment, the scale of uncertainty about the global economic outlook and the distance of the next general election campaign.
However, the Minister and his Cabinet colleagues chose to react to these environmental features in a manner out of kilter with the budgetary stance of the previous administration. Rather than pursuing the tax-cutting agenda ruthlessly, realpolitik seems to have forced something of an about-turn with the tax burden allowed to increase in real terms to fund social welfare increases (good) and the partial implementation of the Benchmarking Report (bad).
To be fair to the Minister, he deserves our fulsome commendation for returning stability to the public finances. His prime responsibility in this Budget was to align spending growth with the changed economic reality. He clearly has the ambition to meet this responsibility with the estimates targeting a 2 per cent increase in total expenditure. Delivery is another issue entirely and already the Budget has increased that target growth rate to 7.7 per cent in terms of net total expenditure. However, the Minister is making all the right noises and it is highly probable that the years of spectacular spending over-shoots have come to an end. The target of a general Government deficit of 0.7 per cent of GDP is prudent, realistic and achievable.
Those of us who are concerned about the medium-term health of the Irish economy can only welcome the partial re-engagement of spending policies with reality. Expenditure growth in excess of the economy’s nominal growth rate will always and everywhere lead to deterioration in the fiscal position or an increase in the tax burden. If the Minister had wanted to consolidate the existing taxation regime (a highly desirable objective in itself) without putting undue strain on the deficit position, he would have limited total spending growth to some 6 per cent.
However, with the benefit of hindsight, it is clear that such parsimony was never a realistic prospect. The need to secure agreement on a successor to the PPF appears to be impacting heavily on budgetary policy this year. Without provision for the partial implementation of the Benchmarking Report, there would be no point in the Government even turning up for the negotiations on the next partnership deal. Consequently, the revenue side of the fiscal equation was required to take some of the strain.
I am wholeheartedly opposed to the implementation of the Benchmarking Report on issues of equity, necessity and affordability. It is impossible to accurately compare the remuneration of the private and public sectors given the variable nature of the employment risk premium over the economic cycle. How does one put a value on two of the central elements of public service remuneration, namely security of tenure and guaranteed pension rights? When the labour market is tight, private sector employment bounteous and equity valuations soaring, these features have little current value attached to them. Things change of course when economies flirt with recession and equity markets crash and the attractions of public sector employment increase exponentially. Equity suggests that there is no case for an upward adjustment in public sector remuneration when, including non-pay elements, it is already more attractive than most private sector packages.
This point is brought home clearly by looking at employment trends. As the Minister for Finance himself pointed out on Budget day, the numbers employed in the public service have increased by about 50,000 during the last five years. Despite the unprecedented buoyancy of the economy and the attractions of the private sector’s supposed lucre, the State experienced no difficulty in recruiting staff.
If the public sector was heavily underpaid at a time when unemployment was well below its natural rate, surely there would have been a flood of public sector employees seeking opportunities in private enterprise while nobody in their right mind would seek public employment. In fact, the official data suggest unequivocally that pay and conditions of employment did not act as barriers to the untrammeled growth of the numbers at work in the public sector.
Finally, we come to affordability. Let’s agree that large-scale borrowing is not a serious runner and that the fiscal policy dilemma refers to the choice of higher spending or lower taxation. Of course, during the years of plenty the rules of economics were suspended and no choices had to be made. We could have it all and frequently did in budgetary matters. Going forward, with growth returning to Ireland’s sustainable trend range around 4 per cent, choice is once again a feature of budgetary management. If we want to spend more, we must tax more. It is as simple as that.
The Minister for Finance has indicated that, subject to agreement on a successor to the PPF, the first phase of Benchmarking will be implemented with a total price tag of E565 million. Full implementation will cost E1.1 billion, which is equivalent to just over 4 per cent of 2002 net current spending. The decision to provide the funds for the first implementation phase of Benchmarking led directly to the stealthy increase in the tax burden in Budget 2003. Full implementation of this unwarranted pay increase will inevitably lead to further tax increases in Budget 2004.
Speaking of tax increases, the non-indexation of bands and the personal tax credit combined with the array of excise duty rises will reduce real disposable income growth in 2003. At a time when the economy is in need of the ongoing support of the consumer, budgetary changes will act to dampen retail activity and overall GNP growth. A continuation of the supply-side policies which have driven and accommodated Ireland’s remarkable growth performance since 1987 would have seen the Government cutting taxes openly rather than raising them stealthily in Budget 2003.
The tax increases will also add at least one per cent to the rate of inflation at a time when it is already high by European standards and is stubbornly refusing to dip sustainably below 4.5 per cent. Consumers and investors should brace themselves for the appalling vista of an inflation rate above 6.5 per cent when January 2003’s consumer price data are published next year.
Of course the corporate sector did not escape the rummage for resources. While higher general inflation rates will erode competitiveness, corporate entities will have to deal with the impact on the wage-setting process of higher public sector remuneration. The reduction in the rate of capital allowances on plant and machinery will also have a detrimental effect on cashflow while the abolition of roll-over relief will act as a disincentive to investment.
Some will argue that companies can well afford such increases given the reduction in the rate of corporation tax to 12.5 per cent. Indeed, other misguided souls believe that companies should compensate the Exchequer for the reduction in corporation taxes by paying higher non-corporation taxes. I can’t quite get my head around this particular viewpoint. I thought that we were in the process of reducing corporation taxes to 12.5 per cent because we believed in the wondrous powers of low taxes. You either believe in low taxes or you don’t. Simultaneous giving and taking away does not amount to a coherent economic philosophy.
This sort of woolly thinking leads neatly to the subject of the bank levy. Some readers, conscious of my employer’s ownership structure will immediately discount my thoughts on this subject. Please bear with me and consider the levy from a logical viewpoint. Why should one industry be singled out for special treatment? Why should one industry pay a higher effective tax rate than all others in the economy? The ludicrous nature of the bank levy is more exposed by the continuing favourable treatment afforded to the bloodstock industry which makes a far less significant contribution in both employment and value-add terms to the well being of the Irish economy.
While the Minister deserves to be congratulated for returning stability to the public finances, I believe that an opportunity to complete the transformation of the Irish tax system has been missed. More worryingly, the budget marked an about-turn from the policy of recent years with spending needs dictating revenue requirements. It was a budget devoid of radicalism, reform and philosophy. The nip and tuck school of economic management is regrettably in the ascendant once again.

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