contd....
Curtail public spending
In the years of plenty, you were not a fan of a counter cyclical fiscal policy. ‘When you have it, you spend it’, you were fond of telling the nation. You added the rider, though, ‘that the mistake is to try to spend it when you have not got it’.
You certainly liked to spend it during the good times. Gross voted current expenditure has grown at an average rate of over 15 per cent per annum in the last four years. Expenditure under the Public Capital Programme has grown at over 20 per cent per annum in the same period. This robust growth in public spending was funded by strong tax revenue buoyancy initially, and, more recently, by raids on surpluses in various State funds.
The party is now over, though. Growth in tax revenue has turned very sluggish while the surpluses on various State funds have been largely used up. If Ireland is to stay within the terms of the budgetary provisions of the EU Growth and Stability Pact, then either growth in spending must be severely curtailed or taxes will have to rise quite sharply.
Income and corporation taxes are unlikely to be hiked by the present government. There is some scope for increasing indirect taxes, although this would add to inflation. Thus, the emphasis in the forthcoming budget needs to be on curtailing growth in public spending.
Curtailing growth in public spending largely means controlling current spending. Voted capital spending accounts for only 14 per cent of the total exchequer expenditure. To maintain stability in the public finances, the 15 per cent growth rate of gross current spending in recent years needs to be cut by half to around 7.5 per cent. Note, this does not mean a cut in total spending, even in real terms. What it implies is that the rate of growth in public spending needs to be reduced significantly.
Public sector pay accounts for 40 per cent of gross current supply service spending. The public sector pay bill has risen by 45 per cent in the past three years, reflecting both a larger increase in the numbers employed and strong growth in earnings. If growth in current spending is to be damped down, it means that growth in the public sector pay bill will need to slow sharply.
Benchmarking, obviously, presents a formidable challenge in this regard. The benchmarking report, which has been accepted by the government, recommends special pay increases for public sector workers, averaging around 9 per cent.
The political reality is that these pay increases are likely to be implemented in full. On top of this, annual increments and general pay increases have to be allowed for. Hence, average earnings in the public sector seem likely to continue growing strongly in the next couple of years.
Thus, it seems that the only way to curtail growth in the public service pay bill is to put a cap on, or even to reduce, the numbers employed in the sector. Such a cap, though, should not be applied crudely across the public sector. Some areas should see increases and others reductions in payroll numbers.
In terms of non-pay expenditure, all government schemes should be reviewed. There can be little doubt that after years of rapid growth in public expenditure, there are many areas of excess and inefficiency in spending programmes. These programmes, which often take on a life of their own, need to be ruthlessly examined to see whether they should continue to command scarce resources.
You can squeeze a bit more from indirect taxes on budget day and push up various fees and prices, here and there, to help balance the books. The bottom line, though, is that the present growth rate of public spending is simply unsustainable. To maintain order in the public finances, you must bring the growth rate of public spending down into line with the growth rate of tax revenue and the economy in general.
The alternative is to push up taxes significantly. However, pushing up taxes and allowing continued strong growth in public spending will only add to inflation, thus further eroding the competitive position of the economy.
Indeed, the experience of the past is that high taxes and high public spending were accompanied by an underperforming economy. The last election did not suggest any great appetite to return to those days.
Oliver Mangan is chief bond economist, at AIB Group Treasury.
Informed comment on spending estimates needed
There is no evidence that the economy is losing competitiveness. Export growth has slowed but is still running around 10 per cent, against flat growth in imports, pushing the trade surplus to new records. Concern about the rise in the euro is also overdone as the single currency has barely appreciated against sterling, which remains Ireland’s main trading partner, particularly for indigenous industry.
Public spending should best be judged in relation to its share of GDP. The ratio was allowed to fall to far from the mid 1990s and is still not back to the proportion seen in 1997, despite the acceleration in the last two years. The Minister might well consider a change in presentation of the spending estimates to generate more informed comment and debate on the appropriate level of government spending in Ireland- he should break down the proposed spending between that required to maintain existing services and any real increase. Ultimately, whether public spending accounts for 25 per cent, 35 per cent or 45 per cent of GDP is a social issue best decided by the electorate, but is never presented in those terms.
A temporary increase in the budget deficit is sensible if the economy is growing below trend, particularly as any deficits in 2002 and 2003 would be solely due to the level of capital borrowing. Higher direct taxes would reduce the supply of goods or labour and should be avoided, with indirect taxes the preferred route should it be necessary to raise revenue. The base for indirect taxes in Ireland is unusually narrow, so some thought should be given to extending it to a broader range of goods and services. Similarly, charges for public services at the point of use are more sensible and equitable than providing services free to the user but paid for by the taxpayer.
There is little evidence that the public sector in the aggregate finds it difficult to attract and retain staff. Public sector pay should reflect market forces as much as possible, and the underlying benefit of benchmarking is that it does away with the old concept of relativities, which has bedevilled public sector pay in the past. This is more important than the issue of the timing of the benchmarking awards.
There is little the Government can do about Irish inflation. The price of traded goods is determined by world prices and the exchange rate and inflation in the service sector is a function of wage inflation and the strength of domestic spending. Wage inflation is decelerating so that will feed through into some deceleration in price inflation but it is fanciful to think that Irish inflation will slow to the EU average or below, as Irish growth will continue to outstrip its peers by a wide margin.
Finally, public policy in Ireland suffers from our lack of a culture of parliamentary debate and scrutiny. Key policy decisions are taken and opposition often emerges after implementation when it is mere rhetoric. The SSIAs and the State Pension Fund are good recent examples of this tendency.
Dr Dan McLaughlin is chief economist, at Bank of Ireland.
Amend payments to state pension fund
In recent television interviews with RTE, Minister, you didn’t seem too perturbed about the state of the public finances, and gave the impression that you could work miracles, and that it would be you who had the last laugh come the end of the year. In my view, this sounds like you are going to resort to further ‘creative accounting’ measures in an attempt to balance the books come December. I wish you well, but there are only so many jokers one can pull from the pack. However, you cannot deny that public spending is out of control, and that radical steps need to be taken sooner rather than later to bring expenditure back to more manageable levels, and whether the Government has the stomach for it remains to be seen. That said, the indications are that you have already asked the other government departments to make large spending cuts over the remainder of 2002, a positive step. However, I still believe that one easy way of generating much needed money would be to change (relax) the legislation regarding the National Pension Reserve Fund, which sees 1 per cent of Ireland’s GNP contributed to the fund annually. In 2002, this will amount to just under e1.1 billion. As the Labour Party quite rightly in my view pointed out in the election campaign, a lot of people could do with some of this money now, and won’t be around to see the benefits in twenty or thirty years time. Furthermore, given that this fund was down almost 4 per cent at the end of June, serious questions have to asked whether this money could be better utilised elsewhere at this juncture.
Short-term/medium-term budget strategy
The worry going forward is that the Government will take the easy option and cut back on capital expenditure, thereby failing to address the serious infrastructural difficulties facing the economy. Reducing current spending rather than endangering the long-term well being of the economy through lower capital investment, would be far more beneficial for the country as a whole. One thing remains clear though, particularly in the current economic environment. We cannot hope to have state of the art public services and low tax rates as well. Giving money back to the people when you have it to give is admirable, but when you are short of money, you have to take it back. The simple fact of the matter is that Fianna Fail/PDs were overly generous in recent years, but now the tax base is too low. Indeed, the Special Saving Incentive Accounts (SSIAs), which may have seemed a good idea at the time, are now a burden the Exchequer could do without. A small rise in income tax rates won’t do too much damage in my opinion.
Value for money
One thing that worries me, is that even with the huge level of government spending in recent years (both current and capital), we don’t seem to be getting improved services. In the Health sector, we seem to be pumping money in willy-nilly without much to show for it. And on the capital side, semi-state bodies like CIE seem to be getting bucket-loads of money, but I don’t see much improvement in either the bus or rail services. It is imperative in my view that a better monitoring procedure is set up to ensure that public money is not wasted.
Benchmarking/public sector pay
We all know that public sector pay places a huge burden on the Exchequer with Benchmarking set to cost the Government ?1 billion gross a year, if fully implemented. As a former civil servant myself, the problem I have here, is that these pay increases will be paid to each staff member (in their individual disciplines) without any regard to performance. I have nothing against paying teachers or nurses etc. whatever they are worth, but I don’t see any logic in paying everybody in similar grades the same, irrespective of how they do their work. The Government must try and get agreement with the unions to adopting a performance-related pay structure, or the public sector wage bill will get totally out of control in the coming years.
New national wage deal
I think the Government should abandon these national wage deals now. Although they served the country well when we were trying to pick ourselves out of the mire in the late 1980s and early 1990s, their importance has become much diminished in recent years. As the Irish central bank pointed out in its most recent economic quarterly, experience here and in many other countries has demonstrated that such income policy arrangements are rarely binding in the face of strong demand and rising prices. Furthermore, with the euro starting to rise against the dollar/sterling on the foreign exchanges, the exposed (exporting) sector of the economy now needs to be in a position to negotiate its own wage deals to take account of an appreciating currency (which damages competitiveness).
Inflation
Despite some falls in recent months, the consumer prices figures continue to show Ireland’s annual inflation running at a much higher rate than desirable. Indeed, it is hard to see the headline rate falling back below 4 per cent in the near future. While there is very little the authorities here at home can do about external factors like international oil prices, there are steps that can be taken in other areas to ensure that inflation is contained. For instance, fiscal policy (higher taxes) has an important role to play with regard to constraining domestic demand. Apart from that, there is the whole issue of sanctioning price increases for semi-state companies without assessing their knock-on implications for inflation. The risks remain very much to the upside in the short-term, with VHI and third-level education increases on the way in September, and the possibility of rises in domestic electricity, bus and rail fares, and cable television charges, as well as another hike in the television licence, before the end of the year. Furthermore, it is difficult for the Government to criticise private retail and service providers for higher charges, when it itself is sanctioning price increases. In simple terms, the Government needs to take corrective action on inflation quickly, if the economy is to remain competitive, and price increases are to be kept under control. Higher inflation will inevitably lead to higher wage demands.
Nice Treaty/related issues
One of the failings of all Irish governments over the years is their inability to fully explain the issues to the general public. In my view it is fair to say that a lot of the time, the public is left in the dark as to what is really going on. For instance, we never had a meaningful debate about EMU, while many here in Ireland remain sceptical about giving too much of our independence away to Brussels. On other more simple matters, it is hard for the public to get their ahead around the VHI for example being granted an 18 per cent increase from this September, when this health insurance body can announce annual profits last year of ?14.7 million. If the Government is granting price increases to the likes of the VHI, CIE and RTE because it thinks there will be serious job losses in these organisations if the price hikes aren’t sanctioned, then the Government should be up front about it, and not try to pull the wool over consumers eyes. Ministers should not be expressing concern about higher domestic-generated inflation, if behind it all it is only a secondary concern to protecting jobs in the short-term.
Alan Mc Quaid is chief economist, at Bloxham Stockbrokers
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Abandon wage deals
The key parameters within which finance ministers in the Eurozone have to work are those set by the Stability and Growth Pact. That requires budgets to be balanced over the economic cycle and prohibits budget deficits over three per cent of GDP. While it is clear that European finance ministers would like some more flexibility in the Pact than it currently has, the chances that the three per cent limit for budget deficits will be changed seem small. The relevance of this to the task facing Charlie McCreevy in December is that the rate of increase in public spending, especially current spending, in 2001 and 2002 would, if it persists, soon see the Irish budget push up against the Stability Pact deficit limit. If such a situation were to arise, the danger for the economy is of the government taking inappropriate measures in order to meet the Pact requirements. The experience of the 1980s should be an object lesson. Then, when politicians could not/would not face up to controlling current spending, capital projects were cut - with the well-known consequences for the country’s infrastructure - and the tax burden on earners and consumers was increased sharply. As a result domestic demand was severely depressed, employment declined and emigration accelerated. Failure to adequately control growth in current spending now runs the risk of a repetition of the 1980s experience not too far down the line.
Expenditure control
Your primary responsibility in framing next year’s budget must, therefore, be to haul back the rate of increase in spending and to introduce a system of controls that is capable of making spending allocation limits stick. So far, efforts to bring growth in spending this year back within the original targeted levels are not reassuring, being a mixture of ad hoc cutbacks and higher charges. This kind of approach is more denial of the problem than facing up to it. The guiding rule for current spending should be affordability, and i.e. growth in spending should be limited to the pace of growth in resources as an over-riding principal. Within that limit, spending should be allocated on the basis of clear priorities. Mandatory cash limits should be set for each government department, ideally within the context of a realistic medium-term framework, with an outright ban on supplementary estimates. If there are unavoidable spending overruns in demand-determined schemes, they should be financed by cuts in lower priority spending. It is essential that the control system is not frustrated by spending agencies using the tactic of starving high profile or high priority schemes whenever spending limits are reached.
More fundamentally, public spending needs to be monitored more closely on value for money criteria and on the extent to which it achieves policy objectives. It is difficult not to conclude that spending is being seriously misallocated when, for example, a doubling of health spending in the past five years apparently produces no improvement in the level of health services. Rather than increasing the value of spending, more might be achieved by re-allocation. In the latter connection, all universal entitlement programmes should be re-examined with a view to directing resources to the point of greatest need.
Pay
Part of the difficulty in the control of current spending lies in controlling public sector pay. The Exchequer pay bill rose by about two-thirds over the period 1997 to 2001 and is set to rise by at least 12 per cent this year. In this connection, the results of the benchmarking process do not bode well for expenditure control in the future. You should, at the least, demand that the payment of the benchmarking increases be phased in over an extended period. The increases should not be paid at all if productivity and efficiency increases sufficient to offset a substantial part of their cost cannot be achieved. Since part of the idea of benchmarking was to break the chain of internal public sector pay relativities, no such claims should be entertained in the future.
On the wider issue of pay, there is a strong case for abandoning national wage bargaining since the terms of the last two deals have not held in either the private or public sectors. More importantly, such deals have involved the government in making tax and spending commitments, which are inappropriate in a period in which expenditure control should be the priority.
Inflation
The main contribution the Government can make to lessen inflation is to minimise its resort to higher public service charges and expenditure taxes. It is noticeable that some of the fastest growing categories of the CPI are areas such as health and education where government decisions have an influence. Beyond that, there is not a lot government can do directly.
Competitiveness
Though pronouncements on competitiveness usually emphasises the role of wage costs, it is arguably the case that most important element of Ireland’s competitiveness - either in attracting foreign investment or in terms of fostering a vibrant exporting sector - is the corporate tax regime. While the general impression is that this would probably be the last area of taxation any finance minister would contemplate changing because of its perceived success in attracting investment, the phased advancement of the timing of corporate tax payments announced in the 2002 budget - which delays the reduction in the effective corporation tax rate to 12.5 per cent - shows that this area is not immune. Ultimately politicians appear to find it easier to raise taxes than to control spending. There should, however, be an awareness that more damage to the country’s competitive position could be done through the tax system than through wage rate inflation.
Other
The idea of discontinuing payments into the National Pensions Reserve Fund has been mooted in the media on a number of occasions recently as one way of ameliorating the slippage in the public finances. This would be a pity and a short-sighted response to a problem that requires more fundamental action. The setting up of the fund was probably one of the most farsighted decisions taken by a finance minister for a considerable time and showed just the kind of responsible thinking that has been lacking in the decisions that have boosted current spending growth so much. A moratorium on contributions to the fund would be purely a short-term measure when more long-lasting reforms in the way spending decisions are taken is needed. In the meantime, the long-term problem of funding publicly provided pensions for a future ageing population would not disappear. You should resist all such calls and you should also resist the idea of investing some of the pension reserves in public infrastructure projects, as has also been suggested. Even where an adequate return for the fund from such investment is identifiable, setting such a precedent could open the way for abuse in the future.
Dermot O’Brien is chief economist, at NCB Stockbrokers.
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No scope for tax cuts
Congratulations on your re-appointment to Merrion Street. It is approaching that time of year again when you will be forced to perform the miracle of the loaves and fishes. You obviously believe in your capability to perform such miracles, and far be it from me to argue with somebody who is a beneficiary of divine inspiration. However, I think on this particular occasion you really have your work cut out. When you sit down over the coming weeks to prepare the budget, you will do so against the most difficult and uncertain economic background that you have ever faced in your current role, and indeed the most difficult one that any Minister for Finance has faced since Ray Mac Sharry in 1987. At least MacSharry had the benefit of a populace that was well aware of, and reasonably receptive to the hard medicine that needed to be delivered. Your task is more difficult, because despite the ranting of a few economists, the populace at large is not fully cognisant of just how difficult the environment has become.
The much vaunted global economic recovery has ran onto rocks and the Irish economy will be doing very well to deliver economic growth of much more than 3.5 per cent this year. Such relatively modest growth obviously has implications for tax revenues and public spending, few of which are positive. However, that is this year’s story and by the time you present the Budget in December it will be almost history. The bigger issue is the economic environment that you will face in 2003 and beyond. Granted my mood at the moment is a bit dark following the capitulation of the Waterford hurlers to Clare, but I find it difficult at this early stage to envisage how the economy could possibly deliver growth of more than 3 1/2 per cent next year, and the risks at this stage would appear to be on the downside. This means that tax revenue growth in 2003 is unlikely to be any more than 7 per cent, while the pressures on spending will remain intense. What this all adds up to is an environment where you are facing into difficult budgetary arithmetic that will force you to make some difficult and politically unpopular decisions.
In framing Budget 2003, I believe that you should take a strong medium-term rather than short-term perspective, particularly as you are presenting what will probably be the first of another five budgets for you. Over the medium-term the economy is probably capable of growing by around 4 to 4.5 per cent per annum, and this is likely to imply that tax revenues will be incapable of growing by more than 8 per cent per annum. In order to achieve broad balance in the public finances over that period, growth in spending should not be allowed grow by more than this magnitude. Given that growth in spending over the past couple of years has been running well in excess of that level, it will need to be reined in quite aggressively.
Competitiveness broadly defined should be the key theme of your budgets over the medium-term. This should encapsulate taxation, infrastructure, education, R & D, the provision of efficient and affordable public services, and internal competition. These are all relatively vague aspirations, but Budget 2003 should set the ball rolling. Clearly there is not a lot that can be done in one budget, particularly this year given the considerable economic uncertainties. |
