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The election may need a big Budget but the economy needs a small Budget Back  
Austin Hughes says the economy needs the Minister to hold a tighter rein than he would like in the upcoming Budget.
Will this be a budget for the economy or the election? Silly question. I think I know what the Minister’s speech will say on this score but I’m not sure that the package of measures Mr. McCreevy announces will point in exactly the same direction. The election may need a ‘big budget’, but the economy needs a ‘small’ budget.

Although there might be disagreement about the scale of impact that budget policy has in an economy as open as Ireland’s, there is little doubt in my mind that the signal it sends makes a big difference to decisions in relation to purchasing and producing. It seems to me that the signal that would make most sense in the upcoming budget would be one that suggests that public spending will be controlled and activity and employment incentivised. I don’t think this was the message of the past two budgets; A giveaway is just a giveaway.

A ‘small’ budget is very different from one that delivers the pre-election wish list of a range of interested groups. The budget should keep it relatively simple and make relatively modest changes. This would point towards a continued albeit gradual easing of the tax burden. It should also show a willingness to make choices in relation to public spending and prioritise particular areas rather than sharply inflating the total.

A little can go a long way. Within EMU, Irish budgetary policy is largely free of the risk of financial market backlash. It is unfortunate that the only constraint appears to be the poorly presented reservations of the EU Commission. This extra leeway was used in the past couple of budgets. These were very expansionary, at least on an ex ante basis (the consequences of these budgets for the Irish economy were not as bad as might have been feared but don’t blame that on the Minister). They took little account of economic circumstances - notably that constraints on supply meant the major impact of largesse was on demand and on inflation, most notably a serious inflation of expectations.

This year’s budget must be more aware of the economic context. Perhaps fortunately, given the looming election, a modest stimulus may be warranted by Irish economic circumstances. However, the key word is modest. Tax cuts of the order of ?500 - 600 million and non-pay current spending increases of just under 10 per cent (pay is largely predetermined) might help underpin demand and yet be consistent with the likely growth in the economy’s capacity.

Public finance
Show clearly that the public finances will remain healthy into the medium term. An old and largely forgotten word may be about to reappear in discussion of Irish budget policy; sustainability. On my reckoning, the underlying outturn (net of asset sales) this year will be close to ?1 billion below target. Given a weaker economic climate, carry-over costs from Budget 2001, benchmarking and rising expectations generally, it is readily possible to imagine how a significant exchequer deficit could emerge next year. While the case for a continuation of huge surpluses may not be particularly strong, the prospective pace of deterioration could be worrisome. The trend may not be Mr. McCreevy’s friend but he must not allow it become his enemy.

This sustainability risk will need to be addressed by delivery of a package that if extrapolated into the future will not imply a dramatic deterioration in the Public Finances. Certainly, he should aim to ensure that broad balance (excluding contributions to the National Pensions Reserve Fund) is ensured into the medium term even on fairly conservative economic assumptions. Trimming the National Development Plan may have helped this year’s arithmetic but this is not a plausible course of action going forward. Again, as I suggested last year, it may be necessary to initiate a review body on Government spending.

Restore the cap on PRSI contributions. I still find it hard to understand the logic behind last year’s removal of the cap on employers’ PRSI contributions. Increasing the effective cost of labour in this manner seems to go completely against the thrust of supply-side policies. If Ireland is to move up the ‘value-added’ chain, this will serve as a major disincentive to employing more highly paid workers. Last year’s decision should be reversed. Acknowledging this mistake would underline a determination to assist competitiveness and would be a very healthy development. Of course, problems with the political packaging of any change of heart may suggest some other forms of adjustment will be contemplated instead.

Inflation is unhealthy too. While we’re on the subject of mistakes, the manner in which duty on cigarettes was increased in the budget before last was clearly a dreadful gaffe. I understand fully the rationale for increasing the cost of cigarettes but the Minister has to be aware of broader consequences. He could either opt for a broadly inflation-neutral package or ensure only a relatively small impact by offsetting higher duty on cigarettes with lower duties elsewhere. If he were to add a net 0.2 per cent to the Consumer Price Index from this combination he could deliver a reasonable increase in cigarette prices this year and prepare the way for a significant stepping-up of cigarette duties in forthcoming budgets without risking a ‘big bang’ impact on inflation.

He might also consider cutting the top VAT rate further but he should not introduce the cut in January, as that would risk seeing the impact swallowed up by euro changeover increases. My preference would be for a pre-announced February VAT reduction. Of course, the VAT move would not only help on the wages bargaining front but would also give timely assistance to e-commerce.

Help job mobility and reduce downside risks to the housing market. Depending on the emerging outlook, the Minister might give thought to significantly reducing stamp duty on house prices below ?350,000. There is some risk that job losses become a more common feature of the Irish economy in the next twelve months. This reflects both the current climate and the longer-term trends in employment where frequent job changes become the norm. In such an environment, mobility becomes increasingly important and, in an Irish context, reducing transactions costs related to housing could assist mobility. Of course such a move would also help sentiment towards the housing market that may not be unwarranted if the economic outlook deteriorates further. So, in the current environment, it may offer micro and macro assistance to the Irish economy.

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