IPPN

Published: 07 December 2008

Source : Sunday Business Post

Lenihan's long road back to recovery

07 December 2008
By Cliff Taylor
Billions here and billions there. It is difficult to get a handle on the state of the exchequer's finances, such has been the rapid pace of their deterioration.

Last year, the state's books were pretty much balanced - in other words, we spent roughly the same amount as we raised in revenue.

By next year, borrowing could be 8 to 9 per cent of GDP, and the government will be under pressure to cut back spending further. By any standards, this has been a very rapid turnaround.

How has it all changed so quickly?

The public finances reflect the economy. The rapid downturn in economic growth has hit revenues hard. In particular, the collapse in activity in the housing market has turned a key source of exchequer revenue growth into a black hole.

Unfortunately, when you are dealing with government finances - spending and taxes - you are dealing with huge numbers. For every 1 per cent that tax revenues fall short of target, the exchequer loses more than €400 million.

Such has been the collapse in revenue this year that taxes look set to fall €8 billion short of target. This means that the state will have to borrow about €12 billion, or some 6.4 per cent of GDP, according to forecasts from stockbrokers Davy. It believes that this is set to rise to €16.6 billion, or 8.9 per cent of GDP next year, well above the 6.5 per cent target for 2009 set by finance minister Brian Lenihan in October.

How come the 2009 forecast looks so much worse now than it did just last month? Some 20 per cent of all the tax revenue collected in a year comes in during November. It is the big month for self-employed payments and for corporation and Capital Gains Tax.The budget sums for next year were calculated without these figures being available.

Unfortunately, November ended up even worse than feared.

Total tax revenue for the month was some €3 billion below target. This knocked a hole in the budget arithmetic in two ways. First, because the tax take this year will be lower than expected, the base figure from which 2009 revenues will be calculated has fallen as well. Second, the trend in the figures will have worried the Department of Finance. What they will find difficult to calculate is when tax revenues will hit the bottom. However, as things now stand, their prediction on Budget Day that revenues next year would be roughly the same as the out-turn for this year, looks over-optimistic.

This is why economic forecasters have been increasing their deficit projects for 2009 so sharply.

Is there any problem in borrowing so much?

The problem is that the pace of deterioration in the government's finances will make it difficult to come up with a plan to get borrowing back down below the EU limit over any reasonable time period, barring very serious efforts to control spending or raise new revenues.

In its budget sums, the government put forward a strategy to get borrowing back down below the 3 per cent EU ceiling by 2011. These calculations have now been thrown seriously off course.

Early next year, it will have to present a new strategy to Brussels - a kind of fiscal consolidation plan. This is now inevitably going to have to involve some hard decisions. It may be that the government will decide to wait until after Christmas to start making these decisions but, one way or another, it will come under pressure to come up with a plan.

Borrowing a significant amount for a short period is possible, but if borrowing continues at 8 per cent above GDP for any prolonged period, then the national debt - which is currently relatively low compared with our EU partners - would rise quickly and the interest payments would become a significant burden, as they did in the 1980s.

The government will also have to be mindful of the cost of raising finance. Money is scarce enough for all borrowers at the moment, because of the nervousness surrounding the credit squeeze.

Already, smaller countries like Ireland have had to pay a premium over big countries such as Germany in terms of interest, and it is difficult at the moment to raise long-term funds.

While the exchequer has enough cash to get it through next year, the cost and availability of borrowing is a serious constraint that will have to be borne in mind.

How does the new 'An Bord Snip' come into this? Last week, Lenihan announced that he was setting up a special committee to advise him on how to save money (called 'the special group on public service numbers and expenditure programmes', if you must know!) There will be a core group of two - UCD economist Colm McCarthy, who will chair the group; and senior Department of Finance official Donal McNally.

They will be assisted by Maurice O'Connell, the former governor of the Central Bank, Willie Slattery, managing director of State Street International, Mary Walsh, a former partner in accountancy firm PWC, and Pat McLaughlin, a business consultant and former senior executive in the HSE.

Early next year, they will receive spending details and proposed savings from all departments. They will go through these and question the secretaries-general of each department. Following this, they will report to the government by next June on where they believe savings can be made. As part of this, they will assess numbers in different areas of the public service. The government has said that part of its reform plan will be to have greater flexibility to move people from areas of surplus to areas of need.

The committee will be encouraged to come forward with any potential quick savings ahead of its final report. It will be free to report to the government at any stage. It remains to be seen how the process will work. A key issue will be the willingness of the government to allow it to examine and recommend savings in all areas - including lowering staff numbers - and whether its remit extends to capital projects, as well as day-to-day current spending.

However, the key focus of the committee will not be on quick cuts, but on a methodical process leading to significant savings in many areas, with a focus on getting these included in spending plans for 2010.

So what will happen between now and when An Bord Snip reports next June? Because the public finances are deteriorating so quickly, the government is under pressure to come up with some quick savings. Fine Gael and Green Party Senator Dan Boyle have both called for the 3.5 per cent public pay increase - due to come into effect next September - to be postponed.

While the government has not publicly stated that it believes the money cannot be paid, senior ministers are now believed to accept that this is the case, particularly as it would cost the exchequer €1 billion in 2010. Indeed, it is possible that senior officials could be asked to accept a pay cut, such is the scale of the problems facing the public finances.

Also, the government is likely to give serious consideration to extending the voluntary redundancy programme in the HSE across some of the rest of the public service.

The alternative to cuts in pay and/or numbers is to seek further cuts in non-pay spending, which is also politically controversial, as shown by the controversy over the medical cards for the over-70s and the increase in school class sizes.

Or the government can seek to cut capital investment spending on projects such as roads and railways. It has promised to maintain this at a high level, though, in reality, some projects are already being delayed.

Lenihan has said taxes will not be increased in the short term. However, further increases are certain in the 2010 budget.

Speaking last Friday, Brian Cowen said that he would be working on a programme for economic renewal with the social partners in the weeks ahead. It is certain that a correction in the public finances will be at the heart of this strategy.