Saturday, October 15, 2011

Deficit targets and the €3.6 billion budget ‘adjustment’

Recent days have seen some debate on the fiscal adjustment to be introduced in December’s budget.  The use of the word adjustment has become standard when referring to expenditure cuts and tax increases.  Maybe we’re cutting back on the number of words we’re using as well.

Anyway, The Four-Year National Recovery Plan which formed the basis for the Memorandum of Understanding agreed with the IMF was the first time the €3.6 billion adjustment for 2012 was introduced.  This was on the basis of reducing the General Government Deficit to 8.6% of GDP in 2012.

In recent days the Independent Fiscal Advisory Council in its first report advocated a €4 billion adjustment (and as high as €4.4 billion to fully eliminate the deficit by 2015). The ESRI have also come out in favour of a larger adjustment, which is also supported by Philip Lane and the Central Bank.  Today the OECD joined the growing chorus.

Before getting into the detail of the adjustment, let’s first consider the target we are aiming for.  The common belief is that under the EU/IMF deal we are targeting a General Government Deficit in 2012 of 8.6% of GDP as laid out in the National Recovery Plan.  This is not (and never has been) the case.  The budget target set for us by the IMF is in terms of the primary exchequer deficit.  See point 4 on page 57 (pdf) of the Third Review.

4. The performance criteria are set on the exchequer primary balance (the exchequer balance excluding net debt interest payments in the service of the National Debt).

The target for the end of June 2012 is a primary exchequer deficit of no more than €7.4 billion.  An end of year target for 2012 is not yet set.  The June 2011 primary exchequer deficit was €8.4 billion which was well below the target of €10.1 billion.  (See table 2 on pdf page 54 of the review).

It is clear that a General Government Deficit (GGD) target and a Primary Exchequer Deficit (PED) target are related, but they are not the same.  The GGD includes interest expenditure but the PED does not.   The reduced interest rates on our EU loans will make reaching an 8.6% GGD target easier but will have no impact on ensuring that the PED is below €7.4 billion in June of next year.  It should also be noted that this target is not fixed and is subject to change by the IMF based on performance.

Hitting the 8.6% GGD target for 2012 does not guarantee meeting the PED target set out by the IMF.  The debate seems fixed by the 8.6% target but the actual goalpost is a little to the side of that.

Anyway, lets turn to the €3.6 billion adjustment.  One important thing to note is that the adjustment for 2012 includes the carryover from measures introduced in the 2011 Budget.

Last year’s Budget  announced €6 billion of adjustments.  However as a result of implementation and other lags the full effect of these will not be felt in 2011.  In the Budget measures document you can see a difference between the 2011 effect and the full year effect.

The tax measures introduced had a 2011 effect of €1,434 million but a full year effect of €2,596.  This gap is implausibly wide and is largely explained by the fact that the 2011 effect of the introduction of the Universal Social Charge was assumed to be zero but the full year effect was given as €420 million.  Still it is likely that there is around €0.6 billion of tax increases to be achieved simply by allowing last year’s changes to continue for the full year in 2012.

For current expenditure last year’s Budget included measures which had a 2011 effect of €2,192 million.  The full year (2014) effect of these measures was assumed to be €2,709 million. This time, it is likely that there is around €0.4 billion of expenditure cuts to be achieved by simply allowing last year’s changes to continue for the full year in 2012.

Although the planned adjustment for 2012 is set at €3.6 billion, Michael Noonan can achieve €1 billion of that by just sitting down as soon as he is called to speak by the Ceann Comhairle on Budget day.

So where will the rest come from?  There will be continued cutting of the capital budget.  The Four-Year Plan outlines that there will be a further €0.4 billion cut here in 2012.   As this will be achieved through the delay or cancellation of capital projects, the victims of the cuts to capital expenditure are unknown, even to themselves.

Thus there is €2.2 billion of the adjustment remaining.  Again, looking to the Four Year Plan (which it must be remembered was drafted and published before official IMF intervention in Ireland was announced) it appears that this will made up of €1.3 billion of cuts to current expenditure and €0.9 billion of increases in tax revenue.

It has already been announced that a €100 household charge will be introduced.  This will raise about €160 million or one-sixth of the total required. 

Although, the exact details will not be released until the Budget we can use the proposals in the Four-Year Plan to provide some guidance.  (See page 138 of the pdf which also gives details of the €600 million of carryovers from last year’s Budget.)

Tax Measures

If the Budget sticks to the details of the Four Year Plan we can expect Income Tax to increase by €10 per week on average and the Excise Duty on a litre of petrol to rise by about 3 cent.

If we can get through the remaining €1.3 billion of current expenditure cuts, this mightn’t be too bad at all.  The Four-Year Plan is less prescriptive when it comes to expenditure cuts but we can infer the following from Table 4.1 (see pdf page 62) and remember that this includes €400 million of carryover from the measures announced last year. (Some outline details of the expenditure carryover can be seen on page 54 as “additional impacts from 2011”.)

Expenditure Measures

The pay savings are due to be achieved through headcount restrictions and efficiency gains as prescribed in the Croke Park Agreement, while other expenditures includes “Subsidies, Grants and other schemes, Procurement”.  The planned adjustment for the Social Protection budget is €600 million.  Last year, almost €900 million of cuts were introduced in this area. 

About €50 million of the planned €600 million will come from carryover effect of last year’s measures. It is clear there is substantial cuts planned for the Social Protection budget.  Although the make up of these is unknown, it has been suggested that around one-quarter will be achieved with changes to the rent supplement scheme.

Michael Noonan has indicated that the actual adjustment to be introduced in the Budget will be €4 billion rather than €3.6 billion.  Where is the extra €400 million going to come from?  Well, it seems that the ‘welfare budget could see €1 bn cuts’ with “about half the potential welfare savings from a new clampdown on fraud”. 

It seems likely that the upcoming Budget will have around €4 billion of adjustment (although Pat Rabitte thinks “€3.6 billion is enough”).   Here is how the €4 billion will probably be constituted.

Budget Adjustments

Will this bring the masses out onto the streets? Not likely.  There will be some pain, but there will not be the same outcry that greeted last year’s budget.  In fact, this looks set to be the most benign budget of the ongoing adjustment process.

The planned adjustment for 2013 is €3.1 billion but the carryover effects will only be €0.3 billion.  Net of carryover effects and a social welfare fraud clampdown the adjustment for 2012 (€2.6 billion) will be lower than the planned adjustment for 2013 (€2.8 billion).  

Of course, this all depends on how we perform in meeting the Primary Exchequer Deficit targets laid out by the IMF but no one seems to be talking about them.

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