Budget pain may be felt for years

The cuts will be harsh but necessary, says business correspondent John Walsh

FINANCE Minister Michael Noonan has repeatedly said the forthcoming budget will be the hardest since the adjustment process began because “all the low hanging fruit has been plucked”.

Rising levels of public anger at bankers’ pay and pensions and the decision to bail out the banks has added to the political noise. Both are important issues but they are wrongly conflated with budget cuts.

There is a yawning chasm between what the Government spends and what it generates in revenue, down to the disastrous policies of the last government.

The former taoiseach Bertie Ahern bought successive elections by removing as many people as possible from the tax net and making the overall personal income tax burden one of the least onerous in the OECD. The national coffers were bloated during the boom years by a massive intake of property taxes, particularly stamp duty. Spending levels rose accordingly.

When the property market crashed, so did government revenues. The implosion of the banking system may have cost this country its economic sovereignty, but bridging the deficit is something that would have to be done anyway.

The backdrop could not be more unfavourable. More than 83,000 mortgage holders are in arrears. The average debt level per head of population is €40,000.

The Government still has to find €13bn in savings between now and 2015 in order to meet the 3% fiscal deficit agreed with the troika.

Of the €3.5bn adjustment in the budget in December, a total of €1.25bn will be found through tax increases and the rest through cuts to public expenditure. This ratio reflects that relationship between the coalition partners, Fine Gael and Labour. The senior government party is adamant that there will be no increase in personal income taxes.

But as the Grant Thornton figures show, a married couple with two children on salaries of €40,000 each will be over €3,000 worse off next year. This is likely to have a huge impact on consumer spending.

What separates Ireland from Portugal, Greece, and other south European economies is that the export sector has been holding up remarkably well over the past couple of years. But the country’s main trading partners are struggling and that is bound to affect demand for Irish goods and services.

There will be no significant pick-up in growth and employment until the domestic economy makes a recovery.

But household spending will come under further pressure the more that is taken out in tax increases and spending cuts. And as long as unemployment levels remains at elevated levels, the mortgage arrears crisis will persist.

And as long as banks are dealing with mounting losses the less they will be lending which further undermines economic growth.

Moreover, if economic growth comes in below forecast over the next few years, the Government will have to make even more swingeing budget cuts, which will lead to a vicious downward cycle.

If there are further increases on labour taxes then it will act as a disincentive to work, which will increase the amount of people caught in the poverty trap. Tensions between the coalition partners will ratchet up as Fine Gael will either look to scrap the Croke Park Agreement or make further savings from the public sector.

Labour will look to more punitive measures on the wealthy.

The Government will come under even more pressure to restructure the promissory notes relating to Anglo Irish Bank. Even though the capital repayment of €3.1bn does not show up in the deficit figures, the interest payments do. The Government is due to pay €500m in interest payments next year which rises to €1.8bn in 2014.

The Government has been praised for the amount of fiscal consolidation that has been introduced so far. But there is still a lot more to do. December’s budget will be the toughest one yet, but the economy faces a number of more years of painful cuts. How many more years depends on the prospect for growth and getting a deal on the promissory notes.

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