Paying the price for past mistakes

THE public was led to believe in recent weeks that Budget 2009 would be very rough and that has indeed turned out to be the case.

The element of shock in the budget was dampened by the fact that expectations had been carefully managed in the weeks leading up, but nevertheless yesterday’s offering is still very rough and will further dampen an already fragile economy in 2009.

The bottom line is that prior to yesterday’s budget there was a distinct lack of confidence in the economy amongst consumers and business people alike. The external environment is turning distinctly nasty, credit availability is virtually non-existent in the ailing domestic banking system, and the savage adjustment in the housing markets continues to worsen.

There was nothing contained in Budget 2009 that will reverse this sense of gloom amongst consumers and business.

From a consumer perspective, disposable incomes were already under pressure and the combination of increased taxes, levies and service charges contained in the budget will just exacerbate the pressures. The 1% income levy on all incomes up to just over €100,000 and a rate of 2% on the balance over that income level will take a lot of money out of people’s already stretched pockets. It is not being described as an increase in taxes, but is actually worse than an increase in tax rates because it is being applied to all earned income.

This income levy, when combined with all of the other penal initiatives such as higher health charges, excise duties, VAT, DIRT tax, car tax, university registration fees and many more besides will just serve to crucify an already ailing consumer. For business, the changes in the timing of tax payments will cause further cash flow difficulties, while the increase in the VAT rate to 21.5% will further undermine competitiveness of Irish business.

There is nothing here that will encourage job creation and, in fact, it is very difficult to identify any sector of the economy that will be a net job creator over the coming year. The bottom line is that an extra €2 billion will be taken out of the economy next year in extra taxation. In contrast, the measures intended to cut spending look pretty harmless at this juncture.

From the perspective of the public finances, the key problem over the past year has been the collapse in the housing market and in tax revenues associated with house building and housing transactions. Some measures were introduced in the budget to lift the market, but in the current environment it is highly unlikely they will have any real effect.

The key changes relating to the housing market include: an increase in mortgage interest relief for first time buyers from 20% to 25% in years 1 and 2 of the mortgage and to 22.5% in years 3, 4 and 5, and the relief for non-first time buyers will be reduced from 20% to 15%; the introduction of a local authority levy of €200 on all non-principal private residences; the extension of the local authority mortgage scheme by increasing the maximum loan available, and a Government Equity Initiative that will assist those seeking affordable housing by taking an equity share. In relation to commercial property, the stamp duty rate has been reduced from 9% to 6%.

None of these measures will be sufficient to turn or even stabilise the housing market, because the key problems have not been addressed.

The problem in the market is one of excess supply and stagnant demand due to a combination of lack of credit availability due to the credit crisis, a seemingly well-founded belief amongst potential buyers that prices will fall further and a general lack of confidence in the future of the economy, and particularly in the outlook for employment. Nothing in the budget will change these issues so it does appear the housing market will weaken further over the coming months.

One of the depressing things about Budget 2009 is that despite the draconian increases in taxes, the General Government Deficit in 2009 is projected at just over €12 billion, equivalent to a massive 6.5% of GDP. Economic growth as measured by GDP is projected to decline by 0.75%. This appears extremely optimistic, given the unfolding domestic and external environments, and the amount of money that the government is going to take out of the economy over the coming year.

One thing we can be fairly sure about at this juncture is that yesterday’s savage offering could well pale into insignificance compared to what the Finance Minister is likely to deliver at the end of 2009. It is unfortunate that we are being forced to tighten fiscal policy significantly at a time when the economic cycle is in a strong downturn. If spending had been controlled over the past seven years, this would not now benecessary.

All taxpayers and old age pensioners are now being forced to pay for past mistakes.