Lenihan’s cuts show we haven’t turned that elusive corner just yet

LAST December the Finance Minister Brian Lenihan declared our plan is working and that “we have turned the corner”.

He also suggested that while the effort demanded of every citizen in Budget 2011 was substantial, and that while further corrections would be needed in the coming years, none would be as big as in Budget 2011.

Alas these predictions could not have been further from the truth.

Yesterday, we were treated to one of the toughest budgets in our history and one still cannot say with any degree of confidence that we have turned a corner.

In many ways yesterday’s budget is a bit of a non-event in the sense that it was well flagged in the recently published National Recovery Plan and was further pre-announced under the terms of the IMF/EU bailout plan that was announced last week.

Budget 2011 means the Irish economy will face a fiscal correction of €6 billion in 2011, with €4bn to come from expenditure cutbacks and €2bn from tax increases.

While many people will severely criticise Budget 2011, the reality is that due to past mismanagement of the economy and a global crisis of unprecedented enormity, the Irish public finances had quite simply become unsustainable.

Furthermore, Ireland would not have been given access to the IMF/EU bailout fund if it did not adhere to the fiscal principles laid out in the National Recovery Plan.

The budgetary arithmetic for 2011 is predicated on the economy expanding by 1.7% in GDP terms and by 1% in GNP terms over the coming year. This distinction between the two growth metrics is important.

The multi-national sector is doing very well in Ireland at the moment and this should help contribute to a reasonably strong GDP outturn in 2011, albeit probably not as vibrant as forecast in yesterday’s budget.

Unfortunately, this growth will not do much for tax revenues or for employment creation.

The GNP metric is more significant in that context. GNP is principally driven by consumer spending, business investment spending and construction activity. Such activities are the ones that generate the bulk of tax revenues and employment creation. The construction sector is obviously dead and will remain so for some years to come, despite the changes to stamp duty on residential property.

There was not a lot in yesterday’s budget that will inspire business owners to get out there and engage in investment or indeed in employment creation. From the perspective of the consumer, Budget 2011 will further erode disposable incomes and will just continue to fuel growth in precautionary savings.

It is incorrect to suggest that the budget has targeted any particular segment of society. All middle and high income workers will face a significant hike in their tax bill in 2011 and with the exception of old age pensioners, most recipients of social welfare will see a hit to their income.

It is clear that 2011 will be another very difficult year for the Irish economy. Significant spending power will be taken out of the economy in the form of expenditure cutbacks and increases in the tax burden. It is hard to believe that consumer spending will stabilise in 2011 given the hit to disposable incomes. The sharp reduction in capital spending will undermine investment.

The reduction in stamp duty on housing could give some boost to housing transactions, but this will be unlikely to significantly offset the negative forces that are impacting on the housing market at the moment.

The key aim of the budget is obviously to try to restore some order to the public finances. Tax revenues are projected to grow by 10.7% in 2011, bringing the tax take up to €34.9bn.

The Exchequer deficit is projected to decline to €17.67bn, down from a projected deficit of €18.75bn in 2010.

Excluding the cost of the banking bailout, the General Government Deficit, which is the measure targeted by the EU, is projected to fall from 11.6%of GDP in 2010 to 9.4% in 2011. The ultimate target is 2.8% by 2014.

Budget 2011 is the most deflationary that this country has experienced in many years, but there is not a lot of choice. The public finances had become unsustainable — the tax take and base are too low, and expenditure is too high. This budget is attempting to bring expenditure down and to widen the tax base.

This is hard to argue with, but it is a risky strategy and it remains to be seen just how the struggling Irish economy will cope with such an extraction of money.

Most workers will end up paying more tax on a progressive basis, pension coverage will be damaged, and those dependent on social transfers will see another drop in income.

Unfortunately, there is nothing in the budget that would encourage employers to go out and create employment.

- Jim Power is an economic commentator