Tuesday, April 7, 2009

Mini-Budget 2009: A 'Fail' Grade

To summarize, mini-Budget failed to deliver the substantial public expenditure savings promised. As a result of destroying private wealth and failing to cut public sector waste, instead of reducing the Gen Government Deficit to 10.75% of GDP as claimed in the Budget (Table 5), Minister Lenihan has left a Deficit of -12.5% to -13.0% of GDP in 2009. Details below.

The mini-Budget 2009 Part 1 is in and the Government has done exactly what I've expected it to do - soaked the 'rich'. This time around, the 'rich' are no longer those with incomes in excess of €100K pa, but those with a pay of €30K pa. We are now in the 1980s economic management mode, full stop.

Microeconomic Impact: Households
  • The heaviest hit are the ordinary income earners and savers: Income levies up, thresholds down. Impact: reduce incentives for work at the lower end of wage spectrum and generate more unemployment through adverse consumption and investment effects. Before this budget, it would have taken a person on welfare living in Dublin ca €35-37,000 in annual pre-tax wages to induce a move into job market. Now, the figure has risen to over €40,000. PRSI ceiling is up a whooping 44.2% to €75K pa. This is jobs creation Lenihan-style;
  • DIRT is up from 23% to 25% and levies on non-life and life insurance are up. CGT and CAT are up from 22% to 25%. The CGT is a tax stripping off the savers/investors protection against past inflation, so Mr Lenihan is simply clawing back what was left to the investors after his predecessors generated a rampant inflation. This is savings and investment incentives Lenihan-style;
  • Mortgage interest relief is cut and will be eliminated going forward (Budget 2010) - I hope people in negative equity losing their jobs will simply send their mortgage bills to Mr Lenihan. Let him pay it;
  • Interest reliefs on investment properties and land development are down. The rich folks who bought a small apartment to rent it out in place of their pension (yes, those filthy-rich Celtic Tiger cubs who saved and worked hard to afford such 'luxury' as a pension investment) are getting Lenihan-styled treatment too.These measures, adopted amidst a wholesale collapse in the housing sector, are equivalent to applying heavy blood-letting to a patient with already dangerously low blood pressure.
Microeconomic Impact: Businesses
  • Providing no measures to support jobs creation or entrepreneurship, Lenihan managed to mention only his Government's already discredited programme for 'knowledge and green' economy creation from December 2008 as a road map for what the Government intends to do to stimulate growth;
  • No banks measures announced or budgeted for, implying that an expected budgetary cost of ca €4-5bn in 2009 due to potential demand for new banks funds is simply not factored into our expenditures. Neither are there any costings or provisions for the 'bad' bank;
  • No credit finance resolutions, PRSI cuts for employers, minimum wage reductions etc;
  • CAT and CGT taxes up, income of consumers down, insurance levies up... Lenihan-styled treatment for business support is so dramatic that it is clear we have a Government that only knows how to introduce pro-business and pro-growth policies for their own cronies.
Microeconomic Impact: Public Sector
The only clear winners in the Budget were public sector workers. They face no unemployment prospect, no imposition of any new levies or charges, no cuts in salaries or indeed no changes to their atavistic, inherently unproductive, working practices.

Yet, they can retire earlier with a tax-free lumps sum guaranteed. And no actuarial reduction for shorter work-life, implying that the cost of the Rolls-Royce pensions to all of us has just risen by a factor of at least 1/3! Happy times skinning the taxpayers to pay the fat cats of the public sector elites? Lenihan-styled sharing of pain.

Pat McArdle of the Ulster Bank in an excellent late-night note on the Budget said: "Our main quibble with the Budget is with the split of the burden between tax and spending. ...contrary to the recommendation of practically every economist in the country, they opted for a 55% to 45% split in favour of taxes".

This is correct. On the morning of the Budget day, Mr Lenihan told the nation that not a single economic adviser was suggesting that the Budget impact should fall onto expenditure side. Clearly, he was either incapable of listening or simpy arrogantly ignorant.

Adding insult to the injury, Lenihan also ensured that majority of cuts were to befall the already heavily hit middle classes. Microecnomically speaking, Minister Lenihan has just dug the private sector grave a few feet deeper. It was at 6ft before he walked into the Dail chamber. It was at 10ft once he finished his speech.

Macroeconomic Impact: When Figures Don't Add Up
In Macroeconomic terms, we are no longer living in Ireland. We are living in Cuba where numbers are fudged, forecasts are semi-transparent and the state knows better than the workers as to what we deserve to keep in terms of the fruits of our labour. Mr Lenihan has torn up any sort of social contract that could have existed between the vast majority of Irish people and this Government.

All data is from DofF Macroeconomic & Fiscal Framework 2009-2013 document.
More realistic assessment of the GDP collapse in 2009 is being met with a relatively optimistic assumption that GDP contraction will be only 2.9% in 2010. Even more lunatic is the assumption that Ireland will return to a trend growth of ca 4% in 2012-2013. So my assumptions are: -8-8.5% fall in GDP in 2009, -3.5-4% fall in 2010, +1% growth in 2011, +2% in 2012 and +2.2% in 2013. This will be reflected in my estimate of the balance sheet below.

Another thing clearly not understood by the Government is the relationship between income, excise and import duties. Imagine a person putting together a party for few friends. She had before the Budget €100 to spend on, say, booze. Now she has €90. Her VAT, excise, import duties on €100 of spend would have been ca €66. Now she goes off to Northern Ireland with her €90. Does the Government lose €66? No. It also looses other (complimentary) goods shopping revenue. Say that the cost of party-related goods is €250 worth of purchases at 21% VAT, 10% duties. Total cost of a €10 generated by Lenihan in income tax levies is a loss of over €140 in revenue. Good job, Brian. Your overpaid economic policy advisers couldn't see this coming?

Notice investment figures in the table above? Other sources of GDP growth? Well, DofF did apply a haircut on its projections in January 2009 update, but these corrections are seriously optimistic on 2011-2013 tail of the estimates. This again warrants more conservative estimates.
Judging by the inflation figures estimates, the DofF believes that the era of today's low interest rates is simply a permanent feature of the next 5-year horizon. Again, this is too optimistic and should it change will imply much deeper economic slowdown in 2010-2013 period.

Now to the estimates Table below summarizes the estimated impact of the measures.
Per DofF estimates, the Exchequer deficit drops, post mini-Budget-1, by ca €2.7bn in 2009 or 2% of GDP. This is rather optimistic. In reality, this estimation is done on a simple linear basis, assuming no further deterioration in receipts and a linear 1-to-1 response in tax revenue to tax measures. This also assumes the macro-fundamentals as outlined in the Table 2 discussed earlier.

Now, building in some of my outlook on the budget side and GDP growth side, Table below reproduces DofF Table 5 and adds two scenarios (with assumptions listed): From the above table, we compute the General Government Deficit (the figure that is the main benchmark for fiscal performance) as in the following Table:
This speaks volumes. The Government promised in January 2009 the EU Commission to deliver 9.5% deficit in 2009. It has subsequently reneged on this commitment, producing an estimated Gen Gov Deficit of 10.75% today. However, stress-testing the DofF often unrealistic assumptions provides for the potential deficit of 12.5-13.0% for this year.

But there is a tricky question to be asked. Has Lenihan actually gone too far on the tax increases side? Note that the estimated gross impact of the overall budgetary measures is €3.3bn for the remaining 8 months of 2009, implying an annual effect of €4.95bn in fiscal re-balancing. This is ca 2.9% of GDP - a sizable chunk of the economy. From that figure, per Table 5 above, the implied net loss to the economy from the Government measure (estimated originally at -1% of GDP) should be closer to 1.5-1.7%. This in turn implies that instead of an 7.7% contraction in GDP, the DofF should have been using a 9.2-9.4% contraction. In today's note, Ulster Bank economics team provides a revised estimate of GDP fall for 2009 at 9.5% for exactly this reason.
Mr Lenihan and his advisers simply missed the point that if you take money out of people's pockets, you are cutting growth in the economy. Of course, our Ministers, their senior civil servants and advisers would not be expected to know this, given they lead such sheltered life of privilege.

If the above estimates were to reflect this adjustment, we have: 2009 GDP of €168.2bn;General Government Deficit of 11% for DofF estimates, and 12.7-13.25% for my scenarios. I will do more detailed analysis for 2010-2013 horizon in a separate post, but it is now clear that the Government has not achieved its main objective of an orderly fiscal consolidation to 9.25% deficit. Neither has it achieved an objective of supporting the economy through the downturn.

Today's Budget delivered a nuclear strike to the heart of the private sector economy in Ireland. It furthermore underscored the Government commitment to providing jobs and pay protection for public sector workers regardless of the cost to the rest of this economy. We are in the 1980s scenario facing years of run-away, unsustainably high public spending and no improvements in public sector productivity amidst severe contraction in demand and investment at home and from abroad.

Minister Lenihan has promised to go on a road show selling Ireland Inc. I wish him good luck and I wish his audiences a keen eye to see through the fog of demagoguery this Government has produced in place of sensible economic policies. If they do, their response to Mr Lenihan's approaches is likely to be "Thank you, Minister. We don't need to invest in the economy that taxes producers, savers and consumers to protect public sector waste. Thank you and good by."
From an investment case point of view - they will be right.

PS: As the first fall-out from the Budget, Moody's downgraded Irish banks (here)... More to come.


Another John M said...

I'm no economist but I have been following various blogs and the news with interest. One thing that disturbs me about public discussion in this country is how quickly a "consensus" emerges and how other views are stifled or shouted down. This happened when people predicted disaster during the housing bubble. It happened again during the run up to the budget. We were treated to a parade of politicians talking about public finances, and the need to cut spending and increase taxes.
Worse still were their "yes men" economists.
With few notable exceptions, no one stood up to explain the difference between accounting and economics! The government's echo chamber economists kept talking about balancing the books -- aka accountancy. There was no mention of the effects of these cuts or tax increases. Or any mention of how to allocate our scarce resources.
Meanwhile, Lenihan dropped the ball by failing to cut the fat in quango land and Leinster House. I've already commented on your blog about how many politicially appointed hacks sit on quango boards. My rough estimate of the cost to them in stipends alone is €500 million. Add in your 800+ CEOs and other public "executives" with duplicate or ill-defined roles, and the numbers soon add up.
These reforms won't happen easily because the beneficiaries are legion and well paid.
Another absolute waste of money is our electoral system. I live in a constituency with 5 TDs. I only need one, and I need him/her the same way a fish needs a bicycle. Yet their base pay is over €100k a year + all kinds of goodies, payments and pensions.
As a US Senator once quipped: "A billion here and a billion there and pretty soon you are talking about real money." We need to get serious about cutting waste and directing our dwindling resources to areas where they will have the greatest impact.

TrueEconomics said...

John, I agree with all you are saying here. We have a culture that actively seeks and destroys any independent thought that it cannot co-opt through handouts and payouts. Hence the mess we face. But in the case of the present Government, the situation is even more venal. The likes of the two Brians and Mary have neither a common link to reality (they live in a world inhabitable only by lottery winners - no talent or real effort required in exchange for lavish pay) nor an intellectual capability to comprehend their tasks. In other words, neither academic learning nor common sense. Hence yesterday's Budget.

Interestingly - our official media - even that part of it which is critical of them - is engaged in the same end game as them. RTE and Irish Times are appeasing their own constituency of the left-leaning 'professionals' who feel a sort of post-colonial guilt for taking a privileged position in this society. To be frank - they should feel guilt, for majority of our 'professional' elites - from doctors to lawyers to academics would not be able to survive in the world outside their protected, self-regulated bubbles. They are no exxceptionally bright, nor exceptionally well educated, neither do they posess inordinately competitive aptitude. So teh circle is complete - lazy and venal Government, small-town corrupt elites, self-loathing underachievers in the 'professions' and pliant media. What freedom of thought can be entertained in this environment? What creativity? What knowledge economy? Our successful, productive entrepereneurs - whether in intellectual domains or business - are exceptions to the rule, only serving to fortify the rule itself. Thus, all truly succesful business persons in this country are, like writers and poets, reliant on external markets.

Anonymous said...

A huge missed opportunity to start turning the country around by focusing on getting people back to productive work. Yet all we got was more taxes on those who have avoided (up to now) losing their private sector jobs. There clearly is no appetite to attack the problem of the hopelessly-out-of-touch public sector and all we get is the bleating minister telling us that it would be unthinkable to apply further cuts after already applying a pensions levy.

It begins and ends with where the culture of entitlement has its roots and that is clearly the salaries and entitlements of all those involved in government. How can the minister apply such swingeing cuts to working people yet fail to notice that his own boss is outrageously overpaid when compared with all other world leaders let alone those leading small economies of the scale of ours.

We cannot and will not reestablish any international reputation or credibility (.. yet another downgrade) while we dance around the edge of the problem pretending that we're taking action.

If the government and the entire public service really believes that it does indeed serve the citizens of ireland then they need to stop pillaging the finances and get in line with everyone else. You just can't talk your way out of a problem yet that's all we seem to be getting. Pathetic outcome on a day when a massive opportunity has been missed. The public will decide.