FISCAL CONSOLIDATION LOST AND FOUND. Michael Taft Unite the Union

Transcription

1 FISCAL CONSOLIDATION LOST AND FOUND Michael Taft Unite the Union

2 The Underlying Deficit The Department of Finance produces an underlying deficit omitting bank payments. However, it does not omit the bank income that has arisen out of the same financial maelstrom that gives rise to the payments. Bank income arising from the crisis is significant estimated to exceed 7 billion to date. The difference between the Government s underlying deficit and the deficit when bank income is omitted is significant.

3 Deficit Reduction Where We Are TABLE 1 Underlying General Government Balance: (est.) GGB -13,129-22,467-48,426-20,158-13,012 Bank Payments 0 4,000 31,575 5,961 0 Bank Income ,923 2,561 2,561* Corporate Tax UNDERLYING GGB -13,239-19,351-18,774-16,507-15,824 Deficit / GDP -7.4% -12.0% -12.0% -10.4% -9.8% Deficit / GNP -8.6% -14.6% -14.4% -13.0% -12.5% * Estimate based on previous year s income.

4 Difference with the Government Underlying Deficit Government Underlying Deficit -13, , , , ,01 2 GDP -7.3% -11.5% -10.8% -8.9% -8.0% GNP -8.5% -13.9% -12.9% -11.2% -10.3% Underlying Deficit excl. Bank Income -13, , , , ,82 4 GDP -7.4% -12.0% -12.0% -10.4% -9.8% GNP -8.6% -14.6% -14.4% -13.0% -12.5%

5 Contributions to Deficit Change Since 2008, there has been a fall of 9.6 billion in underlying general revenue (i.e. when bank income is stripped out). That has been an increase of 1.2 current expenditure owing to the increase in interest payments and unemployment costs. The capital budget (excluding bank payments) has fallen by 8.6 billion. Any change in the deficit has been due to cuts in the capital budget.

6 Contributions to Deficit Change Increases by Category: ( million) 2,000 1,201 0 Underlying General Government Revenue Current Expenditure Underlying Capital Expenditure -2,000-4,000-6,000-8,000-9,550-8,568-10,000 Current Underlying 02,000-10,000-8,000-6,000-4,000-2,000 Expenditure General Capital Expenditure Government Revenue

7 Useful to Examine Current Budget Deficit After next year, there are no more capital cuts planned (apart from a small 100 million reduction in 2014) All deficit reductions after next year will have to come through the current budget The current budget balance will have to return to close to 2008 levels However, we are not making much progress.

8 Underlying Current Budget Deficit TABLE 3 Underlying Current Budget Deficit ( million) (est.) Underlying Current Budget Balance * ,178-13,024-11,583-11,562 GDP -0.2% -7.2% -8.4% -7.0% -7.0% GNP -0.3% -9.2% -10.0% -9.1% -9.2% * Excluding Bank Income

9 Primary Budget Balance The underlying current budget balance has shown little progress since 2009, even with 16 billion in adjustments on the current side. There is some improvement when considering the underlying primary current budget balance. It has fallen by 3.8 billion since 2009 (or 2 percentage points when measured against GDP). Still, it is doubtful that this small fall represents value-for-money when considering the scale of past adjustments. With interest payments set to rise significantly, however, we need to make significant headway. Projections for 2015, though, continue to be revised downwards.

10 Underlying Primary Current Budget Deficit TABLE 4 Underlying Primary Current Budget Deficit ( million) (est.) Underlying Primary Current Budget Balance * 1,967-8,932-8,087-6,440-5,112 GDP 1.1% -5.3% -5.2% -4.1% -3.2% GNP 1.2% -6.7% -6.2% -5.1% -4.0% * Excluding Bank Income

11 Projected Overall Primary Balance for 2015 Projected Primary Balance for 2015 (%) Budget 2011 SPU 2011 SPU 2012 Budget SPU

12 Challenges to Consolidation NERI / Bradley-Untiedt: deficit will not fall below 5% by Downside risk to Government s growth projections: 2.2% annual up to EU / IMF: 1.8% According to Department of Finance, export growth not tax-rich. However, tax-rich domestic demand sector will contribute only about 25 percent to overall growth up to Government hoping for 8,000 jobs decline this year. CSO: employment falling on annually up to 2nd quarter by 33,000. Next year reduced bank revenue of 600 million, increase

13 Smart Fiscal Consolidation How can we engage in smart consolidation? How can we minimise the negative impact on the economy while maximising deficit reduction? There are no silver bullets. There will have to be a range of approaches. How can we put upward pressure on growth/gdp and downward pressure on the deficit? The following examines four areas: the fiscal mix, the content of consolidation measures, fiscal redirection within the envelope and treating investment as a tool of consolidation.

14 1. Fiscal Mix Between Expenditure and Revenue First issue in smart consolidation is to consider the fiscal mix We need to go beyond claims that spending cuts are better than tax increases. No consensus on this. Factors: quality of consolidation, currency and interest rates, Central Banks bias, relationship to the business cycle, duration, income inequality, institutional capability / transparency, historical level of tax / spending, whether trading partners also pursuing consolidation. Country specific endowments can produce widely varying consolidation experiences: cannot be reduced to a simple typology of large closed economies and small open economies. Claims that expenditure-based consolidation take an incorrect perspective.

15 Consolidation Experiences Consolidation Experiences: Average Annual Real Increases (%) Denmark ( ) Finland ( ) Ireland ( ) Government Spending on Public Services Public Investment

16 There is a big difference between slowing the rate of social expenditure and investment in order to consolidate; and actually cutting in real terms; from overseeing a fall in unemployment and letting it rise significantly. Consolidation Experiences During their consolidation experiences, Denmark and Finland still managed to increase Government consumption and investment, despite a high inflation environment. Ireland has actually cut in real terms inflicting damage on social infrastructure and economic growth. During their consolidation experiences unemployment fell in Denmark (from 8.4% to 5%); fell in Finland (from 16.3% to 9.8%). In Ireland, it has increased from 6.3% to over 14%).

17 Expenditure has Higher Multipliers than Tax The ESRI has twice measured the impact of fiscal measures on the domestic economy. They found that spending cuts (public sector wages, public sector employment, investment) have a more negative impact on economic growth than tax increases (carbon, income and property tax). They also found that the deflationary impact of most fiscal adjustments accelerate past the first year. This should warn us against calls for front-loading fiscal adjustment so as to get it over with. Fiscal policy is not like going to the dentist. We get the pain in the first year, and it increases thereafter.

18 1 billion Shock: Impact on GNP (%) ESRI Fiscal Shocks: 1st Year Impact on GNP (%) Carbon Tax Income Tax -0.2 Property Tax -0.3 Investment PS Wages PS Employment Carbon Income Property Investment PS Wages Employment Tax

19 Impact on GNP Medium-Term (%) ESRI: Impact on GNP Medium-Term (% of GNP) Property Tax Income Tax PS Employment PS Wages st Year 3rd Year 5th Year 7th Year st 3rd 5th 7th Year

20 Expenditure More Fiscally Wasteful Because spending cuts are more deflationary, they are less efficient at reducing the deficit. For an equal 1 billion fiscal adjustment, spending cuts are less efficient at reducing the deficit. Cuts in Government consumption only manage to reduce the deficit by approximately 500 million; tax increases reduce the deficit by 700 million or more. The deficit reduction for investment excludes the supplyside impacts which the ESRI calls significant. Therefore, deficit reduction would actually be lower.

21 Impact on Borrowing Requirement ( million) ESRI Fiscal Shocks: 7-year average annual impact on Borrowing Requirement ( million) 1, Carbon Tax Property Tax Income Tax Investment PS Wages PS Employment 0 Carbon Property Income Investment PS ,000 Wages Employment Tax

22 Revisit Fiscal Mix Between Expenditure and Tax These are illustrations based on linear measurements from ESRI s HERMES model. These are confirmed by NERI s HERMIN model. This is not conclusive. But it does invite us to consider alternative scenarios that re-weight the fiscal mix towards revenues. This could have the potential of reducing the amount of fiscal adjustment and the deflationary impact without undermining fiscal targets.

23 2. Improve Quality of Particular Measures The 2nd area: improve quality of consolidation measures. Former Minister for State Roisin Shortall posed: Ø increased prescription charges for medical card patients or reduced drugs bill Ø cutting public health nurses or collecting money owed by insurance companies Ø cutting home help services or imposing a cap on consultants' pay Former Minister raised Issues not only of social equity but of fiscal efficiency as well a critical relationship. Arguable that reducing the drugs bill has a lesser deflationary impact and, therefore, is more fiscally efficient than hitting medical card patients.

24 Improve Quality of Particular Measures What would we find if we measured the impact of Ø Regressive flat-rate tax increases cutting personal tax credits / Household Charge or increasing the effective tax rate on high-earners by reducing tax expenditures Ø Removing all property relief legacies or increasing income tax rates Which is more deflationary / less efficient at reducing the deficit? Again, this raises the critical relationship between social equity and fiscal efficiency.

25 3. Fiscal Redirection within the Envelope 3rd area: potential benefits of redirecting fiscal resources into productive areas rather than withdrawing them from domestic demand. Cutting public sector employment not effective in reducing the deficit because of its deflationary content. Consider redirecting reduction in unproductive or redundant posts into productive areas. Example: rolling out a national early child education network: boost demand-side growth with long-term supply side gains.

26 Fiscal Redirection within the Envelope Doing this on a cost-neutral basis could strengthen our social infrastructure without undermining fiscal targets, when economic impact is factored in. This could be a superior alternative in many areas to the current strategy of taking Croke Park productivity gains and withdrawing them from domestic demand. However, this requires the tools to measure the cost / benefit, and A strategic vision of social infrastructure of which education / human capital would play a crucial role

27 4. Investment as a Tool of Fiscal Consolidation The final challenge is to develop a strategic approach to fiscal consolidation which rejects a zero-sum choice between spending cuts and tax increases. A third key choice is to boost the economy s productive capacity through, among other things, investment. Bradley and Untiedt measured impact of a 3-year 2.5 billion investment programme comprising physical infrastructure, human capital and innovation, using three scenarios where investment is financed by borrowing, taxation and by EU grant (effectively, a free resource).

28 Investment and Borrowing Requirement Investment (Borrowed): Impact on Borrowing Requirement : million

29 With these caveats - including small draw-down of Government s 29 billion cash and asset reserves - what is the impact of investment funded without resort to Investment and Borrowing Requirement If borrowed, cost in first three years would be approximately 1.1 billion. By 4th year, investment cuts deficit. Borrowing is limited by the bailout. Limited fiscal space to absorb increases in borrowing requirement in the shortterm. Proposals to finance investment through off-balance sheet vehicles. Should be cautious. These still create balance sheet pressures - long-term annual payments / contingent liabilities.

30 Investment and Borrowing Requirement Investment ('Free-Financed'): Impact on Borrowing Requirement ( million)

31 Finding Sources for Investment Borrowing starts to fall in first year. Questionable if sizeable investment could be financed this way. However, from a mix of sources borrowing, tax, public enterprise, NPRF, Government cash reserves we might produce a return that approximates borrowing reduction under a free-financed investment programme. Let s assume we can construct a programme that approximates free-financed investment. In terms of reducing the borrowing requirement what would be the fiscal adjustment equivalent i.e. how much tax increases / spending cuts needed to equal the reduced borrowing under investment?

32 Fiscal Adjustment Equivalent Fiscal Adjustment Equivalent of Investment Benefit: Borrowing Requirement ( million) ESRI -Fiscal Adjustment Equivalent (Public Sector Wages)Government: Fiscal Adjusmtnet Equivalent ,

33 Investment more Efficient than Fiscal Adjustments Under Bradley/ Untiedt investment would reduce the borrowing requirement by nearly 400 million. This is equivalent to fiscal adjustment of 531 million (using Government multipliers) and 588 million (using ESRI multipliers for cutting public sector wages). Only measures nominal borrowing. Impact of fiscal adjustments on output / employment go in opposite direction of investment, which boosts both. Therefore, when measured against GDP, amount of fiscal adjustment needed may be even higher. This is only indicative. Not likely to capture all these gains. However, reinforces evidence that investment brings medium-term fiscal gains.

34 Use Investment as a Tool of Consolidation This invites us to reconsider the mix and time-scale of fiscal adjustments. If borrowing declines through demandside impact, this means the fiscal adjustment-equivalent can be postponed beyond 2015 without undermining annual deficit targets. To the extent that investment permanently reduces the borrowing requirement from supply-side impacts (after the third year), we can reduce the overall level of fiscal adjustments There are three particular benefits to such an approach

35 Benefits of Reducing Borrowing through Investment First, reduces short-term impact on domestic demand Second, transfers adjustment to period when economy better able to absorb it. Third, allows time for more authentic public sector reform that goes beyond employment-reduction and working-week targets. Ø European-style social insurance financing of a single-tier health service, including GP care and prescription medicine Ø A rational public-service provision of primary education, rather than fragmented out-sourced system. Structural reforms take time but can produce more sustainable social and economic benefits.

36 Conclusion How can we act smarter, increasing our chances of successful fiscal consolidation? 1. The appropriate mix of tax and expenditure 2. The quality of particular consolidation measures. 3. A redirection of fiscal resources rather than just withdrawing them from domestic demand 4. Use investment to increase our productive capacity which is a tool of fiscal consolidation. This begs the question: do we have the tools to undertake smart and strategic consolidation? Will we use them? And will we act on them? If the answer to any of these questions is no, then we will