Victory can come from budget defeat
Like the imperial Russian general Kutusov, the Government must wait until winter to see any gain, writes Marc Coleman
YOU can lose a battle and still win a war. In fact, some of greatest generals in history have won glorious wars that began in abject defeat. Take Marshall Mikhail Illiaronvich Kutusov, for instance. Kutusov was an expert in sacrificing early battles so that more important victories could be won later. He famously turned up late for the battle of Ulm and put up a half-hearted effort at the battle of Austerlitz.
As the two easy victories pushed Napoleon's self-confidence to excess, he didn't realise that the wily Kutusov was just getting started. Firstly, he drew Napoleon deep into the Russian heartland. He knew that Russian soldiers would fight more fiercely on home soil. He also knew that Napoleon's supply lines would become overstretched the more that his army advanced.
But most of all, he knew, as only a Russian could know, how the Russian winter would fight Napoleon like a second army. And on all three counts, he turned out to be right. Of the 600,000 soldiers in the Grand Armee that marched into Russia, barely 150,000 survived. The rest starved, froze, deserted or were killed.
On first inspection, our last budget looks like a permanent defeat for the taxpayer: The hike in taxes, up €1.8bn this year and €3.6bn next year, will be a source of joy to advocates of a high tax and high spend economy. As a result of the budget, taxpayers will contribute three parts in every four to the total fiscal belt-tightening next year (for every €4 reduction in the deficit, tax increases will contribute three and spending cuts one).
Politically, the budget seems to copperfasten the direction in economic policy that began with the departure of Charlie McCreevy and Seamus Brennan from Cabinet in 2004. Since then, total Exchequer spending has risen from a sustainable level of just under two fifths of GNP to almost half of GNP this year. Between 2005 and 2007 alone, it rose by one third.
Back in January, one of the government's own advisers, Colm McCarthy, noted that "significant tax increases had already been imposed" in last October's budget and that real spending growth had exceeded growth in the economy since 2005. Although spending reductions of just under a billion were announced in the budget for this year (and just over a billion in full year terms), net current spending will still rise by over 4 per cent in value terms. With inflation likely to be a negative 4 per cent, this represents an increase in real spending of almost 8 per cent.
Why is this happening? There are two theories. The first is the theory of total defeat: this says the government is politically obliged to spend the next few years increasing taxation because although it isn't in the economy's interest, this will meet the least resistance.
The immediate reaction to the budget seems to back this up. The medical card demonstrations last autumn showed just how much anger can be created by spending cuts. By contrast, however angry they are, taxpayers aren't marching. And as Fianna Fail's poll ratings have fallen substantially, it may now realise that getting into government without Labour will be increasingly difficult if not impossible. Just as it did for Fine Gael (via their "solidarity taxes"), the same consideration has forced FF to favour tax rises over spending cuts.
But the second theory -- the Kutusov theory -- is equally plausible. It goes like this: with taxes having fallen to under one quarter of GNP, some tax increases were an inevitable but not necessarily dominant part of the government's budgetary strategy. The question then becomes: do you impose those tax increases now or later and closer to a general election?
Fighting a battle for the taxpayer at this stage would be counter-productive and for two reasons. First of all, tax increases in October's budget mean taxpayers are angry anyway and unlikely to reward the government for any restraint in next June's elections. Secondly, the political "weather" -- the slow build-up to a second Lisbon referendum -- makes any confrontation with social partners unthinkable before the winter.
But conditions of battle will change in other ways also. Between now and November of this year, the recession will reach its lowest point and from then to the following summer, the lagged effects of this will produce new headlines of woe. The live register will rise to new highs. In most of the private sector, prices and wages will continue to fall. It may also become patently clear by then that the strategy of tax hikes has backfired.
Whatever about the overall level of taxation, the most recent exchequer returns show that some taxes have become so high that they are strangling economic activity. The clear evidence of this is that they are falling much more then the level of economic output. In contrast with income taxes, where a modest fall of seven per cent occurred (mirroring the economy), stamp duties have fallen by over 60 per cent, excise duties by 32 per cent and Vat by 18 per cent.
These figures are unlikely to get much better between now and November when the Commission on Taxation will have to have regard to them. Redesigning the tax base is an absolute necessity. But as unemployment rises and tax revenues and consumer confidence continue to remain depressed, the case for further tax increases will diminish, as will the case for putting off action on spending.
So we can sum up the budget as follows: it has secured a strategic objective of halting for a time the relentless growth in government debt. It has, on the other hand, lost the battle to slow the trend at the heart of that growth: a public expenditure that continues to grow, albeit at a slower rate. However, that defeat can turn to victory if, like Kutusov, the government waits for winter before turning the tide.
Marc Coleman is economics editor of Newstalk 106-108FM
