Tuesday 25 October 2016

Read the small print to find the harsh reality of Budgets

Published 07/01/2016 | 02:30

Always read the small print. This is especially true of the annual Budget. Some of the print is so small that only experts can comprehend it, and they will tell you that some important stuff is not in there at all.

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As for the experts themselves, they too require careful study. None more so than the annual analysis of the distribution effects of the Budget published by the ESRI (Economic and Social Research Institute.

This is one of the most valuable documents in the process. It uses complex models devised to incorporate economic output, taxation and social welfare and, as such, is a better guide to the impact of budgets than the more restricted examples in other comparisons - usually from some interest group or other.

Quite rightly, it receives a fair amount of publicity and its conclusions are much quoted. This time, the most newsworthy points concerned the combined impact of the budgets from 2009-16, where the loss of income for most groups was between 7.5pc and 10pc, with somewhat larger losses for the bottom and top tenths of the population in terms of annual income.

But read the small print, especially the bit about how the changes are measured. This is not as obvious as it might seem.

Just before the budget, the Department of Finance publishes figures showing what would happen if, in effect, the budget was cancelled and the Minister cleared off on an early Christmas break. This gives the "opening deficit" (very occasionally surplus). The figure published after the budget shows what the minister did to reduce (or increase) the deficit.

The ESRI approach is quite different. It makes an assumption about the increase in wages in the following year. The increase will lead to more taxation, as some workers enter the tax net and more move from the lower tax band to the upper. The ESRI assume that tax bands and welfare payments are increased in line with wages ("indexed"). It then calculates the impact after that.

Taxes rose substantially, especially with the introduction of the USC. Most of those losing their jobs would have seen a significant drop from after-tax income to welfare benefit.

The 14pc fall in the incomes of the top tenth of earners is mostly dues to higher taxes, especially USC, while the 13pc drop for the bottom group is mainly reductions in welfare. These are the effects of budget measures - the infamous "austerity" - and do not include income losses from unemployment or cuts in wages and profits.

Once again, the figures say that there is no "squeezed middle" - a soundbite famous only for being famous. It may be true that the same percentage loss of income is more painful the less one earns, but the percentage increases for top incomes and it is not clear that the middle deciles have more to complain about than anyone else.

If you want to look for squeezes, the greatest losses, at almost 20pc, were for single unemployed people without children - mainly due to cuts in payment rates for the young unemployed.

The lowest losses were for pensioners, with payments increased in Budgets 2009 and 2016. I forbear to comment on the fact that they have also received one of the most generous election promises to date.

Why go through this rigmarole of assuming that taxes and welfare are indexed to wages, when most of the time they are not? The reason is that this particular analysis is trying to measure the impact of budgets at different income levels. The department's "opening balance" method tells nothing about this "distribution" (although it publishes its own impact calculations after the Budget).

The attraction of the imaginary indexation is that this would lead to approximately equal growth (or decline) in income across different income groups. Comparing the actual budget with this benchmark shows the effect of the decisions take by government - the results of policy, in other words.

It is never policy to do nothing and have an early holiday, of course. But perhaps the arguments for changes should be teased out a bit more. For most of the past 30 years now, apart from the periods of correction, a visiting Martian would conclude that the purpose of budgets was to cut taxes. (If it stuck around, it might also conclude that cutting taxes was one of the reasons for the periodic corrections).

Tax-cutting cannot be the centrepiece of every Budget. Especially not when other policies always include more public spending and welfare increases. It would take some ingenious policy-making to fit all those together without doing collateral damage. Needless to say, no such ingenuity is rarely on offer.

Much of the tax cutting down the years is a conjuring trick. Tax revenues increase because national income is growing. Governments amend taxes so that the rise in revenue is not as great as in national income, and call it a cut. Which is also how they define a spending cut.

It has been different during the crash, when income was falling but tax revenues rising. No trick there, just harsh reality. Revenues will have to continue rising for the next five years but the hope is that national income will grow even faster. If it does, we will have "tax cuts." If it doesn't, the trick won't work.

Some countries, including Britain, automatically index tax bands to wages, before announcing the budget changes. This makes conjuring more difficult but, perhaps as a result, Chancellors of the Exchequer have become masters of misleading presentation and the burial of small print.

Irish governments toyed with indexation for a while in the good times but never made it automatic. Each year there is an enormous fuss about changing the entry level for the top rate of tax, but hardly any about the fact that not doing so when wages are rising is in fact a tax increase.

As for this year, there was much elation around the forecast that it will see the first increase in wages since the Crash. It must also come as a relief to the ESRI analysts not to have to pencil in the impact of falling wages before doing their sums. They took a figure of a 2.35pc increase in 2016. Allowing for the fact that bands and rates were left unchanged, but USC reduced, a quite elaborate budget left most groups better off by an average three-quarters of one per cent.

That's all. More interesting is that this is one of the more regressive budgets since the crash, with with no gains for the bottom fifth of households. Surprising? I appreciate that this story is a few week old now, but I'm not sure the small print was read with sufficient care.

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