Recovery is still too weak to withstand any tax cut
Temporary budgetary advantages are no basis for a programme of tax cuts in the Budget, writes Marc Coleman
Is it too early to talk about tax cuts? Normally, it would be. With the Budget now taking place in October, speculation about it shouldn't really be inflicted on anyone until July, right? Fair enough.
But this year is an election year. And many voters would like to, ahem, express a view on the expectations they had regarding the burden of tax. Expectations for tax cuts have also been stoked by recent ministerial comment. Furthermore, the penny is dropping that asking Irish industrial workers to pay marginal tax rates designed for Monaco millionaires is neither politically nor economically sustainable. So please Santa, please, can I have a tax cut?
'Can Government afford to give you one?' is the real question. Were the McCarthy report to be implemented, local government to be radically slimmed down and reformed, and the privatisation nettle grasped and were welfare to be focused on need rather than universality then, yes, tax cuts would be possible. And desirable.
But until politicians get an appetite for radical reform, the case for cuts must rest on buoyancy in the economy. And if the Government's Stability Programme Update (SPU) forecasts are right, that particular beast remains elusive.
As that forecast acknowledges, the real "take off" in our recovery seems to have a rainbow characteristic to it: visible but always just out of reach. In its April 2012 stability programme the Government predicted that the economy would grow last year by 2.2 per cent. It shrank by 0.3 per cent. That 2.5 per cent gap is, according to the SPU's calculations, worsened by the underlying budgetary balance by around 1 per cent of GDP.
And yet the Government met its target deficit. But this was because this structural decline was offset by several "lucky" events, including a €200m benefit from lower than expected debt interest payments (thanks to clever footwork by the NTMA buying back Irish bonds) and a higher than expected Central Bank surplus. The latter windfall is due to a temporary little arrangement whereby bonds sold by Government hang around on the Central Bank's balance sheet for longer than the ECB would like them to.
Even if the NTMA can continue to imitate Muhammed Ali in his prime and even if the Government faces down the ECB, these temporary budgetary advantages are the only buffer against the budget deficit scraping against Excessive Deficit Procedure (EDP) limit. They are certainly no basis for a programme of tax cuts in the coming Budget. GNP growth last year – 3.4 per cent – isn't much comfort here, arising as it does mainly from adjustments in the national accounts relating to multinational profit flows.
What about tax buoyancy? Aside from "lucky" events, if tax revenues started growing strongly enough and of their own accord, that would justify tax cuts, wouldn't it?
If that were the case it certainly would. A fortnight ago news of a 4.7 per cent jump in the first quarter's tax take prompted hopeful murmurings. But the strongest growth rates are coming not from underlying buoyancy but from discretionary tax rate rises: annualised growth rates in March tax receipts for Capital Gains (80.2 per cent), Capital Acquisitions (52.9 per cent) and Stamp Duty (34.7 per cent) are only sustainable if bank lending picks up. After the ECB's November review, bank lending may just do that. But while this itself would be welcome, tax cuts based on this would – as we now know from bitter experience – most certainly not. So a close look at the figures suggests tax revenue growth so far doesn't offer too much hope.
Could that be about to change? SPU forecasts suggest the recovery is about to get stronger. From flat growth last year, economic growth is supposed to start averaging 2.5 per cent a year over the next two years. But these stability forecasts have been saying this for the last three years in a row. In fact, given recent misses in GDP forecasts, it is surprising that the Independent Fiscal Advisory Council (IFAC) has been so quick to endorse these latest forecasts.
In my view, more caution is warranted about our near term fiscal position. Perhaps the IFAC is too understaffed to spot emerging signs of trouble. But they are there. For example, the April 2012 SPU forecasted GDP to grow by 2.2, 3 and 3 per cent respectively over the years 2013, 2014 and 2015. That's cumulative growth over that three years of 8.2 per cent. Instead, GDP fell 0.3 per cent in 2013 and is forecast to average 2.5 per cent this year and next. That's cumulative GDP growth of 4.5 per cent. So GDP will by the end of 2015 be 3.7 per cent lower than we thought. So the Government must work harder – or get luckier – if it is to stick to its deficit targets.
Constantly kicking to touch our national debt ratio reduction underlines the problem. In April 2012 the stability forecast expected the debt ratio to peak at 120.3 per cent last year and fall to 117.4 per cent in 2015. It rose instead to 123.7 per cent last year and is forecast now to be at 120 per cent in 2015. And that's assuming no more nasty surprises on the GDP front.
So if you're dying for a tax cut, don't hold your breath. And if an election candidate promises you one, ask them how they expect to pay for it. The recovery is sadly still too weak to do so. And that leaves only two options: kicking debt ratio reduction below 120 per cent further down the road, or implementing radical, deep structural reforms. Unsurprisingly, few politicians during elections are willing to commit to the latter.
Marc Coleman presents 'The Marc Coleman Show' each Sunday from 9pm on Newstalk 106-108fm