ECONOMICS: Pressure is mounting on the Government to ratchet up the size of the adjustment in the forthcoming budget

Decision time is looming. The size and composition of the budget adjustment next year, and over the medium term, will be finalised in the weeks ahead.

Given the impact the decisions contained in the budget have on almost everyone’s income, interest in budgetary matters is intensifying, with issues around public finances being the subject of three separate events this week.

On Wednesday, Minister of Public Expenditure and Reform Brendan Howlin spoke to a large gathering of mostly senior civil servants at the Institute of Public Administration (IPA). He was, as he has been since his surprise appointment, full of reforming zeal.

But how radical he is on spending reform, and how radical he is allowed to be, remains unknown. Among the commitments made in the programme for government was a root and branch analysis of where taxpayers’ money goes and whether value for money is obtained.

Disappointingly, the Government has not yet published the findings of that spending review, which was due for completion last month. The current position, according to an official at the conference, is that no decision has been made by the Government on when the findings will be published.

One of the purposes of such exercises in other countries is to enhance the quality of the debate about the choices to be made. That is why findings are published well before the resource allocation decisions are made.

An informed debate requires good and timely information. Richard Boyle, head of research at the IPA, who presented a paper on international experience of spending reviews, said that, as a general principle, publishing such studies in advance of decisions on spending allocations is timely and useful.

The Economic and Social Research Institute (ESRI) held its annual pre-budget outlook yesterday, a day after the newly established Irish Fiscal Advisory Council launched its first assessment of the public finances in the same building.

The institute last month urged the Coalition to “overachieve” on the 2012 targets. It has called for a €4.4 billion adjustment package next year, rather than the €3.6 billion the Government planned in order to meet the terms of the EU-IMF bailout. The Central Bank has also urged a bigger adjustment.

Officials from the troika of the European Commission, European Central Bank and International Monetary Fund are ensconced in numbers in the economically significant Government departments. Should they agree with the domestic monetary and fiscal institutions and the ESRI, the pressure on the Coalition to go larger on the adjustment in 2012 will become intense.

There is no doubt that an adjustment of €3.6 billion will be difficult politically and for those whose incomes are affected. A larger adjustment will be commensurately more difficult but it is achievable.

By the widest measure – the EU-harmonised “General Government” spending and revenue measure – the State spent just over €70 billion (excluding bank bailout costs) last year. Note that this measure is much wider than the monthly cash-based exchequer figures produced by the Department of Finance.

It is also the measure that really matters:

Because it is the most comprehensive;

Because the main budgetary targets in the bailout are based on this measure (expressed as a percentage of gross domestic product);

Because it is the measure markets watch most closely.

The chart shows how furiously Governments worked during the boom to spend every cent that came into the public coffers. When the bubble burst, the public finances were blown apart. Revenues nosedived and spending was propelled upwards, both by the costs of recession and the slow reaction of the government to address the problem (only with the emergency budget of April 2009 – almost two years after the bubble burst – did the government ramp up its response in a manner proportionate to the scale of the problem).

According to the last (and thus far only) time the new Government set out its budgetary stall – in April of this year – public spending is destined to stand at just under €70 billion in nominal terms by mid-decade, down from just over €70 billion last year.

This may surprise some readers. Are spending cuts not supposed to be doing most of the heavy lifting of bringing the public finances back to balance?

They will achieve this, for the following reasons.

First, when adjusted for inflation, the real cuts in spending will be considerably larger than the nominal ones, provided, of course, that there is no extended period of deflation.

Second, debt servicing costs will account for an ever expanding share of total spending. Last year the interest bill was €5 billion. In 2015, the Government in April budgeted for a bill of €11.3 billion (although this is likely to be somewhat lower owing to recent lowering of interest rates on EU bailout funds).

Finally, as a percentage of gross domestic product, spending falls by much more than revenues rise.

As the chart shows, closing the gap between spending and revenues depends on collecting more tax.

Some of this will come from new taxes and increases in some tax rates, but most is expected to flow from the buoyancy effects of stronger economic growth.

If that growth does not materialise, Irish public debt levels will quickly rise to Greek levels. It cannot be stressed enough that everything is dependent on the return of economic growth.