ANALYSIS:The bottom line in this afternoon's Budget will be the deficit target adopted for 2009, writes Jim O'Leary
FOR MACROECONOMISTS, the bottom line in this afternoon's Budget will be the deficit target adopted for 2009.
In setting this target, Brian Lenihan must navigate between the risk of appearing indifferent to the deterioration in the public finances and the risk of administering medicine that is too harsh for the patient.
There is no readily available formula that will generate the correct number. However, the broad parameters are reasonably clear.
A deficit target of 7 per cent of GDP (the opening position per Saturday's White Paper), built on budgetary arithmetic that is highly susceptible to being disappointed, would be far too cavalier.
On the other hand, a target pitched much lower than this year's projected 5.5 per cent of GDP outturn, would probably be overly-deflationary of demand in an economy already suffering more than its fair share of negative shocks.
I must confess that as recently as a month ago, I thought a sub-5 per cent target would be appropriate, but actual and prospective economic conditions have worsened so much since then that I reckon the bar has to be lowered (remember, we're talking negative numbers here).
That said, the Minister's economic forecasts for next year are decidedly upbeat, so if I were saddled with the arithmetic that he's dealing with, I'd be aiming for something in the 5 to 6 per cent range, while preparing myself for a bigger outcome.
Mind you, this is not a position I'd choose to be in: I would much prefer to be dealing with a set of economic forecasts that gave me a good chance of being on target.
One way or the other, it is obvious that the EU's Growth and Stability Pact ceiling is going to be breached by a very wide margin, both this year and next.
Indeed, Portugal's record (a 6.1 per cent deficit in 2005) looks to be in imminent danger of being outstripped.
That in itself is not a calamity, but what it does mean is that a medium-term plan to bring the public finances back to balance is urgently required.
Such a plan is as important an element of this afternoon's Budget as anything else in it, and its credibility will be a defining feature.
The essential purpose of a medium-term fiscal plan in current circumstances is to adopt a timescale for the elimination of the budget deficit, and to set out in broad terms the trajectories for Government expenditure and tax revenue consistent with the achievement of that overriding objective. The plan must be based on a realistic set of economic projections.
The events of this year have blown the economy seriously off course, opening up a substantial gap between actual output and potential or trend output. That gap is set to widen a great deal further in 2009, and may not start to close even in 2010.
A realistic assessment of medium-term prospects at this stage would probably not envisage output returning to its trend or potential level until 2012 or 2013.
This provides a handle on the kind of timeframe over which it would be appropriate to restore the budget to broad balance.
It would probably mean achieving cuts in the budget deficit of 1.5 to 2 per cent of GDP on average in the years 2010 through to 2013.
This would probably imply running a deficit above the Growth and Stability Pact ceiling for at least the next two, if not the next three years.
As such, it might be expected to generate considerable scrutiny, and possibly a little antipathy, from the EU Commission.
The very least that can be said on this score is that Brussels will be more involved in the monitoring of Irish fiscal policy in the period ahead than has been the case before now.
Indeed, Brussels's more active oversight may provide a convenient alibi for domestic policy-makers when it comes to unpopular decisions.
Of course, a yawning budget deficit can only be closed by raising taxes and/or by cutting public expenditure. In a medium-term context, this stricture gets to look somewhat less daunting when taxes and spending are cast as percentages of GDP or GNP.
Still, the challenge should not be underestimated: the requirement will be to lower the ratio of spending to GDP relative to the overall tax burden or, equivalently, to increase the tax burden relative to the spending-to-GDP ratio by at least 6 percentage points over a period of three or four years.
It is reasonable to expect that some of that shift will be accomplished relatively painlessly as the eventual recovery in economic activity reduces some areas of spending and boosts tax receipts.
However, these benign effects will be at least partly offset by a significant increase in debt service costs as outstanding Government debt grows, so the greater part of the required adjustment will have to be effected by policy decisions.
In an ideal world, the burden of such policy decisions would fall entirely on the spending side of the equation and would take the form of measures to increase the efficiency and effectiveness of public expenditure programmes.
That way, we would end up with the same quality and quantum of public services as now, but delivered at substantially lower cost. Perhaps that is possible, but there is no robust body of corroborative evidence available on this score.
That being the case, I think a prudently-designed medium-term plan should allow for a modest increase in taxation.
However, I don't think any such increase should be front-end loaded: something on the "old reliables" and perhaps a freezing of income tax credits is about as much as is advisable in 2009.