|
|
|
|
Solid economic growth has led to an improving budget position in most economies in 2006. In the Euro area, the US and the UK, the reduction in deficits evident in Table 1 largely reflects unexpectedly strong tax revenues. This is also the case with the Irish figures. However, as is the case with most indicators whether they relate to growth, employment or even bank lending, international comparisons of budget balances underline just how exceptional the strength of the Irish economy is at present. For a country with an ambitious public spending programme amounting close on 5 per cent of GDP at present, the record of fiscal surpluses in nine of the past ten years indicates how remarkable Ireland’s economy is.
As Table 1 also indicates the emerging budget outturn is extremely different to that envisaged twelve months ago. Indeed, as recently as last Friday a sharp rise in tax revenues in November substantially altered the budget outlook for 2007. October’s pre-budget report and the Government’s early November spending plans were based on tax revenues some €2 billion lower than are now expected. Importantly, last weekend’s White Paper raised tax forecasts for 2007 pro rata and thereby (1) signaled that next year is again expected to be one of buoyant revenue growth and (2) hinted that the government would not opt to squirrel away this last minute windfall. Mr. Cowen’s target of a General Government Balance (GGB) of 1.2 per cent for 2007 implies the Minister is using about €1200 mio of this €2 bio windfall to boost spending and cut taxes. The question which must remain unanswered is what areas have seen sharply changed plans since last week. What’s it all about? As can be seen from Table 2 the budget day changes to social welfare and taxation are large by the standard of recent years. In money terms, the Budget is the most generous on record but in inflation-adjusted terms, we reckon it is about €400 million less generous than the Budget of 2001. The thrust of Budget 2007 in terms of the relative scale of social welfare increases and tax reductions was different than most of it’s recent predecessors. As Table 2 indicates, social welfare increases account for a little over half of the monetary value of budget day changes. However, the share of personal tax cuts is a good deal higher than in recent years even if it is some considerable way below the share seen in some of the budgets introduced by Mr. McCreevy. When changes in VAT are taken into account, this budget was notably more focused on taxation than most other recent budgets. Indeed, the positioning of tax matters ahead of the social welfare package in the Minister’s speech also breaks with recent tradition and seems to underscore the importance of today’s tax package. As the scope for ‘largesse’ came from stronger than expected tax revenues, it does not seem unreasonable that tax concessions are larger in absolute and relative terms than in recent budgets. It might also be argued that Mr. Cowen is also providing the Irish economy with a little bit of insurance against international risks which he noted such as a weaker US economy, a slowdown in the Eurozone, further increases in borrowing costs and ongoing uncertainty about oil prices and exchange rates. That said, as Table 3 indicates, the share of taxation in the Irish economy changes very little in 2007. This diagram also lends some support to a fabled economic proposition; the idea of self-financing tax cuts. More importantly, the evidence of recent years is that low tax rates can deliver strong tax revenues that facilitate increases in spending on services and infrastructure. This is a strong message from Budget 2007 but we leave it to readers to decide whether it is a key principle for Mr. Cowen. (Finfacts comment: see Irish Tax Burden almost unchanged in 1995-2005 period - Table 3 appears to relate to GDP not GNP. The latter partially excludes the big impact of the multinational sector and in 2005, total tax as a % of GNP was 36.2%, comparable with the UK tax burden. In 1995, tax as % of GNP was 36.7%) What will the Budget do to the economy? The Budget will add a good deal to demand in the Irish economy in 2007. We have repeatedly argued this isn’t particularly threatening. Downbeat consumer sentiment and subdued spending per employee suggest demand is not irrationally exuberant. Of greater importance, a surge in employment growth and migration mean the supply side of the Irish economy is a good deal more flexible than generally thought. Budget day changes in social welfare and taxation will add about 2½ percentage points to household spending power. So, consumer spending should be underpinned in the coming year. The Department of Finance’s economic forecast is broadly similar to that of IIB Bank (Table 4). At the margin, we would be a shade more cautious on the outlook for consumer spending. We think higher borrowing costs will dilute spending power. We also reckon a significant portion of SSIAs will go into property which isn’t included in consumer spending. We would also be slightly more cautious about employment growth. The Department’s forecast of a 3.5 per cent increase in numbers at work implies a very strong job market, particularly if it’s comparatively modest rise in investment reflects a softer pace of increase in construction activity than we envisage. We think the changes to BES, the reduction in the administrative burden of taxation on small businesses and R+D tax credits all have the potential to have a significant economic impact. Unfortunately at this stage the likely scale of the effect of these changes on economic activity is almost impossible to quantify. Reflecting some upside risk, our investment forecast is notably stronger than that of the Department. However, we are a touch more conservative on exports on the view that global growth may not be as strong as in 2007. On inflation, the decision to raise duty on cigarettes, coupled with the impact on health insurance costs of higher private bed charges and likely increases in other public sector charges will give an unwelcome boost to inflation. Our guess is that the global inflation climate may not be too threatening next year but we reckon inflation will be just a shade under 4 per cent. The Minister’s attempts to muddy the waters by referring to the lower EU ‘harmonised’ measure of inflation and his request that the Social Partners exclude tobacco related price increases from pay negotiations are unlikely to be successful. Indeed the prospect of a sharp rise in November inflation data to be published next week may cause inflation worries to erode some of the immediate ‘feelgood’ from Mr. Cowen’s budget package. What impact will Budget 2007 have on the property market? In the build up to Budget 2007 a key uncertainty related to measures that might affect the housing market. Our central view has been that a healthy housing market is a natural consequence of a strong economy. Our judgment is that Budget 2007 will sustain strong economic growth and a healthy rise in employment. On this basis, we expect the Irish property market to perform relatively well in the coming year. As Graph 5 suggests, we expect the recent softening in price growth to persist in the near term but to stabilize at a healthy single digit pace of increase in 2007. While we think stamp duty must be reformed, we were concerned that hastily planned changes might not improve the stability of the market in the months ahead. A key task will be to implement a reasoned stamp duty reform on a phased basis in coming years. Mr. Cowen has instead decided to provide targeted support to recent first time buyers and to those thinking of purchasing. The doubling of mortgage interest relief will help underpin the market though the likely limited ‘macro’ scale of impact can be judged from a comparison of the Department of Finance’s estimate that this measure will cost €70 mio in a full year with our estimate that each quarter per cent ECB rate hike takes about €300 mio out of the pockets of Irish borrowers. Looking at the increase in terms of its impact on the individual borrower, the impact at the margin may be somewhat greater; the full year cost of the 5 ECB rates seen to date plus the anticipated rate hike tomorrow is an increase in annual loan repayments of around €2500 for someone with a 250K mortgage. Yesterday’s measure will provide a maximum offset of some €1600. Together with significant increases in after-tax income, – say around €1800 per annum for a typical two income couple on a combined salary of €80K, Mr. Cowen’s budget will go a significant way towards sustaining a healthy level of first time buyer interest in the housing market.
While it could be argued that BES charges will divert investment away from property, we continue to believe that the boost these measures give to the economy as a whole will ultimately support housing market activity. Of course, Mr. Cowen’s budget is only one of many influences on the housing market. Today (Thursday) should see another ECB rate increase. We think we are close to the end of the rate rising cycle. So, we expect Irish house prices to post a solid albeit single digit pace of increase in 2007. Can the good times last? The Irish budget situation looks very healthy at present. Mr. Cowen expects a fiscal surplus of 1.2% of GDP in 2007 and envisages only slight declines to surpluses of 0.9% of GDP in 2008 and 0.6% of GDP in 2009. There is little question that a strong Irish economy should continue to support very healthy public finances. It may be worthwhile, however, to reflect on how sharply this outlook can change. A year ago, Mr. Cowen expected the 2006 outturn would be a full 3.1 percentage points of GDP poorer than it now appears. Is there any risk of a similar scale of deterioration in the future? History suggests such a possibility. As noted above, in constant prices, Budget 2007 is the second most generous in history, just behind Budget 2001. When Mr. McCreevy delivered that budget in December 2000, he expected the Government surplus would be 4.3 per cent of GDP in 2001, 3.8 per cent in 2002 and a massive 4.6 per cent of GDP in 2002. The reality was dramatically poorer. The respective outturns were a surplus of 0.8 per cent of GDP, a deficit of 0.4 per cent of GDP and a surplus of 0.2 per cent. So, the cumulative 3 year surplus between 2001-2003 was 11.7 per cent of GDP poorer than predicted; an amount equivalent to about €22 bio in 2007 money terms. This sort of shortfall is one important reason why long term budget planning may not always be quite as good as might be hoped in Ireland. Importantly, Mr. Cowen has set public spending on an altogether more sustainable trajectory now then it was in 2001. We also think some of the substantial tax cuts of the earlier period took time to bear fruit. So, tax revenues look to be on a healthier course. Because the Irish economy has shown a great deal of flexibility and, partly due to migration, much greater strength of late, we think the Public Revenues will remain on a very positive trend. However, we would underline the need not to take the persistence of economic growth for granted. At the margin we think the greater emphasis on meeting the tax burden in 2007 recognizes this reality. © Copyright 2007 by Finfacts.com |
