Facing up to reality: Austerity is an obstacle to deficit reduction

This is the first part of a two-part post.

Michael Taft: On Sunday, Colm McCarthy wrote:

‘ . . .the programme for budgetary correction needs to be accelerated. There is one, and only one, policy instrument available to Government which will improve confidence quickly and that is the pace of deficit reduction.’

Couldn’t agree more (though equally important is to prevent private banking debt from being absorbed into Government debt). We need to reduce the deficit in a sustainable manner. Therefore, the first thing the new Government should do in its review of public spending is to consign the Report of the Special Group on Public Service Numbers and Expenditure Programmes (aka An Bord Snip Nua) to the rubbish heap. Not only is it so methodologically flawed that it tells us almost nothing about generating savings for Exchequer, the strategy which it promotes (austerity, deflation) has been a failure. Indeed, that strategy may actually be adding to the deficit and debt burden. It is time to junk the report and start a real deficit reduction programme.

Hasn’t Worked So Far

In 2009 the Special Group report called for €5.3 billion in public spending cuts, almost all current expenditure. But in the three budgets in 2009 the Government did a few billion better. They cut current spending by €6.3 billion. In addition they cut €1.5 billion from the capital budget while increasing taxation by €2.8 billion – an overall contraction of €10.6 billion.

What happened next was predictable and predicted. The Finance Minister called in the Opposition Finance spokespersons in the autumn of 2010 to tell them the deficit was still rising.

The last budget cut approximately €2.1 billion in current spending and €1.8 billion in capital; all this to try to get the deficit down to below -10 percent. What’s the prognosis? Not good.

According to newly released papers, the Department of Finance is already expecting the deficit to be higher than last budget’s projections. They were hoping for an Exchequer balance of €17.7 billion; now they project a balance of €17.9 billion – and that’s after only two months of Exchequer returns.

According to the Department:

‘Income tax will be a key determining factor in the achievement or otherwise of the overall tax revenue tax target for 2011’.

If this is the case, there should be cause for worry. The briefing paper stated income tax was down €45 million on the end-February target. The recently released March Exchequer statement showed income tax falling €125 million behind target. This ‘key’ category is weakening. So is VAT, which is down €179 on target.

But this shouldn’t be too surprising. The last Government estimated that for every 1 percent of GDP in fiscal contraction, economic growth falls by half that amount (though the IMF suggests the fall in GDP could be between twice and four times what the Government estimates). This results in falling tax revenue and rising unemployment costs, which in turn adds to the deficit burden.

Already, based on current growth projections, the deficit target has slipped by nearly ½ percent in the first three months. In other words, the Government is not likely to break the -10 percent deficit threshold. And according to the Sunday Business Post (link not available yet), the Government, along with the EU and IMF, are preparing to revise future growth downwards. This will lead to a deterioration of the deficit target.

So what have we got? The Special Group report called for €5.3 billion in spending cuts. The Government responded by cutting public spending by €11.7 billion – more than twice as much as the Report’s recommendations (and this doesn’t count the cuts in the 2009 budget). And yet the deficit still remains stubbornly high, only slight below the deficit level at the time the Report was published.

The pro-austerity camp has only one response to this running-in-quicksand scenario: more austerity. But it is austerity itself that is the obstacle to sustainable deficit reduction. How much deeper down the hole do we have to dig until we realise that it is the digging itself that is the problem?

When do we start facing reality?

Next post: why the methodological flaws in the An Bord Snip report require it to be junked.

Posted in: Inequality • Economics • Economics

Tagged with: deficit • austerity • Bord Snip Nua