Wednesday, April 8, 2009

Not a Budget to savour but we'll save for the next one

Tuesday's budget from Minister Brian Lenihan was definately not a budget for people to savour. The problem is whether it will become a budget that will further lead people to save for the rainy day. It seems in Ireland that we are going to try and tax and save our way out of the recession.

For 2008 the Central Bank reports (Note to Central Bank: your website is appalling!) that there was an increase in precautionary savings of about 2.5% of household disposable income. Along with changes in the labour market this accounts for the substantial drop in retail sales we have seen recently.

In January 2008 Irish households had €26.6 billion saved in accounts with a maturity of less than 2 years. By January 2009 the amount saved in these accounts had risen by almost €10 billion to €36.3 billion. That is €10 billion that might have been spent and added to the circular flow had times being better. What the government wouldn't give for the multiplier effects and their share of that €10 billion had it been spent on consumer goods and services.

It is also worth noting that in April of last year there was €125 billion outstanding in residential mortgages. The most recent figures for February put this at €115 billion. This reduction in debt is a form of savings and that's another €10 billion taken out of the economy. Of course the key driver of this financial indicator is the impact of new mortgage balances. The creation of new mortgages has ground to a standstill so the drop in this number need not necessarily suggest increased rates of repayment but again it is an indication of consumer slow down.

It is likely that continued deterioration in the labour market will lead to further increases in precauationary savings. This is one of the features of a recession that just at a time when we want households to spend more they actually save more.

The Budget is also likely to increase uncertainty and in turn peoples' urge to save rather than spend. Spending will naturally be reduced following the increases in the income levies and PRSI and the reductions in mortgage interest relief and the early childcare supplement. The full year effect of the tax measures introduced is estimated to raise an additional €3.6 billion. Remember that in two years tax revenue has fallen from €47 billion to just over €30 billion. This budget narrowed about 25% of that fall. There's still 75% to go!

Obviously the gap can also be narrowed by expenditure cuts. However the Minister only announced full years cuts amounting t0 €1.2 billion. The government predicts that this year current expenditure will come in at €46.3 billion. It should be noted that current expenditure in 2008 was €44.7 billion. So even with the announced "cuts" the government is increasing expenditure rather than reducing it.

The government is indicating that order can be restored to the public finances through tax increases rather than expenditure cuts. Over the next two years they have indicated they will be seeking to raise an additional €4.6 billion in taxes while cutting current expenditure by €3 billion. The government is clearly of the view (optimistic opinion?) that an upturn in the global and domestic economies will bring back the bouyancy in tax revenues that will allow it to solve the crisis in the public finance without any actual reform of the problems that got us into this mess in the first place.

It is likely that people who live in the real economy will not be as confident. People are likely to save more as they fear the additional pain that is coming down the track. This will be because of continuing deterioation in labour market conditions and also what they see the government planning over the next few years. In the Budget the Minister announced that the next Budget day we will see the following:

  • the complete abolition of the early childcare supplement
  • the taxation (or means testing) of child benefit
  • the introduction of a carbon tax
  • the introduction of a form of property tax

These are is to be considered along with likely additional increases in income and consumption taxes. To prepare for this people are going to further cut their expenditure and try to increase their savings. This is only going to add to the government's woes as more money is stowed away and economic activity (retails sales, jobs and tax revenue) will continue tracking downward. All that we will be increasing are our savings as the forecast for the rainy day just got a whole lot gloomier.

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