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Budget 2021 – rewriting the rule book

There’s less than a month to go until Budget 2021, but already it’s shaping up to be unlike any other we’ve known in recent memory.

Coming against the backdrop of the Covid-19 pandemic and what’s looking increasingly like no trade deal between the UK and the EU by year end, the government has two broad choices; cut back on spending and increase taxes now to buffer the economy for stormy waters ahead or loosen the purse strings in a bid to stimulate troubled parts of the economy and to entice consumers into parting with their hard-earned cash.

While traditionally the former might have been the most likely course of action, the government looks like it’s going to opt for the latter path in Budget 2021.

But far from it being a “splash the cash” budget, any increase in spending is likely to be targeted and specific.

Austerity is so last decade!

In the aftermath of the financial crash in 2008, successive governments pursued a very cautious and prudent approach to the public finances with balancing the books the chief objective.

And that was by and large achieved in recent years with the deficit being eliminated and small surpluses being reported once again.

As well as it being the desirable approach from a purely fiscal perspective, much of it was driven at the insistence of the European institutions.

Debt and deficit procedures were introduced, compelling countries to bring their day to day spending under control, with warnings and sanctions issued to countries that failed to make sufficient progress.

The logic behind the move was to “front-load the pain so that when the next downturn emerged, countries would be in a position to increase spending and respond to a recession with stimulus measures rather that resorting to austerity when the economy is in difficulty.

The mother of all recessions

In the first three months of this year, the chief threats to the euro zone economy were rising trade tensions with the US and the slow pace of negotiations with the UK on the terms of a trade deal.

Both issues were significant threats to the outlook here, but by March, everything had changed radically.

As cases of a novel coronavirus spread globally, the IMF, the OECD and the EC – among other international bodies – were predicting the deepest recession since the Great Depression of the 1930s.

Having learned from their mistakes from the last financial crash, Central Banks responded promptly, turning the taps on and injecting trillions of euro into the global economy.

The EU, the US and other major economies followed suit with huge stimulus programmes. The EU pledged to inject €750 billion into the euro zone economy.

The message to governments was to borrow and spend.

“The rule book has been totally rewritten,” Dermot O’Leary, chief economist with Goodbody said.

“Since the sovereign crisis, budgets were pretty boring affairs because there wasn’t much wriggle room from the fiscal rules. They’ve been thrown out temporarily, and correctly, so it’s up to individual countries to come up with their own measures and really throw caution to the wind in relation to spending.”

Austin Hughes, chief economist with KBC Bank Ireland, said the “borrow and spend” mantra was being enthusiastically adopted, even by countries like Germany, that would traditionally be seen as being guided by “fiscal hawks”.

“The reality is gradually dawning. The remedy to every problem was seen as fiscal prudence. There is now this realisation that fiscal prudence would not only be the wrong remedy, but would worsen the economy.”

Budget 2021

Which brings us to our own budget, now just weeks away.

Speculation had been mounting about the possibility that the ambitious spending that the Government undertook in the early part of the Covid crisis would be wound down substantially.

The move by the UK to conclude its wage support programmes in the coming weeks and the cutting and layering of the Pandemic Unemployment Payment (PUP) in recent days here appeared to suggest that a tapering of spending could be on the cards.

The Government is already on course to run a deficit of up to €30 billion this year.

That’s in stark contrast to the cautious approach adopted last year, and planned for this year, when the government balanced the books in the context of the immediate Brexit threat that was then facing the country at the time.

All the indications in recent days point towards the spending continuing for the coming year.

“There is a strong sense that if emergency measures are not undertaken, then the economy will worsen and finances will be in an even deeper hole,” Austin Hughes said.

He also pointed out that, unlike the situation in 2008, the economy is in much better shape this time around, and that this time, the problem was not one of our own doing.

“This is not an issue that reflects an underlying flaw in the Irish economic model in the same way that the financial crisis exposed difficulties in the Irish financial system. This came out of the blue at a time when the public finances were balanced. It wasn’t a problem in the economy that needed the remedy of austerity.”

Tax cuts

So, will there be tax cuts and measures to encourage those who were in a position to put substantial piles of cash aside while the country was in “lockdown” to spend it?

Paschal Donohoe indicated in recent days that no changes would be made to income tax, USC or PRSI.

The budget would be framed in the context of a no-deal Brexit and against the backdrop of rising Covid cases, the Finance Minister said, adding that major changes would be “counter-productive” at this point.

However, it’s thought likely there will be measures to encourage people to spend.

Although the Government introduced a limited VAT cut in the July stimulus, the hospitality sector will plead the case for further VAT cuts in next month’s budget.

“Consumer confidence has been dashed. If you want recovery, we will need to reduce the very high savings ratios that have been built up and confidence plays a big role in that,” Dermot O’Leary said.

A rare instance of accord

What’s also strange about the current scenario is the extent to which the official bodies, including the Central Bank and the government budgetary watchdog, the Irish Fiscal Advisory Council (IFAC), are ad idem about the way ahead.

They agree that ambitious spending plans should form a big part of next month’s budget.

Even IFAC – which typically takes the Government to task on debt and deficit levels – says balancing the books should not happen before a recovery is well embedded.

It went further, calling for a “substantial multi-year stimulus” to stoke demand in the economy.

The Central Bank – while also calling for further supports – was a little more nuanced.

Governor Gabriel Makhlouf, in a letter to the Finance Minister, bluntly stated that not all businesses could be saved and that it wasn’t in anyone’s interest to attempt to save failing enterprises.

“Difficult decisions may need to be made about the balance between company closures and further fiscal outlay to support their survival,” he said.

Is this the end of the age of austerity?

It’s widely accepted that this is just a temporary spending splurge to attempt to get the economy back on track after an unprecedented shock.

In Irish budgetary history terms, it’s a new departure and something of an experiment.

“This is really the first time in 40 or 50 years that we’re going to have counter-cyclical fiscal policy rather than pro-cyclical,” Dermot O’Leary said.

“This is a new chapter, no doubt, but it’s orthodox. We’ve been doing it in the unorthodox way for decades. The government should come in and fill the hole when the private sector is weak,” he explained.

However, it should be noted that while we made great strides in recent years in bringing down the deficit, our debt levels are still elevated by international standards.

Even before the crisis, the national debt stood at over €200 billion.

Although the money we’re borrowing at the moment is incredibly cheap because of the accommodative monetary policy of the ECB, that won’t always be the case.

A note of caution about our national debt was sounded by the Irish Fiscal Advisory Council and the Central Bank. However, this year, both bodies appeared to give the government a free pass.

“It’s important that the debt is purposeful and not like previous incidents which could be summed up as ‘debt by misadventure’,” Austin Hughes said.

He pointed to the European Commission guidelines which said the borrowing should be ‘temporary and transparent’ and that there’s a clear sense of what’s being done with the money and that it’s time bound.

“The critical thing is to make sure that the economy’s capacity to repay the debt is not mortally wounded and that you put in place measures that can improve the economy’s post-pandemic potential.”

“While the debt may be higher, at least there’s a decent chance that there’s scope to grow your way out of the debt,” he concluded.

The budget will be unveiled by Ministers Paschal Donohoe and Michael McGrath on Tuesday, October 13th.

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