Budget February 1980: Striking a Balance

28 February 1980
Administrator

Dr. Martin O'Donoghue was Minister for Economic Planning and Development from July 1977 to December 1979 and, during that time, was the chief architect of the Government's economic policy, as he had been of the Fianna Fail manifesto for the 1977 general election. The dropping of Dr. O'Donoghue from the cabinet by the new Taoiseach, Charles Haughey, was seen to represent a repudiation of the economic policy of the Lynch Government. In this article, Dr. O'Donoghue previews the forthcoming budget and outlines the options available to the Minister for Finance, Michael O'Kennedy. While the former minister does not reveal explicitly his own preferences, the general line of his thinking is apparent from the article.

At first glance, the shape of the February Budget seems clear. There have been enough warnings of harsh days ahead, to make most people reach for their hairshirts. Indeed, taken with some of the gloomier prognostications about the course of international events - with hints of a nuclear Armageddon now vying with the drying up of oil supplies as heralding the end of the affluent Western society, one might be forgiven for thinking that "the end is nigh".

However, reality is rarely as simple as the popular slogans, and while the economic prospects entering the 1980s are not as bright as would be wished for, they are equally not as doom-laden as might be feared.

The international outlook may be dealt with briefly, not because it is unimportant, but because there is little we can do to change it. Political instability in the Middle East and elsewhere, superimposed on the effects of higher oil prices, have already caused a slowing down in world trade and a scaling down of growth expectations for this year. While this clearly makes it more difficult for the Irish economy to forge ahead, it by no means follows that we are tied to the international trend. In the 1950s, we managed to have a dismal economic performance, in a period of substantial international growth; in the 1960s we improved to come into line with world trends, while in recent years, we have out-performed our trading partners in the EEC and elsewhere.

So what are our prospects for 1980? On the plus side, there is first the strong expansion of industry. The record influx of new, IDA-assisted firms from abroad, coupled with the heavy volume of investment by Irish firms, especially small industry, is reflected in the CII expectation that industrial output, should grow by at least 7 per cent - a figure which would turn most other countries green with envy. In agriculture, the outlook must naturally be more uncertain, but barring a major setback with weather, leading experts are talking of 4 per cent growth. Since much activity in the services sector tends to reflect trends in industry and farming, growth can also be expected from that quarter, though the behaviour of tourism is naturally more susceptible to international events.

The bad news comes when we look at the balance of payments, government borrowing and inflation. Higher oil prices were a major contributor to the massive 1979 balance of payments deficit, as well as/shoving up inflation. While dearer oil didn't help the government's finances either, the main causes for the higher than expected level of borrowing, were the effects of the postal strike and larger increases in costs, especially pay.

While in combination this adds up to a picture of an economy in much better shape than many others in the Western World, it also points to the 1980 priorities - the need to reduce the balance of payments deficit and our Government borrowing.

Action to deal with the balance of payments can take the form of specific policies aimed at curbing imports and boosting exports, or more general action to cut the level of personal spending, which would in turn, reduce the demand for imports. One way of reducing imports is of course, encourage a switch to Irish-made products. But while the Buy Irish campaign and the IDA programme to get Irish firms to manufacture various imported components, have produced very valuable results, the full benefits will only accrue over a period of years and they cannot be expected to produce in this year, the £200 million or more that would be needed, to meet higher oil prices. If more drastic urgent action is needed to curb imports, one possibility would be advance deposits, on the lines of the Italian measures of recent years.

Selective action to boost exports, could take the form of additional funds for CTT to open up further markets, or direct incentives to Irish firms, for expansion of the overseas activities.While action on any or all of these lines could help the balance of payments, they would do little to improve the Government's finances - indeed in the short term they could worsen them, since some of these programmes would need more State spending or tax cuts to get under way. Tough Budget measures on the other hand, would also have a beneficial impact on the balance of payments.

The actual scale on which these measures would operate, must depend on how quickly the balance of payments deficit, is to be corrected. The case for a rapid reduction would point to the fact that higher oil prices are inevitable and must be paid for by export earnings, rather than borrowing; that valuable ground has already been lost in 1979, through strikes and other disruptions, which far from helping us to pay our way, further aggravated our external deficit, and that, as a consequence, our external reserves fell by about £300 million. The case against too drastic action, would draw attention to the special factors which worsened the 1979 position (in addition to strikes, the sharp fall in agricultural exports) and hence permit 1980 to show improvement, to the danger that a too severe deflation would damage the longer-run development of the economy, to the loan and grant facilities available under the EMS, to sustain the development programmes of the less prosperous member states - and the possibility of a major oil find off the West Coast, which would solve the problem within a few years.

In weighing up these factors, the Government must also take into account, the way in which financial markets will react to any particular course of action. If the international bankers were to form the view that sufficient action was not being taken, then the Irish pound would come under pressure and it would become more difficult to maintain its exchange rate within the EMS. At this early stage of our EMS membership, a devaluation would be most undesirable because it would create an expectation of further resort to this way out of future financial pressure, rather than a facing up to the alternative action needed to defend the exchange rate.

The same balancing of arguments arises when the problem of government borrowing is considered. The 1979 figure at more than £1000 million was well over £200 million above the original expectation. This figure must be reduced, a fact that was signalled clearly by the Taoiseach, Mr. Haughey, in his TV address. Again the more interesting but more, complex question is - by how much and by what means?

In that same broadcast, the Taoiseach seemed to rule out tax rises as a solution, and indicated that the remedy must largely be found, in curbing government spending. While we must wait until Budget day to know the full outcome of the Government's protracted meetings, the outlines of the options facing Mr. O'Kennedy, can be defined with reasonable clarity.

The 1979 borrowing figure of just over £1000 million amounted to 13.8 per cent of GNP. Roughly speaking, it would normally be expected that in any year, the rise in tax receipts from greater incomes and spending (much of it due to inflation), would be enough to match the extra spending needed to maintain the real level of services (that is to allow for increased costs of government services). This, of course, would leave the borrowing level unchanged. However, in this year, the position is abnormal because of the carryover effect of the postal strike. This slowed down tax receipts by almost £100 million, and these delayed receipts should accrue this year, which would bring the borrowing figure needed to finance an unchanged volume of services, down to about £800 millions, or about 10 per cent of GNP.

If that were all, the position would not be too difficult. But it is not. First there is the question of whether the volume of spending can be held to last year's level. The pressures for increases will be strong in many areas - more teachers and schools to cater for the growing number of children, more Gardaí, more demands for housing the extra population, more spending to improve telephone and roads, more grants for new industry. . .

the list of areas where a persuasive case for greater spending exists, can readily be lengthened; the list of candidates for cutbacks unsurprisingly brief. In addition to these general pressures for greater spending, there are the specific claims under the headings of public service pay, social welfare benefits and income tax concessions, which all require careful assessment. In the case of pay, the general position, up to the beginning of September, is covered by the terms of the National Understanding. Any further general pay rise would operate only from that date, which is just as well since the full year cost of even a modest 5 per cent rise, would be about £70 million. In addition, there are several outstanding claims for special, increases all of which could prove expensive if conceded, the most notable example probably being, the nurses.

Social welfare benefits are a second area in which some increase in spending must be anticipated. Every 1 per cent increase in benefits can be taken to cost in the region of £3 million, so that the full year cost of even a 10 per cent rise, would be about £30 millions.

An even greater Budget headache arises with income tax. The clamour for relief by the PAYE taxpayer shows no sign of abating; but the cost of any worthwhile improvement is very heavy. To adjust tax-free allowances and the various tax bands for inflation, could cost as much as £90 million in a full year, even before any further concessions to particular groups. And overhanging any such possibility is the question of the tax treatment of married couples, as against single tax-payers. The recent High Court decision would be expensive to implement. Despite the improvements which have been made in the past two years when the tax free allowances for married couples were raised to double those of the single person, and the changes in tax bands which meant that discrimination against married taxpayers begins at incomes above £3300, as against a figure of £1130 in 1977, it would still cost about £75 million to raise all the remaining tax bands for married taxpayers, to double those of the single person.

What these illustrations show, is that it would be quite possible to make improvements in the fields of pay, social welfare benefits and income tax costing at least £200 million, which would still be regarded as inadequate by many people, and a further £100 million, assuming it were available, could easily be absorbed.

To avoid the borrowing figure rocketing back up towards the billion mark, any costly concessions would presumably have to be offset, by increased taxes elsewhere. Here the most frequently mentioned candidates for the tax man's treatment are: (a) the old reliable of drink and tobacco (b) petrol and oil products and (c) V AT.

A strong case can be made for hammering the old reliable, again on health grounds, in the case of tobacco and on social grounds, to discourage young people drinking excessively. To illustrate the money-spinning possibilities in these areas: 5p on the pint would raise about £25 million a year, 5p on the glass of spirits about £12 million and 5p on cigarettes, about £15 million, or in round terms, about £55 million for all three, which could be a useful start for a hard-pressed Finance Minister.

The case for taxing oil products rests not only on the revenue raising possibilities, but also on the added spurt it would give to conservation efforts. An across the board increase of about 10 per cent on the price of all oil and petrol, would bring the best part of £100 million. This would mean an increase of 12p a gallon on petrol and 5p on home heating oil. One of the problems would be that such a rise, would also add a substantial burden to industry at a time when it is important to keep down costs, so as to maintain competitiveness on home and export markets. Confining the increase to petrol alone however, would not be nearly so powerful as a revenue-raiser; 12p on petrol would raise only about £20 million. Some tailored package of different rates of increase for different products could be the best way of combining the need to raise money, without damaging industry and employment, if this source of revenue is contemplated.

The third candidate - VAT - gives rise to several possibilities. A 1 per cent rise in all VAT rates, should bring in about £35 million yearly. Alternatively, if the preference is to leave the basic 10 per cent rate alone, a 1 per cent increase in the higher rates could raise about £10 million. Other possibilities in this area are to move some items from lower to higher tax bands.

In combination, these three sources could be made to produce substantial sums. They also would have the unhappy effect of shoving up the cost of living index. To raise £100 million for example would mean a roughly 3 per cent rise in the price level, which in turn, could spark off fresh pressure for pay increases.

If these possibilities are passed over, the scope for other tax increases becomes rather limited. Increases in post office charges, or CIE fares (as a way of reducing their deficit), would produce the same impact on prices. A rise in Social Welfare contributions would be more attractive on these grounds, but since it would have to come either from the employees - who are none other than our PAYE payers looking for relief elsewhere - or from their employers - who will be trying to keep their costs down, the scope for substantial sums does not look too promising.

All of which suggests that keeping down public spending would be a very happy solution to the problem, of cutting the borrowing level. The need to take account of the impact on prices and on opinion among trade unions and industrialists, as well as on farmers, of any changes, makes the overall picture complex. In solving the budgetary needs of the government, it is important not to lose sight of other requirements, notably, the need to improve the balance of payments position. Just as it would be unhelpful to deal with the balance of payments problem by actions which would aggravate the budgetary position, so too there would be little joy in easing the budget position in the short term, by action which fuelled inflation and weakened the economy's ability to deal with the balance of payments deficit.

This year, the economy is very much on a tightrope, with little safety net available on the international side of the ring. This adds even greater importance to our own domestic behaviour. A repeat of last year's strike pattern for example, would place intolerable burdens on both our domestic and international finances. If the improving climate of recent months in industrial relations could be further developed, and the farmer bodies brought within the ambit of National Understanding type discussions, so that the danger of a rural/urban split could be averted, this would give the foundation for a much healthier performance in 1980.

A final area of importance which would also be highly relevant to the overall success of economic policies is that of monetary management. The curbs on credit in recent months are a necessary way of ensuring that an excessive money supply does not feed inflation or swell our import bill. A continuation of more moderate growth in credit geared to the real needs of the economy, would hasten the time when the benefits of EMS membership, in the form of lower interest rates, would materialise.

Success in walking this year's economic tightrope calls for a careful balancing of international pressures through the balance of payments and domestic pressures on the budgetary, trade union, farming, and monetary fronts.

A mishap in any of these areas could help to topple us over. But a combined effort by all sectors, could produce the degree of harmony and balance needed to bring us safely through. Budget day will be awaited with more than usual interest to see the first major instalment in this balancing.

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