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By John Walsh

The reaction to the December 7th budget has been almost universally negative. Social inclusion groups complain that it will marginalise even further the more vulnerable members of society. Business groups have come out against the budget on the basis that it doesn’t do enough to stoke growth.

After all, if the economy does not grow over the next few years, then it will be impossible to bring the deficit back within the terms of the Growth & Stability Pact by 2015. The deficit for 2011 is forecast at 11.6% of GDP. Under the terms of the Government’s Four-Year plan unveiled in November, the deficit is set to drop to 3% of GDP by 2015. If it doesn’t then the repercussions will be devastating, nit just for this country, but also for the euro zone.

The €85bn bail out package agreed with the IMF/EU/ECB is predicated on a massive fiscal retrenchment on a scale that has never been successfully delivered by an OECD member state.

If the government doesn’t make good on its commitment to restore fiscal rectitude, then Ireland will almost certainly default on sovereign debt repayments. If that were to happen unilaterally, then it would trigger a crisis that would cause the euro zone to collapse.

Even though nothing has been agreed, there are proposals for an EU wide crisis resolution mechanism post 2013. The hope is that by then EU banks will be sufficiently well capitalised to withstand a region wide debt restructuring programme. The portion of debt that is a consequence of putting the liabilities of senior bondholders onto the national balance sheet may then be subject to a debt liability management exercise.

Although there were measures in the budget for tackling subordinated bondholders.
“From a financial markets perspective, there were a couple of noteworthy elements. First, on theissue of burden-sharing of the costs of bank losses, the Minister reiterated that senior bondholders will not play a role. He made it clear that in his view such a course of action was not an option given the banks’ dependency on international investors. But perhaps more tellingly, he was explicit in stating that “unilaterally reneging on senior bondholders” as he put it was against the wishes of our European partners and the European institutions, underlining again that this particular issue was non-negotiable from the European point of view as part of the terms of Ireland’s package of assistance. However, he said there would be further burden-sharing by subordinated bondholders (whose total exposure to Irish banks amounts to around €17bn), and that enabling legislation will be submitted to the Dail next week. Second, the Minister announced that the Government will be proceeding with a proposal put to it by the Irish Association of Pension Funds and the Society of Actuaries. The idea is that Irish pension funds can invest in longer-term Irish bonds (which offer higher yields than currently available elsewhere), and price their liabilities to pensioners on the basis of those higher yields.
For pension fund managers who may opt for such investments, this would have the effect of reducing the present value of such liabilities, albeit with some degree of additional market risk, while for the Government it offers a potentially helpful source of additional domestic demand for new debt issuance at a time when many foreign investors have turned “Ireland-shy”,” noted Ulster Bank economist Simon Barry.

But can Ireland hold out until 2013 and beyond. Much of the answer depends on the external environment and whether the global economy has a healthy enough appetite for Irish exports. To this end, improvements in underlying productivity and competitiveness are needed.

Apart from the retention of the 12.5% corporate tax rate, there was very little in the budget that improved competitiveness. In fact, the proposed higher marginal tax rates will do little to attract mobile talent needed to develop the smart economy.

The domestic economy has to start performing if there is going to be a durable recovery. In this respect there was much criticism of the December 7th budget.

IBEC Director General Danny McCoy said: “The scale of the budgetary adjustment is required, but how it is achieved is just as important. More should have been done to reduce current expenditure, which remains too high given the major fall in tax revenue. The size of the public sector is out of line with the size of the economy and more action is needed to address this imbalance. Business is disappointed that there is little in the budget to help job creation or to restore the competitiveness of the Irish economy.

“The budget should give consumers greater certainty about their future incomes and encourage a resumption of more normal spending and saving patterns. Despite the large scale of the budgetary adjustment, the economy remains on track to recover in 2011, largely on the back of a stronger contribution from the export sector.”

McCoy also made the following points:

Cost of employment: “The reduction in the employer PRSI relief on pension contributions will cost Irish business about €90 million per year at a time when many employers are already struggling to keep pension schemes afloat. Cuts to some working-age welfare rates will also result in higher employment costs for business. Tax changes for employee financial involvement schemes will also be an additional cost to employers."

Capital programme: “The reduction in the capital expenditure budget is excessive and it is particularly disappointing that the Budget did nothing meaningful to facilitate financing from other sources in order to offset the collapse in the Exchequer capital budget.”
 
The reaction of the head of the Association of Chartered Certified Accountants in Ireland Darragh Kilbride was mostly a thumbs down.
“It is said that the path not taken is often paved with regret. In terms of the SME sector, this must surely be the case after the delivery of yet another budget which fails to deliver appropriate stimulus for this sector that is so vital to our economic recovery.

To deliver Budget 2011 is certainly, as everyone can agree, an unenviable task. The country is trading at a loss and clearly radical action is required.  However, the focus was clearly on cuts (in spending) and hikes (in taxes – by reducing bands) but where was the stimulus?

On many occasions now we have heard that the SME sector is the backbone of this country and that any recovery will come largely from this sector. With so many in agreement on this point, why is this path to recovery continually avoided?

The tax policies successive governments have adopted have been much maligned in recent times. However, when used appropriately tax policy can serve as a powerful stimulus, one which can give positive returns to the exchequer and create employment and wealth for all sectors of society.

In the start up phase in particular, Seed Capital Relief (a tax relief for those who start a business) could be increased. This early injection of cash is critical in most start ups and is aimed at the entrepreneur and not passive investors.

We have been told today that the corporation tax exemption for new start ups has been extended. Good news on the face of it. However, a closer reading of the proposal reveals that what is being given with one hand is then been taken away with the other. Yes, the exemption is being extended to companies which commence a new trade in 2011. However, the relief is now going to be linked to the amount of employer’s PRSI paid by the company. Such a link undermines this relief entirely and presupposes that start up companies will immediately go to an employment phase. It ignores many of the other necessary infrastructure costs that a company must first deal with in order to grow and create employment. 

This relief has, since its inception, discriminated against service companies and this matter has not been resolved in successive budgets. Clearly this is an area that should be addressed given the number of service companies in the SME sector in Ireland and the employment that they generate.

In order for companies to move from the start up phase to a growth phase a form of BES relief is required. The new regime, Business Investments Targeting Employment Scheme, seems to lack what its name suggests...Bite. The focus here seems to be on a “simple and efficient process” to quote the 4 year Recovery Plan (ie better administration) as opposed to any real detail as to who and what companies can qualify and what relief, if any, will be given to tempt investors to put their cash at risk to develop new enterprise, and therefore employment, in this country.
To secure the SME sector and move it forward a combination of financial support is required together with improved tax policy in the areas of Seed Capital relief, patent relief (just abolished – although we have a stated goal of wanting to develop a knowledge economy), lowering Employer’s PRSI costs and improving the already existing Research and Development tax credits regime.

Many have commented on the fact that increasing taxes has never given rise to an economic recovery. However, increasing taxes and abolishing reliefs is what was announced today.
What is required is some positive tax stimulus, positive use of tax payer’s money to fund growth in the areas that will generate the biggest return, positive tax incentives to encourage entrepreneurs to take the risk of starting a new company, to grow those companies with tax relieved funding so that further employment can be created. Clearly, the path not taken.

However, despite intense pressure from the EU and our 60 billion bail out partners Ireland has successfully managed to maintain its 12.5% corporation tax rate. This is indeed a success and something to be celebrated in an otherwise harsh budget. This rate of tax is not only vital to securing those currently trading in Ireland but should continue to both attract Foreign Direct Investment and sustain the viability of the struggling SME sector.”

Gina Quin, head of the Dublin Chamber of Commerce raised concerns about the Business Expansion Scheme.   “SMEs are struggling to find the necessary capital for their businesses. In the current environment it has been very difficult for businesses looking to take a bit of risk to expand their businesses. While BES provided much needed financial support for small business, few were accessing the support because of the sectoral limitations and administrative barriers.”