Budgeting in the clouds

I like the structure used in the costings that the PN issued to give a budgetary meaning to the 125 pledges contained in their manifesto.   I like the figures contained therein, not at all.

The structure takes the the starting position for the years 2013 -2015 as contained in the last Budget Speech in Table 2.2 and extends same to the years 2016 and 2017 using a nominal economic growth of 5.2% for 2016 and 5.6% for 2017.

It then overlays the estimated costs, split between recurrent and capital, of the various manifesto pledges and then credits two extraordinary items to the Budgets which were not originally included in Table 2.2 of the Budget for 2013, namely:

• EUR 85 million additional tax revenue over years 2014 -2017from collections resulting from better tax enforcement ( defined as a fight on tax evasion)

• EUR 300 million reduction in expenditure spread over four years 2014 -2017 defined as 2% savings on Government expenditure.

Upon realisation of these two exceptional items depends the feasibility of the projected deficits in the PN costings.   They could make a difference whether the EUR 71 million surplus projected for fiscal year 2017 will instead be a EUR 314 million deficit.

I will come to argue the feasibility of these two special items later,  but first let me explain why the I define these costings as budgeting in the clouds.   It is clear  they  result from some hurried improvisations with inclusion of two special line items to hit whatever figure needed to be hit to issue a pre-determined end result that the pledges can be financed without failing on the objective of fiscal consolidation and the achievement of a budget surplus by the end of the forthcoming legislature.

Start with errors, small as they are in the overall context, in the published statements.  On page 5,  the Extended Government deficit for years 2014 and 2015 is EUR 61 million and Euro 39 million respectively.    These balances are carried forward to page 17 and out of the blue they turn to EUR 78 and Eur 49 million.   The carry forward for the other years is OK.

Also one should remember that these figures were presented by Minister Tonio Fenech who in the first Budget of last legislature, that for 2009 read in parliament in November 2008 in full knowledge of the financial crisis that blow up in September 2008,  had projected a Government debt of EUR 3683 million by 2011 being 56.3% of GDP EUR 6542 million.     Actual results for 2011 were a Government Debt of EUR 4607 million being 70.89% of GDP 6499 million.   The Minister was practically spot on in so far as GDP growth was concerned but EUR 924 million off-target for government debt equivalent to 15% of the GDP.

Minister Fenech comes with very poor accuracy credentials for long term budgeting!!

Two more things.   In the Budget 2013 read in Parliament just 2 months ago the Minister had projected real growth for 2013 of 1.6%.   Now suddenly in the Costings page 2 this growth becomes a range of 2% pessimistic and 2.5% optimistic.

Further the Minister had budgeted an end of year deficit for 2012 of EUR 158 million equivalent to 2.3% of GDP.    Since then, NSO have published figures for the 11 months to November 2012 and these show that to hit the end of year target the December 2012  performance of government finances will have to be cash positive to the tune of EUR 164 million.   Whilst December is seasonally a cash positive month for government given tax payments due, it is certainly optimistic to expect such positive cash performance to exceed EUR 60 million.   So when the figures for the whole year are published after the election, generally last week of March 2013, we may have some surprise in the starting position assumed in the Costings.  

Standard & Poor's in their recent downgrade commentary did not mince words and said:

 " We expect that the 2012 deficit, at just under 3%, will exceed the target of 2.2% of GDP".   

In case you are wondering what's the difference between 3% and 2.2% of GDP it works out to EUR 54 million.

Now let's come to the real thing.   How realistic is it to expect additional tax revenue of EUR 85 million from better enforcement over 4 years and saving of EUR 300 million in government expenditure over the same period?

Given the still undesirable low level of fiscal morality I would say that there is every possibility to get an extra EUR 85 million through better enforcement.   But please bear in mind that revenue from taxes is already planned to increase by 8% in 2013 when the nominal economy is expected to increase by 4.5%.  So there is already 3.5% growth from better enforcement and this amounts to EUR 88 million and this in spite of 2013 involves tax rebates to those earning up to EUR 60,000 p.a. and removal on tax on inter-family property transfers.   So the real tax enforcement additional revenue included in 2013 Budget figures is nearer to EUR 100 million.    Is it realistic to expect to gain a further EUR 85 million in the following 4 years?  

I would probably define revenue from tax enforcement of EUR 185 million over 5 years as extremely stretching but not impossible.

What I find a impossible and fairy tale stuff is the expectation to gain economies worth EUR 300 million over 4 years from 2% savings on the overall government expenditure.

Such saving if it were possible would apply only to recurrent expenditure.  It is not possible to apply savings on finance costs or capital expenditure for obvious reasons.   Total  recurrent expenditure in 2014-2017 before applying the costs of manifesto measures, works out at EUR 10856 ( over 4 years) so 2% thereof would be EUR 217 million not EUR 300 million.

But then one has to realise that 85% of government recurring expenditure is non-discretionary.   So it is useless planning 2% economies on total expenditure, as the non-discretionary expenditure does not permit such economies.   Wages, pensions, social security payments, health and education entitlement costs offer little scope for economies.   So if the 2% savings on total expenditure has to come from the 15% of government recurring expenditure which is discretionary then the latter would have to be cut by some 13% not by 2%.   Some hope!   Alfred Sant had tried to reduce this by 5% in 1998 and the PN made fun of it then.

So what happens if the special line items involving EUR 385 million over 4 years 2014 - 2017 as explained on page 16 of the Costings fail to material?

A combination of these factors will have to make up for such deficiency:

a. tolerate a higher deficit and higher national debt involving higher interest costs
b. reduce investments through capital expenditure, thus reducing economic growth.
c. raise additional taxation, most likely by raising VAT rate.
d. disregards some of the pledges to save on additional costs.

Given that the Minister had missed the three year target 2009 -2011 by EUR 962 million it would be even optimistic to expect that the next 5 year target would be missed by just EUR 385 million.  

In this case the past is a guide for the future.