It's bad. Very bad. But we can stop it being disastrous

Published on Thursday 16 October 2008 22:04

Businesses are not just worried about a downturn. Their deep fear is about whether they will be able to survive over the next six months

THOSE in any doubt as to the gravity of the state we're in should take a close look at developments in Ireland this week. I do not mean the deepening recession: that is well and truly known, both there and here. What is additionally chilling is the budget that Ireland's finance minister, Brian Lenihan, presented in conditions of near uproar in the Dail on Tuesday. By the end of his statement to the parliament, he was struggling to be heard above a roar of protests.

Might this be the budget that's coming to a parliament near us? I do fear so.

Among the measures Mr Lenihan shouted across the floor of the Dail were:

• An additional 1 per cent tax on income for everyone earning up to 100,000 (78,200).

• An additional 2 per cent tax for everyone earning over this sum.

• VAT on most purchases to be raised from 21 per cent to 21.5 per cent.

• Tax on bank deposits to rise from 20 per cent to 23 per cent.

• A new 10 (7.58) tax on airline departure tickets.

• A 200(156.60) annual tax on people's holiday homes.

• Immediate tax increases on petrol, wine and cigarettes.

• Plans to shut down 41 state-funded agencies and close army bases.

As if to make this budget more acceptable, Mr. Lenihan also announced a 10 per cent cut in ministerial salaries.

This is, by any measure, an austerity budget. But it is by no means the last of the austerity that Ireland faces. For the country's borrowing has gone through the roof, shooting towards 8 per cent of GDP and more. The Maastricht Treaty limit is 3 per cent.

The country – once held up as a tiger model – is experiencing an extraordinary reversal of fortune. The economy is tanking, with unemployment set to rise from its current ten-year high of 6.3 per cent to 7.3 per cent in 2009.

And this is in a country where corporation tax has already been slashed to 12.5 per cent to attract foreign investment and stimulate new business. Tellingly, this tax was not raised – posing a continuing competitive challenge to the UK.

Even with all these tax-raising measures, the country is still facing a record 2009 budget deficit of 12 billion (9.3 billion), equivalent to 6.5 per cent of GDP.

And the reason that figure has resonance is that it is almost exactly where the UK's fiscal deficit is now heading.

With the budget rules having been shattered and the Westminster government taking on huge liabilities with the bail-out of the banking system, the deficit is on course to soar from about 57 billion this year (3.9 per cent of GDP) to between 90 billion and 100 billion by 2010-11 (6.5 per cent of GDP).

The hope, of course, is that a British austerity budget can be postponed into 2010, by when, we hope, a recovery of sorts will be under way. Nothing would be worse than raising taxes now and adding to the downward recessionary pull.

But the problem is that we may have no choice as to timing. Once this catastrophic financial firestorm has swept through the banking system and across the "real" economy , it will move on to sovereign debt, with a flight from countries perceived to have taken borrowing to levels with which they cannot cope.

Not only would government credit ratings come under pressure, but their currencies, too. And the further and faster currencies fall, the greater the need for emergency action to prevent a collapse – early and drastic tax increases to staunch an investor flight.

This epic global de-leveraging, proceeding at an electrifying rate, now threatens whole swaths of the economy. What a pity that on Newsnight Scotland's extended programme on the credit crunch this week, the participants were so restrained and polite. The discussion off-camera afterwards was far more frank and brutal about where we are really heading. Businesses are not just worried about a downturn. Their deep fear is about whether they will be able to survive over the next six months.

The government's so-called fiscal stability has been blown away like a matchstick model village. It will now have to create a new fiscal framework by the Pre-Budget Report in early November, and one credible enough to stave off a run on sterling.

There is much to be said for a reflationary package along the lines urged by the First Minister. The problem is that, with UK government spending already running at a record 550 billion, it has already blown the fiscal stimulus money.

As for Scotland, the final draft budget presented last month takes managed spending here to 30 billion, taking in decisions made in the past 12 months, including the 40 million in extra free personal care, a sum of up to 100 million for affordable homes, extra money for the Climate Change Fund and 13 million for additional police.

We, too, have blown our fiscal stimulus – and even with this record spending, we still, astonishingly, have a budget that will cut spending on enterprise, energy and tourism by 24 million to just 501 million, or less than 2 per cent of the total. The call for reflation masks a massive failure to undertake a substantial shift in public spending in Scotland to areas that would give us a fighting chance in this recession.

The gun that needs to roar – and which is now desperately needed to prevent a recession turning into a prolonged slump – is a major cut in interest rates, right down to 3 per cent and below over the coming months.

Austerity budgets will come. Of that there is no doubt. Ireland's example is a chilling premonition. But that is not the immediate priority. The action needed now is to save us from an economic collapse.