Limited options for 2010 budget

The government has little room for manoeuvre when it presents its 2010 budget in Parliament on November 9.

Lawrence Gonzi and Tonio Fench have ruled out both tax increases and tax cuts and have stressed that the main focus will be on reducing government expenditure and improving Malta’s competitiveness.

Tax increases are not on the cards because the economy is still in recession and the government won’t cut taxes because of the fiscal deficit which last year amounted to 4.7 per cent of GDP. The deficit for the second quarter of 2009 reached €94.2 million, compared to €68.1 million for the corresponding period last year, so this is obviously a worrying development for the Finance Minister.

So the UHM’s call for a reduction of the maximum income tax rate of 35 per cent to 25 per cent – as indeed promised in the Nationalist party’s electoral manifesto – as a means of discouraging tax evasion and increasing consumers’ purchasing power, has little chance of being taken on board.

Tonio Fenech has in fact always rejected the idea that one way to get out of this recession is to boost consumer demand, pointing out that the government believes that helping specific sectors such as industry and tourism makes more sense.

The government will also have to keep in mind the European Commission’s demand for Malta to regularise its deficit by the end of 2010. The government is forecasting a deficit of 3.8 per cent for this year, which considering the latest figures perhaps now sounds a bit optimistic, and a deficit of around 3.3 per cent by the end of next year, which will of course depend on how the economy performs in 2010.

This is the second budget of this legislature and the second one to be presented by Finance Minister Tonio Fenech. It is also one of the most difficult budgets for Dr Gonzi since he became Prime Minister in 2004. The Maltese economy has witnessed four consecutive quarters of negative economic growth since the third quarter last year and the Central Bank has forecast that 2009 will witness negative growth of -0.6 per cent and there will be marginal growth of 0.6 per cent in 2010.

So at best we can expect a fragile economic recovery next year, which means the government must avoid “shock therapy” measures in this budget which could disrupt the country’s economic cycle.

The government has made it clear that it intends to cut some of its expenditure, including subsidies, in the next budget.

In an interview with The Times Business last month, Mr Fenech had said: “Let’s continue cutting subsidies because these come from taxpayers’ money and they can be made to better use. There are a number of areas which we constantly subsidise. Today we subsidise transport, the agricultural sector and tourism. We need to make sure we are getting the value of these subsidies and to consider whether the government should continue with these high levels of subsidies, or how we are to recoup some of them.”

Mr Fenech had said the government subsidises tourism by €33 million a year, pointing out that low cost airlines cost the country about €5 to €6 million a year.

“This is taxpayers’ money. We need to get the tourists here but at the end of the day there has to be a value. The government has to recoup back in order to re-invest. No industry can expect the public to subsidise it indefinitely,” he had said.

Here again, Mr Fenech’s options are limited. Can the government afford to cut its support for the tourism industry, for example, considering the present economic climate? On the other hand it might possibly get away with cutting transport subsidies if the service dramatically improves as a result of the liberalisation of the public transport system. Even here, however, the government will have to be careful considering that Malta has the second highest inflation rate in the eurozone.

As regards cutting general government expenditure, the options are even more limited. Over two thirds of the budget goes on social security benefits, health and education, where real cuts are almost unimaginable. Tonio Fenech said he wants to cut down on abuse within the welfare system, and mentioned as an example benefit payments to single mothers. However, how much can the government expect to save from such an exercise? In reality very little. Furthermore, no government will ever take the decision to downsize the over-bloated public sector, for obvious political reasons, so any public expenditure cuts will always be very modest.

The government seems determined to go ahead with its proposed €6.06 weekly cost of living increase, which has the support of the trade unions but which the private sector has severely criticised as being unsustainable. This is bound to create tension between the government and employers and the Chamber of Commerce, Industry and Enterprise has already warned that such a hefty Cola increase would result in substantial job losses in tourism, construction and industry.

The Prime Minister, however, probably feels he has no choice but to give such an increase considering the high inflation rate throughout most of the year, caused in no small part to the huge hike in the utility rates. Furthermore, an announcement in this budget regarding another increase in the water and electricity rates, as the Prime Minister has hinted will take place, will not go down at all well with both employers and unions. The likelihood is that such a decision, if already taken by the government, will be announced at a later stage.

The government is bound to allocate substantial funds for major infrastructural projects in an attempt to boost the construction sector and revive the economy, but at the same time it will have to be conscious of the country’s fiscal deficit. Such projects, which the GRTU has urged the government to support, could include port projects, urban renewal and new roads. The GRTU has also called for fiscal incentives to be given to the construction industry. Once again, the government will have to decide whether the state of its public finances will allow such incentives.