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November 10th Afternoon: The Recession Diaries
Read more about: Economy, Labour Party
Finally, a slim ray of light.
‘The problem we have in the public finances is as a result of the fact that the economy is in a recession . . . we have a problem in the economy which has created difficulties in the public finances. It’s not the other way around.’
So said Eamon Gilmore on RTE yesterday. This is the first breach in the consensus dominating the debate – the consensus that prioritises the fiscal imbalance as if it were the cause, and not the result, of our economic decline.
Up to now the Left has been content to oppose the cutbacks and general tax increases contained in the budget. However, it was in danger of being caught in a two-fold trap, best summarised by Shane Coleman. He first, demanded that Labour say what it would do rather than what it opposed (fair enough – if the Left is to go beyond simple oppositionism and, instead, lead a debate, this is exactly what it has to do). But, secondly, Shane demanded to know:
‘What alternative cuts or tax increases would it introduce if it believes that the education cuts are wrong or that all pensioners, rich and poor, should get a medical card?‘
This is the Right’s fiscal trap – you can decide which course to take as along as it’s a course we approve of. Any other options are off the table, any other way of looking at the problem is taboo, extremist, a non-starter.
Gilmore opened up a new front. He talked of pump-priming the economy. When asked whether this could be done given our budgetary state, Gilmore replied:
‘The Labour Party has consistently argued that it is legitimate to borrow for capital purposes . . . and, secondly, we should be using the National Pension Reserve Fund to get money invested into our own economy and in our own infrastructure to get things moving.’
So, borrowing and raiding the Pension Fund can now be put on the table –a third option. And if some think this third option is an easy way out of the ‘hard choices’ – as the Right put it such a macho way – Gilmore opened another door which Labour left closed: increased taxes on the wealthy:
‘ . . If the Labour Party were in Government and we were faced with that levy situation (i.e. Fianna Fail’s 1% levy) we would have skewed that much more on higher incomes than on low and middle incomes . . . you would have seen a higher level on those over €100,000 per year certainly and much less on those on low to middle incomes.’
And just to drive this point home, Eamon unequivocally renounced Labour’s general election policy of cutting the standard income tax rate by 2% (it actually wasn’t a party proposal – rather, something thought up at the last minute by Pat Rabbitte’s speechwriters to make a headline for his pre-election conference speech).
So, are we there yet? Have we the weapons to take the fight to the Right? No, not by a long shot. While it would be unrealistic to expect anyone to elaborate a comprehensive alternative in a seven minute interview, it is clear there is much work to do.
First, there is a real danger that Eamon will be isolated. He is the first Left politician to open up this new fiscal option (new for Ireland, anyway). But he needs support, not just from his parliamentary colleagues, but from the broader progressive field: trade unions, Left commentators and bloggers, social organisations, etc. If he’s left on his own making this argument, he will be easily overwhelmed by the Right. A once-off interview is no match for the deluge of fiscal conservative nonsense we get subjected to everyday.
Second, Eamon’s position is still not fully formed. His claim that Labour supports investment for capital borrowing is neither here nor there; parties across the ideological spectrum support this. His proposal to tap into the Pension Reserve Fund begs questions: for what projects, to what extent, on what commercial terms. The fiscal issue goes beyond capital borrowing or using Pension fund for capital projects – it is about borrowing over the length of the downside business cycle for both current and capital expenditure; a necessary breathing space while other policies are put in place to get us on the right path.
In addition, Labour still remains stuck in the ‘bricks and mortar’ argument. No doubt, putting unemployed builders back to work on school and social housing construction, can be helpful but it is by no means anywhere near sufficient. We must ‘pump prime’ the entire economy – in the manufacturing and private and public service areas – not just construction. What does this mean? What are the instruments available to us? Where do we focus our resources to maximum medium-term benefit? How much will this cost (i.e. borrowing cost)? Will we need supplementary tax revenue – not just from the incomes of the wealthy (which, at the end of the day, won’t get us too far), but from their capital assets as well? Is there something profoundly amiss in our enterprise and financial base that will have to be addressed at the same time as we reflate?
A radical rethink of the economic crisis is now on the cards. Internationally, there is a decisive shift to more progressive solutions: China’s economic stimulus package, President-elect Obama’s imminent ‘big bang’, the EU’s 100-day deadline to put financial capital to heel. The Irish economy needs its own radical home-grown package.
But, at root, this is not just an issue of economic policy – it is about an essential reconfiguration of our political choices. Eamon referred to this:
‘There’s a fundamental difference of approach between the Labour Party’s view of this and the view of the conservative parties and of some conservative commentators.’
There’s still a mountain range of work to do to fully elaborate on this ‘fundamental difference’ – not just in terms of fiscal policy but in raising domestic demand and creating new enterprise strategies. But knowing there is a cleavage between the Left and the Right (and not just with the Government), puts another conservative trap in perspective.
For just as Eamon has started to rejected the notion that fiscal policy is limited to ‘cutting spending’ or ‘increasing general taxes’, we can take this consensus-busting to the next level – by rejecting the political consensus that the only choice of government is between one led by Fianna Fail or Fine Gael.
Break that trap and the uphill climb will still be hard and arduous – but at least we can dare to hope to reach the top.
This recession is caused by economic mismanagement over the last five to ten years. The government allowed and encouraged a house price bubble and the corresponding debt fuelled binge. As a result, individuals are now so racked with debt that the government cannot raise any more revenue and hence we are unable to use deficit spending effectively.
The government instead should have ensured that we had a productive bubble, instead of going down the dead end of construction. Construction never made sense because it wastes an awful lot of time and resources on a product which cannot be exported and which is NOT in demand at home. The supply of property and rate of building was always much higher than was acknowledged, we ended up building houses faster than the population was rising!
The cause of our current woes is due to the fact that for the past ten years at least we fell into the trap of an unsustainable economy based on high cost/debt/spending and a race to the bottom in incomes/wages. This is a policy that no no one will own up to because most have bought into it even the unions with percentage wage increases worsening the lot of those on lower than middle incomes and bettering the lot of those on higher than middle incomes who are usually the most voiciferous.
It would appear that there are only two solutions to an unsustainable high cost/debt/spending and low income/wage economy. (1)Change the balance between the two by inflation thereby devaluing the wealth of the higher incomes. But obviously with the euro this would not suit the Germans or the French who cannot see why their hard earned cash should be devalued. So that seems to be out. (2)The second solution is recession i.e. cut-backs in employment, spending etc the road we are now following. in the long run both sulutions are equally painful.
It should be obvious that current ideas promoted by politicians and pundits including “priming the pumps” with further debt even for “capital projects” is only going to make things worse and prolong the agong.
Nice article Michael. I’d support Gilmore’s preferred course of action and I think you’re right when you point out that all of the parties are stuck making ‘bricks and mortar’ arguments. It’s quite frustrating that nobody in Irish political life seems willing to address our dependence on the construction industry. Our tax system only really functions when the construction industry is making money. The fate of the economy is tied to that of the builders. If the builders sneeze, we get AIDs, or something. Our taxation system needs to be reformed so that we are not so vulnerable to Parlon’s crowd.
The one thing that didn’t really appeal to me about the article is the importance placed on grouping politicians into ‘Left’ and ‘Right’. I don’t really think it’s all that helpful. The arguments made by Gilmore would be accepted by many in Fianna Fail, the Greens, Sinn Fein and Fine Gael. Any attempt to turn this approach into a exclusive feature of the Labour party or the ‘Left’ would make its implementation that much more unlikely. Labour aren’t likely to find themselves in power any time soon. If such a policy were to be implemented, it would require the support of many on what you refer to as the ‘Right’.
To be honest, I think that one of the main obstacles Gilmore’s proposal would encounter would be the lack of support for it in the press. It’s not so much that many would object to it as the proposals made by the ‘Right’ would excite these writers more. Many of these writers are so eager to prove themselves grown-up and willing to support hard decisions that they’ll support any tough move, especially when it comes to cutting back on public services, or making tax-cuts, regardless of the merits of a particular proposal. Those who oppose such moves, usually don’t point to the obvious alternatives such as raising taxes for those on high incomes.
Aaron, I think it’s simplistic to say that the recession was caused by economic mismanage on the government’s part. I don’t think that they handled the boom particularly well, but we’re hardly the only country facing a downturn. It’s happening everywhere. It’ll be worse than it needed to be in Ireland because of poor decisions on the government’s part, but so much of what caused this recession was out of their hands.
Niall,
I agree there’s a massive international dimension to this, but that is no excuse for Ireland. It’s like going on a drinking binge just because your mates are - and then blaming them for your hangover. (I imagine you agree with much of this).
If the government had put a stop to the property bubble years ago then we would have a much stronger economy now, a much better personal debt position and a better national debt position. Instead of building naff apartments we don’t need, we should have built schools and hospitals and employed medical staff instead of builders. There are so many other, productive, things we could have done.
A recession in your trading partners is never good news, and hence we’d likely have faced a recession anyway, but look at China today. They have good finances (thanks to fools like the Irish buying Chinese stuff on credit!) and hence the Chinese have much more flexibility.
You’re right Aaron. I’d agree with most of what you’d said. However, if we look at China, it was only today they released an economic stimulus package in response to a slowing economy. True, they’re not as badly affected as us, but they’re at a different stage in their cycle and much less vulnerable to the American economy, but they’re still feeling the pain.
One of the funny things about the past decade is that the government found itself less in control of the economy than ever before, but took greater responsibility for it because things were on the up. Now they find themselves with a down-turn, and it’s too late to take back their overstatements. Because they overplayed their hand in the past, they’ll probably find themselves taking more blame than they actually deserve - and they deserve a lot!
A very interesting piece and ideas for the direction we might go in; but sadly I fear not on who is best placed to lead us there.
Taxes are levied on economic activity, so when it declines (or as in the case of our building sector collapses entirely) revenues decline, that leads to problems with the public finances. I’m glad to see the Leader of the Labour Party has finally figured this out as per his pedantic statement on Sunday’s radio show; but I would have thought he should have known that already.
Since we are living through an international economic crsis as much as, if not more than, a national one, our options are limited: we can’t pull out of it on our own because we’re too small a player in the overall scheme of things and as part of the eurozone we don’t set our interest rates etc. any more anyway. But we can bring our national finances back into some kind of balance, mainly through spending cuts. Government spending has increased by some 45% over the past five years, so it’s pick and mix time.
There is very little scope for tax cuts or tax increases - our tax base is far too low, we took far too many people out of it during the boom years. It is middle income earners who would have to bear the real brunt of tax increases if we were to go down that road, or else expand the tax base to include lower income earners, which is what the levy does in a cackhanded sort of way.
Taxing ‘the rich’ whoever they are, most of whom let’s be very clear are in the tax base already, has a grand populist ring to it, but taxing the so-called rich by closing off investment vehicles or pensions’ loopholes however desirable or justified some of those measures might be (a) won’t bring in enough money to close the revenue gap or go anywhere close to it and (b) might unwittingly result in the wholesale flight of private capital from the country; which amounts to cutting your nose off to spite your face. And if you’re going to tax the rich, perhaps it might be a good idea for a start to propose to stop paying them childrens’ allowances and providing the over 70s amongst them with free medical cards at the expense of middle income tax payers?
If the rest of the world, whether their governments lean ‘right’ or ‘left’, especially the larger economies like the UK, the US, etc. are talking about tax cuts based economic stimulus packages that’s fine for them if they can afford it. We can’t. In the coming year we will borrow 13bn euro to fund government expenditure, of which 5bn, more than one third, is for current expenditure (i.e. public sector pay bill and maintenance of basic public services to the people in our community who rely on them).
I hate having to say this but the Labour Party has consistently led the charge over the past ten years in demanding higher wages for various groups of public servants engaged in spurious wage disputes; more and more groups of people to be taken out of the tax net; lower taxation levels for those within the tax net and absolute rejection of any rationalisation or reform of public expenditure or programmes of any kind; except for ‘taxing the rich’, usually an illdefined concept, but always good for a soundbite or a headline or two.
If the so-called solo-run proposal by Pat Rabbitte for the 2% tax cut in the 20% rate prior to the last general election was not supported or even known to the most senior members of his front bench, then how come none of them had anything to say about it, except to speak ardently in its support? Where were the protests? Where were the resignations? Where was the honesty with the electorate? What price did they place on their integrity?
A seat at the Cabinet table of a Rainbow Government perhaps? In politics, people have to make these choices; but retrospective repudiation of them is a bit rich!
Labour’s credibility on economic policy is a bit dented at this stage.
Ideally, it would be great if we could pump prime the entire economy as the writer suggests. We did try it before, in the late seventies and the early 1980s and then by the end of it we were on the point of having to call in the IMF. Let’s face it: people died prematurely because of the mess we got ourselves into then, particularly due to the health cuts that had to be introduced to resolve our fiscal difficulties at that time. Bad mistakes were made in the selection of areas for slash and burn, but chances are it would have been so much worse for our country and our people if the IMF had arrived at the front door dictating our spending policies, and that was a close run thing.
Right now, the budget of October 2008 may have its many flaws but it does modestly try and maintain some reasonable balance between borrowing for current and capital spending purposes. I expect we could jump into the stimulus package mould if we see it beginning to work in the larger economies where it is likely to be tried out in the next year or so.
In any case if it starts working for them, then we derive advantage from that. If it doesn’t work for them, the worldwide recession will be a bitter experience and we’ll suffer the winds of that too, so it would be pointless for us to start throwing good money after bad at this stage.
As for raiding the Pensions Investment Fund - I personally believe that for the next few years any further exchequer investment to the fund should be put on ice because of what has happened to the international market and because we need the money for current expenditure. We certainly should not borrow money to place it in a Pensions’ Fund that can’t make international investments with any hope of anything other than losses. But I do wish politicians would stop so glibly demanding that we fritter the Fund away now as a means of avoiding the pain of reality.
The Fund is designed to be a long term instrument to meet future pensions’ needs when our demographics will make it impossible for us to afford adequate pensions provision for the elderly in our society without crippling income earners with taxes to pay for them. In harsh economic times it’s very difficult to focus on anything but the immediate problems we’re in, but we have to keep a cool eye on the future too.
Well spake, Veronica.
Well written; well argued; factual; unemotional.
All the ingredients that an efficient; competent politician requires.
So, who has these qualities?
Not many hands up!
Realistically, we (Think Albert Reynolds) took millions from hard-working Germans etc. - to fund a road building programme - loading it with extra cost - blew it on motor cars and borrowed to pay for holiday houses.
We had no control over interest rates, which should have been increased to at least 10%++ to cool inflation.
We made our bed of nails; no sense in moaning.
Cut government (1 TD per 100,000 population) cut the back-up services; scrap the Depts. of Health & Education and give the money to the hospitals & the schools. They know the priorities.
Get the Cabinet out of local constituency responsibilities.
It’s not a complete solution, but it would be a start.
I would agree with a lot of what Veronica has written. I think the idea that we borrow for capital spending is, in the main, fairly sound. But that too has its limits. And in any case, we are borrowing quite hard next year anyway for capital projects - as Veronica’s figures show.
Could we borrow even more for additional capital projects as a stimulus? Yes but there problems. First, we would have to carefully design the capital programmes to ensure that they are real investments, not just spending money for the sake of creating activity. It would take time to get those projects assessed, planned, and under way. And unless the recession is really long, the real force of them would only be kicking in as we emerge on the upside (at which time the impact is pro-cyclical).
The idea that we should borrow heavily for current spending is deeply worrying. This notion is often flung out as if a new bright idea as just been found that will avoid all the nasty toxins of recession working its way through the veins of the economy. It’s the equivalent of the hang over drug - we know it doesn’t work or at best has other ugly side effects.
It is certainly wise to borrow a certain amount - even for current spending - in order to smooth the harsh corner of the recessionary curve, but the overall envelop needs to be carefully judged. Given our borrowing trajectory, the optimistic assumptions on which next years estimates are based, and the vulnerability of our small open economy - I think there is a real danger that profligacy now would quickly cause our public finances to spiral out of control.
The level of borrowing would then swing sharply upwards. Like everything you borrow, you have to give it back one day. In this case, it would mean passing on an immense burden to future tax payers who would rightly take a dim view of our irresponsibility.
There is of course one other problem with a fiscal stimulus: the costs are guaranteed, but the benefits are very uncertain. I’m not sure we can afford to pile more uncertainly on top of the mound of unknowns that already lie before us.
As I see it, we, like other nations, are faced with a recession that is likely to be deep. Ours will be deeper than most because we wallowed too long in the fantasy of low tax, high debt, and a pitiful reliance on property as economic engine.
There will be no way to avoid some painful adjustments - which will have to include the postponement of many worthy initiatives. We need to strive hard to protect the most vulnerable - and if we do, no one will be devastated. But make no mistake - everyone is in for some of the agony.
(In fact I think that this is precisely where the debate should be - how best can we protect the vulnerable, with the wisest possible use of the funds we have roughly within sensible sustainable parameters. A part of this should be to ask how can the tax base be made fairer and more sustainable. This would be far more fruitful that trying to imagine ways of avoiding the harsh realities by using someone else’s money)
At this moment in time we will merely slip from one fantasy into another if we refuse to realise that long term progress is built on sturdy, well balanced, economic growth. That needs to be our goal, and until we get there, the idea of significant improvements in our standard of living is truly an abandonment of reality.
Veronika’s comments seem to be very popular. Unfortunately, I’m going to have to spoil it.
I really cannot believe that a levy on high earners wouldn’t raise decent amounts of money. In the US at least, the top 5% of earners pay over half of the total income tax take. So a small levy, say 5%, on earnings over 100K would raise a lot of money. I’ve heard similar figures before for the UK and Ireland and don’t expect it to be any different from the US.
Fact is, tax rises for the rich wouldn’t do this economy any harm at all. It could improve our economy actually - we need to stop importing and to fix our trade deficit, we need to stop the rich wasting our precious euros on fancy imported cars.
Why not keep the top band at 45% even during periods of growth? The idea that this will decrease incentives is nonsense. Those who obsess for power and wealth never care about the absolute wealth, just the relative wealth compared to their peers. So they wouldn’t even notice a slight increase because their mates would be affected too. And there wouldn’t be a capital flight. A capital flight is the result of a decrease in confidence in the returns of assets - so an increase in corporation tax might lead to capital flight. But income tax is not relevant here. Maybe Veronika meant ‘human capital flight’, a fancy way to talk of massive emigration of high earners, but with much of the world in recession where would they have to run? To keep capital in this country we need to keep people across the country working and keep the whole economy is good condition.
I used not to like the idea of deliberately running deficits. But that’s just a moral dislike. But if you are an incredibily experienced economist at the prime of yours powers, like Keynes was, you can see the facts for what they are. He didn’t recommend deficits just because it sounded like a nice idea. He knew that, if and only if used at the correct time in the cycle, it’s a good thing. (PS: I’m not trying to compare myself to Keynes)
Aaron,
Though I agreed with Veronica I did call for a re-examination of the tax system to make it fairer. Your point that the rich could be taxed more to plug the gap is a fair point. And I would favour exploring sensible ways to make the system better. But I think the issue isn’t really around tax rate. After the latest budget, a single person on say 200k pays how much tax? Answer, about 80k. That’s a fair chunk - 40%. You could argue whether it should be higher but I think you’d be wasting your time. The issue is that the number of people with declared incomes about 200k is tiny - really, a faction of the overall working population. So cranking up the rates would bring limited return. In fact - it might bring none because many earners in this bracket tend to be in a position to get their remuneration through other channels - shares, stock options, or whatever.
One issue is that the number of people declaring above 200k seems too small (an article by fintan o’toole lately had this number at around 8000 and his source was the revenue). Now I believe this is completely wrong and that there is a huge amount of tax evasion going on. That needs to be fixed, but even still, the huge hole in our finances would not be plugged.
Keynes broke the fiscal conservative orthodoxy that govts should keep the budget in balance all the time and he advocated borrowing to minimise recessionary drops in aggregate demand. I doubt though if he would approve of setting off on a borrowing path that could become unsustainable even when the business cycle turned up. And it seems that neo-Keynesians argue that the budget should be balanced over the length of the cycle (run a deficit in a downturn then a surplus in the upturn). But our trajectory at the moment, even with the correction of the budget leaves us looking very dodgey. Sadly, there is no easy way out. Either we pay now, or the next generation pays more.
Tomaltach,
As you say, it isn’t just about the rates, the tax system as a whole is flawed. VAT should be looked at also, as it’s a tax that poor people pay, even those on the minimum wage. The government gets almost as much from VAT as it does from Income Tax, according to this graph on Wikipedia.
Just about a third of the government’s income each year comes from income tax. That should be two thirds at least, and payments such as dividends should be classed as income also. Every cent that makes it to an individual is income and should be taxed as such, and this should be the bulk of the government’s income.
Applying Keynes’ policies today is complicated by the fact we don’t control our own currency. Today, the US can print dollars to fight deflation and still keep official interest rates reasonably low. But Ireland is left with asking the other eurozone countries for permission to print and spend. Germany, understandably, wouldn’t want to do this because it was working hard and exporting while Ireland (and Britain) were binging on imports.
As far as I can tell, prior to the bank deposit guarantee, the Irish national debt is relatively low compared to other eurozone countries and this one silver lining for Ireland. I’m worried about institutional international debt however; I suspect our banks owe massive amounts of euros to abroad and therefore this will drag us back as the Irish government can’t devalue to wipe out their debt.
I have long advocated a Distributed Profits Tax (DPT) to replace Corporation Tax (CT).
In so doing, all stock options; dividends; swaps; benefits-in-kind to Directors & Executives; voluntary pay-back of share capital (in a winding-up)etc. would be regarded as a Distrubution and taxed at, say, 40% -
Think of a number, Aaron!
It would not be a social tax, rather an equitable way of creating expansion in industry & job creation, by ploughing back profits into research; new products etc…
It would also remove the necessity for Government to make Grants - propping up inefficient businesses; enriching property developers in return for “political donations” etc…
In this same connection. “Political Donations” should be recognised, once & for all, as “Bribes” and outlawed.
As Aron says, VAT hurts the poor, because it is a lazy, catch-all tax.
Better to replace it with a Consumption Tax and abolish PAYE.
With 100% take-home pay, consumers would be able to exercise choice.
Necessities - Milk; bread; vegetables; basic clothing & similar - would be Zero Rated…
Luxuries viz: Executive motor-cars (such as 4WD; Government Mercedes-Benz etc.); cigarettes; drink; imported luxury foodstuffs, clothing, jewellery, electronics (mobile ‘phones etc.); would attract a consumption tax ranging from, say 5% to 1000%.
It would also have the effect of abolishing “The Black Economy” and would catch the proceeds of the sale of drugs.
Tourism would need to be insulated to some extent and “Tourist Currency” could be issued, allowing a refund of Consumption Taxes.
Finally, Government should give a lead by cutting their bloated numbers.
Consider a reduction of TDs to 1 per 100,000 of Irish indigenous, adult population and an equal reduction in the number of civil servants;
The abolition of the Departments of Education; Health; Transport; Defence & some of the more esoteric, junior departments would eliminate overlap & the consequent inefficiencies & “buck-passing” allowed by such.
Finally, consolidation and streamlining into Five Principle Ministries:-
Justice (incl. Defence);
Finance;
Human Resources (inc. Health; Eduction; Welfare etc.);
Communications and
Natural Resources (incl. Agriculture; Fisheries; Forestry etc)…
… with the five Cabinet Ministers vacating their Constiuency duties
& responsuibilities, providing a modern, businesslike Administration that would be the envy of the World.
These are simple, effective and practical solutions. They do not need the services of expensive, imported Consultants.
There would be a transition period - during the change over from CT to DPT and Consumption Taxation.
A Long-Dated Bond would provide a smooth changeover.
Say, €200 Million might be floated, with a coupon of, say, 6% - payable after an interval of three years,
Of course, it would need competent; professionally trained Executive Ministers, but, with the saving of payments to about 120 TDs & their support civil servants, it should not be impossible to attract people of the right calibre.