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Charting that Economic Recovery
Read more about: Economy, Features, Fianna Fail 
On of the great things about Irish blogging recently has been the degree of transparency it has brought to the debate on where the economy goes now. The demands of newsprint have limited many contributions to simplistic positions without the space to develop positions am defend them. Enda Kenny last week delivered an article full of platitudes, as have leaders of unions and employers bodies. Save for a tax rate of 48% I can’t recall many specifics; “look after small business” “don’t hurt the poor” “broaden the tax base” “look at a property tax” “to after tax exiles”.
All difficult stuff to argue with or against. It has made finding policy to hang your hat on a lot harder though. The ICTU policy document has its ten points but many of them appear more aspirational than concrete. There are specifics around the higher rate of tax, some idea on a property tax but we have been here already. Anyone willing to bite the bullet?
Aside from our own P O Neill, two great posts caught my eye but they are symptomatic of a wider desire to engage with the problem of where we go from here.An excellent post by Sean O Riain on the Progressive economy blog makes clear where we stand;
The booming Celtic Tiger of the late 1990s depended upon a whole set of measures to coordinate the economy – significant initial spending on social and regional infrastructures; social pacts that coordinated wages, taxation and employment; an industrial policy where state agencies worked closely with firms to develop them; and public subsidies for social services such as education, mortgage relief and pensions, that played an important part in the growth of the new middle classes.
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In 1998 capital gains tax was cut from 40 to 20%. Capital surged into the economy, with bank lending between 1998 and 2007 increasing almost five fold. But where did this capital go? 67% of the increased bank lending went into property (construction, developers, mortgages). A further 14% of the increase went into lending between financial institutions. While the rest of the increase was spread across different sectors, relatively little investment went in to the productive sector. In 2007 less than 1% of bank lending went in to high tech – computer hardware, software and research and development.
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Irish tax revenues in both 2000 and 2006 were 32% of GDP, well below the EU average of 40%. What was more serious, however, was the changing structure of tax revenues. Revenues shifted so that an increasing proportion of taxes came from taxes on turnover and growth – the percentage of taxes from VAT, stamp duty and capital gains taxes grew from 35.7% in 2001 to 44.3% in 2006. By 2008 the tax structure was dangerously vulnerable – when growth slowed, the revenues from capital gains, corporate taxes, VAT and stamp duty collapsed.
So it is against this backdrop that Saturday’s attempt by Fianna Fail to excuse themselves from the excesses of the downturn should be seen. They are vain attempts to deny the plain fact that for much of the key economic policy decisions that got us to where we are, they are responsible. It is broadly speaking the role of the state to decide what, if any, regulation is put in place and where the incentives to economic activity lie. The above outlines that it was in property where much too much stimulus was injected and almost nothing given to indigenous SMEs and tech startups in enough time to get them up and running in a competitive environment.
Of course it takes a coherent analysis of how we got here to learn from our mistakes, but it takes a bit of knowledge and vision to get beyond it. Over on Irish Economy, Patrick Honohan has taken a leap at the budget arithmetic that is proving so politically toxic.
Rates and bases of lots of taxes need to be changed. The most complicated one is income tax. In 1996, before Charlie McCreevy’s first budget, standard and higher rate income taxes were 27 and 48 per cent. Yet we were happy, growing rapidly and in effect “Europe’s Shining Light”. Such an income tax schedule did not destroy the economy.
Now the tax rates are 20 and 41, plus the new income levies of between 1 and 3 per cent. (I’m going to ignore the health levy, the public sector pension levy and PRSI in this). Even more important, the standard rate band has been about doubled in real terms and the exemption limit increased by an even larger margin.
He charts the possible changes in tax receipts towards the 1996 levels;
the parameters are: 22% basic rate and 48% top rate (to include the 1,2,3% levies); Tax credit lifted from €1.8K to €2.5K; exemption level reduced from €20K to €10K (ouch); standard rate band reduced from €36.4K to €25K. This is a lower schedule than in 1996, especially for the lower paid, but still a sizable increase from the present.
The net result is a graph that vividly captures the job to be done for Fianna Fail and the Greens:
That green line is where Fianna Fail need to go, the top line is the 1996 rate, rebased and the bottom is where we are now. The amazing thing to recall is the depletion in the tax rate to where we are now left us spending roughly 34% of our GPD on government – compared to 40%+ OECD average.
Cian,
The problem about moving too fast on the tax package is that we need a shift in tax policy probably as radical as what was effected between 1997-2002. We also need to have a political acceptance across the board that this reform is necessary and that every section of society, including recipients of some welfare allowances, will have to pay more or in the case of universally available benefits like child benefit, that this principle must be breached.
If the Government is bounced into introducing a tax package that has not been properly worked through,especially from the point of view of ‘winners’ and losers’, then it risks doing more harm than good and possibly not even realising the projected revenues from the new taxes, never mind causing riots on the streets. A short term package would probably be impossible to agree with the other main parties in the Dail for ideological reasons, with FG and Labour possibly more opposed to one another on some items than either might be to the Government’s view. That three legged political stool that everyone seems so eager to promote would fall apart acrimoniously in a very short space of time. In any case, why should Labour or Fine Gael give up their current advantage in the polls to become associated with severe austerity measures?
Another difficulty with the Government rushing to impose a welter of new taxes is that some, if not all, the measures introduced might lead us off in the wrong direction and then prove very difficult to remove or correct.
Economists can point out the options, but they don’t have to take the political consequences and in many cases, don’t even factor them into their equations. Naturally they are also more inclined to interpret data and propose solutions that are in line with their own personal ideological leanings – nothing wrong with that at all, of course. it’s just worth bearing in mind that the dismal science, is not, strictly speaking,a science at all.
For example,O’Riain’s analysis strikes me as defective in that he ignores the impact of lower CGT and corporation tax levels on the massive inflow of revenue to the Exchequer at that time: in reality, instead of ‘cooking the books’ to avoid what were regarded as punitive tax levels, many companies and small businesses suddenly had no difficulty paying up what they perceived as a fair and reasonable amount of tax. Nor is it particularly surprising that a lot of the freed up capital found its way into property and infrastructural development then either, for which there was a burgeoning pent-up demand.
The problem was that despite the Bacon reports and other warning signals to damp down the property boom, the boom was then encouraged to escalate into a bubble when, in effect, it should have been long over by the end of 2002. The main reason it wasn’t was political and while the Minsiter for Finance and the Government of the day have primary responsibility for this mistake, ALL the main political parties were responsible for demanding that a series of unsustainable policies in this area were maintained.
Also, I don’t think O’Riain takes sufficient account of the impact of progressively narrowing the tax base over a ten year period (as well as lowering tax rates) by continuing to take more and more workers out of the tax net altogether. This was pivotal to securing the continuation of social partnership agreements, particularly when it was no longer feasible to reduce actual direct taxation any further. This policy was also supported by the main Opposition parties who regularly complained it wasn’t going far enough in the interests of ‘ordinary hardworking families’. Remember Pat Rabbitte’s historic announcement at his 2007 party conference that Labour would take a further 2% off the 20% rate if returned to office in the next election?
Richard Bruton was a lone voice crying in the wilderness about the opportunity that was squandered in the Benchmarking agreement with the public sector unions, even within his own party. Certainly the Labour Party kept very quiet about it too; and benchmarking became what Senator Joe O’Toole memorably described as an ATM for the public service instead of an opportunity to change the ant-hill operational structures of the public service and introduce meaningful reform.
There was little appetite either for the development of non-labour related taxes across the political spectrum. There never has been, since they invariably bring parties into conflict with cherished portions of their respective base vote. The water charges, for example, were abolished at the behest of the then Democratic Left partner in Government in the Rainbow Coalition of 1995-97, mainly for electoral reasons. Property taxes were set aside too in deference to the anxieties of the middle-class electorate – Fine Gael was vehemently opposed to property taxes. Labour’s distinctive sop to its new middle-class base at that time was the abolition of third level college fees.
Following the FF/PD coalition return to power in 2002 moves towards the introduction of a carbon tax were arguably stymied by the Department of Environment’s own proposal which set the proposed initial rate far too high. Had a Carbon Tax been introduced at their proposed rate it would have caused serious damage to Irish industry and services (e.g. haulage and distribution costs) as well as generating further inflation in the already severely inflated costs of Government services. Of course the most damning argument against the proposed carbon tax was that the actual emissions savings it was likely to bring about were miniscule in proporton to overall carbon emissions. But instead of demanding a new formula fromthe Department, rejecting the tax fell into line with Carlie mcCreevy’s own ideological opposition to this form of taxation.
The attraction that property and carbon type taxes have for economists right now, it seems to me, is that they are non-labour based taxes and thus more broadly based throughout the economy rather than concentrated in an area which is already under severe pressure. I think that this view may be a bit over-optimistic – carbon taxes in particular inevitably have an impact on business and industry costs. Also, what happens in the future if there is a sudden spike in energy costs?
Once our ‘fair weather’ taxes – stamp duty etc. disappeared, the hole in the government finances has rapidly widened until it has become a chasm. But there is little likelihood of any political consensus emerging as to how it should be bridged, even in the short term. Listening to Alan Dukes and Ruairi Quinn, wearing their hats as former Ministers for Finance, on the radio this evening, it was interesting that they both seemed to set their faces against widening the tax net to include lower paid workers. This is despite the fact that Ireland has an unusually high threshold for income tax exemption in European terms and, as the Government keep signalling, ominously, almost 40% of the current workforce are outside the tax net.
How the introduction of a new property tax would go down with FG is hard to judge – my guess is that they would remain opposed to it or at most accept it only as a ‘temporary’ measure. Labour will not countenance the re-introduction in any form of third level education fees and if neither of the two main opposition parties – and likewise the trades unions – will agree to a widening of the tax base and the introduction of a new tax rate, say 10%, for anyone earning 10k or over. Labour and the unions will want any tax increases weighted soley towards taxpayers already on the higher rate with those paying the lower rates left pretty much as is.
Whether any economic incentive would result from slashing VAT to a new lower single rate (even if we were allowed to under European rules) is also debatable. In any case, that would upset the delicate balance that has developed over the years between receipts from direct and indirect forms of taxation. Also, Labour will be implacably opposed to any breach of universality of entitlement to health and social welfare payments – Eamon Gilmore has nailed his colours to the mast on that principle more than once already.
So how do we chart a route to economic recovery? Perhaps by accepting that in the short term there is none on the way. The EU needs to get its act together and its actions last weekend in refusing to set up the 180bn fund for Eastern Europe wasn’t much of an indication that it’s all for one and one for all. Whether Gordon Brown can persuade Obama to an internationally co-ordinated solution in April is hard to predict. The big problem is that the ‘soft landing’ for the world economy envisaged last autumn has turned into a very ‘hard landing’, with no signs of bottoming out as yet.
I think it’s likely our Government will find they are very much on their own when it comes to making the tough decisions or devising a new taxation package. An agreement may be possible with the social partners – and should definitely be tried – but it may not be enough. As things stand, it’s hard to see either Kenny or Gilmore stepping up to the mark and there’s little political incentive for them to do so.
The post is an excellent snapshot of how the income tax burden has been pared away since 1996.
Veronica covers a couple of points that I would agree with, namely the difficulty in devising either carbon or property taxes that are themselves fair and sustainable. But more important, the low chances of cross support. There is bound to be no small amount of schadenfreude in the ranks of FG and Labour towards FF who have piloted themselves (and sadly us) into this catastrophe. I think too that their long time in power have left FF full to the brim of arrogance. It comes across all the time that they feel so much above the other parties that they can only offer them contempt. For me at least, there isn’t a shred of a possibility that FF have any inclination to open up and be generous with their power and try to build real cross party support (even if the other parties were half willing)
Of course looked at in the round, the current massive gap in the tax base begs for a really comprehensive revision. Even of sacred cows such as corporate tax. That is not to say that I would be in favour of either an immediate or a large increase in corporation tax. But I think that it has to be part of the equation. Though I would like to see the results of detailed economic modelling to establish the likely effects of a small increase (in Corp tax) on the macro economy and especially on our ability to attract FDI. There is good reason to believe that our low corporate model will not be sustainable in the long term anyway. Certainly the big countries will now be looking at ways to close down or dampen the effect of all kinds of tax shelters, something they have wanted to do for some time but were too afraid of, given the pressure now brought to bear on governments by the largest corporate players.
In the end, my own belief is that the taxes which are going to be politically difficult – carbon, property, corporate, wealth, and indeed the lower paid – are going to be eschewed in favour of the old reliable: the middle and upper middle earner. In essence the middle class.
Sorry for the slightly off topic comment, but I want to nail the lie that this economic situation is ‘unprecedented’. There are plenty of precedents and, scarily, plenty of precedents for incompetent government responses. One example is the Long Depression, which lasted over twenty years according to some calculations. History might not repeat, but it does rhyme, and you can’t take any politician or economist seriously who ignores economic history pre-WWII.
This is old news to anybody who looks at economic history pre-WWII. There are too many of what I would call ‘creationist’ economists who think that the economy didn’t exist before 1945, and worse still, they are currently in control of the levers of power. The US and the EU need to initiate suitable stimulus packages. The current US stimulus is actually puny, not ‘massive’. The EU and US policy makers have their head in the sand and 15-20% unemployment for 10 years is looking quite possible. There are no easy options for Ireland, but the eurozone can work together to implement a proper stimulus package.
FF might say that it’s unprecedented for this state. But while a week may be a long time in politics; 90 years is a blink of an eye in history.
Aaron,
You’re right about economic history. (This country, by the way, has come close to going bust four times since Independence – in the 1920s, the ’50s, the ’80s and right now.) But while history generally is littered with failed speculations and the collapse of financial bubbles of one kind or another what makes the present one so spectacular is the scale of it and that it is happening in an age of relatively instant communications from one end of the globe to the other.
After last weekend’s shenanigans, I’ve lost more than a little faith in the capacity of the EU to face up to this crisis and agree any kind of package, stimulus or otherwise. As for the US, the G7 meeting in April should tell us a lot. If at that level there is no agreement on how to stop the rot – or at least slow it down so that the current downward momentum is halted – then this world recession will likely follow the same pattern as the Great Depression, except on a much larger scale.
Meanwhile – and sorry too for going off topic – I don’t know about the rest of you, but if I’m getting sick of anything it’s of the sight and sound and the swaggering negativity of some opposition spokespersons popping up on the media at every turn, appearing to exult in the difficulties we face as a country and the genuine misery that many people are having to confront in their daily lives, purely for their own short term political gain. Almost as sick as I am of the sight of floundering, ‘economically confused’ members of this Government and their particular brand of claptrap.
The lack of political responsibility on display is frightening and certainly unprecedented in a national crisis of this proportion in the history of our state. But perhaps we’re seeing so much of this because there are so many more, and immediate, media outlets than there were in the past?