Thursday, 6 August 2009

Deflationary Threat is Real and will lead us into deeper mire.

Paul Sweeney: The revenue shortfall in last night’s tax revenue figures to the end of July is a hefty €575 million greater than the Department of Finance had forecast only three months ago. If this deflationary tax revenue trend continues, the Government will not meet its projection of €34.4 billion in tax revenues this year. Even more cuts will then be proposed by most economists and the commentariat. Deflation will really take off then.

The exchequer deficit has now grown to a staggering €16.4 billion at the end of July, up from €14.7 billion at the end of June. The deficit is almost €10 billion higher than it was this time last year. It includes €6 billion in payments to bail out failed private sector banks, in borrowed funds which will ultimately be from our tax Euros.

Consumers are holding back on spending – with a fall in VAT the main reason for the fall in taxes, followed by the income tax take falling, as people lose their jobs or see their total incomes curbed, with less demand.

Capital gains tax revenues are less than a third of what they were this time in 2008, while the stamp duty yield has dropped 64 per cent since last July. It had already fallen then, with the collapse in the Government-tax-incentive-driven and bank-driven property boom. This is the result of the utter folly of the government’s shift from income taxes and corporation taxes to consumption and property related taxes from the late 1990s onwards. It should be remembered that this shift was cheered by economists arguing against progressive taxes, i.e. those advocating low taxes on incomes and corporations, and high taxes on consumption.

With the huge borrowing requirement for both day to day and investment spending, it is not possible for Ireland to borrow more for a “Stimulus Package” as some believe, as a wide open economy.

But, on the other hand, the government could make economic deflation worse by massive cuts in public spending, especially for the vulnerable and low-paid, combined with increased taxes. Many of McCarthy’s recommended cuts should be rejected, particularly those which are especially regressive and those which have a deflationary impact.

Overall, the resolution of Ireland’s economic crisis will be especially difficult. It will be particularly difficult if many policy wonks neglect deflation, which - as yesterday’s figures demonstrate - is already with us. Economists who are now openly advocating deflation as an economic strategy are seriously misguided. If they win out, further deflation will lead us in to even deeper crisis.


Anonymous said...

Are the unions suggesting that addressing the fiscal deficit need not entail reducing government expenditure on public sector pay? Is that the position?

paul sweeney said...

This is a blog, not a union comment. I do agree that the deficit is so large that it entails reducing public expenditure. The key is how one does this and in a way which is progressive and has as little additional deflationary impact as possible. This is quite a challenge and one which is getting no traction from most economists. There are many areas of public spending which are regressive and wasteful and much saving can be made with low hanging fruit. On public sector pay, the people at the top are paid too much. But dont forget, Mr or Mrs Anonymous, as most orthodox econommists conveniently do, the Third Benchmarking Report. It was for the bosses and their remuneration was pitched against the bottom quartile of the private sector top exectives. So their remuneration or pay was bid up against the bottom of private sector bosses pay. The gap in pay between low and high in the public sector was thus widened and average public sector remuneration went up.

Slí Eile said...

Cutting public spending can mean a number of things:
* cutting the overall level of spending while maintaining the level as % of GDP (or GNP0
reducing spending as % of GDP (and GDP is of course falling right now)
* maintaining spending but cutting back on health and education as social welfare increases due to more unemployed (notwithstanding any possible cuts in rates of benefit next December)
* cutting spending on wasteful areas (pay of the tops), consultants fees, quangos etc and redistributing that spending to other areas including job-creating, low-income defending options.
I am of the view that overall spending is too low and should be increased both as % of GDP and in absolute terms. In that sense I completely disagree with Jim O'Leary and do not accept his inference that folks who don't sign up to the cutting agenda can't be serious.
However, I agree that wasteful spending should be cut (and redirected) to more productive areas. I think that there is scope for pay moderation for those over a certain threshold. I think that there is a strong moral case for setting a maximum salary in the public service at this time.
Areas that still have not been touched include salary increments and even bonuses.