Tuesday, 13 October 2009

Deficit rising

Michael Taft: Over the next few days there will be considerable analysis of the ESRI’s current quarterly review (password required). I’d like to highlight just one projection – the rising annual deficit.

There are two things to remember: the one and only goal of Government fiscal strategy has been to contain the deficit. They have set no targets for job creation / retention, investment, consumer spending or even a timeline on shortening and lessening the impact of the recessionary dive. The exclusive objective of fiscal policy has been to contain the deficit.

In keeping with this strategy, the Government brought in the supplementary April budget out of fear that the deficit would rise to -12.75 percent. Only weeks earlier, they had published the Addendum where they had set a 2009 deficit target of -9.5 percent (this itself was a downward revision of a target they had set, yet again, only weeks previously in the October Budget – a target of -6.5 percent).

The April budget’s measures, combined with the earlier pension levy, was intended to contain the annual deficit at 10.75 percent for this year and next year – winding down to the Maastricht threshold of -3 percent by 2013.

So what is the ESRI projecting for this year and next? In 2009, they project the annual deficit to be -12.9 percent. That is considerably above the Government’s target for this year. In 2010, the deficit will remain pretty much the same, -12.8 percent.

While we may debate the benefits of varying fiscal approaches, there is one thing that stands out: the Government has failed to achieve the one and only target it has set for itself. It has failed – by a wide margin – to control the deficit. Simply put, its fiscal strategy is not working.

This has significant implications going forward. Government strategy has been to hold the deficit this year and next at 10.75 percent. Over the following three years they intended to reduce this deficit to -3 percent – closing the deficit by 7.75 percent. This was always going to be a big ask. However, if the Government persists with their failed strategy, they will be starting from a worse position. If the ESRI projection holds, the Government will have a -9.8 percent gap to close in three years. With the deficit going in the wrong direction – what chances of reaching the Maastricht guideline by 2013?

ICTU’s David Begg received a lot of criticism for suggesting the target date for Maastricht compliance be postponed a few years. Whatever about the desirability of this proposal (and I believe it is highly desirable), the fact is this is going to happen anyway on current trends. To attack someone for espousing a common sense position shows the extent of denial that is at work in Government circles and among certain commentators.

Perversely, though they won’t admit this, the ESRI vindicates the progressive critique of the Government’s fiscal policy. The ESRI supports the continuation of further fiscal correction. In their projections they have factored in a €4 billion correction – made up of tax increases combined with current and capital expenditure cuts (they acknowledge that now the burden will fall more on spending cuts). What is the result of this €4 billion cut in spending and people’s disposable incomes?

In 2010, the annual deficit will be reduced by 0.1 percent, or nominally by €550 million. €4 billion in cuts to achieve a reduction of €550 million only proves the old adage: pursuing deflationary policies in a recession is like running in quicksand – you use up a lot of energy, you tire yourself out, but you still keep sinking.

Even more provocatively they make the following observation:

"The consequences of such a further sharp correction are, by our estimation, significantly deflationary. Were there to be a neutral budget in 2010, then our estimates would suggest that the recovery in GDP would occur much earlier in the year leading to positive growth in GDP for the year as a whole".

In essence, they admit that the fiscal correction planned by the Government will be deflationary. More importantly, it will lengthen and deepen the recession. If these cuts didn’t proceed, the recession would not only end much earlier – but the economy would be in overall growth for the year 2010 (if the correction go ahead, GDP will fall by -1.1 percent and GNP by -1.7 percent next year).

To get around this, the ESRI takes up a ‘straw-person’ argument. They pose only one alternative to their preferred deflationary strategy – a revenue-neutral budget; that is, a budget that doesn’t take out any money from the economy. However, no one realistically believes that any Government should sit on its fiscal hands and let the recessionary fires burn themselves out. Too many other things in the economy would be burned down as well.

The alternative, as outlined at the recent TASC conference, is to pursue an expansionary fiscal policy based on crucial investment in our economic base – investment that we would have to make in any event if we want to improve our competiveness and productivity going forward.

The ESRI doesn’t refer to this alternative, never mind model it. Whatever (though I would have thought that one of the most important roles an institute can do is provide a range of alternatives with an accompanying fiscal and economic assessment).

We are, therefore, only left with one course – a deflationary course. And as the ESRI report shows – it is a failed course.


Tomaltach said...

But the ESRI report says that the 4billion fiscal package announced by the government is necessary to stabilize the General Gov Deficit. It also asks whether this adjustment is appropriate - and answers in the affirmative. So, will the retrenchment slow a return to growth? Yes. Is it necessary to get our spiralling deficit under control? Yes. In other words, yes, correcting our astonishing fiscal deficit is going to force down living standards. Our problem isn't cyclical - fixable by recovery and return to growth. It is a chronic structural problem that is spiralling rapidly. To argue that we should avoid stabilisation now surely guarantees a more severe burden later.

Proposition Joe said...

"ICTU's David Begg received a lot of criticism for suggesting the target date for Maastricht compliance be postponed a few years ... To attack someone for espousing a common sense position shows the extent of denial that is at work in Government circles and among certain commentators."

I also think David Begg's proposal deserved more careful consideration, by *both* sides.

Had he estimated the additional annual debt servicing costs that his slower unwind would entail, this would have greatly facilitated an informed debate.

Michael Taft said...

Tomaltach - I would just point out that the ESRI's use of the word 'stabilisation' is one way of describing the annual deficit next year. There are others. For instance, the Spring Quarterly Report, the ESRI projected the deficit next year to be -11.5%. In the summer they projected it to be -11.4%. Their projection of -12.8% could be described as a 'significant slippage' or a 'substantial fall'. It certainly represents a significant write-down.

As to the structural deficit, though it is difficult to measure (it depends on the measurement of the output gap), the ESRI suggested that structural deficit was 8% at the beginning of the year and is probably now at 6% following the April budget. Therefore, if the ESRI measurements are correct, the majority of our deficit is cyclical - and that the continuing nose-dive is cyclically driven.

However, you are correct to point to this distinction - something that has gotten lost lately (we seemed to hear a lot more about the structural deficit in late 2008). I'll follow this up distinction in a subsequent post.

Proposition Joe - as you write, I've been trying to calculate the extra interest costs, since this was a main objection by the Mininster for Finace. When I have this done, I'll post it.

Slí Eile said...

It is worth emphasising that any attempt to bring about a net adjustment of some €4bn will require a much larger gross adjustment by way of spending cuts or tax hikes. There is a real danger that Ireland is beating itself up on the deficit and driving it further out of control by cutting into incomes and consumption. Just how much of the freefall in tax receipts in the last 6 months since April is due to the deflationary stance of the December 2008 and April 2009 Budgets would be interesting to know.
On a separate point - isn't it a bit rich to hear extremely well paid folks in the Central Bank and other institutions urging pay cuts and welfare reductions. Not a single 'independent economist' ' middle to senior civil servant' company CEO or private sector manager etc has a clue what it is really like to feed, clothe and heat a family. A government fell on the issue of VAT on children's footwear in 1982. Colm McCarthy says that we have run out of money and not compassion. I suggest we have run out of compassion and common sense and we are shovelling money into NAMA, bank recapitalisation (the sume equals almost the entire education budget this year) and NPRF early payments.
If you want to cut the deficit over time then raise taxes on the rich and get Ireland back to work.

Tomaltach said...

"If you want ot cut the deficit over time then raise taxes on the rich and get Ireland back to work". That's it, slap a huge tax on the rich and bingo the problem's solved. Come on. If that's the best we can do on 'progressive economics' then no wonder the right dominate the debate and generate far more intense discussion. This tired old mantra about simply taxing the rich is a real turn off at this stage. And I say that as someone who believes we need to raise more taxes, have a progressive system, and broaden the base. But let's allow an ounce of reality into the discussion: If we call people earning over 100k as rich, we know there aren't enough of them to raise the kind of money we need. The highest marginal rate is now in the region of 50%. So how high do we want to go? 70%? 80%. Even still we wouldn't come close to fixing the problem. Yes there is certainly scope for closing of the tax 'expenditures' or breaks such as mortgage interest relief and relief on VHI etc. And we need to eventually bring more people into the tax net. The drive by the unions during the tiger to push as many people as possible out of the tax net has been a disaster. Perhaps we do need also to look at corporate tax, but we all know we need to look at it very carefully. And when all of this is done, we still have a huge deficit. But we can of course live in the fantasy world where we are paid too much and think we can just 'tax the rich' and live happily every after.

Proposition Joe said...


A good starting point would be to consider how the income tax burden is current distributed across income levels.

Ronan Lyons put together a useful graph that makes for fairly sobering viewing:


So the question is, how would you propose changing the shape of that graph?

Certainly there's head-room for rises at the very top-end, for example it makes no sense that someone making 650k pays slightly less as percentage of income than someone on 230k. De-roofing some or all of the tax shelters should take care of that anomaly.

But otherwise, how would the distribution curve need to change, do you think?

Tomaltach said...

And of course Ronan's graph doesn't show the extra levies which were progressive

Proposition Joe said...


Quick back of the envelope calculation shows the poor craytur on 631k has seen their levy increase from 2.37% (old health levy) to 9.95% (new income and health levies). Therefore their overall tax rate jumps from 27.5% to about 35%.

Say we were to increase this to 45%. If the income distributions from 2008 remained in force, this would raise .76 billion. We'd need to go to 48% to raise a full billion from these 11,714 individuals, or 61% to raise 2 billion. Obviously this would require a higher marginal rate, as the first 75k or so would be tax more lightly.

On the face of it, sounds like there's at least a billion on the table waiting to be harvested from ultra-high earners (those on more than 275k). However, the reality is likely to be a bit different. For a start, I doubt if the number of earners at that level has held up since '08, neither has their average earnings. Also very high marginal rates (say 65%) are likely to further reduce the occurance of ultra-high income (acting as a disincentive) and the balance between declared and undeclared income.

We could do a similar exercise on those earning between 100k and 275k. However, even after absolutely maxing out the potential for tax rises from these cohorts, we're still likely to find outselves way short of closing the fiscal gap.

Michael Taft said...

Tomaltach, Proposition Joe - I think the points you have made warns us against a 'static' view of taxation and tax revenue. On the issue of Ronan's chart - it is effective at showing the distribution of tax within the income tax code. To get a better look, one would have to broaden this out to all tax and tax subsidies. There would be PRSI (the regressiveess of this would be removed with the abolition of the PRSI threshold), VAT & Excise (regressive), capital income (marginal rates are lower than on standard rate taxpayers - with no levies and PRSI levied on them). And, of course, the tax subsidies (i.e. expediture) which lowers, especially at the upper end, the overall tax rate (though not the marginal rate). Any property tax, which is only a partial property tax (i.e. attached to residential property) will, again, be regressive.

There is, within all this, scope for developing a new taxation architecture. But in terms of raising revenue, one of the best ways is to grow the economy. For instance, in the Government's macro-projections, tax revenue makes up 22.3% of GDP. In other words, for every €1 billion in growth - or 0.5% - the Exchequer gains €223 million. Growth can add billions.

Slí Eile said...

@Tomaltach – there is a limit to taxing the 'rich'. In any case, we don't really know the full extent of income and wealth here or abroad. The data are all over the place and you have to wonder how much of it is really reported and counted. If want to press me to say that we have to raise taxes on the 'non-rich' (now who would they be?) I would raise my hand and say yeap. Local taxes, carbon taxes, higher marginal taxes, fewer tax reliefs - keep going until you had a whopping 10 percentage points in tax take to GDP .... and you get to the EU average - which is only an average of Sweden and Slovakia et al. So, keep going until you reach about 40% and you have closed the deficit. But, seriously I am not proposing to tax our way out of recession and still less to cut our way out. The best way is to grow our way out and that involves some extra borrowing, some extra taxes and some delay in payments to the NPRF. Any stimulus package needs to be very, very forensic like the GND stimulus package of 3% (Comhar) neglect to point out that our tax take as a % of GDP is at the bottom of the EU league.
Even if we moved up towards the EU average of about 37% (and still remain low-tax) our public services will continue to remain sub-standard. Think of those children suffering as a result of a completely inadequate publicly-funded health service for various groups at risk (including children at risk of neglect and abuse). There are huge pockets of income and wealth that escape the revenue net for all sorts of reasons. An injection of €7bn, alone, in the banks to recapitalise just shows that ‘when it comes to the economy and the banks’ money is no problem. Taxing the rich is part of the answer. Other elements are raising local and national taxes on those who can afford to pay, widening the tax base, reforming the public service, drawing on cash at the NTMA, pursuing imaginative funding solutions through European level (e.g. European Recovery Bonds). We don’t need to cut, our already inadequate, public spending bill. Rather we need to redirect it by reducing waste and big salaries and increasing areas that are under-invested. The alternative is deflation – which as the ESRI now admits – will prolong the recession. The Dublin Consensus has only one policy target in mind – reduce public liabilities and assets and crown in a competitive market position by reducing wage income and restoring profitability – and it has only one policy instrument in mind – cut, deflate and privitise.
I would propose the following:
Fast-tracking reform of taxation by immediately ending all tax breaks and non-standardised tax relief except where there is an immediate administrative or economic imperative to do otherwise;
Introduce a new top rate of income tax on all incomes over a particular threshold;
Shift to consumption energy-using taxes over a three year period beginning now;
Raise Corporate taxes to 15% and peg it at this level for five years;
Introduce property taxes on second homes as well as property over €1million;
Fast-track local revenue raising and linking these explicitly to local services where people can see where their tax money is going (early childhood care, local health centres, community facilities);
As part of a selective and targeted stimulus package, fast-track those elements of the Capital Programme that are labour-intensive and that will yield quick gains in terms of schools, early childhood centres, hospital facilities and social housing – there is evidence that the income multiplier effects from such a targeted package would be significant
From within the recapitalisation fund given to banks, take measures to ring-fence an emergency credit fund for otherwise viable businesses in danger of going bust
Immediately terminate the inequitable and costly hospital co-location policy.

Proposition Joe said...


"There is, within all this, scope for developing a new taxation architecture."

I absolutely agree, and it really behooves the progressive left to start fleshing out the detail of new architecture they want with actual tax bands & rates, estimates of yields & deadweight loss, that sort of thing.

The problem for the left currently is that by avoiding putting any hard numbers on this, all credibiltiy is lost. Worse still when numbers are actually advanced, they often don't stand up to the most basic of scrutiny.

Take for example Jack O'Connor on Newstalk this morning decrying a pay-cut for ministers and heads of departments as an attack on "working people". Apart for bizareness of that position, he did offer some figures:

How can it be fair that a public servant on 40k takes a pay-cut of 7.5% while some fat-cat on 175k is only hit with a 6% levy, asks Jack.

Well the pension levy on 40k is actually 5.75%, and is tax deductible bringing the net loss well below 5%. Whereas the new levies on 175k actually add up to 8.5% (including the extra health levy added in the supplamentary budget) and are not tax deductible. Now I agree that the person on 175k must pay more, but Jack cuts the legs off his own argument by being so hopelessly inaccurate with the figures.

How much more? Well Jack reckons 10% would be more reasonable. Raising the current levies from 8.5% to 10% is a delta of just 1.5%. This would only raise a few hundred million at most. Jack needs to be honest and state that a levy of at least 20% would be required to raise significant moula for the ulta-high earners, but of course that brings us into serious distortion territory.

Tomaltach said...

I would agree on ending tax breaks. And also that we need to, as you say, raise "local and national taxes on those who can afford to pay", by which I mean, everyone down to the minimum wage needs to pay 'some' tax.

I have no problem evolving towards average levels of EU taxation - as long as we are spending it efficiently and are paying what we can afford. You asked me to 'think of the children suffering' - as if you have a monopoly on compassion. Let me be clear: I'm as much in favour of a top class, universally available health service as anyone.

You said " We don’t need to cut, our already inadequate, public spending bill.". No, it's not necessarily the level of spending, it's the kind of spending. We are paying many of our public servants far too much. At the top level there is no question : we see how Prof Drumm is earning more than his equivalent in the NHS who runs an outfit ten times the size. And this is replicated right across our senior public service where pay scales have drifted to match the madness of senior private sector pay levels and the culture of bonuses or 'celebrity' level packages and golden handshakes. But the problem reaches down to all levels. A primary teacher with 10 - 15 years experience earns about 55k - 60k, arrives at work at 9.20 and is gone by 3.01 (and, at least those I've spoken to, resent being their for even a 15 minute meeting after 'official hours'). Has three months holidays, a guaranteed pension and job security. Take a software engineer with 10-15 years experience typically earns something in the same ball park, but for working in vastly inferior conditions, and far longer hours, and with a fragment of the annual leave. When compared - the engineer is all round far worse off. And the engineer is supposed to be where the future of our knowledge economy lies. No wonder engineering classes have for years been empty while teaching has been way oversubscribed.

Make no mistake - the public service, in the round, is overpaid, and arguments to the contrary are disingenous or self serving.

That doesn't mean I advocate massive cuts on public service pay now. It would be unfair - people have adjusted their standard of living and financial committments to match their elevated pay. So any adjustment back to where we need to be should be phased, not a shock. But the adjustments must come eventually and I hope the general public are clear sighted enough to give such measures their full support.

You say we must grow our way out of recession. Well, by definition that is the only way. Return to growth = end of recession. But Ireland's problem is not merely its recession, which is deep, but its unsustainable fiscal position. Our borrowing has leaped from 25% to 75% of GDP and we are spending about 60% more than we take in taxes. A return to growth will help this, but only a little. The only solution can and I hope will be a broader and higher tax take generally and a return to public pay levels that are sane and sustainable.

Slí Eile said...

@Tomaltach There is much that we can agree about including:
ending most tax breaks
aiming for EU levels of tax take
spending public money more efficiently
universal health service
over-paid (and some under-performing) top managers in the public sector
urgent need for reform in public services with greater flexibility.
broader tax base

Slí Eile said...

@Proposition Joe
I agree with you that some 'on the left' are disinclined to put numbers on the arguments (notes on the front is an obvious exception...). There are a number of reasons:
lack of access to data sets in a timely way
near monopolisation of economic research business by those in the mainstream who set the questions and make the assumptions
lack of critical numbers and mass.
Have you ever heard of any major economic research institute, consortium or group empirically testing a fiscal stimulus package here in Ireland?. Of course not - it is not even deemed worthy of serious consideration. 'Its obvious There-Is-No-Alternative' Repeat ....
There is, also, a lack of confidence and cohesion – among progressives - in advancing an alternative to the existing rush to deflate.
You are right to challenge the critics to produce the goods in terms of numbers, analysis and convincing strategies. We need to gear up 7 steps.
(it is only right to add that many the mainstream fail to declare their values and world view). they walk through customs with nothing to declare but their bags are bulging).
On the issues of wages, costs and prices - a favourite of those pressing for upfront 'real economy devaluation' - I would suggest after ye - start with excessive profits and big wealth holdings and super incomes and sheltered sector super profits. If anyone is in doubt about a crock of gold consider the cuts in prices in some retail areas - clearly showing the scale of rip-off pre-recession.