Thursday, 26 November 2009

Guest post by JJR: Shifting the tax burden from business to employees will not create jobs

JJR: Fine Gael frontbenchers may not take their lead from the Obama administration, but when White House Chief of Staff, Rahm Emanuel, said last year that one should ‘never waste a good crisis’, they seem to have taken this to heart.

In advance of the 2010 budget, the party has proposed a permanent €900m tax cut for business, financed by matching tax hikes for workers. This is not a tax cut ‘targeted at the most vulnerable jobs’ as they suggest; it is a tax cut that will boost corporate profits with only minimal and incidental job creation. The net effect would be a significant and regressive re-distribution of wealth.

The proposal includes a 20% cut to the standard rate of employers’ PRSI, costing €830m, and a 50% cut in the lower rate, costing €57m. This is to be financed by abolishing the PRSI ceiling for workers earning more than €75k, supposedly bringing in €470m, and through a carbon tax, bringing in €480m, disproportionately from the lower paid. Incidentally, the Department of Finance insist that abolishing the PRSI ceiling would raise €120m, some €350m less than asserted by Fine Gael.

According to Fine Gael, this tax cut will benefit 1.7 million workers. In actual fact, this near €1bn tax cut is aimed solely at improving the bottom line for business. Even accepting that FG’s costings are accurate, half of their tax cut is to be paid for by those earning over €75k as PRSI would be applied to their income over this level. The other half would be financed by a regressive carbon tax with no compensating measures for low income workers.

In fact, the biggest problem with this bumper business tax cut is that it is not targeted. It is a blanket cut that would reduce labour costs for employers for all existing jobs. And now for the ‘science bit’: Economists call this a ‘deadweight loss’; Fine Gael propose costly incentives for businesses to hire people, regardless of whether they were going to hire them anyway. The focus of Fine Gael’s proposal is on ‘infra-marginal’ rather than ‘marginal’ hiring decisions and, in economic terms, that is its core weakness. Acknowledging this fact, party spokespersons nonchalantly brush off this vast waste of money by saying ‘doing nothing would cost more’.

The party insists that ‘these changes are particularly targeted at lower-paid and entry-level jobs’ and the young unemployed. This is clearly not the case. Cynically, they are proffering the limited economic rationale for halving the lower rate of employers’ PRSI, at a cost of €57m, as justification for a blanket cut to the standard rate at 15 times the cost.

If Fine Gael were serious about protecting and creating jobs, they would be proposing tax breaks focused on jobs created or saved; they would focus on the ‘margin’. Reducing or suspending employers’ PRSI for people taken off, or kept off, the dole would be truly targeted and far more cost-effective. But this isn’t about job creation; This proposal is about securing tax breaks for business supported by spurious claims that this would support jobs.

Fine Gael’s proposal implies ESRI endorsement. In terms of tackling the jobs crisis, the ESRI concludes, in the Recovery Scenarios document cited by the party, that ‘priority needs to be given to labour market initiatives that will effectively tackle this skills deficit among many of the unemployed. In preparing for a recovery, the economy would also benefit from increased policy attention to measures to enhance productivity and innovation in the tradable sector of the economy.’ At no point does the ESRI propose a blanket cut in employers’ PRSI as an appropriate policy response to the crisis we face.

PRSI, whether it comes from workers or employers, is not really a tax at all. It is the social contribution made by workers so that they will receive state support if they fall on hard times; it is paid by employers to provide a safety net for staff in times of economic hardship.

Ireland has among the lowest level of social contributions in any advanced economy. Fine Gael cite other countries where reducing social security contributions have formed part of fiscal stimulus packages, but this overlooks the very low base at which Ireland is already operating. Our welfare system is barely keeping its head above water.

In Ireland, social contributions are paid into the Social Insurance Fund, out of which are paid employment-linked welfare payments. When the economy was booming, and at full employment, this Fund was billions of euro in surplus. With unemployment heading for half a million, it is set to move into deficit in 2010. Slashing PRSI contributions would undermine the viability of Ireland’s welfare system altogether and render the Social Insurance Fund defunct. Clearly, Fine Gael’s answer to this conundrum is to slash welfare rates for people who have already taken a hit by losing their jobs.

Make no mistake, this big business tax cut is a Trojan horse for slashing welfare and public services. Fine Gael want to cut the 2010 budget deficit by €4bn, €3.8bn of which would come from cuts to current spending. This would take slash-and-burn economics to a level that even the Fianna Fáil government considers to be beyond the pale.

Under this proposal, ordinary working people would carry the entire burden while corporate Ireland gets a near billion euro handout. This is not compassionate conservatism, or even so-called ‘common sense’ conservatism – this is cynical conservatism at its worst.
JJR is, obviously, anonymous.


antoin O Lachtnain said...

No, it wouldn't, in itself create jobs. But then, what would? What policy will actually create jobs?

However it would provide a way to avoid pay cuts for better paid people and redundancy for people on minimum wage in the private sector.

The carbon tax would have the smallest impact on the poorest people, who are dependent on public transport, foot and bicycle the least, and would hit the wealthy, who use cars, the most. If it is the case that a proportion of low income households (for example pensioners) have homes that are highly energy inefficient, we need to fix that, urgently.

Michael Taft said...

JJR - hopefully your comprehensive critique will become the last word on what is one of the more dubious (I'm trying to be kind) proposals to emerge in this debate over how we can get people back to work. I mean, there's deadweight and then there's deadweight but Fine Gael has taken this wasteful spending concept to new heights. Just one question: would a PRSI reduction for employees hired off the goal also contain significant deadweight? Surely, employers will only hire people once they require more labour for production. If so, reducing PRSI only means 'rewarding' them for doing something they would have done in any event. Unless you're suggesting that the marginal cost of PRSI is a block to hiring people even if employers have a need for more labour?

Proposition Joe said...

@Michael Taft

Agreed, the deadweight losses are likely to be large.

However, I don't think its quite so simple as your "need for more labour" point. Many of the jobs lost are marginal, in the sense that some of those workers might possibly be kept on if the balance was tipped slightly. Firms tend to hoard labour in a downturn beyond their immediate needs, for a number of reasons both altruistic and also hard-nosed (to avoid the costs and risks of rehiring once the upswing occurs). The point would be to tip the balance so as encourage this tendency.

The trick is though to only target the relief at those cases where it would make the difference between a job being lost or maintained. Clearly the FG proposal is sub-optimal in this regard.

Mack said...

@Proposition Joe

"The trick is though to only target the relief at those cases where it would make the difference between a job being lost or maintained"

I'm not sure you can do that easily. Reducing employer costs will make them more competitive. Labour costs are only one part of that. But on the back of lower employer costs, whose to say that new contracts could not be won that safe jobs or even create new ones?

How can we tell what contracts will be one or lost ahead of time? I know for certain of contracts that have been lost to British firms as customers press for terms in the current deflationary environment that their original Irish suppliers simply could not meet...

Proposition Joe said...


Agreed that it would be impossible to target with perfect accuracy, and very difficult even to a first approximation.

But it shouldn't be beyond the wit of man to design a qualification process, that required the company to demonstrate their long-term viability and short-term pain, so as to at least weed out those firms that are doing fine, but also those that are going to go bust eventually anyway.

Obviously all having to be finessed past the EU competition watchdog.

Mack said...

@Proposition Joe -

That sounds very like central planning to me. Which even if it could be done well (and that is open to question), it would surely not be very agile or responsive.

You're sitting in your office and a customer rings - they've gotten a better deal in Manchester or somewhere. Can you match it? Well, get back to them in 2 months after you've filled in the forms, had the audit etc. etc..

Keep it simple, one set of rules for everybody. It's not a bad idea because it will make firms more competitive - it's equalivent to workers taking a pay cut. You just can't know a priori which firms will be able to take advantage and create jobs..

Sean Faughnan said...

@JJR. Am I the only one who finds it somewhat contradictory that a blog, which accuses Fine Gael (FG) of cynicism, is posted by someone who, rather cynically, decides to remain anonymous?

Full disclosure: I am an advisor to FG - but the following comments are purely personal. At the risk of outraging the sensibilities of JJR, I view myself as a "Progressive", sit very comfortably within the broad FG family, and have been following the Progressive Economy site for some time now. I have enjoyed the debates on the site - even when they are not particularly friendly to FG.

Given my connection to a political party, I have not been an active participant in any of these debates. I think it much better if the site is not subjected to the frequent outpourings of politicos. However, given the nature of JJR's blog I have decided that, in the interests of basic fairness and balance, I should interject myself into this particular debate. Sorry Michael, but I really don't think that JJR can have the last word on this issue!

It is not my intention to answer JJR's economic arguments point by point - the FG economic team is in a much better position than I to address such issues. Instead, I would like to respond to JJR's general narrative against FG.

JJR's basic accusation is that FG is both conservative and cynical. I strongly reject both charges and would suggest that both of these descriptions could more powerfully and appropriately be applied to his/her blog.

First, I find it very peculiar that a blog on a progressive website has nothing positive to say about a tax proposal which shifts the burden from labour taxes to a tax on higher income individuals and pollution (in this case carbon). As a general principle, this seems to me to be a pretty progressive thing to do.

Are the proposals perfect? No tax proposals can be. By definition, taxes are a blunt instrument - but they are a very positive step forward in my view and must be seen in the light of FG's overall approach to jobs (see below). If JJR has issues with the ESRI's modelling of the jobs impact of reducing labour costs, then I suggest he/she take it up directly with them.

Second, it seems to me that JJR’s attempts to use the "science" of "deadweight loss" is little more than an attempt by him/her to disguise what is really just a good, old-fashioned political rant against FG. In any event, whatever JJR's motivations, I don’t believe that the concept usefully applies here.

Although the term deadweight loss is used very broadly and loosely in political and economic discussion, at its core it is about the inefficiency/loss caused by the imposition of taxes on markets operating efficiently and at equilibrium. Since markets in Ireland are clearly not working efficiently, and are certainly not at any kind of equilibrium (whatever than means in practice!), I don't see what positive role a discussion of deadweight losses can play in this analysis.

3. To be fair to JJR, I think the essential point he/she is making is that a cut in labour taxes is less efficient than direct incentives which would encourage the retention and hiring of workers. This is certainly a valid proposition - and in some previous proposals FG adopted elements of this approach.

Our current approach is not based, as JJR ludicrously claims, on some cynical interest in lining the pockets of corporate Ireland. Instead, we have become convinced that a targeted "subsidy" system, though attractive in theory, is impossible to manage efficiently in practice. Why? Because, amongst other things, it is open to profound abuse by precisely the same corporates which JJR rails against in his blog. Mack’s comments are very relevant in this regard.

Sean Faughnan said...

I also find the charge of conservatism against FG a little hard to understand. Over the last year:

1. FG has published proposals that will achieve the most radical reform of the health system since the foundation of the State ("FairCare"). Crucially, it will abolish the two-tier health system - a key progressive goal.

2. FG has also just published an update of our 18 bn Euro "NewERA" stimulus plan to reshape the Irish economy and create 105,000 jobs. This investment will be funnelled through a reformed semi-State sector - hardly the approach that a “cynically conservative” party would adopt. In a recent blog Michael acknowledged that it was a very positive proposal, even if he objected to the sale of a limited number of non-strategic State assets to help fund the programme.

3. Enda Kenny has called for a "New Politics", including the abolition of the Seanad, a reduction in the number of TDs by at least 20, the possible introduction of a supplementary list system, and a massive redistribution of power within the political system.

4. FG opposed the NAMA bill tooth and nail, and made it very clear that we did not support any bailouts for the bankers and the financiers who helped get us into such a mess. Not exactly the position of a party that JJR would like to paint as in the pockets of the corporate elite.

5. I am open to correction on this, but I believe that Enda Kenny on Friday became the first leader of a major party, and possibly the first major politician in the history of Ireland, to call for the resignation of bishops (who were complicit in the cover-up of child abuse).

I could go on but hopefully the point is clear. FG is the party of radical change. You can by all means disagree with the details and direction of that change, but the change agenda itself cannot be denied. By contrast, in my view too much of the current debate in Ireland, including JJR's contribution, consists of very old wine/ideas in not very shiny new bottles.

One final, more general thought. Market fundamentalism - the idea that markets are automatically self-correcting - has been completely discredited. The idea that the State has no positive role to play in the economy has also been discredited (see FG's NewERA document on this issue, where we outline a very positive role for the State in developing our economy).

But in Ireland the State has also dramatically failed the citizens of our Republic (see Enda Kenny’s speech on The Republic at the MacGill summer school this summer). It was complicit in the cover-up of child abuse. It allowed enormous regulatory capture on the banking side. It wasted huge amounts of money in our health system (we pay 5,000 Euros year per person for health, if we take into account private expenditure. The Dutch, with no waiting lists and the number 1 system in Europe, pay only 3,500). Crucially, the political system failed to prevent such enormous abuses and mistakes.

What FG is seeking to do, in my personal view, is to define a new relationship, in the light of the above failures, between the State and the market, and between the Government and the citizen. This project transcends traditional notions of left and right. Instead it asks the question: What does it mean for Ireland to be a Republic in the 21st Century? How can we take back our Republic from the vested interests, whether private or public, that have captured it over the last decade or so? All of that seems to me to encompass a pretty radical and progressive agenda. JJR will undoubtedly disagree.

Many apologies for the length of these two posts, but since I will not be a frequent contributor, for the reasons outlined above, I thought I should address as many issues as possible.

An Saoi said...

@ Seán

I as another person who from time to time comments on this site, but note your comment regarding the use of an "ainm cleite". However anyone who has a connection with the Civil & Public Service cannot comment in public, whether free to do so or not in the current climate. Fine Gael are not to my knowledge in favour of extending political rights to those currently restricted but perhaps Enda could issue another one of his on the hoof policy dictats on the subject.

Firstly in praise of Fine Gael, I thought that the New Era publication added considerably to the economic debate. I also felt that it did not get the coverage it deserved.

However in relation to your comments on NAMA, the crucial problem was Fine Gael's support for the Government in September 2008. This made NAMA a fait acompli once the guarantees were in place. That was the time to do the fighting, not a year later. Richard Bruton's ideas were clear and cogent but a year too late.

The Fine Gael plan in relation to the Health Service is a carbon copy of the revised Dutch scheme, which is running into major problems because of widespread failure to pay the "compulsory" contributions. The Labour Party had also previously published a policy on compulsory insurance, which I am not completely against, but have my doubts.

However in relation to employer PRSI contributions, I fail to see that it can do anything other than lead us back into deeper trouble. Irish employer PRSI is the lowest in the EU and the Irish Social Insurance Fund was already in trouble arising from the 2% cut made in employer contributions in 2001. It will not influence costs in even a labour intensive service business such as the restaurant trade by much more than 1%. It also moves the discussion on PRSI back towards just another tax rather than the insurance issue, but that is for another day.

A far greater threat to Irish retail & service business sectors is the level of rents, which is again a separate point for discussion, which maylead us all the way back to NAMA.

In relation to using the tax system to "encourage" business, over 30 years of working with taxation tells me NO! The slighest time spent looking at the property morass & banking crisis, much of which relates to tax incentives, should make all stop and ponder.

My crucial problem with Fine Gael is this approach of a constant flow of meaningless "policy" statements, which the party leader makes without any form of internal discussion. Remember Richard Bruton's face when he made the pay announcement? Or what about the members of the Seanad before that speech? Now his comments about Bishops are muchin the same vein or should it be vain. Who leads or holds positions in the Catholic Church is a matter for the members of that Church, not any political party. However the key issue is their secular role as patrons of national schools. Rather has Fine Gael any policy on that?

However Seán I for one welcome your participation in this discussion and perhaps the best way to go forward is to prepare your own analysis of Fine Gael's policies and submit for posting here.

Slí Eile said...

@Seán good comment though not all agreed. Many of the ideas in the NewEra document are wothty of support and implementation (even is some look like originating in ICTU proposals previously). I wonder what is the minimum a progressive alliance of parties on the left would demand of any possible future inter-party government involving FG? The big challenges in the 2010-2020 period will be:
climate change
the impact of unemployment (especially on young people) and associated issues around mental health, family structure, racism, social cohesion
defending public services - quantity and quality against an unmerciful assault all around us
addressing the fundamental inqualities in Irish society
renewing democracy and active democratic citizenship as the best bulwark against corruption and drift
making a significant contribution to international development, peace, security and human rights.

for the day that's in it - the issue of undemocratic and unaccountable governance structures in schooling is an urgent issue. We should be getting back to the Stanley approach to 'national education' in the 1830s. A non-sectarian, open, child-centered, free and community managed system of public schools is long overdue. We are very odd by international standards (even if we like to think that quality is very good).

Anonymous said...

The starting point for the Fine Gael PRSI proposal is that Ireland needs to restore international competitiveness and export-led growth to tackle unemployment from the declining construction and retail sectors.

Clearly, competitiveness is a multi-faceted concept and is, in the medium term as much about productivity growth as pay and non-pay costs. The Scandinavian countries have shown that the State has a major role in supporting productivity growth through investments in life-long education, training, research and infrastructure. There is an agenda here that Ireland can learn from.

But competitiveness improvements through superior productivity growth alone will not happen quickly enough to absorb the huge numbers of people that now find themselves redundant after the end of the property bubble. Unless we are content to try to solve this problem through emigration or various types of social-employment schemes that have had a poor track record in creating sustainable jobs in the past, we therefore need a national plan to cut business costs quickly. Lower business costs mean extra jobs for the unemployed - there is no ideology in this observation - it is based on the ESRI's empirical research.

The tax system can play an important role here. It is clearly difficult for lower-income workers to accept nominal pay cuts, particularly those on or near the minimum wage, even if the cost of living is falling. This is why FG's proposal to shift the tax burden from labour costs at the low end to taxes on pollution on higher income earners makes perfect sense in the context of supporting employment (and tackling pollution). This contributes to lower pay costs and an improvement of international competitiveness without pay cuts for the lowest income earners.

It is surprising to see criticism of the proposal on the basis of high "deadweight" costs. Deadweight is a textbook concept normally applied to the effect and cost of a subsidy in the context of a free market equilibrium. But FG is not proposing a subsidy, but rather a revenue-neutral re-design of the tax system that results in more employment and less pollution.

Indeed, the concept of deadweight is much more relevant to the alternative proposed - trying to identify particular "vulnerable" jobs that are deserving of subsidy. As Sean has argued, this is much more vulnerable to high deadweight costs and indeed manipulation by powerful interests that FG's proposal.

Finally, it is true that the carbon tax is regressive in its distributional impact. This is not a good enough reason though not too tax carbon. The regressive effects can be offset by targeted social welfare payments, such as an increase in the winter fuel allowance.

Proposition Joe said...


But FG is not proposing a subsidy, but rather a revenue-neutral re-design of the tax system that results in more employment and less pollution.

Reducing the tax burden on employers is indeed a subsidy. The fact that one tax-cut is financed with another tax on some other activity is neither here nor there.

It would still be a subsidy even if paid for by the tooth fairy, or by confiscation of all the holy communion money in the land.

Mack said...

@An Saoi

". It will not influence costs in even a labour intensive service business such as the restaurant trade by much more than 1%"

There are lots of businesses where the cost of expansion are largely determined by wages. Software consultancy is one such area, I imagine. If an employer knows they can knock maybe 10-15% or so of labour costs (falling wages, combined with lower PRSI payments) then they can bid lower for new contracts.

@Prop Joe

It's not a subsidy it's a tax cut. Would it be fair to distinguish universal tax cuts from targeted subsidies (that may also be unfair competitively?)

An Saoi said...

Employer PRSI is payable at a maximum rate of 10.75%. Assume that total wages, (e.g. wages & salaries, pension costs plus E'er PRSI) are around 30% of turnover, then a 10% cut in E'er PRSI would be worth about 2% of turnover.

Of course cutting PRSI is a subsidy because the benefits arising continue to be paid except now subsidised by taxation. PRSI operates as a pay as you go pension scheme, hopefully building up surplus contributions to cover the bad times.

Mack said...

@An Saoi

pay as you go pension scheme

Now there is a contradiction in terms. Perhaps you meant pyramid or Ponzi scheme? As the population ages and the dependency ratio worsens - won't the tax burden rise? In effect, isn't _really_ just a tax?

Not sure about those calculations. A 10% cut in employers PRSI (of around 10% falling to 9%) would surely equate to about a 1% fall in wages?

It's the marginal reduction in labour costs that matters in terms of job creation anyway. The fixed costs are fixed...

Mack said...

@An Saoi

Actually, thinking about it, I presume you mean effectively scrapping employers PRSI - but wouldn't this mean that a company planning to make 10% of staff redundant could make that saving (or thereabouts) without sacking staff?

Proposition Joe said...

Some interesting observations from the Economist on the design of these job-support schemes. Briefly mentioned is a Swedish scheme to allow distressed firms to defer their social contributions, but with a high interest rate to disincent healthy firms from taking advantage.