Wednesday, 10 March 2010

The TASC letter: Fiscally consolidating what?

Michael Taft: The TASC letter raised the prospect of ‘restructuring taxation and expenditure in a progressive and expansionary manner’. This begs two questions – what does this mean for fiscal consolidation; and around what level do we fiscally consolidate. The phrase ‘fiscal consolidation’ is used as if it had some final meaning. It doesn’t. It doesn’t assume any level of tax and spend, just a relationship between the two. Everyone knows we have to achieve the latter. But there has been almost no debate about the former.

The Government has indicated the level they want this re-balancing to occur by 2014 – at the lowest level possible. There is a problem, though. By 2014, we will be paying out a higher level of interest on the debt – nearly four times as much as a percentage of GDP over recent historical levels (by 2014, 3.9 percent of GDP will go on interest payments compared to 1 percent pre-recession). There’s not much that can be done about this in the medium-term. So maintaining a low level of taxation has to factor in this rising cost.

The Government intends to maintain revenue levels pretty much where they have always been. Factor in debt servicing and by 2014 taxation levels will be lower still.

Where does that leave the Government’s spending plans? Little short of slash and burn – despite the Finance Minister’s assertion that the budgetary worst is over. Excluding interest payments, the Government intends to cut public spending and investment in real terms by over €5 billion – or nearly 8 percent – between 2010 and 2014.

The Government’s emphasis on public spending cuts (and the general conflating of ‘fiscal consolidation’ with such cuts) can be seen in a new light – not so much to bring public finances under control, but to maintain a low-tax model whereby spending and investment cuts are inevitable.

Progressives in Ireland have generally argued for a higher tax take – to invest in public services, infrastructure, indigenous enterprise, etc. As the saying goes – you can’t have European-level of services or living standards without paying European levels of taxation. So, what is the optimal level of taxation? The ESRI’s John Fitzgerald has put forward a suggestion that deserves discussion:

‘It is essentially a political question as to what level of public services and investment is likely to be “desired” by the public in the next decade. . . .My own preference would be to target a level of expenditure and revenue in the medium term equivalent to 45 per cent of GDP. However, every government has to make its own mind up on this issue. Whatever that target is should inform the composition of the next budget.’

Fitzgerald’s preference is essentially for an EU norm. If this ‘political’ goal were achieved then it would radically transform the fiscal dynamic.

It would certainly mean higher tax levels – on profits, capital, property, wealth and income. It would also mean a profound debate about what kind of taxation system we want. For instance, as the TASC letter points out - in moving towards a European model, this may mean greater emphasis on social insurance to deliver services and social protection that is now delivered through central funds. It may also mean moving towards higher local taxation – where greater accountability and transparency will hopefully translate into greater efficiencies and higher output.

Nor is it a matter of taking a crude slide-rule approach (a 20 percent increase in tax levels translate into a 4 percent increase on the standard rate). Higher, sustainable growth itself creates higher tax revenues. Even Government acknowledges this when it shows, without raising taxes or introducing new ones, current tax revenue (excluding social insurance and local taxes) will increase by 27 percent – all because of growth.

Even slow progress towards EU norms will give us considerably more resources for investment; a 40 percent tax level would provide an additional €6 billion. To reach Fitzgerald’s preference/EU norms would provide an additional €16 billion. I suspect the higher level will not be possible within four years – after all, restructuring takes time. But anywhere on the way will allow a reversal of spending cuts and a platform for investment.

And this is key – for investment itself will invigorate the economy towards even higher levels of output, which in turn will increase tax revenue. This is the virtuous circle of investment, growth, revenue and lower unemployment costs. And this is before we sit down to the hard work of debating a new taxation architecture.

When the Government says TINA (‘there is no alternative’) they are right: there is no alternative if you want to degrade taxation levels and maintain, despite the economic costs, a low-tax model. But if we move towards European norms, breaking free from a failed model that contributed so significantly to our massive economic and social deficits as outlined in the TASC letter – then more alternatives open up.


Proposition Joe said...

What about the deflationary impact of this 16 billion in extra taxes?

According to the ERSI simulation you referenced on your blog a while back, if modeled on income tax rises this would translate into a 3.2% contraction in GDP and the loss of 32,000 jobs.

Ronan L said...

There's also another concern - we've already more than likely reached 45% of GDP, if that's your target, due to the fall in GDP.

I'm also not sure why the self-named progressives might choose GDP over GNP, when GNP is their preferred comparator of choice for the same group for most headings. Going by GNP, Ireland has the largest tax-income ratio in the EU.

Either way, there's only so far one can go with a single-dimension target like this.

Mack said...

@Prop Joe

"What about the deflationary impact of this 16 billion in extra taxes?"

I think, maybe, this post amounts to a recognition that our responsibilities as members of the Eurozone / EU means that - in the aftermath of the Greek debacle - that some form of fiscal consolidation may be unavoidable , but it need not be limited to or focused on spending cuts..

Although, I may be misinterpreting Michael..

Michael Taft said...

Proposition Joe - as I said, we can't use a simplistic slide-rule on this issue. As I also pointed out, there is a need for a debate on this subject (which we haven't got) and I, for one, am sceptical about the ability of the economyto absorb a tax/GDP ratio of 45% by 2014, though I am more than willing to be convinced otherwise. Movement on tax must be consistent with economic capacity.

Yes, if you try to raise €16 billion through income tax rises you will find yourself in a bleak place. That's probably why no one has suggested it. A rise in tax levels will first be rooted in growth. Without new or increased tax rates/measures, growth will generate tax revenue above unity - that is, as the GDP grows, tax revenue will grow higher. This elasticity should be boosted in times of slack.

It is always easier to restructure taxation during periods of growth than contraction. And in moving towards a European model, we certainly wouldn't be putting too much emphasis on central taxation (income, etc.). More emphasis, as the TASC letter points out, should be put on social insurance and property.

Even so, in starting out on this long road, we should target less deflationary sources. Again TASC has highlighted regressive tax expenditure, while a comprehensive property tax (including financial property). Targeting the savers will do less damage, giving fiscal breathing space to the economy. Once we are on the road to full output, broader taxation measures can be introduced consistent with growth. Of course, this requires a sophisticated fiscal strategy - one unlikely to be obtained from this Government.

BTW - it should be pointed out that the ESRI simulations show that tax increases are less deflationary, less economically damaging and fiscally more beneficial than public spending cuts.

Proposition Joe said...

@Michael Taft

More emphasis, as the TASC letter points out, should be put on social insurance and property.

In one sense I agree with taking the focus away from income, but I would point out that ultimately these other taxes are also generally paid out of income and hence for many they would not be qualitatively different to a straight income tax rise.

For example one could view the recent health levy increases as increased social insurance contributions, as most people associate the health levy and PRSI as being part of the same deduction on their wage packet. But was there really any difference between the health levy increase and the new income levies, even if we tend to associate the latter with the PAYE element? Same reduction in spending power in both cases.

Similarly a property tax applied to anything but one's pile of cash (or other highly liquid assets) must be paid out of current income. If I'm sitting on a million euro house and the government stiffs me with a 1% levy on this, I still have to come with 10k in cash. I can't sell off part of the house to fund this, seeing the bank probably holds the deeds anyway.

If I happen to be retired, no doubt they'll be a general clamour for me to be absolved of any tax liability on the house (for some vague warm and fluffy reasoning, like my prior contribution to the building up the state, fighting the Black and Tans or some-such nonsense). So in the end of the day, only those with current income streams are likely to be hit with the property tax.