Thursday, 30 September 2010

The Governor is wrong

Michael Taft: Patrick Honohan, the Government of the Central Bank, was on News at One today. He stated:

‘€3 billion next year will not do it [move us towards the Maastricht Guidelines by 2014]. The economy has drifted so weak that this will not do it. The balance between moving forward with fiscal correction and allowing the economy to grow is, to some extent, a false dichotomy . . It is not a question of growth versus fiscal correction, its fiscal correction leading to growth.’

This is wrong.

Just as the debate is now, finally, entertaining the common-sense and economically verifiable proposition that austerity measures depress future growth which, in turn, undermines deficit reduction (because they depress tax revenue and maintain high unemployment costs) the Central Bank Governor is trying to pull the debate back. He is wrong.

In a paper widely unread, with analysis largely unreported on, the ESRI put forward two models of growth and the subsequent impact on the deficit.

• In their High-Growth model they projected an annual average growth rate of 4.6 percent between 2011 and 2015. This would result, according to their model, in an annual deficit of -1.8 percent by 2015.

• In their Low-Growth model they projected an annual growth rate of 3.2 percent in that same period. Their projected annual deficit by 2015? - 4.1 percent. We miss the Maastricht target by a significant amount.

See a pattern? Higher growth leads to lower deficits. The ESRI reinforces this in their analysis of the structural deficit:

• Under their High Growth model, the structural deficit is projected to be -1.8 percent.

• Under their Low Growth model, the structural deficit is projected to rise to – 4.1 percent.

Here is the key point that has been made numerous times on this blog: economic growth is, itself, fiscally corrective. It is lower growth that engenders higher deficits.

The Governor wants more fiscal adjustment in the 2011 budget (either spending cuts or tax increases or a combination of both). The ESRI projected that a €3 billion package would knock approximately 1 percent off GDP growth. More fiscal contraction will cut GDP growth further.

If under the ESRI’s Low Growth model we miss the Maastricht target by a wide margin, how does cutting that growth even further assist us towards the goal? It won’t. It will embed more deflation in the economy going forward. This, in turn, will depress growth further. This will result in ever higher levels of debt.

The Governor is simply wrong. But if the Government listens to him (as it appears they are) it is the Irish economy that will suffer – through more spending cuts, higher unemployment, lower incomes and poorer public services.

Interesting 5 min video about austerity

Here is the interesting video

WatsonMedia presents Mark Blyth on Austerity from The Global Conversation on Vimeo.

Wednesday, 29 September 2010

Registration now open for 2010 FEPS/TASC Autumn Conference

Registration is now open for the 2010 FEPS/TASC Autumn Conference, which will take place in the Croke Park Conference Centre on Saturday, October 23rd. The theme of this year's conference is 'Towards Recovery', and the programme is available for download here. Registration forms should be returned to Click here for further information. Places are limited, and will be allocated on a first-come, first-served basis.

Shifting debates ...

Last month, in the UK, Labour leadership contender Ed Balls gave a seminal speech at Bloomberg arguing against cuts and for investment. Until Balls' speech, UK polls showed people heavily in favour of cuts. The impact was immediate,a Populus polls for the Times on Sep 14, just a few days afterwards, put support for govt. cuts at 22%, slower cuts with more tax increases (Labour's policy then) at 34%, and prioritising the poor and the unemployed over the deficit at 34%. Yesterday, it could be argued that new Labour Leader Ed Miliband echoed many of the points originally made by Balls. Even without such interventions, it seems that public opinion here is turning against a continuation of current economic policies: 64 per cent of respondents to the current Irish Times online business poll believe that the recent disappointing economic growth figures should force a change in economic strategy.

Monday, 27 September 2010


Michael Burke: One of the key ways in which fiscal stimulus package have worked in the Euro Area- and the reason why the Irish government's policy has failed so disastrously- is the existence of fiscal multipliers. The measure of that success is that Spain has halved its budget deficit this year on foot of the largest investment package in the EU. By contrast, the deficit here has doubled following the 'austerity' measures.

For some reason the very existence of multipliers is contentious in Ireland, as if either of the economies operating here are subject to a separate set of economic laws. However, a glance at the Input-Output tables will show how all the outputs of the public sector draw on the inputs of the private sector. The detail for all the private and public sector multipliers are set out by the CSO here (see Table 5, the 'Leontief Inverse').

So, every €1bn spent on public administration, defence and social security, causes an additional €3mn of output in the agriculture sector, €1mn in mining, €4mn in food and beverages, and so on. The two biggest impacts are on business services and construction, where an additional €96mn, and a further €66mn is required. Altogether the multiplier for this category is 1:1.508. That is every €1bn of final output in this sector requires inputs of €508mn, overwhelmingly form the private sector. The multipliers for sewage, refuse and disposal activities is 2.172, and for health and social work 1.36 and education 1.302. On the face of it, these latter two seem to be severe underestimates, for a number of reasons. But they confirm the general principle, that the entire output of any economy requires the inputs of other sectors of the economy, and this is also true of the public sector.

It is therefore inevitable that cuts to public sector spending produce a depressing effect on private sector output. And the reverse would be true, increasing public sector output would require increase activity from the private sector too. This would create employment and generate increased taxes (as well as reducing welfare payments as employment rises).

But how to fund the increased government spending? This table below (click to enlarge) is reproduced from the European Commission's QUEST model of the European economies.

In the two columns shown there are revenue and expenditure multipliers for selected European countries. The first column shows what happens if a weighted average of tax cuts were made to labour, profits' and VAT taxes equivalent to 1% of GDP. The second column shows what happens when government spending is increased by 1% of GDP. It is important to stress that in both cases the measures are off-set by increases in taxes after 3 years so that the deficit an debt levels are otherwise unchanged.

I terms of the effects of these different measures, the assessment of the tax reductions is underwhelming. There is not much of a response. But the response from increased government spending is significant, an increase in Ireland's case of 0.4% of GDP.

This is despite the fact that the QUEST model includes 'crowdng out' effects, where increased government spending is supposed to push up borrowing costs and canny consumers, 'knowing' that the the boost to government spending will be followed by higher taxes will educe their own spending in advance of that. Frankly this nonsense should just be ignored. On the first, Irish real yields have soared as spending was cut, while those that stimulated their economies in 2009 have seen real yields fall dramatically. On the second issue of consumer behaviour, spending has had precisely the opposite pattern. When taxes were cut and spending increased during the boom, consumers increased their own spending and then cut it when their incomes and jobs were cut, oddly enough. Finally, the issue of corporate behaviour is not at all addressed by the model, but they entirely misdirected investment during the boom towards speculative activity and have been on an investment strike during the slump. Increased government spending would oblige that investment strike to be broken.

Even so, despite all these shortcomings which understate the real position, the model highlights an important fact. It is is possible to have a revenue-neutral increase in government spending, which will boost activity in other sectors, and create jobs, thereby raising tax revenues and lowering welfare outlays.

Sunday, 26 September 2010

Reading the fine print in export figures

Michael Taft: There was some cheer when the goods export figures were released on Friday. The Irish Times’ was positively bullish: ‘Strong growth in exports signals continuing recovery’.

But, like a contract that reads too good to be true, it is always helpful to read the fine print or, in the case of goods exports, the detailed tables.

On the surface, it certainly does look positive. The value of exports rose, from a low in December last year, by €1.85 billion, or nearly 32 percent up to June this year. This, along with service exports, is what is driving our GDP (even in the recent 2nd quarterly National Accounts, which saw a seasonable dip in real GDP, total exports rose by 7.6 percent over the 1st quarter).

There is a problem, however. This export growth is completely lop-sided. Exports from the Chemical sector made up 88.7 percent of the net increase. The value of exports rose, from December to June by:

Chemicals / Pharmaceuticals: 58.2 percent
All Sectors excluding Chem/Pharm: 6.9 percent

Our manufacturing exports – and, so, our GDP - is being driven largely by one sector only.

This may not be a problem (and there’s always a problem in over-relying on one sector for growth) given that other indicators are impacted positively, namely employment. If history is any guide, however, the impact will be negligible.

Between 2000 and 2007, Chem/Pharm exports increased by nearly €16 billion, or nearly 60 percent. However, employment remained static, rising by just 300. While there might be some short-term bump from increased Chem/Pharm exports, in the medium-term we shouldn’t expect a significant job increase in this capital-intensive sector.

Again, this might not be a problem if there was a strong linkage between increased production and exports, and domestic firms sourcing into the sector. As production is ramped up to meet new export orders, the Chem/Pharm sector will be purchasing more goods, or inputs, to create their products.

The problem is that there is almost no linkage between the Chem/Pharm sector and the rest of the economy. 85 percent of inputs in the Chem/Pharm sector are imported. In other words, increased exports may create jobs downstream – but in other countries, not in Ireland.

We should be grateful that exports sectors are growing (better than contracting). But we should also be mindful of the details, the sectors and the larger economic impact. Even the Department of Finance has accepted that GDP driven by net export growth will not be tax-rich. If it is located in capital-intensive sectors which import most of their inputs, it won’t be job-rich either.

But there’s one more brain-twister. If the composition of the current export growth will have only a limited impact on the economy, we still have to ask: to what extent is even that growth real or fictional?

I’ll follow up that question in the next post.

Friday, 24 September 2010

The view from Frankfurt

"A shrinking economy prompts renewed misgivings". That's the headline over an article in the conservative Frankfurter Allgemeine Zeitung, which goes on to note that:

"In financial terms, Ireland has its back to the wall. Not only is it attempting to cope with the massive structural deficits caused by an unchecked property crisis. Like Greece, Ireland is having trouble dealing with the mountains of debt amassed by major banks [...]. Drastic spending cuts are throttling the domestic economy and, in the worst-case scenario, may result in a deflationary spiral". For German speakers, the full article is available here.

Thursday, 23 September 2010

Q2 GDP - The Irish Depression

Michael Burke: The Q2 GDP data published today do little to alleviate the gloom surrounding economic prospects. Both measure of output contracted in the quarter, GDP by 1.2% and GNP by 0.3%, in real seasonally adjusted terms. GDP has now contracted in 11 of the last 14 quarters, while GNP has contracted for 9 consecutive quarters, that is, the domestic economy has begun its third straight year of contraction. This compares to an Euro Area average contraction of 'only' 4 quarters, which ended a year ago.

The scale of the decline is also well above that in the Euro Area, where the economy contracted by 4.4%. From its peak in 2007, this GDP has contracted by 13.4% in real terms while GNP has fallen by a staggering 17.3%. Worse, in nominal terms GDP has declined by 19.5% and GNP by 24.1%. This measure, GNP at current prices, is decisive with regards to taxation revenues, whose slump is the overwhelming source of the widening public sector deficit. Taxes are paid in cash terms, unreflective of real terms changes in the price level.

As has been pointed out previously, this deflationary economic trend, which seems to be welcomed by many commentators, is actually disastrous for government finances because it erodes the current level of taxation while the debt stock is unchanged. The debt burden, and the activity required to service interest on it, is rising in real terms. Depending on which measure of output is used, the price level has fallen by between 5% and 9% since 2008. Since virtually all taxes derive from the domestic sector, the decisive measure of deflation for these purposes relates to GNP, where prices have fallen 9.2% since the end of 2008. In the US, many commentators fret that that a hollowed banking system and low growth could lead it into a Japan-style lost generation of deflation and rising real debt levels. For this economy that threat is a current one.

In terms of the components of growth, personal consumption fell again in Q2, down 1.6% from the same period a year ago. This repeats a pattern seen in 2009, as the government's attack on welfare and public sector pay feeds directly into lower consumer demand. Government spending on its own account also continues to detract from growth, a real decline of €2.5bn since austerity policies were introduced. Net exports subtracted from growth in the quarter, hence the greater decline in GDP than in GNP, as import demand rose.

It is possible that this rise in imports is partly associated with the modest rebound in investment (gross fixed capital formation) in the quarter, at an annualised rise €2.4bn, which was the one bright spot in the report. However, the rise in imports was than double the rise in investment and, since all other components fell, personal and government consumption as well as inventories, it is more likely that the rise in imports was due to an autonomous rise in the activities of multi-national corporations and their accounting practises.

These universal falls in demand, and modest export growth in the quarter, suggest that the investment uptick has little to sustain it. Even now, investment remains 52% below its peak level. The decline in investment has driven the recession, beginning 3 quarters earlier which is now €27.4bn below its peak, compared to declines of €27.6bn and €22.8bn for GNP and GDP respectively. This remains an investment recession.

Until policymakers recognise that fact, and that government investment must rise to off-set that decline, the effects of this Irish Depression will persist.

Irish Inequality during the 20th century

Rory O'Farrell: There has been some discussion on this site about top income shares in the US. Thanks to a book, Top Incomes over the 20th Century, edited by Atkinson and Piketty (and the chapter referring specifically to Ireland by Brian Nolan), this data is available for Ireland.

The first figure shows wage shares for the top 0.1 per cent income shares. So back in 1913 for the UK, the top 1,000th of the population had about 11% of the income (or 110 times more than if everything was shared equally).

Irish data ends in 1990, but not to worry. The second figure shows income shares for the top 1 per cent for as recently as the year 2000. At the turn of the millennium, in Ireland the income share of the top 1 per cent was 10 times greater than if income was shared equally.

Both graphs show a similar pattern (though more pronounced for the top 0.1 per cent). There has been much analysis done on these patterns (in particular by Atkinson and Piketty, but also by other authors) and the general findings are as follows:

• Inequality decreased in most countries from 1914 to 1945 due to the turmoil of World Wars and the great depression. The greatest effects tend to be in countries hardest hit by World Wars.
• Inequality was kept low by progressive taxation and inheritance tax. The important role of inheritance tax is shown that Germany inequality was quite high (inheritance tax was low there), allowing capital to concentrate over generations. Also in France and the US the importance of capital income in top shares declined (despite a stable share of capital income). This was due to less concentrated capital holdings.
• English speaking countries have shown an increase in inequality since the 1990s, but continental European countries have been relatively stable.

We see the crucial role of inheritance tax. After the 1980s this was reduced in the US, so concentrations of capital ownership will probably increase over time. We can also hypothesise over whether high inequality leads to banking crises (like 1929 and 2008), and the role of equality during the ‘economic miracles’ after the Second World War.

Looking at the evidence, there are some interesting policy implications for Ireland. If we wish to reduce inequality over the long term we need long term solutions. An increased inheritance tax has the long run effect of breaking up inherited wealth concentrations. This means that control of resources will be decided more on merit and less on whose someones parents are. This will allow for a better funcioning economy. Also, if labour taxes reduce work, or capital taxes reduce investment, we need not worry too much that inheritance taxes will reduce our death rate.

Also, what was the cause of the Irish post-war decrease in inequality? Perhaps those with an interest in history can make some suggestions.

Invest, tax and restore spending cuts: Challenging the deflationary orthodoxy

Michael Taft: Previous posts by Paul Sweeney and Sinéad Pentony refer to articles from two newspapers which occupy different ideological zones. Yet they point to similar conclusions that TASC bloggers have been discussing for some time – the failure of the Government’s deflationary policies. Even the ESRI found these policies would fail to repair public finances or prevent the debt from spiralling out of control. That said, what are the fiscal principles that progressives can unite around in the run-up to the budget – principles which would have the capacity to unite the broadest alliance for an alternative strategy?

I would propose five principles. The first two are general.

First, when in a hole, stop digging. Public spending cuts and tax increases on low-average income earners are not part of the solution; they are part of the problem.

Second, repairing the public finances is dependent on repairing the economy and, in particular, reversing the rise in unemployment. We can learn a lot from Keynes’ dictum – ‘look after unemployment, and the budget will look after itself.’ Grow the economy, shrink the deficit.

The next three are particular to the upcoming budget.

Third, investment, investment, investment. Through investment we can repair the major infrastructural, social and enterprise deficits in our economy – succinctly listed in the TASC open letter: physical infrastructure, public services, poverty and low incomes, defects in our indigenous enterprise base and carbon-heavy economic activity. Repairing these defects is not a cost – it is an investment which will return higher growth, productivity, incomes and, most importantly, employment.

Fourth, as the G-20 put it, implement growth-friendly fiscal consolidation. What does that mean? The ESRI has published two papers in the last year that puts the answer beyond dispute – taxation. Increasing taxation is less deflationary and, therefore, yields higher Exchequer savings than spending cuts. In the long-term, taxation will have to increase throughout the economy but for this year, at least, increased taxation must impact primarily on high-income groups – which will have even less deflationary impact than what the ESRI has measured.

Fifth, save, reinvest and remove the deflation from the economy. Where efficiency savings are made in public spending, where savings are made in reduced unemployment costs – take this money and start restoring deflationary public spending cuts. We can’t repair all the damage in one budget but we can make a start. I would prioritise reversing social welfare cuts, health and education cuts, and wage cuts to low-paid public sector workers. Remember: deflation depresses future growth. Therefore, taking the deflation out of the economy will liberate economic growth.

These five principles will not be easy to implement. The Government has painted us in a right corner. For instance, borrowing for investment purposes would normally not be contentious. But their fiscal and banking policies have made a mess of our debt profile in the international markets. Therefore, we will have to look to our cash and assets on hand which the ESRI estimates will amount to over €48 billion next year (or nearly 30 percent of our GDP – significantly higher than other EU countries). In addition, the Government has cut over €6 billion from current spending – that can’t all be restored. Scarce resources meeting high demand will mean some cuts will have to wait to be restored.

But already some organisations are starting to make the running. For instance, the Community Platform’s 4Steps2Recovery campaign – envisaging up to €3 billion in tax increases on the high income and wealth groups - is an excellent example of growth-friendly fiscal consolidation.

Identifying the key short-term investment priorities, drawing up a progressive taxation schedule, ascertaining real savings and productivity increases – and modelling all this to show beyond a doubt that an expansionary fiscal programme is superior to what the Government has been doing: this is the work that must be conducted in the next few weeks. Yes, there will be disagreements over details, priorities, programmes – but if we start from the same principles, those disagreements can be resolved.

The sooner we start, the sooner we can rescue the debate from the cul de sac it has found itself in.

Wednesday, 22 September 2010

... and more from abroad

Paul Sweeney:The penny is dropping with a crash on the failure of the Government’s deflationary policies – everywhere but in Ireland. Today’s Financial Times main editorial on Ireland sounds like some of the TASC bloggers. It urges the government to cut the ground from the banks' bondholders and to cease its obsession with cutting public spending - “a course that anyway might further harm a growth path that looks set to lag the government’s own projections”.

This comment is in stark contrast, for example to Morning Ireland on RTE which yesterday gave a free ride to a representative of Davy stockbrokers, who was allowed to deliver a real TINA speech - there is no alternative to even more cuts, without any hard questioning or alternative views. Morning Ireland did not point out that Davys is a primary dealer of government debt. Such companies makes millions from buying and selling Irish Government debt. They make a two-way market on Irish bonds and are also market makers in Irish bonds.

This morning, Morning Ireland gave Goodbodys a free ride, but the contribution was less partisan. Goodbodys is not a primary dealer of government debt.

Given the lopsided media debate, it is as well the Financial Times is selling well in Ireland. The Guardian also carried a similar piece on Ireland today, as pointed out by Sinéad Pentony here.

Irish laments

Sinéad Pentony: Today’s editorial in The Guardian highlights the dangers for the UK in pursuing Ireland’s policy of austerity measures. As we head into what is being clearly flagged as our fourth austerity budget, the contraction in the economy caused by the financial and economic crises, and exacerbated by Government policy, has succeed in shrinking the economy to the point where there are growing concerns about the capacity of the economy to sustain the costs associated with bailing out the banks. This was reflected in the cost of borrowing reaching a new (and unsustainable) high in the bond auction earlier this week. When you couple this with the latest unemployment figures, acceleration in migration and a lifeless domestic economy - the impact of government policy, which is protecting the banks and the bondholders at the expense of the country and the economy’s capacity to recover, is painfully clear.

Monday, 20 September 2010

Lessons from abroad

Michael Burke: There is an imminent danger with regard to government finances. The government and its supporters have repeatedly argued that their policy would have the following effects:- revive growth, correct government finances, bring down borrowing costs and prevent a disaster such as being excluded from financial markets like Greece/the IMF being called in.

In turn, each of the negative consequences they have warned of has come to pass, as a consequences of their policies. GNP growth (the bit that policy, not world trade, directly influences) continues to contract. Government finances continue to deteriorate. Borrowing costs continue to soar, so much that there is genuine concern about NTMA's forthcoming bond auction.

In a previous post, Michael Taft used the analogy of the Titanic heading for the iceberg . The government can see the iceberg, like the rest of us and its response? Full steam ahead....stoke the boilers with another €3bn. Mr Honohan says it should be more, as if concerned the iceberg should slip out of our course before we reach it.

What would be the result if the engines were thrown into reverse: instead of cuts there was increased spending? How would the economy, government finances and international markets look then? European experience might be useful.

One thing economies do have in common with large ships is that that they take time to respond to changes in direction. In particular, on the whole taxation revenues are a lagging indicator of activity- they are paid after the event, sometimes a long time afterwards. But we know that in Europe, or more accurately the Euro Area most governments increased their spending in response to the recession (many also increased their minimum wage too, just like the older textbooks said they should). The fruits of that policy can be seen in the 2nd half of last year and this.

Take the case of Spain. It had a sizeable fiscal stimulus in 2009 equivalent to 2.3% of GDP. This ECB publication details the bailouts in the EU. This was before it was strong-armed by the EU, the financial markets, the ratings agencies and the banking interests these both represent into cutting public spending. A very modest improvement in the economy has since taken place, but this contrasts with Ireland's continued contraction in GNP. Spain's central government deficit has almost halved in the first 7 months of this year as tax revenues have rebounded sharply. Because of this improvement, bond yields are falling in Spain even while they are rising here. 10yr yields in Spain are now more than 2% low than Irish yields having been the same earlier in the year, half that change having taken place in the last 4 weeks. Bond investors respond to those tax and deficit data.

Or France, where the stimulus was equivalent to 1% of GDP and the growth rebound has been more robust (partly because the measures have not yet been undone, as they have in Spain). The budget deficit is ¤100bn lower in the first 7 months of this year than last, a decline of 22.8%. And of course, yields are less than half of Irish yields.

Germany is the same, a fiscal stimulus of 1.4% of GDP and record growth in Q2. The Federal structure means that the time la for the improvement in government finances will be greater- both the spending was delayed as much of it devolved to regional Laender and the tax revenues will also be delayed. In any event the deficit is on course to widen to just 3.5% of GDP this year.

The same pattern is true all across those Euro Area economies where government spending was increased (as well as being the case in the US and Britain; the deficit is lower as a result of increased spending).

Now, whenever there is an attempt to draw lessons from international experience, the cry goes up that 'N is not Ireland'. Well of, course. Every concrete situation is a unique combination of general circumstances. Not two phenomenon are exactly alike- otherwise they would not be separate phenomenon. The objection usually boils down to two points. First is the issue of 'leakage', this economy's propensity to import. This has already been dealt with elsewhere, and 90% of Ireland's imports are inputs for production, and the value created from that is what accounts for its wealth-creation, including overwhelmingly its exports. The other objection as that Ireland's position in the markets is a function of its uniquely large bank bailout.

But this does not explain its unique status as remaining in (domestic) recession nor the fact that tax revenues continues to contract. The fact is, the bank bailout, which is a millstone, is not much correlated to yields either, since Greece had no bank bailout to speak of and Belgium- which had the next biggest bank bailout- has not come under any market pressure at all. Instead, it is the disastrous impact of fiscal policy on the economy and the effect that this has had on government finances which is the driving force behind the ongoing risis in Ireland.

It is indeed time to reverse course.

Debating on the Titanic

Michael Taft: The confusion between fiscal contraction (i.e. public spending cuts) and reducing the fiscal deficit continues apace. On Morning Ireland, Caoimhghín Ó Caoláin, Sinn Féin’s Dáil leader was being interviewed on the budgetary options facing the Government. The very first question began like this:

RTE: ‘We know the Government is going to cut the deficit this year by around €3 billion ... some doubt about whether it will be a little more than that . . . ‘

This encapsulates all that is wrong with the debate over fiscal policy. For the Government is not seeking to reduce borrowing or the fiscal deficit by this amount or anything like it.

Leaving aside the impact of bank bail-outs – which should be treated as an ‘extra-ordinary’ (with special emphasis on ‘extra-ordinary’) – the Government estimates that net borrowing of central government will be:

2009: - €16,857 million
2010: - €17,346 million
2011: - €16,831 million

At best, if the Government hits its budgetary targets, central government borrowing will fall by €515 million – not €3 billion.

When we turn to the General Government Deficit (the instrument used to measure Maastricht compliance) we find the deficit falling from -€18,720 million to -€17,030. This is a fall of nearly €1.7 billion. Why the discrepancy then with the above figures? And doesn’t this show the Government is at least making some progress? Answer to the second question – no. Let’s answer the first.

The discrepancy is due to the treatment of the deficit in the Social Insurance Fund. In 2010, the Government expects the Fund to be in deficit by nearly €1.2 billion. This is factored into the General Government Deficit. In 2011, the Government expects the Fund to be in surplus again – largely because those on Jobseekers’ Benefit will have exhausted their benefit (they receive it for only nine months).

When we remove the Fund deficit, we find the difference to be approximately €500 million – the same as the Central Government borrowing.

Let’s cut to the chase: if cutting public spending resulted in an equivalent cut in the fiscal deficit we wouldn’t be having a public finance crisis. The Government has already cut nearly €9 billion from public spending. They intend to cut €2 billion plus in the next budget. If all these cuts equalled cuts in fiscal deficit, we wouldn’t be having these discussions about public finances – we’d be in clover.

The ESRI has already assessed the Government’s fiscal strategy and found it incapable of either repairing public finances (at least in this decade) or preventing the debt from spiralling out of control.

Debating a future of public spending cuts is like holding a debate on the decks of the Titanic. Equating public spending cuts with cuts in the fiscal deficit will do nothing to change the course of the ship or melt the iceberg waiting for us. There is only one option – change the captain and, for goodness sake, turn the wheel.

Thursday, 16 September 2010

The bearable lightness of taxation

Michael Taft: In the run-up to the budget we will hear a lot about the ‘dangers of high taxation’. This will be used to justify a programme of spending cuts. Because, as everyone knows, high taxation stymies growth, job-creation and entrepreneurial élan.

No doubt we should be cautious about increasing taxation on low and average income earners next year. Average weekly incomes have fallen by 5 percent over the last two years; the new and increased levies represented a deflationary burden; for families, the cuts in Child Benefit and Early Childcare Supplement hit hard; mortgage owners will be facing interest increases over the next six to twelve months; while employers are demanding a long-term pay freeze which is tantamount to real pay cuts for the years ahead. Scatter-gun tax increases could provoke a new deflationary spiral.

But to the larger question – does ‘high taxation’ burden the economy? Let’s look at some evidence from the early to mid 1990s, when the Irish economy moved into strong numbers.

Between 1992 and 1997 the standard rate of tax remained at 27 percent, while the higher rate of tax was 48 percent. This compares to 20 percent and 41 percent today respectively.

Capital Gains tax was levied at 40 percent.

Corporation tax was levied at 40 percent, primarily for domestic enterprises (multi-nationals had enjoyed much lower tax rates for over a decade). This started falling after the corporate tax rate consolidation but in 1997 the corporate tax rate was still 36 percent.

Surely, this must have had a sluggish effect on the economy? Well, no. GDP growth during this period averaged nearly 7 percent while GNP growth averaged over 6 percent. Not much burden there.

Job creation wasn’t all that affected, either. Employment levels rose by over 18 percent – or an annual average of 3.5 percent. If we managed that trick over the next five years, we’d return to near full employment. Indeed, during this period the economy was still shedding agricultural jobs. The non-agricultural job increase was even higher – nearly 23 percent, or over 4.5 percent average annual growth rate.

What about profits? We get a lot of flak from spokespersons for ISME and the Small Firms Association about high taxation. Could you imagine what they were saying back then when the corporate tax rate was over three times what it is today? Still, it didn’t seem to hurt profitability. Over this period, profits more than doubled while tax receipts increased by even a faster rate – nearly 130 percent.

It could be argued that this profit increase mostly represents multi-nationals who had low-tax rates for a long time (the Export Sales Relief practically exempted most from tax). However, if we look at the distribution of profits in the Revenue tables we see a similar trend between large and small/medium enterprises. Unfortunately, detailed Revenue tables only allow us to examine the period 1995/6 to 1997/8 but these two years are instructive.

• Companies with adjusted profits above €1 million (where we would find most multi-nationals) saw their profits rise by 37 percent
• Companies with adjusted profits below €1 million (where most domestic companies would be found) experienced a profit rise of 31 percent

Even with a 40 percent tax ‘burden’ on domestic companies – profitability rose substantially.

What about capital gains? Those investors playing the market with a big 40 percent anchor tied to their speculative hips? Didn’t seem to harm tax revenue. Like corporate tax revenue, it increased by 130 percent over the five year period, suggesting a similar increase in actual capital gains.

So, ‘high taxes’ and high growth rate, strong employment growth, increasing profitability and capital gains; never mind rising wages, consumer spending and Government expenditure (a huge jump of 42 percent and, even so, debt was reduced by 30 percent of GNP); I’m not suggesting a cause-and-effect. But that works both ways. Substantially higher tax levels than exist today were no bar to building strong growth and prosperity.

If we can get rid of the ‘low-tax’ fetishism that dominates the current debate, then we might just be able to find a way out of this mess we find ourselves mired in.

Tuesday, 14 September 2010

Community Platform proposals on taxation

Tom O'Connor spoke at yesterday's launch of the Community Platform's proposals for progressive tax reform, 4 Steps 2 Recovery. Below is his response to the proposals.

• The government’s fiscal plan has failed. The exchequer figures in August misled the public: there was an Exchequer balance in Aug of €12 billion, actually almost 1 billion more than Aug 2009 if we subtract Anglo and NPRF from the 09 figures. These don’t occur in 2010. Comparing like with like, the Exchequer deficit has widened by almost €1 billion
• The EB at the end of 2010 - and there is no Anglo or NPRF spending - will be €22 billion. The corresponding figure (without Anglo and NPRF) for last year was €18 billion. We are €4 billion worse off after the cuts.
• So, after €4 billion in cuts, €3 billion in current and €1 billion in capital for this year and all the hardship, we will finish up €4 billion worse off than last year.
• Cuts don’t work
• We are spending over €3 billion in social welfare spending due mainly to increased unemployment due to the deflation of the economy. We will finish this year with taxes €2 billion less than the end of 2009.
• Taxes at the end of this year will be €17 billion less than they were at the end of 2007

• The government is deflating the economy. It has driven up unemployment to 466,000. Correspondingly, it has driven down taxes and driven up the deficit as a result. It’s shaving of €3-4 billion a year is causing immense hardship and spiralling the economy downwards, while being eaten up by lower taxes and increased social welfare payments of €3 billion this year.
• The proposals by the Community Platform will help the economy to recover in 2011
• The €3 billion in tax increases will prevent further cuts in current and capital spending, which will help job creation and will stem job losses.
• It will prevent workers earning under €20,000 from entering the tax net, which would create a surge in to the black economy. If this is allowed to happen, then poverty and unemployment traps will be created whereby it would become more expensive to go to work. Taxing the very low paid will ultimately trap them on the dole, increase unemployment and increase the cost to the state of welfare payments. These proposals would prevent this happening.
• In addition, it would be thoroughly inequitable to have these low paid workers enter the tax net, given that we know 3,800 people earning over €100,000 are getting away with paying no taxes (Irish Times Sept 2010)
• The scale of tax avoidance in this country has been a big factor in not allowing Irish governments to build up cash reserves in the good times to allow it to cushion the effect of the current recession: From 1999-2005, the government squandered €11 billion of taxpayers’ money on tax breaks to the rich and wealth (Goodbody’s and Indecon 2006)
• The fact that up to €11 billion of these tax expenditures are still in the system (Commission on Taxation) means that the government is engaging in cutbacks in current and capital spending which have been deflating the economy, dramatically curtailing the tax take and creating huge levels of unemployment.
• These proposals will start a process that will halt unemployment escalation.
• Also, these proposals will address the inequities in the tax system: It will start four year programme of taking €5 billion a year back of the 11 billion in tax breaks, giving the government €1.5 billion extra revenue a year. This will go some way to preventing the cuts that have driven up unemployment and the exchequer deficit.
• It will introduce a tax on property (over €1 million value of property, €100k in income) and wealth as there is in France, Norway and Switzerland. This will have the twin benefits of restoring equity in to the system, while at the same time preventing cutbacks. This will, in turn, help the economy to recover.
• The extension of PRSI and income levies to all income, regardless of source will have the same affect. The abolition of the PRSI ceiling has been something that has been suggested for many years.
• The compliant taxpayers in this country have abhorred the ability of the super rich to avoid tax. The extension to levy tax on citizenship will gather in hundreds if not thousands of extra millions in tax revenue. It will also inspire hope in normal compliant earners that at last everybody will pay their fair share.
• Ruairi Quinn suggested at the launch of the report that non-resident Irish citizens would be expected to obtain a tax clearance certificate before getting an Irish passport. The Community Platform accepted this suggestion.
• The tax increases will only hit a relatively small number of income and wealth holders. As such, these tax increases will not have a negative effect on the economy. In fact, they will allow the preservation of jobs funded by the state in badly needed areas such as community care, disability care, education, primary care and other vital areas. In addition, it will allow capital spending not to be cut by at least €1 billion, which will allow infrastructure projects to go ahead which will increase employment.
• An end to spending cuts this year on the back of these proposals will be a huge psychological and economic benefit to hard pressed Irish people. It will increase consumer confidence and likely increase spending. It will start to renew the economy, and people will breed a sigh of relief that fairness has at last started to shine through. It will prevent savage cuts to programmes for disabled people, children and will prevent any further cuts in welfare payments. It will allow the most marginalised to retain what dignity they have left.
• I strongly recommend these proposals.

Monday, 13 September 2010

A case study in manipulation

Paul Sweeney: This superb, well researched article in the New Yorker by Jane Mayer is a must read for anyone interested in how world politics are being manipulated by the super rich.

Two of the wealthiest men in the world - septuagenarian brothers Charles and David Koch - are spending tens of millions funding far-right think tanks and lobbyists. They set up the the influential right wing Cato Institute think-tank in 1977, and are behind many other nfluential groupings in the US.

They are behind the Institute for Justice, which files lawsuits opposing state and federal regulations; the Institute for Humane Studies, which underwrites libertarian academics; and the Bill of Rights Institute, which promotes a conservative slant on the US Constitution and Citizens for a Sound Economy

They gave millions to established the Mecantus Center. The Wall Street Journal has called the Mercatus Center “the most important think tank you’ve never heard of,” and noted that fourteen of the twenty-three regulations that President George W. Bush placed on a “hit list” had been suggested first by Mercatus scholars, Mayer says.

Democrat Rob Stein says of Mercatus that “It’s ground zero for deregulation policy in Washington.” It holds that “grant-makers should use think tanks and political-action groups to convert intellectual raw materials into policy “products.”

Mayer says “The Kochs are longtime libertarians who believe in drastically lower personal and corporate taxes, minimal social services for the needy, and much less oversight of industry—especially environmental regulation.” Ironically, their vast wealth originated in Stalin’s Russia. Their father started his fortune when he set up oil refineries in the Soviet Union in the 1930s. He married another Mary Robinson.

Americans for Prosperity Foundation — an organization that David Koch started in 2004 - has worked closely with the Tea Party since the movement’s inception. Indeed they funded the Tea Party too. Big fans of economist Fred Von Hayek, they are “at the epicenter of the anti Obama movement” and “are out to destroy progressivism.” David Koch says he realised that “big government was bad, and imposition of government controls on our lives and economic fortunes was not good.”

Charles Koch’s approached to both business and politics has the deliberation of an engineer. “To bring about social change, requires “a strategy” that is vertically and horizontally integrated,” spanning “from idea creation to policy development to education to grassroots organizations to lobbying to litigation to political action.” The project, he admitted, was extremely ambitious. “We have a radical philosophy,” he admitted.

You can read the company's own view here. One of the Koch subsidiaries is Georgia Pacific, the huge forest company which has a manufacturing subsidiary in Ireland, making Kittensoft toilet paper and more.

The company is very active in its anti government anti- environmental and anti progressive policy influencing. In its corporate “Perspectives” only a few weeks ago, it had an article by Michael Hofmann, Koch’s Chief Risk Officer, arguing against economic stimulation and for austerity. Hofmann was fulsome in his praise for the Irish Government’s “painful” programme of austerity.

It is perhaps naïve to believe that this is the extent of the influence of Koch Industries on the Irish Government and its Depts of Finance and Enterprise, Trade and Innovation and on our policy makers.

Leakage, and hot air

Michael Burke: One of the main objections to the government adopting measures to boost the economy is the concept, or more accurately the notion, of 'leakage'. That is, the mantra goes, we are a small open economy and if the government boosts activity it will all leak abroad via imports.

This objection would be simply ridiculous, if the outcome weren't so serious. That's because it completely misunderstands some of the most fundamental processes in this (or any other economy). Of these, the most important to note here is that the division of labour increases productivity. For all but the very largest economies this means participation in the international division of labour. When there is a high level of participation in the globl economy (international division of labour), such as there is here, imports are primarily used as inputs in production, not consumption. Furthermore, most of that producion is for re-export, whose value significantly exceeds the value of all imports.

If, say, oil is imported that is counted as a debit in the national accounts even if it is only an input into the generation of electricity or production of glassware, production of transport services, etc. In the latest data the total use of imports in this economy was €112.8bn. But the final consumption of imports was just €23.4bn. The remainder were inputs for production and re-export.

The spreadsheet can be found here.

Yet no sensible person thinks that this should be halted. On the contrary, it needs to developed as this adding of value is the basis of any country’s prosperity. In particular it is the primary source of this economy's increased prosperity over several decades.

What opponents of measures to boost the economy seem to have in mind is the personal consumption of imports. Perhaps the belief is that the masses are chewing too much chorizo, or swilling too much chardonnay. But in the same year, personal consumption of imports was just €10.6bn, just 9.4% of the total import bill. It was also just 10.7% of total personal consumption of €98.7bn. The overwheliming bulk of personal consumption is of goods and servces produced here (mainly the latter).

These ratios are lower than in many countries which did adopt measures to boost growth. They in no way undermine the case for government action to revive the economy.

Gambling away our future

"[...] while politicians do not want to recognise the costly social problems that arise from “austerity”, they are already manifesting themselves in ghost estates and hospital AE units. Neither are the politicians debating the detrimental effects on our potential economic output from reduced investment in education and a structurally higher debt burden." You can read the full text of Michael O'Sullivan's opinion piece for today's Irish Times here. Earlier this year, Michael wrote a guest post for PE.

Friday, 10 September 2010

Seven Principles for Progressive Income Tax

Nat O'Connor: On an earlier post about indirect tax, I was asked to sketch out some principles about income tax.

Specifically, the questions were "how much income tax should everybody pay, and what proportion should that income tax be of the total tax intake? ... (a) at what point on the income scale should a person start paying tax, and at what rate and (b) at what point on the scale should the maximum rate kick in and at what rate ... So what do you propose in relation to entry level tax rates, and top tax rates?"

This is not meant to be a complete policy on income tax, as I'd need a lot more data (and time!) for that. But I am going to answer these questions in four parts. Firstly, I am going to set out some general principles for taxation. Secondly, I respond to the issue of people on high and low incomes not paying enough (or any) income tax. Thirdly, I am going to give some illustration of the effect of changing tax credits and bands. And then, finally, I am going to consider the question of how much tax someone should pay.

Part 1
Seven principles for taxation are that it should be stable, sustainable, adequate, progressive, efficient, transparent and responsive to economic, social and environmental externalities.

Stable – A stable tax system should be based on sources of revenue that do not fluctuate excessively as part of economic cycles. For example, this will require taxes on wealth, as well as income and consumption. Taxes on wealth (such as property tax) tend to be more stable during a recession. Property tax is common in many countries and is used to fund local government.

Sustainable – A sustainable tax is drawn from a source that will not become exhausted. Similarly, a sustainable tax system is not undermined by excessive tax expenditure.

Adequate –A country’s tax system must provide sufficient revenue to pay for the level of public services that people want, as well as other state liabilities, such as servicing the national debt.

Progressive – A progressive tax system is one where those who gain more from the economy (in terms of wealth and income) make a proportionately larger contribution. This should be the net effect across the whole tax system, not just income tax. Public services are one way of making the net benefit from the economy more progressive for people on lower incomes.

Efficient – Economically efficient tax is one which minimises economic distortion. The tax system should seek to encourage economic activity.

Transparent – All taxes, and to whom they apply, should be clear. In addition, all exemptions, tax relief, etc. should be transparent.

Responsive – The tax system also has role to play in influencing behaviour, by being responsive to market failure/externalities. Taxes can be used as policy tools to achieve economic, social and environmental goals. For example, carbon taxes discourage carbon-heavy activity such as burning of fossil fuels.

Note, sometimes these principles may be in tension. For example, responsiveness to externalities can conflict with progressivity, and hence something like carbon tax may need to be balanced with other measures, so that regressive effects do not occur which cost low income households disproportionately more of their income.

Part 2
In relation to income tax, the comment was made that "As things stand we have a very skewed tax take. The lower 50% of citizens pay no income tax, at the other end of the scale, neither do 4,000 individuals earning €100,000 +."

Sarah Carey claims that the facts about high earners not paying any tax are misunderstood, if not exaggerated. In particular, she refers to Section 23 of the Finance Act 2010, which increases the minimum rate of tax ('effective tax') from 20 per cent to 30 per cent that certain high earners must pay if they qualify for and use certain tax relief measures.

However, she misses the point that this only applies to "certain reliefs". Upon checking the relevant section (485C) in the latest Tax Consolidation Act guidance notes on Revenue's website, page 60, unrestricted reliefs (e.g. business expenses, other unnamed unrestricted reliefs) are always taken into account before restricted reliefs. Hence, there is some scope for someone to shrink their taxable income before the 30 per cent effective tax rate applies.

On the question of low paid people not paying income tax, the principle of progressivity requires the whole tax system to be progressive. So, there is not necessarily any problem with people on low incomes not paying income tax, if this compensates for the higher proportions of their incomes they pay in indirect taxation (like VAT), as I argue in the previous post. Also, as the worked examples below show, a single PAYE worker on €20,000 pays a small amount of income tax; so I don't think it can be true that 50 per cent of citizens pay no income tax, unless you are counting pensioners and people on social welfare. Certainly, most workers pay income tax; only those near the minimum wage do not.

However, the principle of adequacy requires that, if people want European levels of public services, then these have to be paid for. So, in order for the tax system to be adequate, everyone may need to pay more – although, in line with the principle of progressivity, those who benefit more from the economy should pay proportionately more.

Part 3
For reference, the current rates are 20 per cent on all income up to €36,400, and 41 per cent as the marginal rate. A single person gets €1,830 in personal tax credits. PAYE workers get an additional €1,830 (Citizens Information). For example, single PAYE workers on €20,000, €40,000, €60,000 and €80,000 would pay income tax as follows:

Obviously, this simplified example excludes income levy, PRSI, etc, as well as other possible tax credits or reliefs.

The Minister for Finance has announced Budget Day will be Tuesday 7 December. With all the talk of 'broadening the tax base', I guess that he will consider lowering tax credits and band thresholds, but not rates, in order to increase income tax on lower paid workers.

For example, if the single credit and PAYE credit were reduced to €1,500 each, our PAYE workers would now pay as follows:

Note, that this has the effect of tripling the proportion of the lowest income (€20,000) that is paid in income tax, while having proportionately less effect for those with higher incomes.

If the Minister instead chose to lower the marginal rate of 41 per cent to those earning over €33,000, a similar result would occur for those earning €40,000 or more, without increasingly the tax yield from those earning €20,000, as follows:

Obviously, this measure would generate less extra revenue overall. To maximise revenue, without raising rates, the Minister could combine both measures:

Now, all this is speculation, as I don't know what the Minister is going to propose. But I think it is worth pointing out the effects of changing credits and bands, as these kind of changes are often less obvious to people than rate changes, while they can have just as significant an effect.

Also, these examples give some facts and figures for illustration of the original question: how much income tax should people pay?

Part 4
I don't think increasing income tax is the best policy for Budget 2011, except maybe for those earning €100,000 plus. Instead, I'd prefer to see some kind of progressive system of property tax, as that would bring wealth into the equation as well as earned income. Since there are relatively few taxes on wealth in Ireland, that would be more progressive than simply increasing income tax.

In principle, in the medium term, as direct income tax (with higher marginal rates for higher earners) is more progressive than (flat rate) indirect tax, I'd prefer to see more tax on income and less VAT in the overall balance. Although, actually, I think any future increase on direct tax should be to address the low level of social insurance paid by employers and employees.

The last Budget unilaterly cut the amount of time people receive unemployment benefits for, as well as the amount paid, which shows how vulnerable the social insurance system is to political decisions. I'd prefer social insurance increases to income tax increases, alongside a more robust legal structure that gives people stronger guarantees about what level of benefit they receive when unemployed. In this context, I'd be quite happy to see much higher levels of unemployment benefit, which should be subject to income tax. But, as above, Budget 2011 is dealing with a jobs crisis, so it is not the time to increase social insurance, as to do so would increase labour costs and discourage job creation.

Income tax could be made more progressive. For example, Ireland is unusual in only having two bands (20 per cent and 41 per cent). There would be scope to have a third band, say 48 per cent, for incomes over €100,000. I would consider splitting up the existing bands too to have more bands with less difference between them. If the Government was to increase the standard rate of income tax, I think it would be important to increase personal credits, so that people on lower incomes are not made worse off.

Overall, I can't say what level income tax should be without access to a lot more data, namely costs for efficiently implementing West European standards of public services in Ireland, alongside data on the distribution of wealth and incomes. Such data would make it possible to calculate how much those services are going to cost (along with the banks and servicing the national debt). But we would be looking at moving towards Government tax revenue and expenditure at 45 per cent of GDP (which is still only average in Europe). The debt and banks may actually raise this much higher in the medium-term.

To conclude, I reiterate that everyone in Ireland pays tax – including indirect tax (VAT, excise, etc) – so I'll continue to dispute that only income tax counts when discussing 'broadening the taxbase'. As well as indirect taxes, new taxes on wealth (such as property tax) could have a significant role to play.

Ultimately, the taxation discussion should begin with what kind of public services people in Ireland really want. And when we can calculate the likely cost of these services, we can present people with a realistic tax model for how we can afford to pay for them.

It's at that point that democratic politics should provide people with real choice, depending on their preferences and how well or badly they'd do under each model. The conservative parties might continue to peddle low taxes, while they really mean returning public service spending to 35 per cent of GDP or less once the recession is over and the bank debt paid off. Progressive parties should be able to present a model of moving towards European norms at 45 per cent of GDP.

Wednesday, 8 September 2010

As Stiglitz says ....

"Mr Stiglitz said historical evidence showed that increased state spending helped economies emerge from recession. He added that the example of Ireland showed that austerity leads to declining output, rising unemployment and high bond spreads, instead of renewed investment". You can read the full report of Stiglitz's remarks in today's Daily Telegraph here.

Tuesday, 7 September 2010

Killing three birds with the one stone: education improves equality

Rory O'Farrell: While access to education is usually thought of in terms of equality of opportunity, it can also lead to equality of outcome.

The OECD has recently published data on educational attainment. Comparing this with OECD data on the Gini coefficient (probably the best way to measure inequality and present the income distribution into a single figure), we can gain an insight into how education affects inequality.

The above figure shows a clear downward relationship between the proportion of adults with a 3rd level degree and inequality before taxes and transfers, suggesting high education levels compress market incomes (the relationship is stronger when we only look at the male population). This could be due to a large supply of graduates helping to reduce the wage premium of education. Evidence from the US also shows how the increased supply of graduates can reduce the education wage premium (Card and Lemieux, 2001). This may be due to a spike in US college enrolment during the Vietnam War, in order to avoid the draft, was followed by a decline in the education wage premium (though it then recovered an inequality increased).

However, is it that equality leads to higher educational attainment? Comparing educational attainment and inequality after taxes and transfers show that there is no clear relationship, suggesting that the causation runs from education to equality [see note]. In the US due to inequality students will incur the expense of education (or some highly educated will migrate to the US) in order to gain the higher wages for college graduates. However in European countries, the benefit in terms of a wage premium would be lower, but the cost of education (to students/families) is also lower. Also, a more equal distribution of income before taxes boosts the social solidarity necessary for redistributive policies).

So what are the policy implications? Improving equality of opportunity is itself a worthy aim. However improving access to higher education (whether through free fees, grants, or improved primary and secondary education) can also boost equality of outcomes. So combined with promoting the smart economy, we can kill three birds with the one stone.
[note]: Card, D., and Lemieux, T., (2001). Can Falling Supply Explain the Rising Return to College for Younger Men? A Cohort-Based Analysis, The Quarterly Journal of Economics, 116(2): 705-746

Monday, 6 September 2010

Compare and contrast

Michael Burke: The yield on Irish 10-year government debt climbed to 5.7% by close of trading on Friday. This is shown in the chart here. This is back close to the high of 5.85% last seen before the multilateral €750bn bailout of European banks last seen in May. That bailout had the effect of temporarily pushing yields sharply lower- interest on Irish 10yr debt fell then by nearly a 1% as the immediate risk of debt default seemed to have been averted. The resurgence in interest rate costs implies the perceived risk of default has risen once more, back towards its peak.

The yield spread over Germany has widened to 350bps (or 3.5%). Other Euro Area borrowers who can still access the markets have also seen their yields rise and spreads widen; Italy (140bps over Germany), Spain (170bps), and Portugal (330bps). But none has quite the yield premium over Germany of Irish government debt. Only Greece, which cannot borrow in the market, has a higher 10yr yield premium (920bps).

These interest rates ultimately reflect the likely costs of sovereign borrowing in the market. As such, irrespective of any action by the credit ratigs' agencies, they are determined by the average market perception of the creditworthiness of the borrower.

A Wall Street Journal article earlier this year commending the government's austerity policies received much attention. It relied heavily on the fact that Spanish short-term yields were higher than Ireland's, although this is more an indicator of immediate default risk than ultimate creditworthiness. But Irish 2yr yields have since risen sharply and, despite a modest recent retreat, now stand at 3.25%. By comparison, 2yr yields in Spain are currently 2%. This indicates that both Ireland's creditworthiness is seen as lower and its risk of default is higher than that of Spain.

Supporters of the austerity policy have persistently claimed that there is no alternative; to do otherwise would cause yields to rise intolerably higher and increase the risk of being shut out of financial markets altogether. But it is the austerity policy, combined with repeated bank bailouts, that have created just such a situation. The policy has clearly failed, not least because tax revenues have not revived.

By contrast, in countries such as France, the budget deficit has fallen because tax receipts have revived by €60bn in the latest 3 months compared to a year ago. This reflects the prior stimulus measures the government had adopted. A similar pattern is evident in all the countries that adopted stimulus measures, as tax revenues have revived. In Germany, combined Laender and Federal tax revenues are up 2.1% in 2010 to data compared to the same months in 2009, which the Finance Ministry attributes to the prior government spending programme. Of course, all these government now have 10yr yields below 3% - fraction of Irish yields.

The mantra of the second-rate bookkeeper, that 'we can't afford a stimulus package' is the opposite of reality. The proof (negative in Ireland's case) arises from those countries that did adopt these measures; growth has resumed, taxes revived, yields lowered and the deficit has not widened with stimulus measures, it has narrowed.

IFSC shadow of its intended self

In an opinion piece for the Irish Times today, Jim Stewart concludes that "In the short term, changes in tax regimes raise issues for economies dependent on financial centres or low-tax regimes as a key component of economic strategy. But longer term, tax-haven type activities are unlikely to provide a basis for a diverse, skill-based economy. Such activities may attract an increasing share of resources in terms of talented individuals working on tax and regulation avoidance activities and in terms of State agencies and legislators ensuring tax and other legislation facilitates the operation of low-tax, low-regulation type activities. Such legislation may in turn unintentionally diffuse to the wider economy.

As a result of the economic and financial crisis, a new political economy is emerging within the EU. Competition for investment via low tax rates and light touch regulation may no longer be an option."
You can read Jim's full article here.

Friday, 3 September 2010

Guest post by Dr Pauline Conroy: Welfare for work

Pauline Conroy: The proposal that 10,000 unemployed people will be offered 19.5 hours of social or environmentally useful work a week is an answer to a question that few are asking. The question ought to be: how can the economy provide skills, further education, creative opportunities and decent employment for those the tens of thousands who are unemployed?

Instead, we are offered a solution to the question:
How can the government force ever growing numbers of unemployed people into a state of submission and subordination on the labour market?

The OECD has examined in detail Ireland's approach to and outcomes of labour market activation programmes (Working Paper No.75 8. January 2009). They note criticisms of Community Employment Schemes relating to limited impact on regular employment, limited training content and repeat participation. The OECD observed tha,t while Community Employment was supposed to be a training and stepping stone to regular employment, in fact it became a form of subsidised employment for those with 'reduced work capacity' and a form of funding of social services (page 103).

My own studies of some of the schemes found that they were recipients of large numbers of lone parents who had not been referred for skills training from which they might have benefitted, and people with disabilities who wanted part-time employment in a more sheltered environment than the open competitive labour market could provide.

The OECD recommends that, if creches are needed or maintenance of the local environment, these services should be purchased by local government at prices that reflect cost rather than the coincidental availability of Community Employment Schemes (page 136).

The suggestion that the unemployed should provide free labour is certainly likely to depress the lower levels of wages on the labour market. That pressure is already present.The minimum wage of less than €9 euros an hour is not obligatory in several regards. It is not obligatory for young people taking up their first job or for people with disabilities who have less perceived productivity compared with others. It is not obligatory in those instances where potential employees are asked to start out on probationary periods or internships.

Perversely, the Minister's proposal may actually displace existing volunteers who are not registered as unemployed.

The proposal to engage 10,000 unemployed should be scrutinised as to its specific objectives and whether these can be achieved in the current labour market context, consistent with such objectives as increasing the education and training levels of the population and providing decent work for all.
Dr Pauline Conroy is an independent social policy analyst

Irish economy at its most vulnerable

"The Irish economy is now more vulnerable than at any time since the crisis began. The process of rebuilding the economy has not even begun, while the public finances have not being stabilised, and neither is there any end in sight to the costs being generated by the banking crisis.

The mythologies and the revisionism that have been nurtured in Ireland in recent times are now being deconstructed by events.

The budgetary decisions and fiscal strategy have not been “courageous”; they have been wrong [...]"
You can read the rest of Professor Ray Kinsella's opinion piece in today's Irish Times here.

Thursday, 2 September 2010

Jim's equation

Michael Taft: ‘The bank is something more than men, I tell you. They breathe profits; they eat the interest on money. It's the monster. Men made it, but they can't control it.’

So wrote John Steinbeck in The Grapes of Wrath. It could easily be applied here (except for the profits part – but the Government is doing everything possible to get them back into the black with our money).

So how do we slay, or at least cripple, the biggest monster of them all – Anglo Irish? Jim Stewart has put forward an incredibly simple, practical and far-reaching proposal that can save the taxpayers’ billions (this was followed up by Brian Lucey).

In its Recovery Scenario the ESRI estimated that the bail-out of Anglo-Irish and Irish Nationwide would cost a combined €25 billion. We have moved on a bit, but let’s take the ESRI’s calculations as a proxy for Anglo alone (it will serve the purposes of this analysis). It will cost, when the bail-out is fully paid over, approximately €1.25 billion a year in interest payments.

But there is an additional, even more substantial, drain. The ESRI estimates that the banking crisis could contribute up to 15 to 20 percent of the permanent loss of output due to the recession. We won’t factor this in (partially because it will only be permanent if we persist with current policies) but the ESRI warns us that this indirect cost could be substantially higher than the direct costs in terms of lost revenue and higher unemployment costs.

Now, let’s take up what I call ‘Jim’s Equation’. Simply put, Jim argues that we should:

‘ . . negotiate with all bond holders and purchase bonds, not at face value but at some fraction of face value. Writing down the 2009 balance sheet value of Anglo Irish debt by 50% would reduce balance sheet liabilities by €8.7 billion. Writing debt down to 10% of face value (a generous value in the event of liquidation) would reduce balance sheet liabilities by €15.6 billion.’

Jim, along with Professor Louis Brennan, makes the same point in the Financial Times:

‘A more effective approach from the perspective of Ireland’s taxpayers and economy is to negotiate the purchase (at a fraction of face value) of the bonds from the reckless lenders that funded the banks’ foolishness.’

At the very minimum, what would this save the taxpayer? A write down between 50 and 90 percent would:

• Save between €435 million and €780 million per year on interest payments– not an insignificant sum.
• Reduce our debt/GDP ratio by between 4.3 and 7.6 percent

So, we make a real public expenditure savings and reduce our overall debt. Not a bad day’s work for a simple renegotiation.

But we can do so much more. What if we took the money saved through Jim’s Equation and reinvested it back into the economy. Spreading out the savings over five years, here is the result using the Lane-Benetrix multipliers.

If we were to discount 50 percent of the debt and redirected it to investment spread over five years, economic growth would climb – by up to €7 billion by 2015 (an increase of nearly 3.5 percent in nominal GDP). What’s more, tax revenue would increase by nearly €8 billion over the five year period – a significant return on the initial investment.

If we were to discount 90 percent of the debt and redirected it, economic growth would climb by over €12 billion by 2015 (an increase of nearly 6 percent nominally). And naturally, tax revenue would yield a greater amount over that 5 year period - €14 billion.

But the fiscal and economic benefits don’t stop there. Using the ESRI fiscal multipliers, we’d find that employment would increase:

• Under the 50 percent discount into investment, 32,000 jobs would be created, of which 20,000 would be potentially permanent.

• Under the 90 percent discount, 70,000 jobs could be created, of which 43,000 would be potentially permanent.

Then we have to count the savings from reduced unemployment costs (in 2010, the Government estimates that it pays out approximately €15,000 on average for each person in receipt of Jobseekers’ Benefit/Allowance.

And then there’s the supply side benefit – the economic benefit that persists long after the ‘building phase’ is completed. This can be measured as anything between 5 and 10 percent of the original outlay, depending on the particular project. But it can be better understood by looking at what we could have on our asset sheet:

• IBEC estimates the cost of installing Next Generation Broadband to be approximately €2.5 billion (for 90 percent business/household coverage). Imagine the productivity gains at enterprise level.

• Fine Gael has estimated the cost of fitting out a modern water, waste & sewage system to, again, be in the order of €2.5 billion. Imagine the annual savings to local authorities in reduced maintenance costs on our current Victorian-age system.

• Comhar estimates that for €4 billion, approximately 500,000 energy deficient buildings could be retrofitted. Imagine the savings on fossil-fuel consumption and the redirection of those savings into business investment and consumer spending.

And here’s the real knee-slapper: by adopting this approach, we’d bring the fiscal deficit into Maastricht compliance within a few years while substantially reducing our debt/GDP ratio. This is in contrast to the ESRI’s estimate that the current Government policy won’t be able to do that at all.

On any metric, writing down Anglo debt and redirecting into investment is win, win, won.

Of course, some will point out that we’d still have to borrow the money. But we can be comforted by the Central Bank Governor’s assurance that borrowing this money is ‘affordable and manageable’. Now, if it's ‘affordable and manageable’ to borrow money in order to burn it in Anglo’s balance sheet, then how much more ‘affordable and manageable’ would it be if we used that money for investment – with all those benefits mentioned above accruing to the economy and society.

And, yes, we’d still have to fork up billions for Anglo-Irish – there’s no escaping that. But using the ESRI’s baseline projections in its Recovery Scenario, we can measure the significant and long-lasting gains from this simple, yet far-reaching proposal in relation to Anglo-Irish debt.

We are stuck in a corner with little room for manoeuvre. The main benefit of ‘Jim’s Equation’ is that it gives us more space and more options – something we desperately need. Even if you don’t buy into all that investment lark, writing down Anglo-Irish debt will save us billions on the debt and hundreds of millions a year on interest payments at a minimum.

‘Jim’s Equation’ should be taught to every Government Minister, starting with the Minister for Finance.

Wednesday, 1 September 2010

'Pluck' and reckless banks

Paul Sweeney: Regular Progressive Economy blogger on Finance, Dr Jim Stewart, has a letter in today’s Financial Times - co-authored by his TCD colleague Prof Louis Brennan - on the Anglo Irish bailout.

Commenting on that newspaper's Editorial last Friday on the debacle that is the foolish and costly Government bailout of Anglo Irish Bank, they suggest “negotiating the purchase (at a fraction of face value) of the bonds from the reckless lenders that funded the banks’ foolishness.”

Another alternative, they suggest, is that “as proposed in a recent BIS document, is that debt instruments could be written off entirely.”

Stewart and Brennan rightly warn of the “inevitable self-serving noise from the usual suspects, continuing to indulge at any cost the lenders that engaged in wholesale recklessness is a luxury that Ireland’s taxpayers and economy can ill afford.”

Is it not time to call a halt to this disastrous Government decision and for it to negotiate, hard, with the “reckless” bondholders? Or are our leaders so incompetent that they multiple every error they make. At our immense and growing cost.