Friday, 15 October 2010

Impact of TASC Budget Proposals

Michael Burke: One of the strange features of the debate on the economy and government finances is that the consensus has solidified around further deep cuts in public spending even as the evidence mounts that this policy is wholly counter-productive. We are told repeatedly that it is impossible to invest our way to recovery because it would lead to a wider deficit, higher bond yields and even being shut out of the international markets altogether. Yet all this has come to pass while a fiscal contraction equivalent to 9.1% of GDP has been implemented. A further €4.5bn in cuts this year would bring this total fiscal contraction to approximately 12% of GDP.

Therefore the contribution from TASC to the 2011 Budget debate, Investing in Recovery, Jobs, Equality, is extremely welcome. Breaking entirely from the dominant misconceptions that spending cuts will restore either the economy or government finances, the proposals centre on tax increases for the wealthy and spending increases to boost jobs.

Tax increases for the wealthy are not simply about fairness, although it is monstrously unfair for PSRI contributions to be capped on salaries above €75,000 and not to be levied at all on unearnt income on financial and other assets. Personal consumption has fallen by nearly 11% and €10bn in real terms in the course of the recession. These income groups have the lowest propensity to consume of all, and the redistributive effect of higher, fairer taxes on the rich while boosting employment will be to increase overall demand in the economy.

Increased spending to maintain and create jobs would have a decisive effect on both economic activity and the Budget deficit. TASC proposes a €3bn Economic Recovery Fund, financed by funds from the NPRF. This would be an important contribution to addressing the real decline in investment during the recession, a fall of €22bn, down 49%.

'What would be the effect of such a policy? Thanks to Philip Lane on Irish Economy, who provides a link to an IMF paper, Will It Hurt? The Macroeconomic Effects of Fiscal Consolidation. Its author Daniel Leigh spoke at a TCD on October 14th. The Irish Times carries this report, which includes this important point, “The research also points to the negative effects of fiscal tightening being twice as large in the absence of monetary loosening (ie cuts in interest rates). It is twice as large again if fiscal tightening is taking place simultaneously elsewhere".

The charts below highlight those propositions, that the negative impact of public spending cuts is doubled when there is no ability to cuts interest rates simultaneously, and increased too by simultaneous fiscal tightening globally, as is currently the case. (Canada is chosen because of its openness).

Crucially, those two conditions apply to this economy currently, an inability to lower interest rates (in fact Irish market rates are rising) and the negative impact of simultaneous public spending cuts elsewhere. It can be seen from the charts that the response to a fiscal tightening equivalent to 1% of GDP lowers GDP by 2% in the first year alone. Cumulatively, the IMF research shows that over 5 years the lost output is approximately 6% of GDP.

Any shock which lowers output by 6% will of course negatively impact government finances, by far greater than the initial 1% ‘saving’. This is precisely what has happened- spending cuts have led to a wider deficit.

These responses tend to be symmetrical; the change induced is the same positively or negatively. So, to take TASC’s €3bn in investment, this IMF estimate suggests it would have a €6bn positive impact in the following year and provide a cumulative boost of approximately €18bn.

What then of government finances? This would need to be based on both parts of the public sector accounts, increased tax revenues from higher levels of activity and lower welfare payments as people are brought back into work and poverty declines. The DoF estimates that the sensitivity of public finances to changes in output is 0.6. So, government finances would improve by €3.6bn in the following year (€6bn X 0.6) and by €10.8bn cumulatively (€18bn X 0.6).

That’s a genuine deficit-reduction plan based on growth.


Paul Hunt said...

The brutal reality, Michael, is that Brussels is demanding, and will get, its 4-year fiscal adjustment programme. The hope - and that is all it is - is that the NTMA will be able to re-enter the sovereign bond market next spring. If it fails, it's hello, EFSF and IMF.

Michael Burke said...


Given that the direct response of austerity measures to date has been a collapse in private sector cosumption and investment, I'm unsure why anyone thinks matters will improve for the economy - or NTMA - this time.

While understanding the relish with which you greet the prospect of IMF/EFSF intervention (privatisation is very much on their agenda), the IMF experience doesn't offer much encouragement that the outturn will be different with their participation.

Here, in their own evaluation of their programmes, the IMF shows that (non-Eastern European) countries were expected to improve their budget balances by 2.3% of GDP on average, while the outturn was a worsening by 0.5%, because of lower growth. The shortfall accumulates over time.

I'm all in favour of a multi-year fiscal adjustment programme. I'd just like the fiscal adjustment to be a positive one.

Anonymous said...

The "austerity" that Michael keeps going on about doesn't exist.

Spending in Ireland actually looks like this.
2006 €58 billion
2007 €66 billion
2008 €73 billion
2009 €75 billion

Meantime, economic activity collapsed due to a collapse in the construction sector of the economy. That collapse was itself the consequence of a lending and borrowing spree.

Despite what Michael keeps saying, the collapse in the economy and the boom in state borrowing have essentially nothing to do with a reduction in state spending. There hasn't yet been a reduction in state spending.

David O'Donnell said...

The present 'austerity' is based on a further €40 billion in borrowing (McCarthy is unavoidable on certain facts) .......

So sensible to KUT 'regressives' from Gov spending -

and STIMULATE (where I agree with Michael Burke) .... and maintain productive wealth creating capacity ... €90 billion in serf-dosh being minded due to uncertainty - productive capacity is being destroyed in indigenous small biz sector, reducing future revenue and increasing deficit .... small biz needs a functioning bank ...

Paul Hunt - you astutely identify the forces and I agree with you on abysmal dysfunctionality of political policy making - but we are more than capable of DOING this ... pragmatic realism ...

Feck the EFSF and IMF - this can be done ... (but we desperately need a political clear out ... to lend any legitimacy .... with respect to GP's original intentions they are presently simply "Lenny_nists' Useful Idiots" - best they could do right now is walk ...

Michael Taft said...

Anonymous - so all those spending cuts the State implemented didn't actually happen. Oh. The pension levy and the public sector wage cuts; the cut in Jobseeker's and Supplementary Allowance for under-20s; removal of the christmas bonus; reductions in rent supplement; the abolition of the Early Childcare Supplement; the cut in social welfare rate; cuts in Child Benefit; cuts in the dental and optical scheme; cuts in the Drug Repayment Scheme; the imposition of co-payments for GMS patients (a cut in their disposable income); cuts in special needs and language teachers; increase the pupil-teacher ratio; cuts in student support grants; the cuts in arts grants; the €2.6 billion cuts in capital spending; the overall cut of €8.6 billion in current spending - all these didn't happen? That's a relief.

Anonymous said...

On the TASC budget submission ... I think you guys underestimated the savings due to reducing the tax relief on pension contributions.

Only €750 million?

Shure, the savings on tax relief applied to public sector superannuation and pension levy payments alone would account for nearly as much again!

Oh yeah, I see where ye're going with this ...

Exempting yourselves, right?

Paul Hunt said...


I don't greet the EFSF/IMF prospect with any relish. It's just that this interminable can-kicking by Government is making things worse and they are rapidly running out of road. I happen to agree broadly with Ciaran O'Hagan:

But, while I agree that the 'good money' that Ciaran mentions may be willing to give Ireland a chance, I fear there are many other players in the market who will see the opportunity to make money by using Ireland to test the EU's resolve. Still, I expect the EU will come up with some fudge to square a syndicate of big investors.

Michael Burke said...


Two points: The oft-repeated idea that this is all a construction slump is incorrect. Construction activity has fallen by sizeable €7.4bn in cash terms, while GNP has slumped by €27.8bn. Construction accounts for only a little over a quarter of the Depression.

Secondly, those of us opposed to austerity measures pointed out that they wouldn't work even in the narrowest terms, that is either increase tax revenues (as activity slumps) or reduce nominal outlays (as joblessness and poverty are increased).

But that doesn't mean austerity measures havent been implemented- just the cuts don't equal savings.

Concretely, if, say, you cut benefits by 15% but the numbers on welfare doubles, welfare spending will rise by 70%.

Expansion of the deficit is the effect of current policy, not expansion of the economy.

Behold, they make a wasteland and call it expansion.

Anonymous said...

@Michael Taft.
Those cuts in the specific things you selected may have happened. Other spending rose more than enough to make up for it.

Austerity didn't happen - at least not for the public sector - and in any case the collapse in the economy happened well before those few cuts.

Spending needs to actually fall, for real not just for pretend.