Monday, 14 July 2014

Government Priorities, Jobs and Taxation

Nat O'Connor: Jobs has (rightly) emerged as the number one priority for the Government for the remainder of its term in office (Link: Statement of Government Priorities).

But are the economic ideas underpinning the strategy sound? And will it add or subtract from Ireland's level of economic inequality? I have selected five points from the ten-page strategy document to illustrate some strengths and weaknesses of what is being proposed.

1. "Our economic strategy will ... return the economy to full employment (2.1 million people) by 2020." (page 2)

Employment in Ireland peaked in 2008, at 2,147,300 employed (Link: CSO). At the time, there were 2,792,362 people aged 20-64, which gives an 'employment' rate of 76.9 per cent.*

*With the caveat that some people younger than 20 or older than 64 were probably in employment, so this percentage figure is an over-estimate. However using the age group 20-64 is nonetheless the Eurostat standard and relates to the EU's 2020 employment targets.

The CSO has estimated (here, page 38) that the population in 2021 will be 4.9 million people, of whom 2,837,800 will be aged 20-64.

On this basis, the Government's target of 2.1 million in employment by 2020 would be 74 per cent of working age adults (20-64), which is nearly three percentage points lower than the level of employment achieved in 2008. The 2.9 percentage point difference would mean 82,296 less jobs than if the same employment rate of 76.9 per cent was achieved by 2021. Hence, talk of 'returning' to full employment or 'restoring' all the lost jobs may give some people unrealistic hopes - especially older workers with low skills or specialised construction skills that are surplus to the economy's needs. And it might dissuade people from taking up re-training opportunities.

The Government has defined 'full employment' in 2020 as 2.1 million jobs. But there are better definitions. We could define it as everyone who wants paid employment should have it. More specifically, we might specify full-time employment, as many people work part-time involuntarily.

On the positive side, this new target is higher than under the national EU 2020 targets, where the Irish Government's target was an employment rate of 69-71 per cent, probably reflecting the higher number of younger people in third level education, plus the historically higher level of people (mostly women) working in the home or in unwaged care work, voluntarily and involuntarily.

The CSO population projection report focuses mostly on labour force population rather than total population. This makes significant assumptions about the percentages of people in third-level education, working in the home, disability, care duties, etc. Yet it is precisely policies to achieve structural changes in these areas that could change these proportions and get more people into paid employment.

For example, Ireland has among the most expensive childcare in the world. A shift to a state-subsidised system would have two employment effects. In the immediate term, it would enlarge child care as a sector of employment, with career options for women in particular (based on the experience in other countries). In turn, an even larger cohort of people who are currently full- or part-time carers for their children (again, mostly women) would be released to seek employment in line with their preferences and qualifications. Both of these effects would enlarge the labour force as a percentage of the working age population.

Structural changes such as the child care example show how paid employment can be extended to more people. But of course, this would only be possible if higher taxes were levied on all households to pay for subsidised childcare (essentially a redistribution from everyone to benefit young children, who in turn will have a better life start and will benefit us all when they are employed and paying taxes in future).

Childcare has to be paid for anyway, but a national system could achieve real efficiency savings through economies of scale. But this kind of structural change to sectors of employment is not visible in the Government's job plans. So how else can employment be generated?

The total population of Ireland is expected to grow significantly between 2008 and 2020, according to the CSO's projections. We know population growth expands the economy: there are simply more people needing the same basic goods and services, and that creates more jobs to be done. However, a bigger population also means more people seeking work, so while GDP may rise, GDP per person may not.

Beyond population growth, there are two further major options for job creation: money and new ideas. But where will they come from?

Last time Ireland achieved 2.1 million employed it was at the height of the boom. A great deal of money was borrowed by private households and businesses, and spent on property. In many cases, tax breaks - from mortgage interest relief to hotel tax breaks - spurred on this process. But at the core was borrowing from the future to pay for the present. Inevitably the bubble burst and Ireland lost around 300,000 jobs - many of which were directly or indirectly linked to the property bubble - or which were collateral damage, as businesses went down because their owners had taken on debt, possibly leveraging business assets. Meanwhile, national debt went through the roof due to lost tax revenue and the costly bank bailout, while private debt had also become among the highest in the OECD.

Where is the money going to come from to bring us back to 2.1 million jobs? While there may be some pent up demand for housing, people's ability (or desire) to take on mortgage debt has hopefully been tempered by recent history. We know that companies continue to complain of a lack of lending by financial institutions to SMEs. So, hopes for debt-fueled growth are limited. Never mind the fact that debt-based growth is risky and can go badly wrong, as we know all too well.

The Government seems to be betting on 'new ideas', which are an uncertain foundation for future job growth.

2. Actions in the revised Government priorities include "Using the new network of 31 Local Enterprise Offices in every local authority to support entrepreneurship and small business activity" (page 3)

Actually, the new LEO structure could be quite dynamic. There are exciting possibilities to focus on the different strengths and natural advantages in each local area, and they are a way to spread work around the country. There needs to be free rein to allow local experiments, including at the edge of traditional paid work sectors: possibly involving co-operatives, non-profits and social enterprises.

The Government could probably do more by supporting the development of LEOs in each local authority: a few more staff could operate forums and meetings with local people and businesses, do market research, and generally maximise the potential for idea generation. Of course, nine out of ten ideas might not work - LEOs need to encourage trial and error, and to give people the opportunity to keep returning to the drawing board until they can come up with viable business models. And LEOs have the advantage of small scale in many cases. For many areas, the creation of even ten new sustainable jobs would be a big win.

However, 'entrepreneurship' is not a magic wand and the creation of jobs from new ideas alone is rare. Investment money is needed too for LEOs to become a real engine for job creation.

3. "Local authorities will retain 80% of the proceeds [of] the local property tax, with the option to vary the rate by up to 15%." (page 10)

There is an opportunity, as the Local Property Tax could represent 'new money', at least for some areas. Ireland's funding of local government is among the lowest in the OECD. While there is currently a populist political rush to lower LPT, mature reflection about job creation might lead some local authorities to conclude that increasing LPT might be the only money for investment their areas are likely to see for some time.

Other changes to local government are worth considering too. Currently, they are not permitted to take on debt, even if they have substantial assets. If LEOs are going to involve a coming-together of local communities to generate jobs, and 'crowd in' private investment through publicly-funded seed investment, more capacity to borrow money locally for jobs projects should be considered.

4. "We will establish a Low Pay Commission" (page 4)

This is a good idea. As argued on, paying people a Living Wage satisfies the social justice argument that everyone working full-time should have a minimum, decent standard of living as a result.

But there is also a strong economic argument for living wages. Raising low pay will boost aggregate demand across the country, with most of that money spent on local goods and services. Whereas profits may be used by companies to pay down debt sooner - or invested or repatriated abroad - re-balancing companies balance-sheets in favour of wages should help local job creation.

Company profitability obviously sets a limit to wage-led economic growth, but there is almost certainly scope to make significant changes in favour of people currently living below a Living Wage.

5. "...individuals and families on the average industrial wage can be paying a 52% marginal tax rate. [...] In Budget 2015, we will announce a tax reform plan to be delivered over a number of budgets to reduce the 52% tax rate on low- and middle-income earners in a manner that maintains the highly progressive nature of the Irish tax system." (pages 4-5)

Taoiseach Enda Kenny is reported as saying “The Government wants to make work pay for Ireland’s families,” ... “Now especially we want to make their lives that bit better and easier.’’ (Link: Irish Times)

This is where the wheels fall off the Government's job plan.

Economic output (measured as GDP) can be described in terms of four components: Consumption (C) + Government Spending (G) + Investment (I) + Net Exports/Imports (X-M).

Ireland has among the lowest tax and social insurance take in the EU, at three-quarters of the EU average. If tax take is cut, then the level of public services, social transfers and/or public investment must fall.

Lower public services will just mean that people will pay more in charges or fees for services, which will eliminate the benefit of a tax cut. (In fact, young healthy single people might pocket a tax cut, but families with children or people facing illness will face worsening services and higher costs). Lower public services will also simply reduce the G component of GDP, shrinking the economy.

Evidence from the ESRI and Central Bank (presentation and report) suggests that higher earners will simply pay down mortgage debt, rather than spend more. This means that the C component of GDP is unlikely to grow to the same extent that the G component will fall due to tax cuts. In normal times, that might give the banks more money to lend - but they are not lending.

If social welfare is cut further, the C component will also fall, as people on welfare spend practically all of their incomes on essential goods and services.

Ireland already has the lowest level of investment (I) in the EU. So further cuts to public investment will shrink GDP and also lower Ireland's potential future growth trajectory, due to the lack of crucial infrastructure.

Hence, the first problem with the tax cuts strategy is that it is unlikely to boost economic output. On the contrary, it is more likely to shrink the economy and cost jobs. (The above arguments are outlined in more detail in A Defence of Taxation, pages 24-28).

The second problem is that only 17 per cent of income earners pay anything at the 52% marginal tax rate (See Minister Noonan's response to PQ). Cuts to the 52% marginal rate are not tax cuts for low and middle income earners: most of the benefit is likely to accrue to people who have higher incomes, worsening economic inequality in Ireland (See here for details).

In conclusion, Ireland had a once-off boom due to a large number of people and businesses taking on high levels of debt. The failures of the weakly-regulated banking sector led to another layer of debt being taken on across all of society. It is not plausible that much more debt can be taken on, or that debt-fueled growth is going to generate more jobs.

We have had over five years for private investors to see the opportunity of low prices and come pouring into Ireland, but this hasn't happened as our investment statistics show.

Lowering taxes won't cut people's cost of living. On the contrary, many people will pay more to replace lost public services. And people on the lowest incomes, reliant on welfare and public services, will see their quality of life further eroded.

The currently most readily available source of money for investment and jobs is the public purse. The deep contradiction at the heart of the Government's new priorities is the idea that we can maintain services and investment, while lowering taxes and giving everyone higher net incomes. But this is a recipe for having your cake and eating it: in reality, it will worsen economic inequality and it won't generate jobs.

The alternative is to re-balance the economy in favour of higher wages, and to strengthen public services, social transfers and public investment based on progressive taxation.

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