Fiscal stimulus packages everywhere but Ireland November 11, 2008
Posted by WorldbyStorm in Economics, Economy, Irish Politics.trackback
Watching Channel 4 News last night one might have been surprised to hear Faisal Islam (one of the best financial reporters around – and a remarkable assured one compared with his first appearance on C4N some years back) report.
He argues that on foot of the stock market rise after the injection of capital by the Chinese:
“… governments all seem agreed that fiscal stimulus, cutting taxes and increasing spending, is the tool to get the economy motoring again.
In the USA 60 billion pounds of tax rebates were pumped in this Summer, now another 110 billion package may be unveiled by President elect Obama.
In Germany another 40 billion pound plan was agreed last week and balanced budgets were abandoned…”
And he points to the Japanese experience over the last fifteen years of an example as to why there is this sudden appetite for fiscal stimulus, because that intervention came too late…
Andreas Prindl, former Chairman of the Nomura Bank, a major Japanese bank, noted that…
The Japanese authorities didn’t want to recognise the problem to be as big as it was. So they didnt do very much at first. They did small packages a little here and a little there. It didn’t really work. I think people here are much more ready to do larger stimulus much more quickly.
But what of government debt as a percentage of GDP?
For the moment I’m not worried about 40% of our GDP being government debt. I’d say, so what? The European average is 80%… we’re way below that…we’ve lots of room to stimulate to borrow and without any serious worry yet.
By way of contrast with the UK the Irish situation as outlined by Jim O’Leary is as follows:
As a result, by the time the problem was eventually addressed effectively in 1987, government indebtedness had grown to almost 120 per cent of GNP and annual debt service absorbed the equivalent of almost the entire income tax take.
By comparison, today the ratio of debt to GDP is about 35 per cent and servicing that debt costs less than 2 per cent of GDP.
Lower then than the ratio in the UK.
As Faisal notes ‘put it together with that slashing of interest rates last week in two short weeks a total transformation of a macroeconomic model that’s lasted two decades as Britain follows an international fashion for fiscal jump-starting’.
Er… not so Faisal. For there is one government, far to the west of Europe which believes that low taxes and cutting spending is the way to go.
Not for them investment in social housing, or other programmes. Instead a penurious, and perilous reliance on those very models which haven’t succeeded in the past.
You know, I’m a fairly sanguine kind of a person who tends to the view that things aren’t usually as bad as they may seem.
But this time, reading the Cowen interview in Hot Press and seeing the way the economic crisis is being addressed in this state, I’m not so sure about the future.
And then reading in the Irish Times a week or so back I see this from Noel Whelan:
IT’S JUST not sustainable. This country cannot continue to operate the low-tax, high-welfare, big-government model which has been the legacy of the Ahern era.
We just can’t afford it.
…
Ireland’s tax base is too narrow and our tax rates are too low. Our inheritance taxes are negligible, our corporation taxes are among the lowest in the world, and our domestic homeowners pay no property tax (except when they buy a house, which very few are currently doing).….
Our consumption taxes are relatively low, and in Ireland, unlike in many other countries, these taxes are not charged on food and most clothes.
Our motor taxes are also low except when we buy a new car (which very few are currently doing).
Even after the new income levy is applied, our income taxes will still be among the lowest in Europe, and we are unusual in excluding those on the minimum wage from our income tax system altogether.
But it’s not just taxes, because he also argues that:
Ireland’s public expenditure is too high.
When measured as a percentage of GDP over the last couple of years it may have been comparable to euro norms but now that our growth rate has gone into reverse it is relatively high.
We can no longer afford to keep the pupil-teacher ratio as low as we had managed to reduce it to in recent years, especially if we continue to pay teachers at the same rate without any increase in their classroom hours.
We certainly won’t be able to do so if large chunks of the education budget continue to be spent on State subsidies to private secondary schools or on funding universal free third-level education.
Neither can we continue to pay the same level of farm subsidies and grants while tacking such low taxes on larger farm incomes and imposing no taxes at all on land or farm assets.
Now, as we see, the US and the UK would beg to differ, as does Germany. And these are broadly under centre or centre right governments.
It’s refreshing then to read a piece from the Summer in the Irish Times which argues somewhat differently. Under the heading: High earners must pay more income tax…
In the lead-in to last year’s general election a peculiar consensus emerged about income tax policy. All the main political parties promised tax cuts and all, including Labour, promised cuts in the top rate. Having sold themselves as tax cutters before the election, all parties would have credibility problems if they were now seen to support income tax increases.
However, these pre-election promises were premised on projected growth rates of about 4 per cent. Most commentators now predict a growth rate of less than half that. The slowdown in the US economy, the international credit crisis and rising oil prices combined with difficulties in our own property market have caused a dramatic slowdown.
Who can disagree?
The economic situation has been transformed and, to paraphrase Maynard Keynes, now that the facts have changed, the parties should change their minds.
When the public coffers were bloated we had the luxury of lower income tax for the better paid. In leaner times it is the better off who should make a greater contribution to the tax take.
The most efficient and equitable way to achieve this is by increasing the top rate of income tax. Most of our public spending goes on health, education and social welfare so any cuts in these will inevitably hurt those most in need. Tax increases, however, will impose on those who are better able to pay.
Fine Gael’s Richard Bruton has a point when he suggests that savings can be made through greater public sector reform and more efficient public expenditure. The Government itself acknowledges that there is room to cut public sector spending without having too severe an impact on frontline services. However, it is dishonest to suggest that efficiency drives alone can plug the deficit opening up in the public finances.
Absolutely. And while I’m not as keen on the following paragraph…
Similarly, Labour’s Joan Burton is right to focus on high-rollers who use tax relief or non-residency exemptions to ensure they pay little or no income tax. However, it is delusional to think that there exists some crock of gold in unpaid taxes from the very wealthy that could resolve all our difficulties.
It is possible that it is true that such a crock of gold doesn’t exist and that other measures should be taken.
One should also note that the following was written at a time before the rulebooks were torn up.
Ireland is close to the government borrowing limits with which we must comply. Therefore hard decisions must be made on either the tax or spending side of the balance sheet. The public must be more realistic about the level of services which the exchequer can afford and public sector workers need to be realistic about wage levels.
The author of this broadly sensible programme?
Why step forward Noel Whelan.
If the messages emanating from our media are so inconsistent on these matters small wonder that our government is so visibly unable to deal with this situation in any sort of a sensible fashion.
Let’s face it, the bad guys won a long time ago. This place was probably @%*#ed the day James Connolly went and got himself killed. . .
I agree with your overall approach WbS: there is no question but this is a 1929 dimension of financial crash with the potential to turn into a 1931 style slump. The outcome will in large measure be determined by whether a seriously global strategy is followed by all concerned or a proliferating number of self defeating “beggar my neighbours” approach by national governments. The Cowan government’s record displaying an amazing lack of consulation even with Ireland’s EU partners on the initial bank deposit guarantees does not bode well. G. Brown is not entirely wrong when he calls for a serious Bretton Woods Two (plus European and global regulation on the entire financial sector). Thus far the EU have been providing a modicum of leadership in this direction. But to succeed not only will Obama have to come aboard but also the Chinese and Gulf State regimes. Viewed globally the surpluses and deficits balance. It is in the interest of the surplus savings states (especially when they are export dependent) to help finance a truly massive ($3 – 10 trillion?) reflation package over the next year or two. Even if the recovery strategy is successful, the debt crisis into which the neo-liberals and the banks have got us may take a decade or more to work off.
At a time like this Ireland would not want to risk the kind of isolation Iceland experienced recently. Yes … there are lessons to be drawn on that score too.
Let’s face it, the bad guys won a long time ago
…Everybody knows that the war is over
Everybody knows the good guys lost
Everybody knows the fight was fixed
The poor stay poor, the rich get rich
Thats how it goes
Everybody knows
Leonard’s worst song, IMO.
Anyway, back on topic; did anyone see the Observer business section last sunday? They had a big page on the possibility of ‘Bretton Woods 2′ replacing the old BW institution. It ended with somebody claiming that Nigel Lawson told them that the French keep asking for a new Bretton Woods, but you should pay them no heed, because it will never happen. . .
Have you heard “If It Be Your Will”?
That’s presumably not the Observer piece berated on Stumbling and Mumbling? Presumably not as it doesn’t appear to mention Nigel Lawson, who is, I suppose not as objectionable as his son.
I do like the way “the French”, who were briefly heroes to the media for voting for Sarkozy, have now become “what we don’t like” to these people again. I hope Jon Henley gets caught in a strike soon.
You won’t hear me disagree with your thoughts John. I think that the fact the Chinese are taking precisely the same road as the US, UK and Germany indicates that they are de facto on board.
Bretton Woods 2. Great idea if it knocks away some of the previous power of the financial institutions.
Leonard’s worst song, IMO.
How can you tell?
It seems that Ireland and the eurozone generally are constrained by the Maastricht criteria. A common currency without political integration inhibits a common eurozone response. Cowen’s response and economic orthodoxy in Ireland, appear grossly inadequate, and ill-informed.
The last Great Depression was finally conquered by the massive government expenditure required for WW11.
The financial and economic crisis presents Obama with a great opportunity: massive government expenditure on social and physical infrastructure is precisely what is needed to compensate for the failure of the market system which threatens to become another Great Depression. And economic and political opinion in the U.S. is moving quickly towards this solution. Hopefully Europe,including Ireland, will follow.
I think you’re right CL, Europe will follow. But Cowen et al appear to be working according to a different rule book.
CL – To be fair the EU has led the way on global reflation. It was as a result of EU intervention that the US authorities agreed the present “bail out” strategy. Within the EU itself massive sums have already been earmarked for the same purpose. If Germany has so far agreed a lesser sum, it is measure because the crisis has had less effect on their domestic economy. Meanwhile the EU has unfolded the outlines of a global regulatory strategy designed to bring the private financial markets under public scrutiny and ultimate control. No doubt more – may be much more – will be required but it is wrong to say the process is being led by the US rather than the Europeans. What the Europeans can learn from the US is the use of the cops and courts to try and bring those responsible for this massive crisis to book (as with Enron before). Not even the European “left” has picked on this. Why?
WBS, your brief survey of Noel Whelan’s bon mots prompted me to do a bit of digging on the issue of ‘high public expediture’. Anyone familiar with the area knows that Noel is way off course on this one but it’s always good to put some hard numbers on the argument – which I have done over at Notes on the Front. In short, we are one of the worst public spenders in the EU – just edging out Romania and Slovakia. Were our current public expenditure to reach the EU-15 average, we’d have to spend €12 billion more a year. I am always amazed that the media continues to give space to people who can’t be bothered to look up the odd fact or two.
CL – I meant to add a question. In what way are the Irish authorities “constrained” by the Maastricht Treaty in responding to the financial/economic crisis? Surely you know that the “exceptional circumstances” clause has been invoked to cover euroland states which have to run up much higher budget deficits (measured re the usual limit of 3 per cent of GDP) to try and grow their way out of recession. What might be pointed out is that some countries have emerged relatively unscathed by the quasi-criminal shannigans of the banks and the other financial institutions. Spain is a good case in point. Why? Because they imposed much stricter controls on the banks effectively prohibiting the extensive use of financial instruments which created the out of control debt nightmare that has now plunged us into a recession and the risk of a depression. I am amzed how both the governments in both Dublin and London are getting away with murder by not be obliged to justify their inction.
JP, my reference to Maastricht was just to point out that having a common currency without political integration inhibits,even prevents. a common fiscal policy. Ireland in the Eurozone is equivalent to a State within the U.S. Individual states cannot individually embark on their own fiscal stimulus without implications for their creditworthiness. Neither Ireland nor the state of New York has its own central bank. But in the U.S Obama has promised aid for state and local governments. In the Eurozone their is no such effort to aid the member states because there is no central government.
The political economy of the Eurozone seems unduly influenced by the hyper-inflation in Germany which brought Hitler to power.
The cause of Ireland’s problem lies in Ireland,-massive inflation of property prices aided and abetted by the crony capitalism of Fianna Fail.
My impression is that whats being done in Europe is completely inadequate given the global downturn. China has acted more appropriately. As for the U.S bail-out strategy, no one knows at this point just what is being done with the allocated money. Here too we are waiting for Obama. Is it being used to re-capitalize the banks? or?
Its doubtful if the coming Washington conference on regulation will accomplish much in the absence of the Obama team.
‘ those responsible for this massive crisis’-I doubt if capitalism’s inherent tendency to crisis can be traced to any particular group of people. No doubt de-regulation, and the underlying market fundamentalist philosophy, aggravated the problem, and re-regulation would help ameliorate it, but the vagaries of capitalism are not so easily overcome.
Its no very encouraging to see Rubin and Summers,-de-regulators from the Clinton era-prominently displayed at Obama’s first news conference. But economic circumstance will force Obama to do the right thing: massive public expenditures. Hopefully Europe’s tentative steps in the same direction can be increased.
WbS,
I don’t really see where the inconsistency lies in Whelans two pieces. We should raise taxes to reduce the shortfall but there is no way it can cover it. The problem is that the tax model we’ve been following (which Whelan points out well) works only in a boom period. The central question facing those who regard themselves as progressives is how to fund an adequate and improving welfare state. Income taxes won’t do it – look at the figures and its stark. A wealth tax is useless when the asset prices are nosediving and no one wants to buy. Ireland has a pretty poor welfare state and we can’t fund it except when we have an unsustainable boom in housing or some other bubble. That fact is frightening. And there seems to be no escaping it.
CL – You are right, of course, that a single currency requires eventually serious fiscal and budgetary powers. The fact is, however, that those countries who are part of the euro as it is now have benefitted from being shielded from full impact of the financial crisis. That is – of course – why the Icelanders want EU (and euro) membership soonest, that the Danes are bringing forward the date for a new referendum to join the euro, as are the Hungarians, Slovaks and the Poles. The Swedes are also debating euro accession again. But it is important not to miss what IS happening on the fiscal/budgetary front: EU states are taking unprecedented steps to coordinate measures to try and head off a slump ( recession is unavoidable now). They have also shown remarkable unity on the need for far tougher European (and global) regulation of the financial markets. Even the Brits under G. Brown are now pretending they are leading this process: the truth is that “in defence of the City of London” the UK has dragged its feet for more than a year to block proposals for comprehensive regulation put forward by the Commission and the German government.
Does all of this add upto “socialism.” Of course not. Indeed the labour movement is going to be fighting some very elementary defensive battles around employment and social standards for some time to come. But the massive ideological/political impact of this crisis on the heart of the neo-liberal project PLUS the clear evidence that the “nation states” are utterly impotent on their own DOES open up important space to argue for societal changes which amount to much more than the kind of state capitalism which is on offer just now. Just look at the demands for the wholesale “nationalisation” of the US motor industry – led by GM, Ford and Chrsyler! This is an environment which should be exploited to the full by those on the left who are serious about systemic change.
The 2005 revision of the Growth and Stability Pact undoubtedly means there is more room for manoeuvre. But this does not mean that limitless (in extent and time) deficits will be tolerated. They cannot be tolerated – for the very reason the GSP was required in the first place: profligate fiscal policy undermines the currency.
As far as I know the new terms mean governments have more time to correct the excess borrowing and can call on a longer list of extenuating circumstances. But in the end any sanction or political pressure comes down to an interpretation which will be a function of politics.
I have heard it said that one factor feeding into the analysis will be how the offending government behaved during the positive part of the cycle. That hardly leaves Ireland in a favourable position.
In any case, it seems to me that Ireland’s ability to employ a fiscal stimulus now is not so much curtailed by the GSP and Europe (though the gov may choose to paint it that way) but by the way in which they have carved down an already low tax base. Basically they left us running on empty.
Agreed Tomaltach. The low corporate taxes were always a recuipe for disaster in the longer run. The best we can hope for in the near term is that the globally coordinated stimulus will put a floor beneath the fall in output over the enxt couple of years. But then the cumulative indebtedness will have to be dealt with over the decade which follows. If you add into this equation the imperative of sustainable growth (climate change et al) then you have a very different set of imperatives imposed on the form of capitalism which survives. Slow growth/sustainable growth can only be support by far greater social equality.
>>>far greater social equality.
And what are the chances of that happening?
They cannot be tolerated
By whom?
Tomaltach, the UK and the US beg to differ. Why are we so different?
treey, if you look at the way Whelan argues his case it is clear that he has shifted from the pro- taxes on higher incomes side some months back to the pro-cuts in services side and steady as she goes on low taxes side. Obviously I think that’s a pity. More to the point he, like all our bien pensant commentators of the centre right cannot tolerate the thought of increased spending, or borrowing to sustain same, when all elsewhere see it as the *only* way out of this mess.
While I accept there is a shift in the focus, to me it doesn’t seem inconsistent. He doesn’t say don’t raise taxes – it seems implicit he thinks the opposite:
“Even after the new income levy is applied, our income taxes will still be among the lowest in Europe, and we are unusual in excluding those on the minimum wage from our income tax system altogether.”
While I think in the short term borrowing to prevent a massive dip in the level of public services would be the right thing to do for social reasons, the fact is that there is nowhere to raise as much taxes as we used to do – thats what Whelan is pointing out imho.
“Ireland’s tax base is too narrow and our tax rates are too low.”
A 5% increase in income tax on the higher rate would result in around 800 million increase in revenue. Thats a really, really rough figure based on no deductions and on the 2006 income statistics and assuming there is no feedback in a reduction in consumption spending (and thus gov revenue) as the money will simply lesson the deficit rather then fund expansionary policy. Lets say in reality the actual marginal increase in revenue is somewhere in in between €500 – €600 million. Where is the difference between that and the current deficit going to come from? The housing boom funded the weak welfare state we had and thats gone and nothing will replace it.
The logical conclusion seems to me to be that there has to be some adjustment in the spending side until a way can be found of funding the welfare state.
Its a ferociously frightening situation when a country can’t even fund a minimal welfare state and to me that seems to be the point Whelan is making.
WBS,
The truth is I don’t know why we are so different. But here is my stab at a possible explanation. If we hadn’t had our budget, next year we were heading for a borrowing requirement I think in the region of 9%. As far as I can see that exceeds the levels on the radar in either the US or the UK. But even if it doesn’t there may be one other crucial difference.
Our tax base was placed on an unsustainable footing over the last 7 or 8 years (or longer). This meant that our deficit now (after the huge correction going on in property) is not just cyclical – but structural. Even if the business cycle in Ireland were to obediently bend upwards to recovery in say 12 months, we are still in major deficit territory. Not because our spending is too high ( we have all seen on these pages and elsewhere that our spending is, relatively speaking at the lower end) but because we don’t have a tax base to support even the low spending levels that we have set.
…. which I ought to have said, would lead to the conclusion that the challenge in Ireland isn’t merely to devise a borrowing strategy and worthy stimulus projects, it is to begin to think, how in hell can we re-establish a tax base? And of course all the usual voices are already stiffling that debate “we cannot increase corporate tax, we should lower it more”, “we must lower taxes to stimulate employment”, “our direct taxes are too high”.
In effect, we have untaxed ourselves into a painful fiscal quandary and no simple solutions are available.
Ah yes, just wait for VAT to enter the discussions.
treey, I think that it’s a bit more than a change of focus. Whelan has neatly aligned himself after an – admittedly cautious – burst of populism with the current FF consensus. Note how his article in the IT argues we can’t afford the ‘high’ welfare… we don’t have ‘high’ welfare. We’re well below the EU average as noted by Michael Taft.
I think that IIRC the costs to the revenue of the drop in 1% in the higher rate some years back was the equivalent of €480 million. It’s up on Finfacts. That’s only 1%. That excludes any of the measures Michael Taft has been arguing for on the Irish Left Review.
But I think you and Tomaltach each give voice to the argument that first Ireland is in some sense ’sui generis’, that the only reasons revenues were so high was due to housing and now that that has gone we’ve no alternatives. I’d think that each of those propositions is entirely contestable.
WbS, Tomaltach and Treey have a point in the sense that the centre-right economic policies in this country have always been of the view that ‘if we cut taxes, we take more in’. That is the fundamental structure of the Irish tax base.
Corporation Tax is an example.So too is Social partnership: tax cuts to make up for wage restraint.
Add in Income tax, Capital Gains Tax, Stamp Duty and so on and so on and you come to the realisation that much of the economic success this country has enjoyed is because of this general policy.
The bankruptcy of it has now been exposed in recent months but there is a real fear out there because our general economic model is bust. We need to create jobs that don’t exist because of a low-tax base, we need to create public services which aren’t dependent on stamp duty intake. In short we need a whole new model. That’s why cutbacks in education are particularly galling. We are cutting off our nose to spite our face.
I would broadly agree that we have to seek a new model, but it’s worth noting that the economy has diversified significantly beyond the construction/housing sector. Note that in the UK the tack appears to be government funding of the private sector to extend social housing hugely. Amongst other things. The point is how long is the crisis expected to last, how much are we willing to borrow across that time, and how are we intending to extend the tax base? Again, Michael Taft has some interesting thoughts on the latter issue. I believe that we should see the former as an opportunity for a strategic investment in this economy through borrowing to start to reconstruct it in such a fashion that the risk is, as it were, spread.
J.P., I’m basically in agreement with you. Just because I pointed out the difficulties associated with monetary union without political union doesn’t mean I’m anti-Euro. As you point out the Icelanders are surely sorry, and the Danes are having second thoughts. And state capitalism is a fairly apt description of what’s happening. I wouldn’t be too hard on Gordon Brown though. He waited but he seems to have got it more right than the Americans. Paulson just announced today that the bail-out money will not be used to purchase ‘toxic assets’, meaning assets without value, or as K. Marx said ‘fictitious capital.’
There is much to play for. The neo-liberal ideology has been dealt a severe blow by really existing capitalism. Obama has called it a ‘failed economic philosophy’. It will be interesting to see what policies he implements-and what will be the undergirding economic philosophy.
Has Obama called it that? Wow. Any links?
WBS,
I would agree that one consideration should be to borrow to, as you say, reconstruct.
But when I mentioned sliding towards a 9% borrowing requirement next year if we hadn’t had the budget, my concern was that much of this borrowing would be for current spending.
Still, back to the ‘borrow to reconstruct’ argument. This really has merit. But in my opinion it is something that would have to be taken on as a separate project – with a team of specialists appointed by government to examine what areas to reconstruct and to see how feasible it is. We have heard the argument about building schools etc – but I’m not convinced that this would be anything near the scale required to plug the hole left by other construction. In other words, it would be rather a whimper instead of a stimulus. Perhaps social housing is one way. Though again, it is questionable whether the stimulus effect would come in sync with the tough of the downturn (and I suppose since we don’t know the length of the downturn it is hard to estimate) but certainly it would take considerable time to get a significant stimulus package off the ground. A huge amount of planning and so on would be required.
If we thought this was going to be a 30s style depression then we could assume a long trough so the delay in getting these projects off the ground would not be a problem since the stimulus would still come at the right time.
But my point is that while a building stimulus makes sense – it would need to be very well planned and delivered in a way that doesn’t waste too much of the borrowed money. I’m not saying it cannot be done, but it presents particular challenges and I wouldn’t want to trivialize the complexity of executing an effective stimulus package.
On the other hand the government should appoint a team of experts (economists, planners, etc) to do a feasibility into which areas might be effect for a value for money stimulus. I think such a feasibility might be possible fairly quickly.
But better still, should the government – all governments – not have a plan like this ready to roll in the event of a serious downturn. Yes, but they probably don’t, because a) there are a whole lot of other things they should have done to leave us more robust in a downturn but didn’t, b) they were imprisoned by the orthodoxy that the market self corrects and does all these things for us!