Notes On The Front

The Unacknowledged Demise of the Government's Fiscal Strategy. The Recession Diaries - July 29th

Strange how some things don’t get into the debate. For instance, the ESRI’s recent Recovery Scenarios judged the Government’s fiscal strategy a failure. It estimated that not only will the Government fail to bring public finances under control by 2014 (if we take the Maastricht guideline as the ‘control’ threshold), it will not be able to do so by 2020. Did any of this get into the debate? Were there discussions on the failure of spending cuts? No. The debate is impervious to such awkward interventions. Spending cuts are good. No amount of reality will be allowed to perturb the consensus.

You can read the rest of this post on Progressive-Economy.

Beyond the Spin - Finally a Good News Story: Investment Works. The Recession Diaries - July 27th

Fair dues to the Government. They take old news, an old set of policy projections, repackage it with a shiny new bow, and launch a fresh programme – which is presented as a stimulus and investment-driven job creation programme. And a lot of folk go along with it (though some like Miriam Lord sees the three-card trick being played). Let’s look at the headline figures behind the new capital infrastructure review - for there is spin, but there is (finally) a good news story.

The Government announced as early as December last year that capital investment would be cut to €5.5 billion annually from 2011 to 2014. Yesterday, the Government announced that capital investment would come in at €5.5 billion annually from 2011 to 2016. Same ol’, same ol’.

Actually, the Government has been taking a hatchet to capital spending projections. In January last year, they projected capital spending to come in at €27 billion for the period between 2011 and 2013. Within a few weeks, this was cut to €17.5 billion. Now it will be €16.5 billion.

This is important as here lies a big spin. It is claimed that since tender prices have fallen by 30 percent from a peak in the second half of 2006, the volume of spending and, therefore, the level of activity, won’t be affected. However, the tender index published in the review shows that tender prices have fallen by about 20 percent since 2008. Yet, capital spending in nominal terms will fall by nearly 40 percent. The volume cut is still considerable.

Any growth and job creation arising out of the new capital review was already factored into projections last December. Yesterday’s launch doesn’t change those macro-numbers. And capital spending has been cut – whether measured in nominal terms or in volume. So much for stimulus.

But let’s look at one set of figures that can help us reconstruct an alternative perspective. The ESRI asserted that capital spending is inefficient when it comes to creating jobs. As mentioned before, they asserted this but didn’t put forward any arguments or data to back up this assertion. They did cite another ESRI study, by Edgar Morgenroth, but this hardly backed up their contention.

The Department of Finance measured the job creation element of the programme. They found that there are between 8,000 and 12,000 short-term jobs created for every €1 billion spent (with HSE capital spend having the highest job density and water services having the lowest). These numbers are consistent with Morgenroth’s study.

Of course, these numbers don’t include downstream, or induced employment (arising from sourcing, extra demand, etc.). Again, Morgenroth’s study suggests this element – which remains in the medium-term after the project has been completed and the direct jobs are gone – is about half the number of direct jobs created.

So let’s examine the benefits of a significant, temporary boost in capital spending. If it were increased by €3 billion over and above what the Government projects, this could create:

• Between 24,000 and 36,000 jobs directly
• Between 12,000 and 18,000 indirect jobs

That would be quite an accomplishment. With some boldness, some vision, some courage (I like using that latter word, since deflationists are forever advising the Government to be ‘courageous’ when it comes to fleecing pensioners, the jobless, the sick and low-paid), the Government could make serious inroads into growth, employment and the fiscal deficit.

On the latter, the Morgenroth study quotes Construction Industry Federation numbers showing that – adjusted to our sample €3 billion extra boost – tax revenue would rise by about €900 million with a further €900 million saved on the social welfare budget. That’s a big turnaround – and probably doesn’t include further tax revenue arising from increased consumption.

So capital spending can be a useful instrument in terms of job creation and the fiscal deficit. But the real benefit is the long-term addition to our economic base. For instance, IBEC estimates that installing a Next Generation broadband network to cover 90 percent of all household and businesses would cost €2.5 billion – with about two-thirds of that cost composed of civil engineering works.

If such a project were undertaken, we’d get a jobs boost and a public finance boost. But we would have an extremely valuable asset on the national balance sheet, an asset that would facilitate indigenous enterprises’ ability to compete in the traded sector. In other words, the good stuff would keep coming.

All this to say that, beyond the spin, investment works. It puts people back into jobs, it helps repair the public finances and it can leave us with wealth-producing assets for years to come.

Now, isn't that a good news story?

We Must Cut Growth to Increase Growth - Seriously. The Recession Diaries - July 26th

What would you say if a Government Minister, discussing Budget 2011, came on to a current affairs programme and said the following

‘To increase economic growth, we intend to cut growth. To promote employment, we’re going to cut employment. And as for emigration – we don’t care if it increases. Indeed, the Government sees some upside.’

If you heard that, you’d probably say, ‘how ‘idiotic’. Or you might say, ‘how so Fianna Fail.’ You’d be right in both cases. And, yes, if that Government Minister were honest with the public, that’s exactly what they’d say; if the ESRI is anything to go by.

In another installment of ‘pieces-of-information-that-never-make-it-into-the-debate’, the ESRI assessed the impact of the Government’s proposed €3 billion contraction in the upcoming budget (taken from full report which won't be available on-line for another couple of weeks):

‘The impact [of the €3 billion contraction] on the wider economy is to reduce the growth rate by approximately one percentage point. In addition, the level of employment is lower and emigration flows higher than in the absence of such a package. These are real costs attached to the programme of fiscal consolidation being pursued by the government.’

So – the Government intends to cut growth and increase unemployment and emigration. What an odd thing to do. The ESRI estimates the domestic economy will contract by -0.5 percent. The Government’s estimate is worse: -0.75 percent. You’d think Government policy would be concerned with giving the economy – consumer spending, investment, employment – some legs. But, no, it intends to put more obstacles in the way of growth.

Indeed, it might be worse. The ESRI, without knowing exactly what the composition of the budget package would be, used the following breakdown: €1 billion cut in capital spending, €1 billion cut in current spending (though not public sector wages and social welfare rates), and €1 billion in increased tax revenue from a combination of income and property taxes.

However, the Government has signaled they intend to increase the ‘cuts’ element of the package. If they do so, GDP could be cut further (by between 0.1 and 0.2 percent according to my calculations). What fun.

Why isn’t this a subject for debate? Why are not Government ministers grilled on this? Why isn’t a fundamental question being asked – how smart is it to cut economic growth when the economy is trying to recover from recession? Why is this debate so surreal?

Or am I being naïve to even ask such questions?

Spending Cuts or Tax Increases - What would Jesus Support? The Recession Diaries - July 20th

Dan O’Brien – who is producing work at the Irish Times at a phenomenal rate – quotes approvingly from the Department of Finance:

‘In formulating policy, the Government took on board evidence from international organisations, such as the EU Commission, the OECD and the IMF, as well as the relevant economic literature which indicates that consolidation driven by cuts in expenditure is more successful in reducing deficits than consolidation based on tax increases. Past Irish experience also supports this view and suggests that confidence is more quickly restored when adjustment is achieved by cutting expenditure rather than by tax increases.'

You could write mountains of posts on just this one quote but I’ll just content myself with a small hill. ‘Relevant economic literature’ is one of those catch-alls – you can find just about any viewpoint, perspective, set of prescriptions from the economic literature you’re looking for.  And if it agrees with your viewpoint its ‘relevant’ and if it doesn’t its ‘irrelevant’. Increase spending, cut spending, increase taxes, cut taxes, increase borrowing, cut borrowing – it’s all out there in the ‘economic literature’. Take your pick. You can even discover that Jesus wasn’t so hot on the minimum wage if you look hard enough.

Fortunately, we have some really relevant literature to our current economic condition.  The ESRI assessed the impact of tax increases (income, property and carbon) and spending cuts (public sector wages, public sector jobs and public investment) on the economy and fiscal deficit. Here’s what they found for ‘consolidation’ packages worth €3 billion each.

Well, well, well. Spending cuts would cut GNP growth by five times more than tax measures; five times as many jobs would be lost through spending cuts as opposed to tax increases; but – tax measures would yield more savings than spending cuts – 50 percent more savings.

Let’s put some numbers on all this for 2011:

• Spending cuts will result in a fall of €1.5 billion in the GNP more than tax measures.
• Spending cuts will result in a fall of approximately of 24,000 more jobs than tax measures

That’s why spending cuts will deliver less net savings (after you factor in higher unemployment costs, less tax revenue and less economic activity) – over €800 million less than tax measures.

In other words, spending cuts will result in moe business failures, more unemployment and less deficit reduction.  Tax increases, on the other hand, have a far less negative impact and greater yield for the Exchequer.  These findings from the ESRI model were published eight months before the Department of Finance made that statement above. So this ‘economic literature’ was known to them. It’s just that it didn’t fit the viewpoint of the Government. Therefore, it was not considered ‘relevant’. Isn’t that convenient?

Now, I wonder what Jesus would say about spending cuts.

Raise €500 million in tax? Easy-Peasy. The Recession Diaries - July 19th

Brian Keegan from the Chartered Accountants Ireland says that finding €500 million in tax revenue for Budget 2011 will be ‘very difficult to find’. There are no easy choices, he writes in the Sunday Business Post. He does flesh out two ideas – a flat-rate property tax which could raise €500 million and a reduction in personal credits which could raise €300 million. In the former, someone owning a one-bedroom terraced house would pay the same amount as Denis O’Brien’s crib on Shrewsbury Road. In the latter, an ultra-low paid worker on €9.50 an hour would suffer a tax rise of €14 a week; an income-earner on €100,000 a year or more would suffer a tax rise of . . . €14 a week.

Now you could argue these are deeply inequitable. But as Brian says,

‘ . . we have an urgent need to raise exchequer finance . . . (and) the international bond markets are breathing down our necks.’

Of course, such tax increases as Brian suggests will so hammer demand that tax revenue will dive and unemployment will rise – leaving us little gain (which is one of the reasons why Moody dumped on our bond ratings today: sluggish growth).

So in a helpful spirit I’d like to suggest to Brian that he look to other areas – ones that won’t impact on demand and, so, would yield greater savings to the Exchequer:

First, apply the Health Contribution Levy to rental and dividend income. This would bring in €89 million according to Fine Gael.

Second, apply PRSI and other income levies on capital gains, inheritances and gifts. This could bring in up to €290 million.

Third, apply PRSI to executive share options. This would raise €29 million according to the Commission on Taxation. If share options are exempt from the income and health contribution levy, apply them. This would bring another €29 million or so.

Fourth, remove the employers’ PRSI relief on pension contributions made by employees (currently, employers’ get this relief even though they make no pension contribution themselves). Fine Gael says this could raise €185 million.

Fifth, abolish the PRSI contribution ceiling. This would raise €120 million.

So, five simple proposals that would raise over €700 million. And we haven’t even looked at income tax and business taxes (all those tax breaks that do nothing for the economy but line the pockets of high income groups). All we’ve done is applied a simple proposal – that all income, regardless of source, should be treated the same. No new taxes, No hit on low and average income earners.

So there are easy options. The difficult ones – for the economy and for households – are when you  hit the living standards of those who can least afford it. If you go down that route, all you will end up doing is lengthening the recession into next year.

And give Moody’s another excuse to downgrade our ratings.

IBEC's Spin. The Recession Diaries - July 19th

IBEC has just released a ‘report’ (which Finfact’s Michael Hennigan has described as ‘a marketing brochure’) that highlights the Irish economy’s strengths – educated labour force, low-tax regime, falling prices, etc. They probably released this as an antidote to their previous economic commentary which revised downwards key domestic indicators (GNP, investment, etc.). So, it was time for some upbeat news.

But there’s upbeat. And then there’s spin. Take their section titled ‘International confidence is returning’.

‘Ireland’s decisive and credible action in curbing its deficit has gained recognition in the international markets. This has differentiated Ireland from Greece, Spain and Portugal in financial commentaries.’

Then they produced a chart comparing Ireland’s 10-year spreads with Greece. This, of course, shows Ireland in a positive light. Why wouldn’t it – Greece isn’t even in the markets anymore. But they didn’t show Spain and Portugal which they mention, never mind that other super high-debt peripheral country Italy. On Friday evening, this is how the markets perceived us, using the 10-Year spread (with German bonds)

• Portugal: 2.86
• Ireland: 2.84
• Spain: 1.86
• Italy: 1.48

If they had produced that chart, it would have put the ‘decisive and credible action in curbing its deficit has gained recognition in the international markets’, into a far different perspective.

And on the same day that IBEC produced their international-markets-love-us report, Moody downgraded the Government’s bond rating, citing banking liabilities, weak growth prospects and a substantial increase in the debt to GDP ratio (just to clarify - the reason that growth prospects are weak is because of the Government's 'decisive and credible' deflationary policies).

All this, according to IBEC, is an expression of international affection.  Can't you just feel it?

What Goes Round The Track Goes Off the Track. The Recession Diaries - July 15th

Remember a few months ago, when ICTU proposed postponing the target year for Maastricht compliance to 2017? There was a widespread rending of garments and universal condemnation of this most irresponsible and reckless proposition. I recall an interview with our erstwhile Minister O’Dea who went apoplectic at the idea predicting economic Armageddon and the wrath of the Furies (I stepped away from the radio in case he exploded and I got hit by his bodily shrapnel).

Oh, and now the IMF. In their recent report they projected, under current fiscal policy, when the deficit would come into Maastricht compliance. What year? 2016 or 2017. This didn’t get much prominence. I read the newspapers this morning and not one mention (if I’m mistaken, please let me know). Still, when this becomes known, I wonder what the response will be. Condemnation of the IMF? Exhortations to cut even more (Dan O’Brien wants us to have a go at pensioners)? An apology to ICTU? Guess which response is the most likely.

The IMF’s projection shouldn’t surprise us. A few weeks ago, Ernst & Young / Oxford Economics examined the issue and, on current strategy, projected the deficit wouldn’t come into Maastricht compliance until 2018 or 2019. Indeed, I have not met any economist – regardless of their ideological complexion – who, hand on heart, believes that 2014 is a realistic goal.

One merely has to compare Government and IMF growth projections up to 2015 to understand why 2014 is merely aspirational. IMF estimates growth to be substantially less than what the Government is predicting; in particular, the IMF suggests that GNP growth, or domestic activity, will be nearly half what the Government expects. With limited growth comes lower tax revenue and higher unemployment expenditure: hence, a consistently larger deficit.

Why would growth be so understated? The ESRI is ready with an answer (from the full commentary, not yet available on-line).

‘The impact on the wider economy [of the Government’s planned €3 billion fiscal adjustment] is to reduce the growth rate by approximately one percentage point. In addition, the level of employment is lower and emigration flows higher than in the absence of such a package. These are real costs attached to the programme of fiscal consolidation being pursued by the government.’

Of course, the ESRI feels we should proceed with the deflationary fiscal adjustment regardless. Why? Because we have to reduce the deficit. But is it reducing the deficit? Not really; it is resulting in sluggishly high deficits and higher overall debt levels. But we have to cut the deficit . . . and so we are trapped in a vicious circular argument.

So if we proceed with deflationary spending cuts to cut the deficit we will reduce growth which will, in turn, create higher than anticipated deficits. How can we escape this deflationary-deficit trap?

The first step, in any agenda, is to establish a starting point grounded in the real world. Therefore, it is imperative that we scrap any notion that we can, or should, strive to reach Maastricht compliance by 2014. We should abandon any strategies that are premised on bringing the deficit to below -3 percent by that date. A credible strategy cannot, by definition, have a fantasy as an endpoint. And if that bothers some of you budget fundamentalists, get over it.

And while we’re scrapping the fantasy 2014 target date, let’s remember what the real key to repairing the public finances is: as Clinton might have said, ‘It’s the growth, stupid’.

Economic Common Sense and the Low-Paid. The Recession Diaries - July 8th

Social Justice Ireland has produced a well-argued proposal for refundable tax credits - a long-standing demand to make the tax system more equitable. In essence, as SJI describes it:

‘A refundable tax credit is one where, in the event that the income of an individual is insufficient to use up all of his or her tax credit, the remaining credit is paid to the individual by means of a cash transfer.’

Let explain this by example: Mary earns €15,000 a year. Her gross tax liability is €3,000 (20 percent of her earnings). Her tax credit is €3,600. This offsets any tax liability. But – and this is the key issue behind refundable tax credits – she has €600 of ‘unused’ credits.

A tax credit is, in effect, a cash subsidy – one that is delivered by reducing one’s tax bill. Anyone above the income tax threshold, by definition, uses up all their credits. But those below the income tax threshold don’t. Therefore, they don’t get the full subsidy. What SJI proposes in simplicity itself –return the ‘unused’ portion of the tax credits to the worker in the form of a cash transfer. This is nothing more or less than treating all taxpayers equally.

Such a programme – costing €140 million - would benefit low-income workers and families. SJI estimates that over 113,000 low-income workers would get a refundable tax credit. Of this, 40 percent of the beneficiaries (recipients and dependents) would come from below-poverty line households. The average returned credit would amount to nearly €24 per week – a substantial boost to low-incomes.

SJI rightly poses this proposal in terms of tax justice and social equity. However, there is more: refundable tax credits make economic common-sense. It will increase demand and consumption, raise tax revenues, help protect jobs and boost the GDP. The net effect on the Exchequer will be plus. In other words, this is a great stimulus programme. Let’s churn some numbers with an old friend – the marginal propensity to consume.

We can reasonably assume that low-income earners will consume most of any extra income they receive. Let’s say the marginal propensity to consume (MPC) for low-income earners is 0.75 – that is, they earners spend 75 percent of an extra Euro. If this holds for the entire refundable tax credit, low-income earners will spend €105 million (75 percent of the total cost of €140 million).

There are two positive benefits to this:

• First is the multiplier effect: spending increases businesses cash flow which in turns helps secure jobs. The IMF suggests that ‘targeted transfers’ (to what they call ‘hand-to-mouth’ households) are the second most effective form to boosting economic growth, even if temporary; the first being capital spending.

• Second, the Exchequer – through increased tax revenues.

Conservatively, if we assume that households will spend 75 percent of the refunded tax credit and that of the spend, 12 percent represents indirect taxation as per the ESRI / Combat Poverty Agency, then the Exchequer will receive a boost of €13 million. This, of course, excludes any extra revenue arising from the general boost to GDP growth (business taxes, their purchases arising from increased sales, etc.).

At the other end, if we assume that in the first year GDP will increase by a multiplier of 1.2 (that is, GDP grows by €168 million from the total cost of the refundable tax credit) and further assume that the GDP / tax ratio holds (approximately 30 percent), the Exchequer will benefit by €50 million.

In real life, the boost to revenue will lie somewhere between €13 and €50 million.

So how do we pay for this? It is far, far preferable to pay for such measures – which don’t embed an asset into the economy as would be done with capital spending – out of current resources. But we’re broke! How do we do this? Simple: take money from those who have a low MPC (i.e. high income groups) and give it to people with a high MPC – the IMF’s ‘hand-to-mouth’ households. No borrowing, no fuss.

I have a small suggestion. According to Fine Gael, those who receive income via rental and dividend income are exempt from the Health Contribution Levy. This amounts to a taxpayers’ subsidy worth €89 million. Therefore, remove the subsidy by applying the levy to this income. If we were to apply the 4 percent levy to net capital gains and inheritances, we could raise another €92 million.

These are not ‘soak the rich’ proposals – merely treating all income equally. And it would raise €181 million. This would pay for the refundable tax credit and leave some change over to reduce the deficit (or invest it into a capital spend projects to get people back to work, raise more tax revenue and reduce unemployment costs).

There’s another boost to the economy. By taking money off high-income groups, we are not only reducing the deflationary impact of increased taxes, we may even be reducing import-dense consumer spending. High income groups’ spending is likely to contain more imports. For instance, 76 percent of all hotel expenditure abroad, which helps other economies but not ours, comes from the top 20 percent of households. Those on lower-incomes are likely to spend more on domestically produced products.

So if we take money off high income groups and give it to the low-income groups, not only do we boost economic growth, increase tax revenue – we reduce ‘leakage’ and ensure more of our spending stays in the economy.

All this to say - proposals like the SJI’s refundable tax credit are not only fair, but good for the economy in all sorts of ways. While the Government is dreaming up ways to take more money off the low-paid, we should be working on creative ways to invest in income equality, public services, poverty-reduction, etc. These are not luxuries, these are absolutely essential to a prosperous economy and sustainable growth.

In other words, people and their living standards are not an obstacle to economic growth, they are the solution. When we understand that, we will begin to understand how we get out of this mess.

The The Unbearable Lightness of Economic Ignorance. The Recession Diaries - July 6th

I have to admire those who claim we must bring the low-paid into the tax net. I admire their chutzpah, their audacious willingness to flaunt in public their remarkable ignorance of the tax system. For the low-paid are already in the tax net – big time. Let’s go through the arguments and see if those making these claims are agenda-driven or just badly misinformed.

First, nearly half of all tax revenue comes from indirect taxation – VAT, excise, etc. In 2010, 47 percent of all our tax revenue will come from these sources. Ireland is somewhat unique in the EU for its over-reliance on indirect taxation. In 2008, the latest data year, indirect taxes made up 34 percent of all taxation in other EU-15 countries; in Ireland it made up over 42 percent.

Second, indirect taxes are highly regressive. The ESRI-Combat Poverty Agency found that households on the lowest incomes – the poorest 10 percent – paid over 20 percent of their gross income (social welfare, work income, etc.) on indirect taxation. Households on the highest income – the top 10 percent – paid 9.6 percent. While this data is somewhat dated, the proportions are still relevant; after all, taxes on consumption are regressive throughout the EU and the US.

Let’s pause here for a moment. In our biggest tax revenue stream old age pensioners living alone, lone parents, the unemployed and disabled, casual workers, part-time minimum wage workers pay more than twice the tax ratio as those on the highest income. Hmmm. And yet, we have commentators urging the Government to take the ‘bold, courageous’ decision – and bring the low-paid into the tax net. Hmmm.

But it gets more weird and creepy. A Department of Finance survey found in 2007 that of high-income taxpayers earning up to €500,000:

• One-fifth paid less than 5 percent of their income in income tax
• Over a third paid less than 10 percent

This tax avoidance is due to the proliferation of tax breaks.  We have to be cautious about putting two different studies together (different methodologies, different source data, etc.). However, if only as an exercise, let's combine the ESRI-Combat Poverty Agency study with the Finance survey,  We still find that that the poorest in society pay a higher tax ratio than many making hundreds of thousands of Euros a year. The Government tightened up slightly the ability to avoid tax in the last budget but it will be interesting to see what numbers the next tax survey produces (even so, none of this includes income streams which are exempt such as income from woodlands profits, artists, etc.).

The issue therefore, would seem obvious: how can we bring the highest income earners into the tax net, how can we increase the tax ratios of high income groups above that of the unemployed and the low-paid.

Then there is the economic ignorance of arguing for hitting low income earners – whether that hit comes via increased taxation or reduction in income supports. What happens when you hit such groups? You reduce consumer spending which in turn reduces tax revenue, hits domestic business which in turn reduces payrolls (either laying off staff, cutting hours, cutting wages) which in turn cuts revenue even more while increasing unemployment costs.

Of course, our economic ignoarti don’t get this simple ‘1-1-1 = -1’ equation. They keep shouting for more courage, more boldness, more ‘tough-love’ policies - without the love, of course. And when consumer demand falls by more than 10 times the Eurozone rate, when tax revenue collapses, when employment keeps falling – what is their response? Hole-shovel-dig-more.

So are such policy demands based on misinformation, laziness (looking up facts to back-up one’s argument can be such a drag) or plain ideology? Is there a connection between the demands to ‘bring the low-paid into the tax net’ and the warning that ‘if we tax high-income groups too much they’ll (a) leave the country, (b) go on an investment strike, (c) have a hissy fit, etc.’?

I’ll leave that to you. Whatever the reasons, the demand to increase taxation on the low-paid is a recipe for further bleeding the economy of demand – a low-growth, high-debt future in which unemployment will remain high, poverty will grow and the proceeds of any minimal growth will be concentrated among high income earners.

It’s time we got a bit angry about all this.