Improving the fiscal tradeoff

I apologise for yet another post on fiscal policy.  But it is better to err on the side of too much with crunch-time less than two weeks away.  I sense wide agreement on the two most pressing goals for the April 7 budget: minimise the contractionary impulse; and maximise the positive impact on creditworthiness.   Unfortunately, these goals tend to pull apart in terms of their implications for the optimal size of the adjustment.   I read much of the recent fiscal-related discussion on the blog as exploring ways to lessen this tradeoff.  It seems worthwhile to gather a number of the ideas together. 

(1)  Emphasise Type-1 adjustment (wage bill and transfer reductions) over Type-2 adjustment (tax increases and deferrals of positive net-benefit capital projects.  The international evidence (and arguably Ireland’s own experience) shows that Type-1 adjustments are better sustained and less contractionary.  This would allow either a smaller overall adjustment for any given target for creditworthiness, or a greater boost to creditworthiness for any given size of adjustment. 

(2)  Front-load certain structural deficit reduction measures but combine them with a temporary stabilisation offset.   Take immediate actions to lower the structural deficit to boost credibility.   Such actions could include increases in income tax rates or decreases in public-sector wages.   Combine these measures with explicitly temporary stimulus measures.   Possible measures include temporary reductions in VAT rates (which should move some expenditure forward in time) or temporary reductions in employer PRSI rates. 

(3) Pre-announce detailed plans for back-loaded structural deficit reduction measures.  In a post some time back I advocated a degree of “constructive ambiguity” on the details of out-year plans to raise taxes and cut spending.  I was rightly chastised for this economics heresy.   A detailed plan is critical to the credibility of the programme.  (I now put my hopes in liquidity constraints rather than myopia to lessen the contractionary effects of lower expected after-tax/benefit incomes.) 

(4) Reform fiscal institutions to enhance the credibility of future deficit reduction.   In general, credibility is improved by emphasising fiscal rules over annual discretion.   (An example would be a requirement to keep the pension system in balance over a long-time horizon.   Imbalances would require currently legislated actions such as indexing retirement age to longevity.)  It would also help to move to a system of multi-annual budgets. 

(5) Introduce a notional defined contribution (NDC) pension pillar.   This provides a long-lasting revenue injection with relatively benign demand- and supply-side effects.   Properly designed, it would not add to long-term fiscal imbalances.   It also meets a pre-existing need to improve retirement income security.   It should be a valuable component of an overall package from a union perspective.

(6) Formulate the plan in terms of a revised Stability Programme for the European Commission.  The plan should focus on achieving a 3 percent target for the structural deficit by 2013.   A focus on the structural deficit allows for a more politically robust programme and thereby enhances credibility.   It would also help to signal that the government takes its obligations under the SGP very seriously.

5 thoughts on “Improving the fiscal tradeoff”

  1. Regarding credibility of backloaded measures, I think the minister for finance (if not the Taoiseach) could contribute here by pledging their resignation if some clearly defined targets aren’t met at some clearly defined points over the next few years.

  2. “Emphasise Type-1 adjustment (wage bill and transfer reductions) over Type-2 adjustment (tax increases and deferrals of positive net-benefit capital projects.”

    Translated into Red Top Speak: cut the payments to single mothers, pensioners and other journo friendly poverty sectors to put money into the pockets of CRH, Treasury Holdings, Veolia and GAMA Construction. Hard to see how the government isn’t all over it really. Totally agree with you though 🙂

  3. @Mark
    Well said!

    @John
    The NDC is a good idea. As the private sector is in withdrawal and state socialism is in vogue, paying CRH et al, aka Ansbacher, via this mechanism will help appearances.
    The SCALE of the problem however, dwarfs the ability of the government to act as it lacks all credibility. 20% pay reductions are an idea. But ti is all too small, too late. Integrity is a valuable commodity but it can only be sold a few times and then the price drops totally. Given the hotel vacancies, do we need new hospitals? Once we can afford one the other will have become more expensive. Think MV Atlantic Conveyor as aircraft carrier? REAL structural thinking never seems to come from economists, just mealy words to aid the pollie who needs to pay off a contributor?

  4. It’s all nice in theory to say this is what should be done, but the problem we’re also dealing with is a government incapable of competence, and potentially worse, one that is malevolently seeing to protect certain friends and interest groups. As Dan O’ Brien has implied the greatest obstacle to recovery is the current government. I have no faith in a government that believes in a pyramid scheme style property economy, I expect they will fail and April 7th will be another car crash.

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