What Should The Government Do? Post author By Philip Lane Post date April 1, 2009 Ciaran O’Hagan gives his opinion here. Drawing on a contribution by Patrick Honohan on this blog, Vincent Browne gives his opinion here. Categories In Fiscal Policy Tags Irish budget 7 Comments on What Should The Government Do? ← Credit card sales → An aside on the term ‘macro’ 7 replies on “What Should The Government Do?” Mr. Gill of S&P may have overstepped the mark when discussing S&P’s downgrading of Ireland’s sovereign debt on a radio interview by mentioning the requirement for “new faces at the Cabinet table”, but the reflexive Irish response to shoot the messenger, in particular, a “foreign” messenger is entirely unhelpful. The section or division within S&P (and those within other ratings agencies) that rated securitised packages containing dodgy mortgages as AAA bears considerable responsibility for the current toxic asset problem, but this does not mean that the sections within S&P that rate sovereign debt or the credit-worthiness of businesses are equally negligent, conflicted or imcompetent. In fact, to the contrary, the ratings agencies, mindful of their reputations, have taken steps to improve governance and quality control. What is equally unhelpful – though not uniquely Irish, it has become a standard line of attack (or defence) – is the tendency, when confronted with a reasoned argument, to pick on one minor factual inaccuracy or an aside to the main argument that may not be fully substantiated or justified and to seek to use this as justification to ignore, reject or demolish the entire case without giving it any further consideration. We have evidence of both with regard to this incident. I must confess I have been surprised and disappointed to see evidence of both in some threads on this site. We are better than that; and need to be better. Sometimes one has to be outside of Ireland looking in to gain some appreciation of what external assessors see. For them the facts of the case look pretty damning. As external conditions turn malign, they see a government overwhelmed by the impact of the wrong-headed fiscal policies it and its two predecessors pursued. They see a panicked response to a major banking crisis, a sequence of inept attempts to restore some fiscal stability, a naive faith in the co-operation of unelected “social partners” to sell harsh medicine to the general public, a continued unravelling of the credibility of the banking and financial regulation system, a seriously underfunded national recovery plan (“The Smart Economy”) and a Jesuitical attempt to focus on a lower, but definitionally difficult-to-quantify, “structural” deficit while, all the time, the economic and fiscal situation deteriorates at a rate of knots. Though it may have been wiser to keep them to themselves, should there be any surprise that S&P harbours doubts about the ability of this Government to begin to resolve these multiple crises? Nevertheless, irrespective of wthat opinion polls might indicate, this Government has a legitimate democratic mandate to take effective measures to tackle these multiple crises. The more, and more quickly, extremely harsh medicine in terms of tax increases and public expenditure cutbacks are implemented on April 7, the more rapid will be the recovery. However, it is equally, if not more, important for these measures to be accompanied by a major stimulus on the capital expenditure front. To continue the medical metaphor, admistering extremely harsh medicine without an accompanying nutritious diet and recuperation regime could kill the patient. The Government would be well advised to give serious consideration to Fine Gael’s stimulus plan. It is the only alternative available that has considerable support in the Oireachtas. Although both plans target similar areas, as pointed out above, the Government’s plan is seriously underfunded. In contrast, Fine Gael proposes to take expenditure and funding off the Government balance sheet, to increase both expenditure and funding and, while the banking system remains clogged, to tap into non-banking sector savings in pension and other funds. A key feature of Fine Gael’s plan is the reform and restructuring of the semi-state (and local authority) energy, communications, IT and water service activities. The current policy and regulatory arrangements, particularly in the energy sector, are damaging and dysfunctional. Based on data and information published by the CER, the ESB and BGE, I have made a preliminary estimate that, since the establishment of regulation to the end of 2008, Irish gas and electricity consumers have paid almost €4 billion more than they would have if rational energy and regulatory policies had been implemented. The detrimental impact on household and business budgets – and on Ireland’s international competitiveness – should be obvious. For obvious political reasons, Fine Gael is coy about privatisation, but leaves this open as a medium-term option for some semi-states. Fine Gael’s proposal to vest the semi-states in the relevant sectors in a new over-arching semi-state authority is a necessary first step. It will bring them to heel and allow necessary restructuring and recapitalisation, but it should be accompanied by plans to sell-off restructured portions of these businesses. In particular, for the energy sector, this would be in line with emerging EU primary legislation. The proceeds would replenish the NPRF and fund further critical infrastructure investment. It would also give a clear signal to international capital markets that Ireland is serious about getting its house in order. Is any of this likely to happen? I’m too long in the tooth to be optimistic. I fear we are in for a more savage repeat of the lost GUBU decade from ’77 to ’87. Perhaps Vincent Browne should read Hayek’s ‘The Road to Serfdom’ given that he is so offended by inequality. Inequality is a function of freedom, the freedom to trade, the freedom to work, the freedom to engage in business, the freedom to walk away and bargain elsewhere. If prices (or fees or wages) are high, this is because certain goods or services are scarce. This is a fact of life. If we interfere we are taking a particular view that a specific group or groups deserve to be paid more or less than the market dictates, or in Vincent’s world, in return for no work whatsoever. The chances of getting agreement on who gets what are, of course, slim but the cost to freedom is high. Better to let people choose for themselves in the market place. It is not a coincidence that societies with high levels of individual liberty are also prosperous and well functioning societies if unequal. In Vincent’s socialist world someone must decide who gets paid what, and not by the voluntary agreement found in markets, and this person is the dictator. With regards Ciaran O’Hagan’s article, unfortunately the effects of S&P and other rating agencies actions are far more loosely correlated to overall market perceptions than is indicated. The actual impact of S&P’s downgrade was minimal, to the most extent the market had already downgraded Ireland. As such, given the markets willingness to drop Ireland before the rating agencies, there is reason to suggest pleasing the agencies may not have the desired effect on borrowing costs. Frankly, I believe its clear that the market is being overly pessimistic with regard Ireland’s prospects, a 2-3% risk premium over German bunds far surpasses the real risk of a default given the externalities associated with it. Today a number of institutions recommended Irish bonds as ‘buys’ which reflects this anomaly quite well. With regard Vincent Browne’s article its hard to know where to begin in terms of its worrying contents. The knee jerk reactions for vertical equity ignore: the deficiencies in the equity statistics, the great opportunity costs of much of this wealth (less time with kids, long commutes etc.), the current great reliance on high earners for income revenues and their procyclicality and other factors too numerous to mention here. Clearly a 48% higher rate is not without merit but this must be accompanied by a widening of the tax base to achieve the kinds of returns necessary. As for the text message tax it is not only inequitable, inefficient but clearly not researched. I am not sure what kind of “social bad” a text is that it causes harm greater than a phone call and as such warrants greater taxation than the current VAT rate. Clearly texts and calls are highly substitutable and the revenue generated would as such be small, with a great deadweight loss. Lastly, I suspect that Vincent Browne is unaware that the overwhelming majority of text messages are provided as no MC to the user either because of bundling or offers such as “free texts if you top up 20e per month…” as such it would be impossible to implement!! Another gloomy article here http://www.independent.co.uk/opinion/commentators/sean-ogrady-next-stop-in-the-crisis-could-be-the-collapse-of-the-euro-1658937.html from the Indie, managing to drag An Taoiseach’s underpants in to a discussion of the euro Just to clarify… the Ciaran above is not me. I do judge a hefty level of income distribution as merited, requiring the heavy hand of the tax collector. Yes the actual impact of S&P’s downgrade was minimal on the day. Keeping your doctor please will not cure you per se. But taking his/her medicine just might. The 2-3% risk premium does not reflect just the risks on Ireland. It reflects the cumulative risk on Ireland, or circumstance ELSEWHERE, that could push Ireland over the cliff. It is the cumulative sum of many low probability events… e.g. a blowup in some other member state could conceivably lead to a sharp change in policies in Ireland. I would be far more worried about some external situations forcing Ireland into a catastrophic adjustment, rather than fear policy or political mismanagement within Ireland leading to such an outcome. The risk of an externally imposed catastrophy can be reduced by getting the government balance sheet more in order now. The 2-3% risk premium by the way is far more outlandish if expressed in breakeven terms on short-dated fixed income securities. These can only loose money in relative terms if matters do actually get much worse. Paul – don’t know who you might be, but very well written ideas ! The real question will be of course how the government proceeds next Tuesday. My expectation is that they will waste a one-time only opportunity to tackle the ridiculously high social welfare budget by slashing payments to levels which reflect lower cost of living and our closest neighbours such as the UK. Decreasing even more the incentive to work. We simply can longer afford our gold-plated social welfare payouts. The Government will instead (of course) target the middle income group > €30k and the so called ‘fat cats’ earning more the 100k i.e. those whose voice is not represented on the streets! On top of doubling the levies and not dealing with social welfare, the morons in government will also abolish +/or introduce the following: (a)the DIRT rate 23% ceiling removed i.e. make it subject to income tax (bye bye billions of savings!!!) not to mention it wont actually raise any money as rates collapse and returns are made in Nov 2010 – but it will scare the big money overseas. (b) The PRSI ceiling lifted – hitting the middle/upper income bracket with a stealth 4% tax on top of levies up to 6% – Bye Bye wealth creators, entrepreneurs and prospective international employers (c) means test or limit child care allowances (this I agree with BUT not combined with the other hits on the middle/upper income bracket!! (d) announce property tax on private residence for next year: this is the most insane of all so it warrants further analysis: We have plenty of evidence from our pre-98 property tax days – it was a disaster which produced no net income. AND I believe if any attempt to re-introduce this it will be a spectacular failure – do we honestly think people who paid huge stamp duty and saddled with big management fees and mortgage costs will do their patriotic duty and pay? short answer is NO!!! This property tax will cost too much to collect; it will be political dynamite – up for abolition at every election. Contrary to David McWilliam’s view that it is not a tax on work and therefore should be pursued I would strongly disagree. For instance who does he think would be asked be pay such a tax? those who are jobless, NO; those on pensions, NO; those on low incomes NO: those on middle to high incomes YES; so in fact it would be yet another tax on work NOT to mention further damaging the already crippled property sector. Which by the way we own through our guarantee of the banking system. The time to consider this type of annual property tax is (if ever) only when we see clear signs of recovery so it can be truly counter-cyclical, but not beforehand. (e) water rates for next year – I agree with this and have no choice anyway EU requirement (f) reduce tax breaks on redundancy payments (excusing it by saying it will only affect to ‘rich’ i.e. payments above €100k – of course these unfortunates wont be rich for long as there aint any jobs left and the banks will want this €100k to payback loans/mortgages etc. (g) and of course the unexpected sneaky option – which will be designed to keep the Vincent Browne and Fintan O’Toole’s of this world happy. As for me and many others I will be looking at every way for me and my 30 colleagues to leave this sinking island – possibly the UK or Holland – if my dire expectations of left leaning, populous, lost opportunity budget prove correct! Slan KARL: I have to say I understand the pessimism, and I agree to an extent, but there are some spectacular clangers in your predictions, such as grossing up DIRT and removing some of tax benefits on redundancy. Although who knows how stupid they will be given the record of all our politicians so far. Like you I think a property tax is unworkable for many of the reasons you highlight – the problem is we are in the minority. Perhaps building it into water rates might work or be more palatable? You have main one central prediction which is spot-on and that is FF and its new trade union buddies will take aim on the better paid jobs – all done under the badge of fairness. This strategy will fail and it will ultimately backfire on the very group they say they are protecting. Rational economics will be kicked out the window in favour of good old fashioned raw politics. Lenihan, just like his rivals would (especially Burton), will always pluck the birds that squeal the least – regardless of the financial consequences. Like you, if this budget is as bad as we fear I will be canvassing my masters in the US for relocation AND I FEAR I WILL HAVE TO JOIN A BIG QUEUE! Comments are closed.