Macroeconomic Adjustment and Fiscal Policy in Ireland Post author By Philip Lane Post date November 2, 2009 Here is the background note on this topic that formed the basis for my talk at today’s DEW/UCD Economics Workshop. Categories In Economic Performance, EMU, Fiscal Policy Tags Irish fiscal policy, Irish macroeconomic performance 31 Comments on Macroeconomic Adjustment and Fiscal Policy in Ireland ← The Future of the Public Sector → Mis-Diagnosis 31 replies on “Macroeconomic Adjustment and Fiscal Policy in Ireland” This is frighteningly precise. Krugman argued over the weekend that the stimulus package in the US was insufficient – yet there appears to be no possibility of any form of stimulus package here. What is even more frightening is that the political system here may not be up to tackling what is the equivalent of an ‘economic war footing’ or of projecting and communicating a realistic medium term strategy – and then decisively implementing it. The news to me in it was that estimates of the structural deficit are higher than before. This deficit will not even come close to correcting with whatever “recovery” comes along. For all the talk of tough decisions already made, there are tougher ones ahead. I was about to write this before my prior post about the awful fate of ministerial advisers was deleted so in a spirit of consistency I will continue. @Philip I disagree with little in your paper. It is commendably well written and commendably direct. Some points: 1. Private sector wages in the boom escalated as public sector wages did. Now it is clear that the private sector labour market is not clearing. I believe that data from the CSO is so far showing no fall in private sector wages. Firms are regaining competitiveness by firings not wage reductions. Why not an across the board cut of average 9% on all wages public and private? I propose this seriously. Public sector workers are resistant to another cut. We know that private sector wages are sticky. This is a once in a generation crisis. Everyone knows there was a runaway boom. An average national wage reduction of 9% might stop unemployment of 12% from going to 15% or even 18%. 2. It is going to be exceptionally difficult to combat monopoly power in a downturn. Taxis were deregulated by the courts. Unless our technocracy makes this a national priority little will be done, probably not much in the short term even if they do. All the more reason for options 1 above and 3 and 4 below. 3. The very low effective tax rates paid by many of the rich and their tax breaks are scandalous. I believe in America they may have a minimum rate of tax that must be paid. We must do the same here. 40% would seem more than fair. 4. A once-off wealth tax on the windfall gains of the Celtic Tiger. Many of those it hits will be getting it back through Nama anyway. I think €5 Billion would be appropriate. Taxes on the superwealthy are disliked by right-wingers. Windfall taxes and government wage controls are not usually advocated by economists. However, in an unprecedented situation were public sector wages will have been cut twice, the deficit is over 10% and unemployment is 12% and rising I think the situation more than warrants extraordinary measures. @E76 “I believe that data from the CSO is so far showing no fall in private sector wages” A couple of things on this one 1. 2009 bonuses are likely to be way down on 2008 or non existent. This made up a large percentage of many higher earners wages in the private sector. The effect of this will only be seen in Q4 2009 when bonuses tend to be paid. 2. The level of drop in self employed income should become apparent with the tax take for October when taxes are due. 3. My experience is pay freezes rather than pay cuts are in operation in the private sector and yes the savings are coming in layoffs. But layoffs increase productivity as the remaining staff pick up the slack. Many businesses are less busy anyway. Cutting everyone’s wages doesn’t improve productivity and may have a bigger effect on consumer spending than unemployment as everyone cuts back not just those who lose their job. 4. Staff turnover contributes to lower pay in the private sector. In one place I’m connected with a financial controller left and was replaced by one earning €5k less. You’d like to think the new CEOs of the banks will earn considerably less than their predecessors. 5. I didn’t think public sector wages have been cut – they have to pay more for their pensions but this hit the private sector a few years ago as schemes switched from defined benefit to defined contribution. With DC the employee has to put more in (via AVCs) if they want a reasonable pension. 6. Don’t disagree with you about the tax breaks – no one should pay no tax except the very low paid. We’ll see what they do in the budget. 7. As for a wealth tax good luck finding the money. The tax on second homes is only for Irish ones. An incentive to keep money/invest offshore. @76 It is very dangerous to get data from CSO I got a form from them yesterday and when I rang them the information sought would allow them to provide some statistics for 2007. What good is that? This is the end of 2009. The world has moved on a bit I would have thought. Any trades in the private sector who are trying to sell to the public has had to reduce their wages by at least 40% I am talking about electricians, plumbers, plasterers etc. Wait until the returns go is and you will see a huge hole in taxes from this sector. They will be trying to get tax rebates. If they could reduce their wages and stay employed that would be an achievement in itself. Unfortunately many are just joining the ranks of the unemployed or emigrating. @E76, Pay levels in key internationally traded parts of the private sector did not escalate as the public sector did. Pay in software/IT services fell well behind. The headline numbers in manufacturing make it look like pay escalated strongly, but there was a big shift in the composition of the workforce towards higher paid/skilled categories. When one discounts for this by looking instead at pay trends within occupational groups, one can see that pay in manufacturing actually fell behind, although not as badly as in software/IT services. I put together some numbers on it a while ago, which are here: http://congregg.wordpress.com/2009/08/20/its-not-just-public-versus-private-its-traded-versus-non-traded/#more-132 I understand that David Blanchflower gave an interesting talk yesterday. Is it likely that discussion will take place on his contribution in this forum? @ E76/Stuart quick example of the organisation i work for: – employees in my individual section down 19% vs 18mths ago. – wages ex bonus down around 25% as a result in my section – pay freeze for all who are still employed here – bonus in my section cut in half despite y-o-y income growth, so my gross pay will be down 15% y-o-y. – total organisation income likely to be down 5% y-o-y but expenditure down 10%, so operating profit up 6%. Don’t know if anyone saw the Frontline on RTE last night? They had a tax specialist on who worked out that if you wanted to raise €4bn through the income tax system, you’d have to create a rate of 75% for all those earning over 75k. This would not mean individual people, but individual tax units, which in most cases would be a married couple. So, to quote the example used last night, a garda and a nurse who are married would almost certainly be paying some tax at 75%. Do these count as the super wealthy?? And all so we can maintain public sector pay and benefits. Philip, You understandably give emphasis to the market for our Sovereign debt. This begs a couple of questions: 1) Where would our spread (10-Yr over Germany, for example) likely be if our banks weren’t buying 30% of our Bond issues? 2) Flush with NAMA funds, won’t this buying power be boosted to the extent that our ‘determined’ government won’t have to overly concern themselves with the debt market anytime soon? Possibly all the way until the sunny uplands of renewed growth (2011?) rescue all?? @Vincent Yeah, the deafening silence on this blog about the Blanchflower contribution yesterday speaks volumes, doesn’t it? “Pay no attention to that man over there….” But of course the likes of Blanchflower and Stieglitz couldn’t possibly know what they’re talking about because “Ireland’s different.” @Stuart The private sector emphasis on pay freezes and firings instead of pay cust may be increasing productivity at organizational level but it is not increasing productivity at a national level and is in fact costing the exchequer far more. The unemployed don’t pay taxes and have to be paid from the ever dwindling tax revenues. @Ernie: I agree with you. @ Ernie i might be in favour of directing government funds into productive job creation/protection schemes in the private sector, i just think creating/maintaining permanently unproductive and overpaid roles in the public sector, or boosting disincentives to get off social welfare, are not the best use of these funds. @Eoin Have you considered a tax on poverty? You know, to provide an extra incentive to get off social welfare? @Garo Are we suggesting some sort of centralised economy where the government tells businesses what to do – can’t lay anyone off, must cut wages across the board. We’ll get like the old Soviet Union where everyone was employed but productivity was very poor. Basically businesses get leaner, makes them more competitive, they win more business and have to take on more people again. On taxes if everyone takes a pay cut of 9% as E76 suggests the government loses the income tax on that 9% at the higher rate. Lets say you employ 10 people on €40k. Payroll is €440k (inc employer PRSI). Assuming the employees are all single they pay €5k in tax and €3k in levies. Total income to revenue is (8*€8k+40k emp PRSI)= €104k Business fires 1 and saves €44k and initiates pay freeze. Tax effect is to reduce by €8k + €4k emp PRSI= €12k for fired employee Unemployment benefit = €288 for a single person inc allowances according to website I looked up. Cost to state is €15k. Laying off person costs state €27k Reducing everyones pay by €4k * 10 reduces tax for each person by €1.5k. Reduction in tax is 10*€1.5k + €4k emp PRSI = €19k Net benefit to state is €27k – €19k = €8k. So yes it costs the state more for someone being laid off than paycuts. Still can’t see how it can be enforced. Perhaps the €8k differential or €800 per employee could be used as incentive in some way. @ Ernie super contribution as always Ernie. Very level headed. Father of three, married, single earner, with a mortgage, loses his job. Total welfare entitlements? €38,888 (give or take). Gross wage required to clear this in net terms? Roughly €47k. And this doesn’t take into account the indirect costs of employment (travel, clothes). So this guy needs something close to €50k, US$75k, or almost 1.5 times the average industrial wage, to make it worth his while to come off social welfare. Does this not strike you as somewhat insane and a huge disincentive to finding a job? But hey, as long as you think of us as crackpots and ultra-right-wingers trying to destroy the public sector via class warfare, then who cares right? @Stuart: I did not advocate government interventions. Businesses should be free to hire and fire as they please. All I was pointing out was that there is a negative revenue consequence to firing someone and ultimately we all have to pay a price through increased tax rates down the road. By the way, I read in this morning’s paper that union bosses also think that cutting public sector numbers will be necessary. Again, we will all pay for this through higher taxes. @ Garo “By the way, I read in this morning’s paper that union bosses also think that cutting public sector numbers will be necessary. Again, we will all pay for this through higher taxes.” Huh? Someone in public service earns 50k, married, single income family. Total cost to taxpayer including pension provisioning, 60k? Pays total tax (PAYE, PRSI and Income Levy) of 7,715. Pays pension levy of 1,992 after deductions. So net cost to the taxpayer of 60,000 – 9,706 = 50,293.75. Cost of social welfare = 20k? (not sure what the exact entitlements would be?) Either way, net saving for the taxpayer of 25-30k+ or so. How can you assert that “we all pay for this through higher taxes”? @Eoin Can you clarify the composition of your €38,888 calculation? @ Ronnie of course. It’s a very particular, but the maths apparently stacks up. Supplementary welfare allowance €23,083 Mortgage interest supplement €14,400 (nobody seems to know about this) Back to school and footwear payment of €905 Medical card €500 (value of) All of these are tax free. I assume this doesn’t include child benefit either (which he’s always entitled to, but counts as another social transfer). What about fuel allowance? Anything else? http://www.feargalquinn.ie/index.php/News/Seanad-Contributions/Social-Welfare-and-Pensions-Bill-2009 @Eoin, By taking extreme levels you are distorting the picture. For example, the rate you have chosen for the mortgage interest supplement seems to be incredibly high. It seems to be based on (and please correct me): Someone who lives in Dublin; Has a mortgage the guts of €500k; Has no appreciable income from other sources; Has no capital (e.g. redundancy payments); From the revised estimates for public services, the total expected cost of this supplement in 2009 is €40m, or 0.5% of the total SW bill, or one-tenth of the rent allowance, which gives it its true (lack of) importance. To say that someone needs to earn €50k to ‘break-even’ in this country is a distortion of the true picture. Mathematically, you may be right, though your example applies to 0.01% of the population. @ Ronnie yes, very extreme example, though in our very extreme economic situation i think it’s at least worthy of discussion. It was not an attempt to distort or paint as the average. My point was that suggesting cuts in social welfare is not akin to a “tax on poverty” (per Ernie) and that some social welfare entitlements may be disincentivising returning to some form of employment. How many couples with a few kids are going to find themselves without an income over the next year? What will the average net entitlement to them be? Unless these guys can find themselves decent paying jobs they’ll be better off staying on social welfare. It’s also a useful example of how big our welfare state is becoming at a time of rising unemployment, much of which will be long term, and that social transfers to married couples with children, whether employed or not, are already enourmously generous by most measures. 80% of government expenditure (and so 120% or so of government revenue) goes on either public sector wages or social welfare. To deny that these need to be cut back seems to ducking the problem. For the record, i’d far prefer the remedial actions to involve the following: – large cuts in public sector wages – small cuts in social welfare combined with allowing people work part time without hurting their entitlements – increased govt expenditure on job creation/protection in the private sector for long term productive employment. @Eoin/Stuart Everyone in the private sector is disputing the data from the CSO and saying well in my business…. Everyone in the public sector is disputing the data from the CSO and saying when you take account of this…. But what is not in doubt is the 12% on the dole queues. I am proposing a very blunt instrument. I am not turning us into the Soviet Union. In fact I fully support Philip’s call for deregulation and cartel smashing. I also fully support the reduction of the deficit, although I would warn that trying to reduce it too fast and not focusing on the structural deficit could be very damaging. In the medium-term it is up to the voters to decide if we want to be closer to Boston or Berlin. But in the short-term we are in a war. We should take the actions needed to resolve our problems now. Whether they are left-wing or right-wing is unimportant. What matters is that in the short-term they make us competitive, lower unemployment and reduce our deficit. The wage reduction would be a once-off measure and should be followed by several years of wage restraint. I am not making the suggestion as part of the NAMA debate, but I would point out that putting a floor under the property market is a giant statist measure, that will also keep our costs high. As Philip has stated private sector wages need to come down. Without state intervention this will be done slowly and with unemployment at 12% or more for several years. Many of those who welcomed East European immigration are now hoping out loud that those who came to build their lives here will return en masse. Maybe they will, but I don’t regard that as an optimal solution either. If Britain had “encouraged” Irish immigrants to leave during their recession we would have been appalled. We need to start discussing private sector wages cuts. @ E76 the private sector will, eventually, automatically correct for excesses in a particular industry. It can’t run at a loss for more than a couple of years (less in most cases) before it is faced with a do-or-die decision. We’ve already seen the unemployment leg of this, and i’d argue that we are currently seeing the lower-pay leg at the moment, and which will be very evident in the end of year figures in light of the bonus issue that Stuart noted. The problem i have with the public sector is that the Unions are currently asking for their adjustment phase to last a decade (2007-2017), and paid for by Joe Taxpayer. @Eoin The private sector will eventually correct but there is a strong risk that 10% unemployment will become the new normality. And while we wait for the correction if the East Europeans don’t shove off in huge numbers, the international recovery is weak and other people cut corporation taxes we will be toasted. Time to declare war. @E76 “We need to start discussing private sector wages cuts.” I’m with Eoin on this one, the private sector will correct itself or go out of business. Stage 1 is job losses. If you employ 20 people and your business is 20% down in simple terms you lay off 4 people. Unless your staff have some level of skills that you will find hard to reproduce in a few years time you’re not going to keep them on twiddling their thumbs on lower pay. I have seen some use short time working to keep everyone on board. Stage 2 You get to the bare minimum of people you need to run the business. Now you cut pay if need be. Stage 3 You go out of business if 1 & 2 don’t work. The difference with the public sector is basically it can’t go out of business, the government effectively calls on the tax payer/borrows for the extra cash (until some outside agency shouts stop). There is not the same urgency as the private sector to take corrective action. Not sure how you would police a workforce wide pay cut anyway. What would you do if someone broke the rules? In the boom most businesses ignored all the various pay deals, they were seen as the starting point. @Stuart The private sector will eventually correct – but you’ve probably heard the line about us all being dead in the long-run. Once unemployment goes up and stays up it can be very hard to get down again. 10% becomes normal. Wages were regulated generally in the 70s and through social parthership through to the present day. If IBEC and ISME agree – and I think they would – that would leave the unions, who are trying to sell a double cut in public sector wages. As part of a national pay cut I think they would come on board. Owners and shareholders generally would agree. Top managers maybe not, or just for the staff – you saw what they did to the banks so we know where they are coming from. But I think they would grit their teeth too. If our establishment had done even minimal preparation after entering the Euro for big sterling declines all national wage agreements etc would have included a clause cutting wages automatically when this happened. We need to start including these clauses while we continue to diversify our exports. Private sector wage cuts are needed now, or it’s mass unemployment for the indefinite future. @ E76 there’s a difference between a social partnership agreement on wage cuts, and the “state intervention” and “declaration of war” that you originally suggested up above. I’m not against the national wage agreements in principle, though i would argue that it could prove counter productive in terms of attracting/keeping highly skilled staff in certain industries. We could possibly overcome this via very focused personal tax relief for certain industries or skillsets, as is used in Spain and Denmark among other countries. @Eoin On further reflection I can’t see ISME and IBEC having many objections. ISME will want 15%. But to workers an average 9% across the board will seem draconian. Given the difficulties we face I think using the analogy of a war is appropriate. And if the state needs extra legal powers to make the cut then so be it. @E76 I still don’t see how you impose a wage cut across all sectors. You have an inspectorate that goes in and fines companies for not cutting wages? I repeat you don’t improve productivity by keeping everyone on at lower wages. If the work is not there you let people go. Don’t forget employing people is more than just what you pay them. There are a whole host of ancillary costs associated with employing people – canteen, uniform, pension, telephone, IT equipment, insurance (employer’s liability is based on salaries), expenses and most of all space. If the government lets go 17,000 employees think of the space they don’t need. Keep them all on at lower pay and you keep all the ancillary costs. We need to face reality sooner rather than later. If taxes are back to 2003 levels then expenditure has to at least head back to those levels too allowing for a lift in the next year or two. This is the same for private business as well as the public sector. I can assure you the private sector is moving there at a fast pace. Take just one company (who I used to work for), Grafton Group. They have cut overheads like for like by €33m in the first 6 months of this year versus the first 6 months of last year (as per interim report). Most of this will be in employee numbers. Another company I am advising will have moved their payroll costs back to 2004 levels in 2010. Their income will have dropped to 2004 levels too. Check any of Ireland’s PLCs and it will be the same story. The SME sector can afford even less time to act, they don’t have the reserves or access to funds PLCs have. What is interesting is there are still jobs out there. In the last year quite a few people I know have lost their jobs, all found jobs probably at lower pay. These are pretty qualified, a couple of chartered accountants among them. I for one have no faith in the State, IBEC, ICTU or ISME deciding what’s best for the businesses in this country. If a business is making money and giving its employees raises good luck to them. If they need to save costs then the business will know the best way to do it and when to do it. @Stuart Blythman Lets ask IBEC and ISME. Many firms will be delighted. Wages never correct quickly enough, and after the multiple economic shocks we have suffered and the fiscal retrenchment we are embarking on it will take many years, during which the economy may have adjusted to a permanently higher level of unemployment. This is what has happened in France. They have structural unemployment of about 10% i.e. it never goes much below that. After our mismanagement in the eighties we were stuck with unemployment of 15% or more for many years. Private sector wages are too high for our present level of prosperity. They will eventually adjust downwards. But as they were artifically inflated by a credit bubble we will now have to artifically bring them down. Or just get used to mass unemployment. Or hope all the East Europeans and many of the builders leave. That I am afraid is the traditional establishment solution. @ E76 what i find bizarre is that at no point have you really addressed the expenditure side of this problem. You want to increase taxes significantly and reduce wages significantly, but this, by itself, is only going to worsen the economic picture. At no point do you suggest what sort of expendiutre cuts you think may be warranted, if any at all. You’re actually more one sided than what most of the Unions are suggesting. Comments are closed.