Month: December 2009

Tax Deductibility of the Pension Levy

Eilis Quinlan of ISME has been at it again. On the Last Word on Today FM this evening, she again said that it was a mistake to say the public sector pension levy was a pay cut. The key argument she produced as to why the reduction in net take home pay related to the levy was a pension contribution rather than a pay cut was that it was tax deductible, just like other pension contributions.

Let’s think about this for a second. Consider a worker on €50,000 facing a 20% marginal tax rate. Now the government introduces a pension levy that see her gross pay reduce by €3,000. The pension levy isn’t taxed, so the worker now has a taxable income of €47,000. Consider the alternative in which her pay is cut by €3,000. In this case, the worker also has taxable income of €47,000.

So, in either case, whether it’s a pay cut or a “tax deductible” pension contribution, the worker has the same level of taxable income—the pension levy may be tax deductible but the government also can’t tax salary that a worker hasn’t been paid.

In other words, from the point of view of the worker’s take-home pay, the pension levy is identical to a pay cut. Now, of course, there are reasons why various tax breaks exist to encourage people to make pension contributions: The government wants to encourage people to put additional money aside to build up their pension entitlements. But, of course, the payment of the “pension levy” doesn’t add a cent to public sector worker’s pension entitlements.

To recap, the fact that the pension levy was tax deductible doesn’t make it different from a pay cut. It makes it exactly like a pay cut. And the fact that it doesn’t add to pension entitlements means that it has all the features of a pay cut and none of the features of a pension contribution.

To be honest, I don’t see how it serves the interests of the hard-pressed small and medium-sized businesses of Ireland to have the Chairman of their representative organisation continually making provative and misleading statements that only serve to upset thousands of public sector workers that have experienced very significant losses in take-home pay.

UK Pre-Budget Report

Proof we’re not alone on the fiscal crisis front: The UK Pre-Budget report. The UK government plans to reduce its deficit from 12.6 percent this year to 12 percent next year and then gradually to 4.4 percent in 2014-15. One highlight of the statement: An immediate 50% supertax on bankers’ bonuses paid between now and April. Bankers, apparently, are furious and were seen crying into their Dom Perignon all over the City of London.

Budget 2010: Welfare Cuts

The idea that social welfare recipients should take cuts is normally considered politically unacceptable. I have mixed feelings about the measures taken today.

On the one hand, when one looks at measures not taken (whatever legal reasons there may be) such as the failure to cut pensions for retired public sector workers (traditionally linked to pay levels which have now been cut) and the failure to freeze public sector increments, as well as measures taken such as the VAT and excise cuts (costing €257 million on a full year basis) and the range of dubious so-called stimulus measures (vouchers for cheap rail travel for senior citizens visiting Ireland from abroad?) one could conclude that these cuts were avoidable.

On the other hand, against a background of significant deflation and with wage rates falling and the potential for serious poverty traps (where people are better off unemployed than in low-paid jobs), one can argue that cuts in unemployment benefits may unfortunately be a necessary part of any policy mix aimed at limiting unemployment over the next few years. (This particular argument does not apply, however, to disability or carer’s allowances). Moreover, with social welfare spending taking up such a large share of total expenditure, it was not realistic to draw a line in the sand and declare it to be off limits.

As an economist, I can manage to hold both sets of opinions at once.

Budget 2010: Public Sector Pay

The government has cut public sector pay in the budget. A description of these cuts is available on page 27 of this document.

Pay has been cut by 5 percent for low earners gradually rising up to 8 percent for those earning €125,000. The cuts stay at 8 percent between €125,000 and €165,000 and €175,000. Those earning between €175,000 and €200,000 have cuts of 12 percent and those earning over €200,000 have cuts of 15 percent. An Taoiseach Brian Cowen gets a special cut of 20 percent.

Annex A of the document linked to above also described the cumulative cuts for different classes of workers, including public sector workers. To give one example, a public sector worker earning €75,000 in a one-income household with two children over 6 years of age has had a total reduction in net pay since last year’s budget of 18.2%. The comparable figure for a similar couple in the private sector was 5.4%.

I know there are many who will feel that these cuts have been too extreme. More interesting, I guess, is whether those who favoured cuts in public sector pay now think that this is enough or think that the government should come back and cut public pay some more.

Budget 2010: Stimulus

The budget contains some measures that have been advertised as stimulus. The opposition parties will certainly argue that these measures didn’t go far enough.

I’ll take a contrary attitude here. All the parties put forward plans in which the net fiscal adjustment was about €4 billion so the fact is that all parties are agreed that the overall macroeconomic effect of the budget needed to be contractionary. It’s easy to paint a budget that has €5 billion in spending cuts and €1 billion in new spending initative as “having stimulus” and a budget with €4 billion in spending cuts and no new initatives as being “devoid of stimulus”.

The reality is that, by and large, these two hypothetical budgets will have the same effect. Of course, one can always argue that some types of tax cuts or spending increases are particularly stimulatory and that one can think of a better mix than the government put forward. But, by and large, this is a secondary issue to the principal one related to the overall macroeconomic stance.

My contrary attitude extends to the government’s own limited stimulus measures. The idea that the the half percentage point increase in the VAT rate triggered an huge increases in cross-border shopping was always ridiculous: See two articles from the early days of this blog by current adviser to the Minister for Finance and former blog alum Alan Ahearne (back then blog posts were written in the third person apparently!) and a later crankier post by me.

To my mind, cutting the VAT rate is just a kneejerk response to a wildly inaccurate public perception based on a desire to be seen to be doing something “positive”. Cutting excise duties on alcohol similarly won’t do much to reduce cross-border shopping. I wouldn’t care much if these were measures that didn’t give up much revenue. However, the summary of budget measures shows that these two decisions alone will cost €257 million on a full-year basis. For comparison, the cuts in child benefit will save €220 million.

And, of course, I never liked the scrappage idea. And I still don’t.