Despite all the focus in the past few days on 2014 and European Commission, the key issue facing us right now is the how to convince sovereign bond markets that we are back on a stable fiscal path. Without access to the bond markets, you can be sure that the EU will be imposing the 3% target on us whether we like it or not.
Last December, the government told the EU that our general government deficit would be 11.6% in GDP in 2010 and 10.0% in 2011. So the questions we should now be asking are whether we should still aim to achieve the 10% target and, if not, what are the consequences of missing this target.
Michael Noonan appears to have said yesterday that the Department of Finance briefings called for €7 billion in adjustments. The department is now saying that “Given the current working macroeconomic forecast, indicative deficits were set out for consolidation packages of the order of €3bn, €4.5bn and €7bn.”
Fair enough, they could have set out a no-billion in cuts scenario for all it matters. However, as far as I can see, only the €7 billion scenario sees us meeting the 10% target and this likely explains why Noonan emphasised the €7 billion figure.
This isn’t rocket science. There are four elements to this calculation, none of which are complex or require access to secret figures:
1. Lower GDP: Last year, the government projected that €3 billion in adjustments would get the deficit to 10% of GDP. However, they were projecting GDP in 2011 to be €170 billion. Now, both the Central Bank and the ESRI are projecting GDP in 2011 to be closer to €160 billion. So, hitting the 10% target now requires a deficit of €16 billion rather than €17 billion. Hence, an additional €1 billion in adjustment, bringing the total required adjustment to €4 billion.
2. Promissory Note Interest: The 2009 budget figures did not include the interest on the promissory notes, which appears to be 5% on average. This adds €1.5 billion to next year’s deficit, bringing the total required adjustment to €5.5 billion.
3. Lower Tax Revenues: Tax revenues for 2010 are on target. However, last year’s budget projected a €9 billion increase in nominal GDP in 2011. The Central Bank are currently projecting a €5 billion increase in nominal GDP next year while the ESRI are projecting an increase of only €3.6 billion. Undoubtedly, any credible projection for next year will feature lower tax revenues. In my ongoing calculations (updated here to also include the ESRI’s GDP forecast) I’ve subtracted €1 billion from tax revenues next year. This brings the cumulative adjustment required up to €6.5 billion.
4. GDP Effects of Larger Adjustment: Unfortunately, if additional adjustment of this magnitude is required, then the GDP baseline in the ESRI and CB forecasts are probably too high. Hitting the 10% target will probably require about €7 billion in adjustment.
I’m happy to be corrected about any of these above points but, particularly when one factors in Noonan’s comments, I think it’s reasonable to assume that €7 billion is required to meet the original 10% target.
Is meeting the 10% target really necessary? Might an adjustment of €4 billion to €4.5 billion—perhaps getting us to somewhere between 11.5% and 12% of GDP—be ok if it was accompanied by an impressive-looking four year plan?
It might be but then again it might not. I’d be inclined to recommend assuming the latter. The current EU-agreed plan is already our second plan (there was a previous one in which we reached 3% in 2013). Ripping up this one, so we can start again with a third plan where, after years of cutting, we’ve still only got as far as a 12% deficit next year, doesn’t sound to me like the kind of plan that’s going to work.
So, that’s the debate that needs to be had. Wishful thinking involving only €4 billion in adjustments and still hitting the 10% target just isn’t helpful.
A side-issue in all of this is what exactly the government is (and has been) up to in relation to the budget figures. In relation to point one above, as Philip has pointed out, most of this downward revision in GDP stemmed from the CSO’s annual revision released this summer. Indeed, the Central Bank were projecting nominal GDP in 2011 of €163.7 in July, already over €6 billion short of the original budget projection. So the government has presumably known the 2011 adjustment requirement was drifting outwards due to this factor for a number of months.
On the second point above, since the government started issuing the magic promissory notes early this year, they will have known about the effect of this on the budget figures for some time.
It seems clear, then, that the government were clinging publicly to a figure of €3 billion in adjustments long after they must have known that this figure wasn’t tenable (e.g. as late as the mid-September Fianna Fail think-in the €3 billion figure was being held to).
Equally, it could be argued that yesterday’s dismissal of Noonan’s comments from, among others, the Taoiseach, also served just to obscure the full scale of the fiscal problem that we face.
Update: I’m not sure if this story pre- or post-dates what I wrote above. It says that “Government sources have firmly ruled out a €7 billion adjustment for 2011.” If so, it looks like they have ruled out meeting their previous target for next year of a deficit of 10% of GDP, though it may be some time before they admit this.
107 replies on “Sticking to 2011 Deficit Goal of 10% Requires €7 Billion Adjustment”
The banks criminally increased the credit aggregates above the long term growth rates of the economy yet the Exchequer is expected to bail out the risk debt of the banks.
This is the most peverse policey imaginable.
The banks want to run down the productive elements of Industry so that they can become solvent again.
This can be seen everywhere when even prime property in central locations remain vacant to hide the destruction of the banks balance sheets.
If after the banks are wiped out there needs to be more austerity so be it.
But this is putting the cart before the horse.
What we are witnessing is a gigantic wealth transfer experiment overseen by the ECB.
You raise the key question.
I doubt if anyone disagrees that a €7 billion would be an enormous shock to the economy. The question is if it can be avoided while still maintaining credibility. This is why the nature of the 4-year plan matters so much.
I am still not sure what exactly the government has in mind. In his September 30th morning Ireland interview the MoF referred to “realistic options”. I have also seen it referred to as laying out a “menu”. If that is what they have in mind, then you are probably right that the front-loading extreme is the only option consistent with bond market access. What is needed is to credibly commit to the future actions — preferably real US-style multi-year budgeting. Of course, this is problematic given the limited time horizon of this government. This is why some degree of inter-party cooperation was so important. The Irish political system has not covered itself in glory. Unless I am being too pessimistic about what sort of 4-year plan they have in mind, and also about the constructive role of the opposition might play, then I would reluctantly have to agree that keeping to the 10% intermediate target is necessary.
The IMF will be a bigger shock.
Rock meet Hard Place, shake hands lads.
Thanks for emphasising this is black and white again (it must be the 3rd time in a week).
I have a feeling that your words will be wasted though, as I fear that the FFers will bottle it.
This time last year, Lenihan was all doom and gloom and managing expectations about the severity of the budget rather well. This time around Cowen et al are being overly-optimistic and are not managing expectations well at all.
Perhaps their heads are in the sand, but a cynic would suggest they are going for a smaller target, which will be criticised by Fine Gael and give FF a fighting chance in an election early next year. Of course this would mean that they are taking a huge bet on a benign 2011 bond market for purely political purposes.
re: Promissary Note. It is possible that the government thought they could roll-up interest in the note by reissuing a supplementary note. This after all would be “developer” type thinking. Otherwise omitting the note interest payable from Govt accounts is more than disconcerting.
Re: Overall deficit. So an adjustment of 4.0 to 4.5 billion will only get us back to a deficit of 12% of GDP. Imagine that from the point of view of national credibility, borrowing capacity or how Europe views our commitment to get back to living within our means. Even as we have the highest paid public (at upper levels) in Europe.
Solution. Go for cuts of 10 billion. Take them from salaries of better off in the public sector, increased taxes and getting rid of all tax breaks.
If Ireland is interested in survival as a nation it needs to get real.
A debate around supposedly savage cuts which only get us back to a 12% deficit is surreal.
I’d be careful about labelling the €7 billion as “the front-loading extreme”.
By my calculations, it would make the underlying deficit (ex. the balloon payments that make the deficit go to 32% this year) go from 12.3% in 2010 to 10% in 2011. If in the next three years, we were to reach 3% this would require an average improvement of 2.33% per year (7/3).
So you’d want to be careful telling the EU Commission that this is the front-loading option when they might just see it as part of a steady 2.3% per year improvement.
Of course, many have in mind lots of nominal GDP growth in the out years so that the improvement in those years is coming less from painful cuts and more from the denominator and positive cylical effects. Hopefully that will be the way it works but it might not be.
Under a normal IMF intervention we would very likely be able to partly default on our sovereign debt. The EFSF/IMF arrangement (and its parent, the Greek rescue) involves no default whatsoever – instead the lucky recipient country is gavaged with more and more (subsidised but expensive) debt to pay off the existing loans as well as the ongoing primary deficit. Thus Greece’s sovereign debt is still rising, and this is all part of the plan. The purpose of this approach – placing most of the cost of the adjustment on the bad debtor and none on the bad creditors – is to perform a concealed bailout of financial institutions in the Eurozone core, and of important persons in the country being “rescued”. Don’t take my word on this: see the former head of the Bundesbank. You might ask why the IMF is willing to go along with this arrangement. Part of the answer is that the current head of the IMF very seriously intends being the next president of France.
So: IMF? We should be so lucky.
“Solution. Go for cuts of 10 billion. Take them from salaries of better off in the public sector, increased taxes and getting rid of all tax breaks.”
I don’t think you would get €10b if you fired every single high paid public sector worker in the country.
Come to think of it if you fired the entire public sector, every single member of staff, and paid statutory redundancy would you even get to €10bn?
Your calculations are not in agreement with ESRI’s. This is what they say in their report published yesterday.
“For 2011, we expect the deficit to be 10 per cent of GDP, based on a budgetary package of €4 billion in savings.”
Of course, you would be perfectly within your rights to say that, since ESRI’s migration forecasts for 2009 and 2010 were way out (see numerous other threads) and their forecasts for export volume growth in 2010 were way out (original 2010 forecast published in summer 2009: 2% fall, latest 2010 forecast published yesterday: +7.5%), you have no faith in their ability to forecast accurately and that your own forecasts are more credible. That would be a perfectly valid point for you to make.
As to who is right and who is wrong in this case, as I posted on other threads, it depends to what extent the lower-than-predicted inflation, that results in lower-than-predicted nominal GDP and lower-than-predicted tax revenues, also results in lower-than-predicted government spending. Again, as I pointed out on other threads, so far in 2010, government spending is around 800m below target, while tax revenues are around 40m below target. This factor needs to be taken into account in all calculations.
Based on the recent Aidan Kane numbers, total income tax is ~€11 billion. Total VAT is ~€10 billion. According to Mary Harney recently, total HSE staff spending is ~€10 billion.
So, if you increase VAT by 30%, increase total income tax by 30%, AND cut everyone in the HSE by 30% you get your €10 billion.
Just cutting some high paid public servants and increasing tax doesn’t get your €10 billion. Not by a long way.
Thanks for clearing up the difference between a ‘normal IMF intervention and a joint EU/IMF New Model Intervention
The assumption throughout (point 4 accounting adjustment excepted) is that spending cuts/tax increases equate to savings. They do not.
If they did €10.6bn of fiscal contraction (not including the 2010 Budget) would have led to a measurable narrowing of the deficit. At that time it was equivalent to approximately one quarter of government outlays.
If, instead, these measures simply saved the publc finances from an even worse fate, the effects would still be measurable. The fiscal tightening was a nominal €10.6bn and the fall in output was €20.3bn on the same basis. Now the normal rule of thumb used hereabouts is that tax revenues are about one-third of GDP.
Therefore, the decline in tax revenues (outlays tend be overlooked a bit, but we’ll come back to those) should have been approx. €6.8bn. And then our fate-saving fiscal adjustment should have produced a Budget surplus of €3.8bn (10.6 – 6.8).
Yet, as we know the deficit didn’t narrow at all – it widened. From the Exchequer Statement (not comprehensive but widely followed) tax revenues fell by €14.3bn in 2009 and government spending rose by €3.2bn. Now some might be tempted to argue that this still means that the fiscal tightening prevented an even greater fiscal chasm. But, since €17.5bn of fiscal deterioration plus €10.6bn of tightening equals €28.1bn, this cannot be true- the ‘prevented’ fiscal disaster would be far greater than the actual decline in GDP (or in GNP, which fell by €23.4bn). Government would be responsible for 138% of GDP.
Instead, since government spending is both a component of GDP and interacts with it, perhaps it would be better to begin with the effects of fiscal tightening. The average output multiplier (Leontief Inverse) effect of 4 categories of government spending is 1.59.
Therefore the effect of the fiscal tightening is likely to have been an output contraction of €16.9bn (€10.6 X 1.59).
Of course this will have a negative effect on government finances. It is a false notion that the impact will be one third of the change in output. While taxation revenues are one third of output, the relationship in not linear, as many activities are only taxed after threshholds, with exemptions, rebates and so on. In addition, with any sort of social safety net, outlays will change inversely to output. The sensitivity of Irish taxes to output is estimated 0.6 by the DoF (SGU). Others put it higher.
On that basis, the €16.9bn decline in output arising from the fiscal tightening led to a deterioration in governemtn finances of €10.1bn.
Since the output gap now is considerably larger than in 2005, the actual multipliers are likely to be greater. And the DoF estimate of the fiscal sensitivity may be an underestimate as fiscal policy changes are not factored in.
In any event, even if both are correct, the net improvement in government finances was marginal. It is more likely that the deficit widened as a result.
Why would fiscal tightening in 2011 lead to deficit reduction when in failed to do so in either 2009 or 2010?
@ Michael Burke
What’s the alternative? Is there any, other than to cut/raise-taxes and hope the world starts buying all things Irish?
“Again, as I pointed out on other threads, so far in 2010, government spending is around 800m below target, while tax revenues are around 40m below target. This factor needs to be taken into account in all calculations.”
The €800m is exclusively on the capital side (Actually €900m on the capital side and -€100m on current spending)
The DoF pointed out in August that this is due to the timing of projects and the “savings” are expected to be spent over the remainder of the year.
I think I get the gist of your (extended) comment and I also think you are making an important point, viz, that attempting to reduce the deficit at the rate envisaged risks shrinking the economy at an even greater rate. Ergo, the deficit will increase as a % of GDP.
If this is a real possibility – and I would welcome the views of others – is it not time to call for mercy (and directly from the IMF as the EC/ECB seem to be in Teutonic punishment mode)?
Michael Burke is assuming multipliers on govt spending and spending cuts that are either old, or old and incredible, or not applicable to the situation.
Karl Whelan talked about this last night on Tonight with VB (Forgive me father for I have sinned. I watched Vincent Browne on TV) and pointed out that this approach is a fallacy in our current situation.
@ Michael B
As you note, I didn’t actually assume that the adjustments could occur without knock on effects on GDP.
However, the idea that adjustments simply can’t get the deficit to 10% because of effects on growth doesn’t stack up.
Let’s look at the rough numbers.
Starting Deficit: 22.5
Starting GDP: 160.0
Starting Deficit Ratio = 22.6 / 162.0 = 13.9
Now suppose, as Michael Taft said on the TV last night, that each billion in adjustments reduces GDP by one billion.
Now cut by the 6.5 billion that would be required to get to 10% on a non-GDP-effect basis.
Deficit: 22.5 – 6.5 = 16
GDP: 160 -6.5 = 153.5
Deficit Ratio = 10.4%
You’re nearly there. The point is that the proportional reduction in the deficit is much larger than the proportional reduction in GDP.
Try 7 billion in adjustment
Deficit: 22.5 – 7 = 15
GDP: 160 -7 = 153
Deficit Ratio = 9.8%
Since we’ve debated these issues before, I suppose you’ll say that the multipliers are larger than the one I’m using here. I’d suggest they may be smaller. But you get my drift.
Agreed that my calculations don’t seem to agree with that ESRI statement. I understand the basis for my calculations. I’m not sure I understand the basis for theirs.
“Why would fiscal tightening in 2011 lead to deficit reduction when in failed to do so in either 2009 or 2010?”
1. The wrong trousers were tightened. There’s plenty of other trousers that need to be adjusted that will not damage the real economy.
2. The workoff of bubble GDP had not completed then; I’m not sure whether it has completed now, but JohntheO assures us that exports are booming and that BOP is coming into surplus. Apart from a couple of caveats, I don’t see a reason to doubt these.
3. GNP in current money seasonally adjusted has finally turned positive. It may well be that the tradeable sectors of the economy have bottomed for the moment. Any adjustment that is made must not damage these sectors and ideally would improve their changes.
4. The increase in debt service costs was not factored into previous adjustments. The interest rate the NTMA is paying had not increased appreciably until recently, the quantum of debt had. Increasing the amount of debt will increase the amount of debt service costs. Yes, there’s an element of running to stand still, but how fast do you want to run in two, three, five year’s time?
5. I would like to see some figures as to what generates VAT such that subsistence payment reductions will reduce the tax take. My Lidl receipt helpfully shows a breakdown of the VAT paid. It is zero most weeks. So where does the tax spend go?
It seems very unlikely that the IMF will help us escape the EFSF noose, at least as long as DSK runs the shop. Assuming that indeed we won’t be able to stay solvent through austerity, no matter what fiscal course we choose from here – not something I’m necessarily saying is true – then our best bet is that the Europeans themselves – the Germans, really – will at some stage give up on the EFSF and activate their Plan B. Plan B is “orderly restructuring” [title: “UK to consider altering EU treaties”] of sovereign debt, something German figures have been muttering about for months now. Another possible salvation is that things get so bad that the ECB is finally persuaded (or scared enough) to shatter its strong-currency piggy bank and start serious QE.
[…] not speculative. There is experimental evidence to support the hypothesis. Consider (for instance) the Republic of Ireland. I have quite a bit of sympathy for the Irish, actually – the Irish government has dutifully […]
BOP would have come into surplus already had the coalition not given a digout to the car import industry this year.
I suspect we can manufacture one for our friends in the Bond Markets simply by removing scrappage allowances ….and flagging that as quickly as possible lest the car import industy truckroll the cars in during THIS quarter.
Sure if Lenny announces ‘no scrappage’ this week they might get them out of the country by christmas and we may then go into surplus in Q4 2010 as reported March 2011
Calls for reliance on income tax increases then to keep those multipliers down…
Personally I thought during 2009 that the December 2009 budget would be the difficult one but I should have run with my natural pessimism (expecting a crash since 2000 – the year of all the new millennium zero-zero new cars) and accepted that there will be next to no growth in the economy for 10 years. Why anyone ever projected that we could return to above-average growth rates of 4% p.a. after the mother of all property bubble bursts and the greatest bank failure in the modern world just goes to show that the delusions of the Bertie Tiger are still with us.
Growth, the wonderful get out of jail card for any deficit ridden MoF, will not return in any meaningful sense for a decade.
The consequences are too awful to contemplate.
“The consequences are too awful to contemplate.”
Unfortunately, the consequences of no/low growth are too awful NOT to contemplate. They should be our baseline scenario with any growth a happy risk. If we get a happy risk, we can adjust down what is required in terms of austerity, but banking on growth is class-A hopium smoking.
I remember during early summer a leak of €4billion as opposed to €3billion which people at the time thought was a mistake on behalf of the news reporter as it was never heard of again.
Think it’s criminal to have held off on telling people the parameters they’re/we’re all playing in.
1. The public sector pay and pension bill is approx 19billion as I understand it. There is plenty scope for for reducing it by €3 billion and not cut anybody below 40,000 pa. I have no time for protecting salaries or pensions of those paid more than that.
2. Cut out all payments for sick days right across public sector. Introduce voluntary subscription based insurance scheme. Savings close to .750 billion?
3. Eliminate all tax breaks including pension breaks. the TASC proposals say that 1 billion could be saved by a reduction to 20% pension relief. Total for complete removal? up to 2 billion.
4. Property Tax. TASC are optimistic in saying €3 billion, about 1.5 billion I would say.
5. Eliminate PRSI ceiling.
6. Introduces Excess Directors Emoluments Tax payable as part of corporation tax. All emoluments in excess of 150,000 pay equivalent in additional corporation tax.
7. Reduce all subventions to State/ semistate by excess remuneration eg RTE licence fee subvention reduced explicitly by total “excess remuneration” paid by RTE.
8. Remove universality of child benefit, ESB, Travel etc.
9. Eliminate concession day payments and all standard holiday pay in excess of 20 days per annum.
No problem whatsoever in finding 10billion from a gross total of somewhere near 70 billion and not cut one home help job or cut the wages of anybody less than €40,000 pa.
Yep. It’s sad.
It’s life though. We are witnessing the end of the era of the golden age of the consumer.
Back to old style victorian capitalism now.
“Now suppose, as Michael Taft said on the TV last night, that each billion in adjustments reduces GDP by one billion.”
In a sense, Mr. Taft is correct in his absolute description – each billion of cuts that reduces borrowing by a billion euro reduces government ‘income’.
The problem, though, is that each billion of borrowing effectively reduces GDP by 4% (or whatever average interest we are paying) of one billion in years to come, as interest paid does not generate economic activity. In the past two years, 100 billion has been added to the national debt. This will effectively reduce GDP by 4 bn forever and by more if/when we pay some of the debt back (i.e. by the absolute amount paid back). If we used a ten-year repayment period, the reduction would be over 10 bn a year.
Seriously – time to dump the Euro.
Let’s realign along the Anglo-American Axis. It’s where we belong.
What part of we cannot afford 7 billion is so hard to understand?
And I know that going by the past performance – leaving the Euro won’t be properly debated in Economic circles until after it has happened
@ hmw: “… … but banking on growth is class-A hopium smoking.”
@ MO’L: “Growth, the wonderful get out of jail card for any deficit ridden MoF, will not return in any meaningful sense for a decade.”
Glad to see that other people recognise what the real predicament is. Within the next decade we are due an oil production shock! Growth on the rocks! Kinda bothered that the academic economists not appear (yet anyway) to be discussing the probability of energy (and food) price increases which will derail developed economies.
Its much worse then that – this is so sad but I suspect it is true.
Listening to RTE radio now and they are reporting reports that the Industrial corporation Siemans have offered to give Ireland credit to install water meters to tax the population so that we can pay other Irish debt holders interest.
We will be paying twice over to issue money !!!!!!!
John Gormley seemed to entertain the possibility of this despicable arangement.
Gormley is making a mockery of sovereignty although he may be doing us a favour with his candor.
Adam Smith and other classical economists are turning in their Grave.
As I have said many times before the ECBs policey of equality between corporate and goverment paper is at the root of their plan to steal the rest of our Independence.
The monetory malice of these bastards is beyond even my cynical comprehension.
I think there is a fundamental flaw in your analysis, in that you are assuming that the decline in output is due almost solely due to the fiscal contractions by the government.
Even without any new taxes/cuts I believe that the economy would have continued to decline over that period.
I don’t think that the multipliers are much larger than the ones you are using- because you aren’t using a multiplier at all (or, technically you multiplier is 1:1). This implies that government spending has, as you say, a ‘non-GDP effect’, beyond the reduction in the government component of GDP.
This is completely at odds with all the analysis of the Input-Output Tables, and the simple observation that the public sector is frequently the biggest single customer of the private sector both for its inputs and in terms of consumption.
Following your logic, for end 2008 the numbers were as follows:
Starting Deficit: 9.6
Starting GDP: 180
Starting Deficit Ratio = 9.6 / 180 = 5.3
[I’m aware GGB was higher along with the deficit ratio, but custom & practise here seems to be to refer to Exchequer Statments not SGU. The logic doesnt’ alter.]
Now cut by the 10.6 billion that actually occurred, on a non-GDP-effect basis.
Deficit: 9.6-10.6 = -1
GDP: 180 – 10.6 = 169.4
Deficit/GDP Ratio = -0.6% (ie small surplus)
But we know that didn’t happen, nor was there even a move in a that direction. The deficit widened. This logic, based on no multiplier effect from spending cuts, has no explantion for the widening deficit.
In addition, there remains the issue of the sensitivity of government finances to changes in activity, which DoF puts at 0.6. You might imagine that a ‘non-GDP effect’ change in govt. spending would not need any sensitivity analysis. But since the output of the government sector requires inputs purchased from the private sector (goods and services, including labour), and these generate govt. tax revenues and spending liabilities, then the changed incomes of these private agents would of course impact government finances.
Then the position currently would be:
Fiscal Tightening (Recommended) 7
GDP 160- 7 = 153
Sensitivity of Govt Finances (7 X 0.6) = 4.2
Deficit reduction 7 – 4.2 = 3.8
Deficit (22.5 – 3.8) = 18.7
Deficit/GDP (18.7 /153) = 12.2%
Not even close. And all this with the assumption of a ‘non-GDP effect from tightening’, that is an implicit assumption that the output of the public sector only equals its inputs, ie that it provides no net value added at all.
Now, I know some here believe that, but you don’t surely?
If fiscal tightening worked in a recession 2009 tax revenues would have increased and expenditures would have declined. Expenditures were flat and taxes plummeted.
I believe in Zimbabwe they only issue their money from one source – at least they do something right , unlike this cold wet Angola.
The rule of law is over – the moneyed interests have control of EVERYTHING.
Karl, I found this part quite telling.
“Is meeting the 10% target really necessary? Might an adjustment of €4 billion to €4.5 billion—perhaps getting us to somewhere between 11.5% and 12% of GDP—be ok if it was accompanied by an impressive-looking four year plan? ”
It seems that it is all about guessing what Govermnent bond market participants and commentators wiil find acceptable to open the markets to Irl – and doing that.
It may be that none of the options that are currently politically likely (given the closeness of an election and all those public sector votes) can pass muster, so in that sense it might not matter.
What might be far more relevant is the outlook for global GDP and more particularly in Irl.s key markets. If Germany starts to roll over along with the US then the domestic guessing game might be a bit of a waste of time.
I think the government’s track record suggests that officialdom is of the view that is unlikely.
Again, the economy had started to collapse before spending was cut.
The collapse of the economy was not caused by the spending cuts.
And not to mention the second wave of home mortgage defaults that’ll hit next year too.
These shocks are visible and should be prepared for
If it is true that the state is dependent on credit from a corporation other then the ECB and the bond markets should it not be front line news of the equivalence equal to the change from the Punt to the Euro.
This corporate state is a fascist state.
This is big news – I am expecting RTE news to have this at the front of the RTE 9 oclock news once this is confirmed………..
@ Hugh Sheehy
The government still purchases from the private sector, be it goods, services or labour irrespective of the business cycle. Only the quantum can change. The weight of the literature is that large output gaps, low interest rates and constraned credit increase the multipliers. That’s disputed- but they exist.
@ Paul Hunt
My fear is that this policy increases that likelihood. From the discussion above, it seems likely that it might be the EFSF, which would be even worse.
My recollection is that no frequent contributor to this site argued for very different spending cuts at the time. Since public sector pay has been cut, along with capital programmes and welfare spending I’m not sure what other category of cuts there can be which will work a miracle now.
I don’t argue that policy caused the entirety of the slump in 2009, simply that government spending is both a component of GDP and will impact other components. In a boom, that influence might be diminished, but in a recesion it is magnified. How much it is magnified is the topic for debate.
Yes, the govt purchases from the private sector.
Still, the economy started to collapse before the spending cuts.
The spending cuts did not cause the economy to collapse.
“My recollection is that no frequent contributor to this site argued for very different spending cuts at the time. Since public sector pay has been cut, along with capital programmes and welfare spending I’m not sure what other category of cuts there can be which will work a miracle now.”
You mean contributor or commentator?
The site, as I am reminded betimes, only came into being in the middle of last year, so arguing for cuts in the 2009 budget was note really possible on it. Those of us who post and blog elsewhere have been arguing for some time about both the cost of the banking bailout, the implications of a spiraling national debt on the negative multiplier that is interest payments to foreign bondholders, the exhaustion of the Social Insurance fund, and of spending out of control.
–> Quangos! Quangos! Quangos!
–> Tax reliefs.
–> PS expenses – all vouched, all standard rated. Same as it is for everyone else.
–> Salary cap in PS, semi-states, state-owned banks.
–> No bonuses for doing your job.
–> Review of overtime and staffing levels.
–> Universal pensions. A second tier state pension above the current one. Contributory. Capped. Buy years with existing pension money. Get the rest back in cash – taxed. Unless you use it to pay capital off debt, in which case tax free. No exceptions.
–> Universal health. Increase the health levy component in the social insurance tax until it pays for this. No private health insurance access to public facilities. No sharing of staff. Public health system buys in admin and even hospitals where appropriate. Money follows the patient. If surgery does not happen, surgeons and theatre staff don’t get paid.
For revenue raise?
–> Social insurance on all income (whether welfare income or not). No ceiling. Initially at a level high enough to cover 70% of the current welfare bill, falling as the welfare bill falls.
On your pension scheme..
So if I want not to pay tax on my pension investments when I have to cash them out I should borrow money to get myself into debt, buy and hold an asset with the money, download my pension savings, pay off the debt with the now tax-free pension money, sell the asset and then I’ve just saved xx% of my pension fund. Cool.
Also, I have to trust the Irish govt to have my pension money in xx years time. On what basis should I trust an Irish govt? Why won’t they just spend my money on TASC induced R&D into Irish based wind energy research, with particular focus on a company that’s owned by a cousin of that well known TD from the 17 seat constituency of South-East Longmeath, Brian Cooper-Lowry-Haughey?
Sorry, I’m a cynic. I particularly struggle to trust lawyers, bankers, priests and governments.
@ Michael B.
I don’t want to be too critical of your opinions. I think your arguments are valuable reminders that fiscal contractions can depress the economy and so the full amount of the planned deficit reduction is rarely the amount achieved. I am not a member of the expansionary fiscal contraction club and I understand your concerns.
However, think again about the case of the €7 billion adjustment I’ve outlined. Suppose the calculation you did above was right and this only reduced the deficit to 12% instead of 10%.
Is this an argument for not doing any adjustment or for doing no adjustment? I don’t see why it would be. What would the deficit be then? And who would fund it for multiple years in a row?
I guess you believe that Irish fiscal multipliers are such that we could go and spend whatever cash the authorities have left on public capital programs and the expansionary effect would be sufficient to reduce the deficit rather than raise it.
Fair enough, that’s what you think but we’ve agreed to disagree in the past on the size of Irish fiscal multipliers and also as to whether movements in Irish aggregates in the recent period are appropriate ways to measure these multipliers. So we’ll just have to leave it there.
“So if I want not to pay tax on my pension investments when I have to cash them out I should borrow money to get myself into debt, buy and hold an asset with the money, download my pension savings, pay off the debt with the now tax-free pension money, sell the asset and then I’ve just saved xx% of my pension fund. Cool. ”
Ah, sorry I should have said existing debt. Yes, it is unfair on those with no debt. Perhaps capital gains tax could be used as the tax rate? (Which you would be liable to if you did your nifty asset washing. Of course, you could just look for over-rounds and wash it on the horses, I hear it’s popular among the criminal classes).
Anyway, as I say it is unfair on those with no debt. But the purpose of it is to remove the debt overhang on the economy and give the state a cash boost to clean up some of its own mess.
Do I trust them with it? Not the current lot. Do I see any chance they would do it? No. They all have too fat a pension to look forward to. When I say it applies to everyone, I mean everyone. From el Pres down, or up (depending on how you look at these things).
Karl – you have assumed that the budgetary contraction of €6.5 billion equals a reduction in the deficit of €6.5 billion. I believe this is a mistaken approach. The ESRI data shows that, for instance, a reduction of €1 billion in non-wage-rate Government consumption leads to the following: GDP deflation of 0.8% and deficit reduction of 0.2% of GDP in the first year. Therefore, in this instance, a cut of €1 billion does not equal €1 billion in the deficit but rather €315 million – or less than a third of the nominal cut. The cut of €1 billion results in a GDP deflation of €1.26 billion. Therefore, the deflation impact is four times that the deficit reduction in nominal terms. That has to be factored in when assessing the benefit or not of cuts in current expenditure.
We also have to take into account that the economy may be reacting to fiscal measures through its GNP rather than the GDP. Fortunately, the ESRI provides these estimates. Keeping with the non-wage-rate cut in Government consumption, the impact is even more deflationary (1.0%). Unfortunately, the ESRI doesn’t provide the resulting deficit reduction. The reason we should be sensitive to GNP impact is confirmed by the Government when it stated in last year’s Stability Programme Update that GDP rises will not be tax rich.
But even worse is the recent IMF finding (posted by Philip Lane) that in open economies pursuing fiscal consolidation in zero-floor interest rate conditions and where other countries are pursuing fiscal consolidation –a fiscal contraction of 1% of GDP can equal a 2% deflation in GDP in the first two years. The implications for deficit reduction are such that it could produce a perverse result that cuts equal deficit deterioration.
All this to say, x cuts do not equal x savings. The ESRI allows us to measure some of the fiscal impacts but we must be sensitive to the GNP and IMF measurements. Further, we must note that these are linear measurements. Multiples of these €1 billion impacts could produce a new equilibrium. And it might not be a good one.
Hugh – you may have made the same mistake: ‘each billion of cuts that reduces borrowing by a billion euro’. That is not the case. Further, no one argues that cuts caused the economy to collapse. But it is certainly the case that cuts both lengthened and deepened the recession. It’s still doing so. According to the Central Bank, domestic demand will flatline next year: 0.0% growth. Further contraction, beyond the €3 billion will, on current trends, send that 0 into negative.
Okay, then do tell what the negative multiplier of per % of GDP that leaves the country in interest payments is? And in capital payments?
I don’t see that we can outgrow the rest of the eurozone.
I don’t see that we can outgrow the level of debt we are piling up.
I don’t see that your strategy is much more than jam today – growth now at the expense of growth later. And that the implications for growth later are much more serious than the benefit of growth now (as population ages).
PS Whether we think it is a good idea or not we are going to be making these cuts and raising these taxes. The bond markets are not going to go for the “fiscal expansion in a small open economy”. Our european partners are not going to go for the “we’re bust” with the highest paid politicians and senior public servants in Europe and the second richest country.
We can neither borrow nor default without making a serious adjustment. Rather than whinging about it, I suggest some of you figure out the least painful, most effective and particularly the most equitable way to do it.
hoganmahew – Unfortunately, the ESRI does not provide a multiplier but warns that both the direct and indirect effect (e.g. effect on output, etc.) will be high. Interesting to note, the risk premium rises as growth is lowered. Given that the impact of sustained contraction will be to deflate growth, we might find the perverse situation that the more we cut the higher the premium. This is a situation we have experienced. The Government cut €12 billion out of the economy (through spending cuts and tax increases) in three budgets in 2009/10. Borrowing costs increased by 50% while now we are entering a second fiscal deficit because on current strategy the deficit would be even higher next year than in the beginning of 2009. Is there a pattern?
But I fear you are right – there will be cuts and deflationary tax increases. The Government doesn’t seem to learn.
They’re not “European partners”.
You are asking us to choose between being hung and being shot.
I say it’s still worth making one last mad cap at escape.
The only escape we will have is to be in control of our own destiny. Relying on the interest levying kindness of strangers is not that situation.
You have a great way with words…
I put it to you that the negative multiplier of interest payments abroad is at least as high as the highest multiplier you can think of for economic activity in Ireland. This is money that is lost to the economy that will not come back. It is the best of money that is lost.
If 12 bn was cut, how come we are still spending more than we were in 2007? And getting less income? This suggests to me that the multiplier effect of social welfare payments is very low. Rather than them being a support to the economy, they are a drag. Most of what is purchased is imported and is zero-rated. This does not mean they should be lowered, but it does mean that they should be examined closely in the context of automatic stabilisation.
Given that most of what we buy anywhere, anyhow in Ireland is imported (we export stuff that we do not consume), I doubt that tax increases are all that deflationary.
As others have raised the question for Mr. Burke, I’ll raise it for you – what level of GDP do you think accounts for the excesses of the bubble? What do you think the sustainable baseline economic activity in this country would be for GDP?
I plump for 2002. Not adjusted for inflation… we have some adjustment to go yet…
@ Michael Taft
“you have assumed that the budgetary contraction of €6.5 billion equals a reduction in the deficit of €6.5 billion. I believe this is a mistaken approach.”
No Michael, I don’t agree that this is what I’ve assumed. I know a bit about macroeconomic theory and I would not catagorise the calculations above as anything other than accounting calculations. What I’m saying is that, relative to the starting point, the deficit needs to be reduced by €6.5 billion. A correct approach to implementing this should use a model of the macroeconomy to incorporate the various negative feedbacks that tax increases and spending increases create.
However, I do believe — and this seems to be the essence of disagreement — that while these negative feedbacks exist, they are not so negative as to lead €1 in adjustments failing altogether to reduce the level of the deficit or its ratio relative to GDP.
Trust me, Michael, I get no joy whatsoever from adpoting this position. I’m well aware of all the negative consequences that will stem from a very large fiscal contraction. And I would love to able to propose countercylical policy whereby we could be cutting taxes and boosting spending now: Every mainstream Keynesian economist would do so. But when the folks who have the money think you’re going bust, that analysis doesn’t work.
I really appreciate a genuine engagement with these arguments, which is rare enough.
But, if you don’t mind my saying- you’ve conceded almost everything. ‘My calculation’ was yours, just additionally taking account of an objective DoF (probaby under)estimate of the sensitivity of govt. finances to changes in output.
Even this was implicitly premised on the unlikely idea that the private sector’s output, incomes and expenditure are not at all influenced by public sector spending, your ‘non-GDP effect’ scenario . As before, I’m reasobaly confident you don’t believe that.
Perhaps we could agree, there is a genuine multiplier effect from cuts in govt spending (ie greater than 1). I have pointed to the ONS’s 1.59. The Daniel Leigh/IMF research suggests 2. Both of these are simply first year effects; you seem not to take account of multi-year effects at all.
You ask me to think about my example where the deficit/GDP ratio falls to 12.2%. In reality that’s your logic with the DoF’s 0.6 sensitivity of government finances applied. That amounts to a fall in government spending of 4.4% of GDP to achieve a deficit/GDP of reduction 1.8% of GDP….you see where this logic tends.
As per the last two years, there’s no amount of spending cuts that can deliver the requisite deficit reduction.
But, where cuts in government spending do have a greater impact on output than their own values, and these have an impact on government finances it is entirely possible, even inevitable, that budget deficits will widen following ‘fiscal consolidation’.
There are a number of European countries which temporarily raised government spending in 2009 and their defcits, however measured have fallen.
Now, I know it’s fashionable to assert that their multipliers are much higher as their import ‘leakage’ is lower, but this assertion cannot be sustained.
All EU economies, including this one, have a multiplier greater than one for government spending, as the data above shows. Therefore the damage done to the economy from reductions in government spending is greater than the change in government spending itself.
But if it is argued that some deficit reduction is better than none, with which Iagree – it is necessary to take account both of the economic impact of fiscal contraction and, from that, the likely impact on govt. finances.
Otherwise you are in danger of repeating the 2008 and 2009 nonsense that cuts equal savings. They didn’t equal savings. They led to deficit widening.
@ Michael B.
“My calculation was yours, just additionally taking account of an objective DoF (probaby under)estimate of the sensitivity of govt. finances to changes in output.”
Could you direct me to the source of “the sensitivity of government finances to changes in activity, which DoF puts at 0.6.”?
Taxes are one-third of GDP. I could see how this could put this figure at a minimum of 0.33. But I can’t see how welfare costs could boost this figure up to 0.6.
But I’m happy to read the source of this figure and assess it once I’ve done so.
Mr Whelan / Mr Burke / Mr Taft
Surely it depends on what government expenditure you cut?
In good economic times, if you let middle income earners keep £1 rather than take it from them in tax to give to someone else, the net result should be no change in GDP and a £1 fall in the budget deficit. The money is still being spent in the economy, just by someone else (the taxpayer, not the erstwhile recipient of the government benefit). (Of course, in present circumstances that may not hold as the taxpayer, if let keep his £1, might choose to save it (or use it to pay off his own debts), whereas the benefits recipient is, presumably, more likely to spend it than save it.)
Where the taxpayer is still taxed the £1 but the government uses the £1 to pay off debt (or to see that the State doesn’t have to borrow as much as it would otherwise have to borrow), there is of course a £1 fall in GDP. The money is not being spent by the erstwhile benefits recipient (or, for that matter, by the taxpayer) but is being used by the State to pay off or avoid debt. But I can’t see a reason why GDP should fall by more than the £1 by which government spending has been cut (in favour of using the money to reduce debt instead).
Of course, the position is much more complex where the government spending concerned is not on giving money to the unemployed or the elderly but on, say, employing a nurse. If the nurse earns say 40k a year but between income taxes, PRSI, levies, VAT and everything else, he pays say 15k in tax a year, the net result of cutting his job will be a 40k fall in public spending but at most a 25k reduction in the deficit. But what if the nurse stays in Ireland but goes on the dole? He will receive at least 10k in benefits. So, on cutting the 40k a year job, GDP reduces by 30k but government spending by only 15k. Thus, it costs you (at least) £1 in lost GDP to reduce the deficit by (at most) 50p.
But Mr Burke must be right that cutting public spending can have a broader impact. It may well be that if the nurse’s post is cut, the broader economy will lose out because, say, some people are off work sick for longer than they would have been if the nurse had been around to help them. So, cutting the nurse might lead to a further fall in GDP and further lost government revenue. So, cutting the nurse’s 40k/year job may lead to a reduction in GDP of, say, 40k and a reduction in the deficit of only, say, £5k. (Of course, I have no idea what the true figures would be and living with 90 nurses when ideally you would have 100 would presumably have much less of this sort of impact than living with 50 nurses when ideally you would have 100.)
Needless to say, the position would be different again if the government expenditure concerned was on, say, nurses’ uniforms and not a nurse. You would have to think through what the likely consequences would be as regards lost tax revenue on the purchase, damage to the seller/ manufacture of the uniforms (at least if Irish-based), their employees etc. etc.
The short point is, however, that if the name of the game is cutting the deficit while keeping the corresponding GDP reduction to a minimum, the cuts will need to be carefully targeted.
2 obvious candidates for cuts fitting the bill (it seems to me as a non-economist putting his oar in) are (a) social welfare spending (because I can’t see why a £1 cut should lose you more than £1 in GDP – you are simply no longer borrowing £1 to give to someone to spend in the economy) and (b) taxes on people would otherwise use the £1 to save or pay off their own debts. Presumably, as regards (b) just mentioned, you are talking about middle to high income earners.
So, if I was Brian Lenihan, I would cut benefits and increase income tax on high and middle income earners (perhaps introducing a 50% band for those earning more than, say, 100k/year).
As regards both options, it is interesting to note the position on the other side of the Irish Sea. The Tory Govt is keeping the 50% tax band and has reduced the maximum amount of higher rate tax relief on pension contributions by almost 80% (from about 250k/year to 50k/year). The basic state pension in the UK is £96.75/week. In Ireland, it is well over 200 euro a week. There is a similar difference is unemployment benefits.
Lastly – Mr Burke, you say:
“In any event, even if both are correct, the net improvement in government finances was marginal. It is more likely that the deficit widened as a result.”
“If fiscal tightening worked in a recession 2009 tax revenues would have increased and expenditures would have declined. Expenditures were flat and taxes plummeted.”
Ireland has no option but to cut government spending (or massively increase taxes, which I suspect would risk disaster – huge numbers of mortgage repossessions (or a need for yet more money to be pumped into the banks), flight of footloose multi-nationals, mass emigration etc). You cannot seriously suggest that the State can spend the country out of recession? Who would lend it the money?
it’s the DoF’s estimate in the SGU (latest version, p.16 or so, I think). But I will dig it up tomorrow if needed.
Others have it higher.
Logically, if the first X of all activity is tax free or tax-lite (incomes, profits, consumption) then tax revenues are a function of X-plus. If X-plus rises, or falls, so will tax revenues. I often hear people hear complaining their marginal tax rate is 50% or 60% of higher %. This is the senstivity of personal taxation.
Likewise, if cos. can reclaim tax paid because profits have fallen (or there are losses, or R&D can be set against it , even it it took place in Delaware, or sales were booked in the Bahamas, the sensitivity can be greater than 1).
Others put the sensitivity at 1.
Reciprocally, can I ask a question?
Have you ever asked Philip Lane about his 4.14 multiplier for one-off govt. investment over 5 years, 2.19 multiplier for permanent investment over the same timescale?
Karl – thanks for that and having re-read your earlier contribution I now see that you referred to a non-GDP effect and further you make the point above that these are accounting calculations. I accept that I didn’t acknowledge this and apologise for the assumption.
Unfortunately, whereas you made that important caveat others in the debate have not. This has led to false conclusions arising from faulty reasoning (I’m not attributing such to you). In a real sense, an accounting approach is the very problem – and my fear is that the Government did just that when it produced its estimates in last year’s budget. We see where that got us. Let’s try to address that. Using the proportions contained in the ESRI’s stylised budget in their Recovery Scenarios Update and their fiscal multipliers in Working Paper 287 we find the following using your €6.5 fiscal contraction, GDP and deficit baselines:
Deficit 22.5 – 3.6 = 18.9
GDP: 160 – 4.4 = 155.6
Deficit Ratio = 12,1 (I note that you used 162 above; if this is the remainder of the underlying growth rate, then the new deficit is 12).
The ratio of contraction to deflation is less than zero but that is because the ESRI’s stylised budget used property tax (which is less deflationary and has a higher deficit reduction ratio than most other fiscal measures; it should also be noted that this formulation assigns a third of contraction to capital spending cuts; the ESRI admits their data underestimates their deflationary impact and, therefore, over-estimates its deficit reduction). In any event, the deficit reduction is only 55% of the fiscal contraction.
If we run these numbers through a GNP-type impact we find the following:
Deficit 22.5 – 2.7 = 19.8
GDP: 160 – 5.8 = 154.2
Deficit Ratio = 12.8 (12.7)
In this formulation, the deficit reduction is 42% of fiscal contraction.
If we use the IMF’s formulation – a 2% GDP deflation to a 1% fiscal contraction, then we’re in serious problems. We get a perverse result – with the deficit rising. I seriously doubt we have yet reached that level of deflationary cascade but we should be mindful that some parts of the economy could be disproportionately hit and that this could accelerate with higher contraction.
Of course, this doesn’t take into account a nominal GDP growth above €2 billion (in the brackets), but with the ESRI projecting that nominal growth will be a mere €3.6 billion after a fiscal contraction of €4.5 billion next year, we shouldn’t expect the numbers to change qualitatively.
That is why it is all important to go beyond accounting approaches and try to get a real GDP effect. None of the above is anything other than indicative but since the Central Bank and the ESRI have been revising downwards both GDP and GNP for this year and next we may be seeing the impact of past fiscal contraction acting on the economy. How further contraction is will impact is difficult to assess with only linear measurements. But clearly cuts do not equal similar levels of savings, while at the same time deflating the economy, increasing unemployment and putting more businesses to the wall. The Government are preparing to roll some pretty heavy dice.
As hogan and I and several others keep pointing out, we are borrowing all this money that the various Michaels want to keep spending to encourage “growth”.
We have to pay interest on this money, which suppresses the economy until we pay the money back, which will probably be 30-40 years.
We have to pay this money back, which suppresses the economy until we pay the money back, which will probably be 30-40 years.
OT? The SE has become worse than a casino. Trust not those who ask for OPM!
The only way out of this is a 10 year plan with a low interest bailout. IMF are actually preferable to our Euro buddies at this stage
“Just cutting some high paid public servants and increasing tax doesn’t get your €10 billion. Not by a long way.”
I did outline some ideas above which concentrate on the better off.
I am not an economist but there seems to general agreement with Karl Whelan that the 2011 deficit will be about 12% GDP even with about 4.5 billion cuts. We are not living in the real world if we believe this is sufficient to survival.
There is also a lot of talk of multiplier effects etc. I know little of these except the following.
A person who earns €400 a week will spend all of it. A person who earns €2000 per week in a recession will certainly not spend all of it.
Therefore if the burden of cuts or taxes fall on the low earner, the negative first off spending effect will be 100% of adjustment. If the burden falls on the higher paid the negative first off spending effect will be negligible.
@Michael Taft. I am a bit surprised the The ESRI is forecasting growth of €3.6 billion next year (approx 2%?). I really wonder where this is going to come from. Both Sterling and the dollar have fallen quite a lot against the euro in recent months making it much harder for exports and better for importers. The UK cutbacks will also have a negative effect.
Personally even without cuts or tax increases, I believe that the economy would contract next year and planners should plan for that, not some optimistic wishful thinking growth that will not happen.
“Personally even without cuts or tax increases, I believe that the economy would contract next year and planners should plan for that, not some optimistic wishful thinking growth that will not happen.”
Absolutely. If you can see it, I can see it, and Hugh can see it as a risk, why is nobody talking about the risk of it happening?
If we want to be better off in the future we have to do something called investing. Investing comes from savings. If all we do is spend money instead of saving it then we have a quick road to the side of the road.
The crash was caused by bad investments, and worse it was borrowed money. The solution cannot be borrowing and forcing people to spend.
Besides, if you tax high earners then the €2000 euro a week may not remain €2000 a week. There will be rational decisions to work less. That deprives the economy of that income, the tax from that income, and the work that would have generated that income. Oh goody!
Also, as I’ll remind people of again, income in the private sector is volatile. Just because someone’s making good money this year is no guarantee it’ll continue. Super taxation of income is simply easily administered theft.
“Besides, if you tax high earners then the €2000 euro a week may not remain €2000 a week. There will be rational decisions to work less.”
Sure. People suddenly stop being acquisitive because their marginal rate has gone up.
@HS: “Super taxation of income is simply easily administered theft.”
Really? What’s PAYE then – more easily administered theft? NAMA is NOT theft? Not your usual stuff Hugh.
@EB: “Sure. People suddenly stop being acquisitive because their marginal rate has gone up.”
Really? When was the last time you encountered someone (on a pretty good salary) who was ‘rational’ about their income and went about computing their daily marginal rates? Yes, I know New York taxi drivers do it – but they are a tad bizzare anyway!
Set a living wage for two adults and three kids: multiply by 6. This gives you the upper bound. Now, as an emergency measure – say until 201* or whatever – it gets a 100% rate. There must be absolutely no allowances, write-offs, etc. whatsoever. Its on the gross. Suck this and see. You might be agreeably suprised.
Not bad! But remember unemployment? Do you want to share public service jobs or encourage emigration?
Recall BPW who has pointed out the addition of 1Bn employees competing for jobs but consuming less than we do? Corporate profits increase, but wages world wide drop, per capita for those with jobs and increase for those currently without. Prices continue to fall ….. except for bulges in demand for commodities.
Irish Food has to become a World leader…. No option there. A Cultural Revolution? To the fields, comrades? If the world is going to cool, then additional sources of food become critical.
Set a living wage for two adults and three kids: multiply by 6. This gives you the upper bound. Now, as an emergency measure – say until 201* or whatever – it gets a 100% rate.
That is the daftest idea yet on this site-and it has a high bar. Who sets the “living wage”-some quango? Then there is the prospect that some of those lucky enough to earn at the top end (hospital consultants, University professors etc, CEOs of quangos) leave. Others will split their time between the black and white economy. You should google the Laffer Curve.
These are the facts that faced the USA in 1931 or so. Some estimate 7Mn people died in the following decade. What we have done now in Depression 2.0, is to pump the bubble higher than then and finagle, with accounting and derivatives, that the result can be reductions lasting over two decades, for Japan, so far. Three decades of deflation? That enables the BRICs to equalize income per capita more quickly…..
I applaud the greater parity. How will Ireland fare in such a regime? Quite well, compared to many other countries, if they can sort out the character flaws in leadership. And if it can keep the low CT rate. But how about the other countries with such rates? Will the tightening of tax havens, from which Ireland will benefit, continue to a single tight band of ct rates across the Double Tax Treaty system?
However bad things are now, they are going to worsen. Not having a leadership in which we can trust is a major problem in a team game.
When will the penny drop – we cannot afford to pay through the Euro anymore.
Take someone on €160k per year. The actual wealth generated by the people in this economy is not enough to support that.
Now, if you implement a pay cut in Euro it’s absolute. If you have your own currency you can implement automatic pay cuts but the income of various groups in terms of their purchasing power in the domestic economy remains intact.
Price controls etc would have to be introduced
I haven’t explained this well but we don’t create enough of wealth to use the German-backed Euro.
Hope somebody gets what I mean – can’t explain it properly
re: “Besides, if you tax high earners then the €2000 euro a week may not remain €2000 a week. There will be rational decisions to work less. That deprives the economy of that income, the tax from that income, and the work that would have generated that income. Oh goody!”
Please allow me to be a little facetious here.
Wouldn’t it have been great if the bankers, regulators, developers, pension fund managers etc had their earnings reduced back in about 2001. They would have worked less (if that were possible for some of them) and the country would now be far better off.
I don’t subscribe to the view that higher pay will mean better results. It is from the “because I’m worth it school”. We have just had a very hard lesson telling us they were definitely not worth it. It is a lesson that is not going down well in some quarters.
If 2010 GDP is €160bn and the range of estimates (including the latest ESRI estimate) for GDP growth in 2011 is 2-3% (ie €163-165bn). And you are saying that there is a strong correlation between Dec Budget adjustment and GDP, say it was 1:1 which would mean a €7bn adjustment would by itself reduce GDP to €153bn.
Does that mean under that scenario to get to a 2-3% growth in GDP that we would need a 6.6-7.8% spurt from €153bn to get to €163-165bn? And if so is there any evidence to suggest that what on the face of it looks like major growth is in any way realistic?
By the way, if I understand the IMF correctly they say that on average a 1% downward Budget adjustment equals a 0.5% downward adjustment to GDP over two years. It’s from their recent World Economic Outlook which I can’t find online but Britain’s Telegraph has the story.
“The idea of front loading a fiscal adjustment is idiotic, please quote me on that.-Lawrence Mishel at TASC conference
Fasinating arguments. I’d love to be, and yet hate to be in the DoF these days. An old sales codger I used to know said “easier to ask for forgiveness than beg for permission”. Our minds will be concentrated over the next 2 months on problems which seem almost intractable. Perhaps it’s time to step away from looking at the debt and deficit as the primary problems, and instead view them as symptoms.
What would we like to see in two years time? A contry that is growing, not worried about going bankrupt, competitive with neighbours, something like we were around 97.
How do we do that? Government can start by dramatically reducing all costs to doing business, rates, electricity, minimum wage, anything controlled by the government that feeds into costs of doing business, slash…by a lot (I’m thinking at least 30%)
Less revenue for the government, will that be a problem? Maybe, but at least you have set the productive side of the economy on the right track. Then start your cuts, be as vicious as you feel brave enough to do.
If its not enough to bring the deficit down to 10% next year, which is where it surely must be, at least business can do business, and perhaps the government will have to look for [debt] forgiveness.
@ Tull: Thanks for the comment.
We have a predicament Tull. Declining incomes, rising debts.
The Laffer (or should that be The Laughter) curve: Emirical evidence please – for different types of contemporary economies: PC and FIRE, developed and developing. Should get someone a PhD.
I can give you some anecdotal.
Self-employed marginal rates are now 55% of income (41%+8%+6%). That doesn’t kick in to 174k income. Over 75k, the marginal rate is 53%. Under that, it is 51%. If you are a high-rate taxpaying self-employed, the state take is more than 50% of your higher rate income.
For me, I have reached the point in the year where it is not worth my while to work and hire someone to do jobs for me (gardening, painting, household maintenance, whatever). It is cheaper for me to forego the earnings and do them myself.
So that is what I now do.
By contrast, tax rates in Cuba for the self-employed are 10% income tax and 25% social security…
Until proponents of this move credibly outline how this can happen without collapsing the economy, it will remain in the realm of pub-stool economics.
Klaus Regling, chief executive of the European Financial Stability Facility signalled this week support for the German initiative to reopen EU treaties in order to set up a new, permanent bail-out procedure that leans more heavily on private creditors.
The position as agreed in May when there were fears that the sovereign crisis might spread, does not mean that Greek debt will not be restructured in 2012.
It’s common these days for Germany to be singled out for behaving now as we should have had in the recent past, while a poll this week showed that 69% of the French public support the protests against raising the pension age from 60 to 62.
The experience of Japan shows that high standards of living are not guaranteed and the changing model of globalisation shows that advanced economies will have to battle to maintain living standards against the expanding educated populations of the emerging economies.
A focus on the structure of the economy may be more useful than on multipliers.
About 400,000 net jobs were added from 1998 while the number in the internationally tradeable goods and services sector was 11,000 to 2007.
Simply, almost all jobs growth was built on the property/credit bubble.
With the collapse in tax revenues and over-borrowed households inevitably scaling back on spending and debt, how can the bubble effect be maintained by borrowing overseas at punitive rates?
In the US in the debate on reversing the Bush tax cuts, it has been suggested that the affluent are responsible for 25% of consumer spending.
In Ireland, apart from food, drink and local services, imports account for most other consumption.
So the biggest proportion of property tax revenue, would have little impact on consumption.
Look at all the time the other policies that ARE collapsing the economy are receiving!
I’m not qualified enough to do the analysis. But others are and should devote at least some time to it – or maybe it’s too difficult for them
Oops – just fell off my stool!
“Thousands of people turned out in Belfast this afternoon in protest over cuts announced earlier this week”
What is wrong with us???????
Are we just complete punks screwed by empire, church and Anglo and never say boo.
7 billion is crazy – just plain crazy! And anyone who thinks it isn’t is plain crazy too!
You no longer being able to hire servants really is a tragedy that must be avoided at all costs.
How do you think money circulates? What do you think specialisation is? Come to think of it, what do you think servants are? Is a painter and decorator a servant? Or a landscape gardener? What about someone who does hedge laying? Or someone who fixes computers? Or is it all self-employed people?
Indeed: I mentioned this above, and I have been trying to draw attention to these preparations for some months now. That said, I’ll firmly believe it when I finally see it. And whenever the change in policy does happen, it may not be a time most congenial to us. For example, we could be eighteen months into our EFSF binge-and-purge by the time the treaty modifications come into force – or maybe the Germans just get bored – and “orderly restructurings” promptly begin.
That particular brand of supply-side, trickle down snake oil proved to be toxic in America in the 1980s and led to the extreme gap between rich and poor that we see to this day there. Given a choice between cutting the pay or jobs of working people in the public sector or increasing taxes on the wealthy, nothing is going to persuade me that we really ought to keep the rates down on the rich because they might grace a few out of work nurses with some nannying jobs. It’s a big lie: people on modest incomes spend more on food than you do on gardeners and chauffeurs.
I am a servant. My doctor is a servant. My waiter is a servant. My plumber is a servant. In a market we are all servants of each other.
If I can provide more value doing what I do than it would cost me to paint my house, then I should work extra and pay someone else to paint my house. Society would be better off, I’d be better off and so would the painter. If the taxman takes so much of my income that this decision is changed, then I stop working and so does the painter. That’s a bad outcome, and is only one example of the damage that high marginal rates can do.
As for the remark that people would “stop being acquisitive”, it illustrates both prejudice and ignorance.
Of course, if I am a thief or a destructive fool (as per several of your example villains) then I should be stopped from doing what I do. Taxation policy is not the right tool to do that.
What are you talking about?
As I say, tell me who you think are servants? Do people who fix computers count as servants? Because that’s what I do. How about plumbers, are they servants? Painters? People who maintain hedges? How about home help or carers? Are they servants too?
I contract in the services of another self-employed person or a small company to perform work for me that it is either beyond my specialisation or that I am too busy earning a crust for me to do. The balance between what it is worth me to spend time doing and what it is not has changed.
My household income is the same as two average incomes. I’m a long way from chauffers and you are a buffoon.
Let me correct myself…the example villains were actually Joseph Ryan’s, but I suspect Ernie would agree with his list.
PAYE, with its steep progressive taxes, counts for me as super taxation and yes, as theft.
NAMA may also be theft. I suspect that if the Commission had not intervened it would have been.
As for the idea that people are not rational on marginal tax rates, I hate to disappoint you, but rationality enters into it all the time.
If, for instance, a brain surgeon could invest 100k Euro in additional training but his additional income will be taxed at 100%, will he do the training? Unlikely.
If a self employed IT contractor could take a contract in Hamburg, away from his family for 2 weeks, and his extra income is going to be taxed at 75% – will he take the contract? Will tax rates feature in his decision? You betcha. If a sports star will be taxed at high rates, will he move to Monaco? Oh yeah.
As long as the left cannot see that high income does not equal villany, then it is blind. I, who you would probably mistakenly position on the right, can see villains all around.
The use of the word servant is unfortunate
It implies somebody who has an unequal right to aspiration as the person being served.
It also invokes class.
We are taking, however, about the trade of services.
It would be good to have non-inflamatory words for:
The person who provides the service (servicer) and
The person who receives the service (servicee) but it can all sound a tad dodgy too – can’t it!
Or we could stick with ‘buyer’ and ‘seller’…
You are right. The pity is that I was particularly proud of my late night musing and now, I have to take it all back.
Good point re taxation and income too btw.
Problem as I see it is that we have become so poor now that we must accept that we cannot afford to hire the “top” people for our public sector any more.
We are learning a really important lesson in “why it is important to run your country well”. But we are learning it too late. Look at the irish times pic of the Healy-Raes dancing on a road and you’ll see the point.
There comes a time when you have to admit that you have lost – and we have lost. You can continue to play the game (and lose even more) or you can, like a spoilt petulent child throw the board on the ground and start a new game.
Whether we like it or not – we only have the last option open to us.
Nobody will debate this here but we will only survive if we force a European context onto this.
We are not stupid – we are simply too nice to survive in the real world. Our misfortune is that we were colonized by a relatively benign power which sheltered us to some extent from the realpolitik of Prussia/Austrian domination.
So get real here. Colm McCarthy seems to think that the markets are logical and rational -they’re not – they’re profit hungry. You can cut all you want but if they sense a profit in shorting you they will.
The game is up. We have lost. Let’s do the childish thing and tell them all that we don’t want to play anymore. They can heve their pesky Euro.
Unsavoury as it sounds that is the way it is.
Ok – just realized how rambling all that is but here are the essentials:
1: We are too nice (too eager to please) to play Europe properly
2: We have lost this game and must start another
3: We have underplayed the European context to this completely
4: Buyer and seller is alot more sensible (and less tawdry) than servicer and serviceee
Karl – thanks for the explanation and clarity on this. I would add one point: the magic number of 10% GDP budget deficit next year won’t satisfy bond markets. Bond markets will want to see solvency, and the fact is 20% of our GDP belongs to foreigners and pays little tax (and we are terrified to raise the tax on it because they will leave if we do). So our tax base and solvency is linked to GNP. When investors see our budget defict at 10% of GDP = 12.5% of GNP + we have unknown bank exposures paid by the sovereign + we are embarking on a masive fiscal cut in early 2011 to get to this budget target, they will surely refuse to buy our bonds at affordable interest rates. Our net debt may be around 70% of GDP at end 2010, but it is 90% of GNP, and our gross debt is 123% of GNP at end 2010. These are dreadful solvency indicators for a country entering the major fiscal contraction you describe. All that makes our future profile of debt including interest unsustainable. So we need to get on with bringing in the IMF, give up on bond market financing for several years, and most likely (when the EFSF ends, alongside Greece) restructure all our sovereign and bank debts just as we have started to do with Anglo last week.
I used the word “servant” knowingly and to make a point. The context was hoganmahew giving his “real world” example of how high marginal rates impact economic activity. Implicit in the example was the idea that rates are already so high for the well-off that it’s affecting his economic decisions in a way that has a deleterious impact on the economy.
Plenty of people make these claims. They are no doubt true but provide an incomplete picture. For the political context in which they are made is one in which they are meant to support the broader false claim that personal tax rates, particularly for the wealthy, cannot possibly go any higher and that, therefore, all budgetary adjustment must take place through spending cuts alone. I’m looking at you, Hugh Sheehy not to mention the Economic Sage of Kuala Lumpur.
My last post was pointing out: 1) that this sort of trickle-down nonsense has been entirely discredited in the US where it was explicit policy for over a decade; 2) that, obviously, the multipliers for the activity of less wealthy wage earners, whether in the public or private sector, buying food and the like will be higher than for the small number of hoganmahews with their gardeners and valets. Therefore increases in marginal tax rates on the wealthy are not to be avoided, even if it means hoganmahew has to do his own cleaning and maintenance for 3/4 of the year.
You’re such an eejit, Ernie, do you know that 😆
Not implicit Ernie, explicit.
Other than that, what the heck are you talking about with sages?
Jagdip Singh – apologies for getting back late on this, was away yesterday. First, I believe that Karl used 160 to facilitate his calculations, not as a prediction for 2010, which is fair enough as his calculations (and my subsequent ones) are not altered by minor changes in the baseline.
The ESRI is projecting 2010 GDP to be 157.8 rising to 161.4 in 2011 in nominal terms– a real GDP growth rate of 2.25% (this is pure volume with no price lift). Further, in this projection they have factored in the impact of a €4 billion contraction based on the following: 1.5 taxation, 1 current expenditure on goods and services, 1 capital spending, 0.5 social transfers. Using their fiscal multipliers we can estimate the GDP deflation to be 1.6%.
Were we to increase this fiscal contraction by €7 billion (using the same proportions) we would find economic growth slowing down further. The GDP deflation would be -2.7, resulting in a nominal GDP of 159.5 in 2011. This would probably reduce the real GDP growth rate below 2%, depending on price movements
It should be note, however, that this deflation may not impact on the GDP in the first year – it may lag or it may accelerate. The ESRI makes clear that its fiscal multipliers are best used over a medium-term period. But if all things hold, the deflation will hit sometime.
As to the IMF – the link below will get you to the report. Yes, the IMF estimated a 1:0.5 ratio contraction to deflation. However, this was in the context where interest rates fall and currency is devalued. Therefore, it estimated the impact (using Canada as an open economy proxy) where interest rates have hit a zero floor. In this situation, the ratio becomes 1:1.1. With a zero interest floor and where other countries are in fiscal contraction, the ratio rises to an alarming 1:2. Ireland has an interest rate floor and, now, other countries are starting to fiscally contract.
The ESRI refers to the possibility of serious and embedded deflation. The estimate that a total €15 billion contraction package over the next four years (double what the Government had intended to do) would produce an average real growth rate of 2.25 percent up to 2015. They then state: ‘There is a danger that a growth rate close to 2 per cent, following on a prolonged recession, could send the economy into a period of prolonged deflation.’ As I said in a previous comment: that’s pretty heavy dice to roll.
Sensible observations. One of the reasons for the credit bubble was the trickle down nonsense.
But it seems that others do not want this said. Why not?
“One of the reasons for the credit bubble was the trickle down nonsense. ”
I don’t accept that the credit bubble was fuelled by trickle down nonsense. Ridiculously low taxes on capital, the movement of capital, capital gains, CFDs, shares, dividends ex-state, intellectual property, etc.; those are the result of trickle down nonsense.
In fact, taxes on property transactions (e.g. stamp duty), were contrary to trickle down, mind you, they only applied to residential in any significant way. Commercial transactions could and did avoid stamp and other taxes (resting on contract, for example, or offsetting capital gains).
Finally, I don’t accept that me, or anyone else, buying services has much to do with trickle down. What it does have to do with, though, is multipliers; with the amount of economic activity a unit of income generates.
I’m afraid that Ernie’s observations are not sensible, and trickle down was not what caused the bubble in Ireland.
The bubble in Ireland and Spain and (a different kind of bubble) in Greece was caused by a badly designed Euro.
Karl and Paddy and Jose were three business men in a small town.
Karl sold cars. Paddy designed coputer software and Jose had a really nice restaurant that other people wanted to visit.
Karl was the richest and Paddy and Jose were just about breaking even.
Now Karl was too mean to buy computer software and too frugal to spend any money in Jose’s house but he still needed people to buy his cars.
So Karl gave his excess money to Paddy and Jose and told them to buy cars with it. He told them that they could pay the money back over several years at low interest. And he told them to keep making the software and keep the house open for visitors because, although he wouldn’t be buying them somebody else would.
And Jose and Paddy believed him. And they spent the money he lent them on cars and on other stuff too. Karl didn’t really mind because ultimately he soon realized he wasn’t selling them products any more – he was selling them debt. And it was a great business.
So Karl had no incentive to stop the flow of liquidity to the less productive periphery – he in fact encouraged it.
Now Jose and Paddy are in trouble. They still have things to sell but Karl still won’t buy them. Instead he wants all his money back – fast.
That’s what happened. So Jose and Paddy will soon realize that Karl is not really much of a friend at all. In fact history would show that he isn’t capable of forming meaningful relationships with anybody. And the great monetary union he designed which allowed all this to happen will go. All that matters is how much sacrifices Jose and Paddy will have to make before they’re out of the bind.
I didn’t say trickle down caused the bubble. Rather, I rejected the idea that trickle down is any part of the solution, which is what many here suggest: i.e., if we only make sure to keep taxes for the wealthy low (even if it means cutting social welfare, say), they’ll spread the money around. This was false when Reagan proposed it in the 80s (it was reviled by his own chief of OMB as “voodoo economics”) and it’s false now. Given a choice between allowing hoganmahew to keep his gardeners on all year and allowing those on social welfare to have something approaching a reasonable life, the latter is the choice that we, as a society, should make. It also makes more economic sense.
Nicely put. When Paddy hit troubled times, Karl fell off his barstool laughing when he learned that one of the stimulus measures introduced was a car scrappage scheme – now he thinks Paddy is insane and not just foolish and irresponsible.
Let’s assume that the goal for those on social welfare, or at least for those on unemployment benefit, is to remove the need for social welfare in the first place i.e. they become employed. Now where exactly, are these jobs going to come from? Maybe the government can keep borrowing money to fund jobs in the public sector, but somehow I think that may not be sustainable. Guess that leaves the private sector. So a tax regime that severely penalizes the creation of wealth and jobs is the answer? I would suggest that such an approach shows absolutely no understanding of how companies are started and how they grow.
There are clearly many, particularly among the higher paid in the public sector and protected private sector, that do not justify their salaries (private companies subject to real competition tend to be self-correcting in this regard). The answer here is to fire those people or reduce their salaries – using tax policy to solve this problem is not the answer. For leading companies in the high tech/smart economy arena, it is not uncommon to routinely fire the poorest performing 5% or 10% of employees each year. This prevents complacency, means the majority are not penalized by having to work with non-performing and uncooperative co-workers, and generally moves people out of positions for which they are just unsuited. Would you object to such a policy being introduced for government funded/subsided jobs? People might be more willing to pay higher taxes if they were convinced the money would be put to good use and they would see some benefit; however there are no indications so far that the government is serious about redesigning and reforming the public sector.
Agree with Ernie….higher earners may well hire a gardener with their extra income and help the economy in a trickle down fashion, but they are also just as likely to find a way to spend that income abroad or save it, more so in fact these days. so our economy gets no benefit. at least by taxation we ensure it all stays here, not just some of it.
govt is in no way serious about doing anything with the public sector, since the pension levy, public sector average weekly wages have fallen by 4.4%…but they are still in receipt of yearly salary increments. so that small 4% reduction wont be long about disappearing thanks to the croke park deal, and all our crowing about being the first to take austerity measures will be shown up for the fallacy it is. the only real genuine cuts the govt has made has been to capital spending…which is in effect their contribution to private sector wages…..no bother to them telling a few hundred thousand young men there is no work so they may just head for the airports..the path of least resistance is always chosen in ireland. want to know why there are no protests here?? come on, public sector are safe after slight cuts on what were already massively high wages compared to elsewhere….private sector workers are so fearful of losing their jobs they just have a head down get on with it policy now….those not falling into either category have left…and those on welfare are probably just glad they live south of the border!
Those higher earners may also hire a doctor or web designer or make an investment in a new business with their money. It’s not trickle down it’s flow around. The person that they pay is facing the exact same decisions. Should they work and get taxed or not work. The “welfare trap” is a similar thing at a lower income level.
Also, if these earners – at either income level – are taxed to the point that they stop doing what they do, then we don’t get the benefit of that either. Then there’s no trickle in any direction.
Meantime, the idea that you get to tax a pre-existing pot of wealth is one of the fundamental errors behind the high income tax idea. It’s nonsense. A self employed IT specialist is unlikely to have a pot of pre-existing wealth. There is only this year’s income, which is the result of long ago investment in education and of hard work. The moral and financial basis for punishing this person for earning money this year is very weak.
Then, this continued idea that higher earners spend more outside the economy and that savings are bad…where does that come from. I suspect this is a pure emotive line. The example purchase that riles Ernie so much is services, which are 100% domestic. You´ll struggle to import gardening services. Then, savings do horrible things like giving the banks enough cash to lend, how terrible. The money doesn’t disappear, it becomes available for other uses. Spend it and it’s gone, invest it and it may well pay you back twice.
Also, what would most people on lower incomes spend most of their money on? Energy. Imported. Clothing. Almost all imported. Shoes. Imported. A car. Imported. Food. Unless they live on potatoes, turnips, steak and lamb then it’s largely imported too, and apart from land most of the factors of production are imported. Bread? Is this about how people are going to eat Irish bread and that’s the key difference?
If we imagine a wealthy person with loads of domestic servants, just to use Ernie’s example, isn’t that money 100% retained in the Irish economy? If you find the idea that someone might hire a gardner rather than do it themselves, but not the idea that they might hire a mechanic instead of fixing their own car, or a labourer to help them on building a wall rather than doing it themselves, what’s behind this idea? Are you stuck in some “Upstairs Downstairs” timewarp where some jobs are demeaning? Crickey..you’d better talk to the guy who empties the toilets on commercial jets….he’d probably prefer to be gardening.
Can anyone, even Brian Cowen will do, explain to me what on earth was going on in INBS? Reading through the stuff in the papers over the weekend about the INBS unique approach to loan approvals had me again tearing at my hair that the taxpayer is on the hook for INBS.
With what measure of integrity can senior government politicians and commentators face the people and declare that bailing out INBS is in the continuing ‘national interest’? How did INBS with its comparatively small though excessive bad debt book become systemically important?
Sorry to raise a political point but the answers aren’t out there in clear view.
Apologies in delay in saying “thanks” for the explanation and the link to the IMF World Economic Outlook. The succeeding post from John McHale focusses on this one aspect but I think it marvellous that expertise is being shared so openly. Thank you again.
Re INBS – NONE. It is the baddest little baad-bank in the world – and the serfs landed with an OBSCENE bail-out greater than the amount to be stripped from their backs this December ….
High quality of discourse – morel pls.