Daniel Gros: External versus domestic debt in the euro crisis

This post was written by John McHale

In recent articles, Daniel Gros has emphasised the importance of a country’s financial wealth for its solvency.     He further develops his controversial arguments in this VOX piece, with particular emphasis on the distinction between external and domestic debt.  An extract:

In a monetary union, the usual assumption that public debt is riskless is not valid. Countries like Greece don’t have access the ultimate option of printing money. In this sense, the public debt of Eurozone countries resembles that of emerging markets (Corsetti 2010). 

The crux of the importance of external debt lies in the fact that even Eurozone nations retain full sovereignty over the taxation of their citizens. The logic is somewhat subtle and best explained by an extreme example that makes the point extremely clear. Suppose a nation’s entire debt is held by one man and the nation faces a debt crisis. If this bond holder is a resident of the nation, the government could impose a tax on him equal to, say, 50% of the value of his government bond holdings. Using this new tax revenue, the government could pay down its debt by 50%. Of course this would be an outrageous expropriation and make it harder to issue debt in the future, but it would not be a default.

By contrast, suppose the sole bond holder where a foreign citizen living abroad. In this case, the government could no longer freely tax the individual. Governments do not have a free hand in taxing non-citizens; they are bound by existing treaties and international norms. 

The baseline point is that as long as Eurozone members retain full taxing powers, they can always service their domestic debts, even without access to the printing press. For example, governments could reduce the value of public debt held by residents by some form of lump-sum tax, such as a wealth tax. The government could just pass a law that forces every holder of a government bond to pay a tax equivalent to 50% of the face value of the bond.2 The value of public debt would thus be halved, much in the same way as it would be if the government ordered the central bank to double the money supply, which would presumably lead to a doubling of prices. 

This is why, I believe, it is foreign debt that constitutes the underlying problem for the solvency of a sovereign, even in the Eurozone. 

Of course, we have recently seen a tentative move towards wealth taxation with the (temporary) levy on pension assets.   Dominic Coyle does not mince his words in criticising the new tax in this Irish Times piece from Monday.

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54 Responses to “Daniel Gros: External versus domestic debt in the euro crisis”

  1. Hugh Sheehy Says:

    In this article Mr Gros has nicely illustrated one of the reasons the pension levy will turn out to be a mistake.

    For the sake of comparatively little money, sensible Irish people have now been given very significant advance warning. Never hold assets that the Irish govt can easily trace. Irish govt bonds fit in that category, at least if held directly.

    The methods the govt will have to use to “encourage” people to hold assets in Ireland are likely to become progressively more draconian and destructive.

  2. John McHale Says:

    More techically oriented readers might be interested in the literature on optimal (efficient) capital/wealth taxation.

    Public finance economists have generally been quite sceptical of capital taxation, pointing to large deadweight losses. A well-known result from the optimal taxation literature is that the optimal rate of capital taxation in is zero in steady state. However, putting aside all issues of fairness or rights, efficient taxation could have an initial rate of capital taxation of 100 percent — complete confiscation! — followed by zero capital taxation thereafter. This runs into obvious problems of time inconsistency, and governments who can’t credibly commit to eschew capital taxation in the future would destroy any incentive to save. Although the treatment is quite technical, Section 7 of this survey paper by Auerbach and Hines contains an excellent discussion.

    http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.22.1678&rep=rep1&type=pdf

    I think most public finance economists would be quite surprised by Daniel Gros’ embrace of the wealth taxation idea.

  3. The Dork of Cork Says:

    In a real physical sense it does not really matter if you tax labour gains or tax savings - both is energy saved that is subtracted and socialised.

    But the psychological aspects of saving confiscation is intense.
    To be honest I see no real function for the pension industry - they say we must save for the future like as if the paper wealth has value - it has not , it is just a metric that seems to be invested pretty inefficiently if at all (much of this inert money goes to pay city types who have no physical function in the world of reality but excel at abstractions that function as a magicians distraction.
    You will only have a pension if the industrial world continues - if no such wealth exists you will not , anything in between and it would depend on the secret of your success in the peeking order.
    The pension industry is a bureaucracy like any other , some work and some do not.
    In the interests of social cohesion perhaps its best to have a Japanese post office system that would have neutral or modest growth rather then the predictable hyena bone crunching and social chaos that would be the result of D. Gros more extreme experiments.

    We all know how animistic Irish Culture is under its very thin Veneer - lets not go there.
    Again the money supply is externally owned to a extreme level here - either we jump ship and devalue or we socialise the money supply.
    Tax would be playing into the continentals hands as even more of our money would flow to the holders of external bonds.
    The one fear I have is that the ECB may decide to monetize after the funds got trapped - vapourising Irish pension funds that once were in inflation protected equities

    You just can’t win against CBs if you give them all the power - its not rational really, this power structure - but when have the Irish ever been rational.

  4. grumpy Says:

    @John McH

    Interestingly throughout even the late eighties and first half of the nineties there was a common instinct in UK private asset management circles to hold assets in offshore locations.

    I really do mean instinct, not clever accounting wheezes. Even after the ‘79 - 95 total domination of UK politics by the Tories there was a latent assumption that sooner or later there would be unsustainable deficits and confiscatory attitudes towards privately held assets be employed. It seemed irrational at the time, but the experienced guys had no problem with it.

    Once you go down that road you quickly find out it is close to being a one way street and its not too long before you reach a dead end.

    I think your concerns about the consequences of sovereign default on international fund assets (yes some is ultimately Irish held) is overdone in comparison to the effects of confiscation of the capital of Irish people by Ireland.

  5. Ceteris paribus Says:

    @ Hugh
    Just watched the MOF reassuring us that he won’t grab our bank deposits. The savings of citizens are sacrosanct. What a relief….. Which way did you say the exit was?

  6. anonym Says:

    (Off topic: that /Spiegel/ article about Eurosystem collateral has showed up. ECB, EBS and CBoI, oh my!)

  7. John McHale Says:

    @grumpy

    Not sure how I gave the impression that retrospective wealth taxation is anything other than a very bad idea. Perhaps your point is about comparative ink spilled: I suppose I am less worried about the instinct to protect financial assets than the instinct to protect reputational assets. I doubt there will be a wealth-taxation bandwagon.

  8. JohnTheOptimist Says:

    What Gros writes is very similar to what I have posted here many times:

    “Ireland, which is on course to run a current-account surplus this year, should be able to withstand the crisis much more easily than countries like Portugal or Greece which are still running sizeable current-account deficits.”

    Let’s get real about this. At the end of the day, the dispute about whether to default or not default should be thought of, not as an intellectual debate between two groups of pointy-heads, each motivated only by what they think is good for the economy and society, but rather as a battle between two groups of gamblers, which have invested large amounts of money in mutually-conflicting outcomes. Depending on the outcome, one group is going to make a lot of money and the other group is going to lose a lot of money. Its as simple as that. The issue is not which is right, but which will win.

    One group has kept its money in Ireland, where, because of very high real interest rates in recent years, it has achieved an excellent rate of return. This group is gambling that its excellent-to-date rate of return will not be retrospectively wiped out by a default/devaluation. I have never made any secret of the fact that I belong to this group. The other group has moved its money abroad, where, because of very low real interest rates in recent years, indeed in many cases negative real interest rates, and, in relation to that portion moved to the UK, a currency devaluation on top, it has achieved a derisory or even negative rate of return. Look how much 1000 euros invested in UK government bonds in 2007 is worth now compared with how much it would have been worth if it had been invested in Irish government bonds. This group is gambling that its derisory-to-date rate of return will be retrospectively made good by a default/devaluation in Ireland. If that doesn’t happen, quite simply, they will have gambled and lost. I suspect that this group is heavily represented on this site, and that their fury, every time someone like Gros points out that Ireland has no economic need whatever to default/devalue, is because of this. If they wish to claim that I am motivated similarily, but in the opposite direction, so be it. I have never hidden that fact.

    A default/devaluation would be the largest-ever transfer of wealth within Ireland. Those who had gambled on it would make a killing at the expense of those who hadn’t. People who had invested their savings in Ireland and people on low incomes, with no savings to invest anywhere, would suffer a dramatic fall in their standard of living as inflation went through the roof. But those wealthy individuals, who had moved their money abroad in recent years, would make a huge capital gain. McWilliams was recently discussing with Pat Kenny the possibility of a 90 per cent devaluation. Think how much those who had invested their money abroad would make if that happened. They’d be absolutely rolling in it, while those on low incomes, with no savings to invest anywhere, would suffer a dramatic fall in their standard of living from the resulting inflation. Because of this, all politicians, commentators, journalists etc, who have the power to influence people in the default/devaluation debate, should be compelled to disclose what financial interest is involved for them. That applies all round, of course, and, as I said above, I have never hidden the fact that I have a financial interest in a no default/devaluation outcome. Others should be equally forthcoming. Everytime someone, whether politician, commentator, journalist, or poster on here, advocates default/devaluation or says that it is ineviatble, the reponse should be “what’s in it for you?”.

  9. Philip II Says:

    Daniel in this and other pieces seems to be explicitly, warmly, arguing for some form of confiscation of “foreign” wealth, is that the case?

  10. Peter Stapleton Says:

    Note that according to Daniel Gros’s regression the market is seriously underpricing Ireland’s debt - the spread on Irish bonds ’should’ be somewhere between Spain and Italy - round 2%.

  11. Philip II Says:

    John
    A followup : you are on the pension board are you not? Do they/you have a view on this?

  12. The Dork of Cork Says:

    @John the optimist
    I like your bluntness - I believe you are essentially correct.
    But many of us have not invested in anything productive either at home or abroad as this flow of funds seems to be net energy negative due to inertia in a obsolete financial system.
    Even cash/bonds earning 1 -2% in Germany or getting destroyed by QE in the UK is getting a yield - it just so happens to be a real negative one.
    Monetary metals do not have a yield - they just are.

  13. Kevin Donoghue Says:

    @John McHale: “I think most public finance economists would be quite surprised by Daniel Gros’ embrace of the wealth taxation idea.”

    I don’t see that he needs to commit himself to wealth taxation in order to support the claim he is making here. He can tax interest income instead and achieve essentially the same result. Just modify his text as follows:

    Suppose a nation’s entire debt is held by one man and the nation faces a debt crisis. If this bond holder is a resident of the nation, the government could impose a tax on interest equal to, say, 50% of the interest on his government bond holdings. With this new tax revenue, the government’s (net) interest burden is reduced by 50%.

    Of course there are problems with either approach, but the question of whether income or wealth is taxed is not crucial to this argument.

  14. JohnTheOptimist Says:

    @John McHale

    Dominic Coyle does not mince his words in criticising the new tax in this Irish Times piece from Monday.

    JTO again:

    Dominic Coyle’s piece is a gross over-reaction, bordering on hysterical.

    The government put a modest tax on pension savings and reduced taxes on other items, particularily VAT on tourist-related expenditure and airport taxes. This is perfectly sensible in the present circumstances. It does not mean that, when circumstances change, it would not then be equally sensible to reverse these changes.

    There are several separate issues.

    The first issue is the extent to which these tax changes are likely to result in a reduction in overall saving and an increase in overall consumption.

    The reality is that this is exactly what the economy needs at the present time, indeed to a much greater extent than these very modest tax changes are likely to bring about. Quite simply, at the present time, Ireland Inc is saving far too much and spending far too little. Savings ratios are through the roof. That doesn’t mean that the reverse might not apply in a few years time, just as it did a few years ago, in which case the sensible thing would be to then reverse these changes. At the present time, these tax changes are likely to have a net beneficial effect, although probably a modest one.

    The second issue is the extent to which these tax changes push Irish pension funds into investing in foreign government bonds, rather than in Irish government bonds.

    The reality is that that is what they are doing allready. In case the man from the pensions industry hadn’t noticed, virtually all pensions funds in Ireland have, for the past year, been turning their noses up at the prospect of investing in Irish government bonds at interest rates of 8% to 10%, while eagerly investing in foreign government bonds at interest rates of 2% to 3%. That is their free choice. I’d be against any government compulsion on them to do otherwise. But, if they choose to do so, they lose any bargaining power they have with the Irish government, which then has nothing to lose by imposing such taxes. In regard to the very small amount of Irish pension funds currently being invested in Irish bonds, the current sky-high real interest rates more than compensate for this very modest tax.

  15. Edward v2.0 Says:

    @ JTO
    I understand completely… you’re talking about a debate between two side representing ‘hope’ and ‘experience’. I wonder which one will triumph?

  16. grumpy Says:

    @JOhn McH

    Ok, read again with the following in mind. |David McW and some others say you default on the ELG or gilts and “the market has no memory”. You go back to fund management and bond desks the next day and say - “look no unsustainable debt load, would you lend us some money for our expensive public sector please”.

    David would have you believe they cannot logically think of any reason not to. There is a reputational element in reality (the piont you have previousy made) - not to mention the question of how sustainable the cost base is long term. But the market would lend, at a price, and after a few years, logic and the objective approach of professional managers of diversified funds would mean the default per se was hardly of consideration.

    What I am trying to get across is that confiscatory type capital taxes, levies or whatever, (in high inflation times, this is comparable to very high investment income taxes) have a much longer effect on the behavior of individuals, almost to the point of paranoia. I am not guessing about this.

    If you go down that road, you have to expect the impact to resonate decades into the future.

  17. Aidan R Says:

    This is an excellent article and should be considered a serious policy proposal. It highlights the misguided obsession by the Irish government, IMF and ECB-EU Commission on ‘fiscal adjustment’. This is not to deny the importance of adjustment but it is not the core problem.

    The crux of the argument is that Ireland, Greece and Portugal cannot print money and therefore have the option to avoid a default by taxing those who hold domestic debt. This does really apply to Ireland but does directly apply to Greece. Ireland, it is argued, should mobilise existing resources (in the form of savings and other assets) to finance itself - in practice this would require some level of capital control. Capital controls should not be dismissed on the basis of market-econometric assumptions. If one is opposed to capital controls they need to produce more than market regulating assumptions (i.e. the type of logic that emerges from the CATO institute).

    It is a secondary argument (and not in this article) that a similar approach could be used to tax assets (i.e. a wealth tax) to raise revenue for investment. Whether this is a tax on productive wealth or dormant wealth is particularly important. Taxing wealth that is in flow and generating jobs is not a good idea for obvious reasons. But, this does not apply to pension funds etc or to the financial speculation industry.

    On a side note - we can learn a lot from economic history on how domestic savings were used to finance public debt. The entire western economy was premised, at some stage, on public institutions taping into private wealth for efficient gain. If we have learnt anything from the past 15 years - it is that we cannot assume private actors used capital productively. See this article on the Netherlands in the 17th century.

    http://journals.cambridge.org/action/displayFulltext?type=1&fid=8194360&jid=JEH&volumeId=71&issueId=01&aid=8194358&bodyId=&membershipNumber=&societyETOCSession=

  18. grumpy Says:

    @Aidan R

    ” Whether this is a tax on productive wealth or dormant wealth is particularly important. Taxing wealth that is in flow and generating jobs is not a good idea for obvious reasons. But, this does not apply to pension funds etc or to the financial speculation industry.”

    About a decade ago greater awareness of Ireland’s capital taxes regime encouraged a lot of newly wealthy people to stuff funds into things the capital tax regime regarded as “in flow and generating jobs” because it was going to be taxed if it was left “dormant”. It had a predictable effect and was part of the motivation (there were other tax angles at work too) for all the public houses, hotels etc.

    Tax regimes can and does and has distorted economic choices. Incentivising people to invest more directly in businesses rather than have them save or invest more indirectly (the only “dormant capital” is probably reserves at the CB) through collective investment is part of what got Ireland into the mess it is in today.

    Savings have a useful role in the economy.

  19. Hugh Sheehy Says:

    @Aidan R
    I wonder how we’ll finance the deficit once we run out of assets to confiscate?

  20. zhou_enlai Says:

    Mr Gros really annoys me.

    He says a country can control its own citizen’s wealth but not debts owed to other citizens.

    “By contrast, suppose the sole bond holder where a foreign citizen living abroad. In this case, the government could no longer freely tax the individual. Governments do not have a free hand in taxing non-citizens; they are bound by existing treaties and international norms. ”

    He [wilfully] ignores the fact that the Government has sovereignty over any debt governed by its laws and courts (save to the extent to which any amendments is deemed contrary to EU laws or the EU Charter of Findamental Rights - whoever the creditor is).

    This is of course why the choice of laws and choice of jurisdicton clauses in sovereign bonds are critical.

    There is no legal reason that I know of why Ireland could not impose collective action clauses in all bonds issued under domestic law.

    Accordingly, rather than discriminate based on nationality and on the basis of choice of investments by imposing a wealth tax on those who invested in bonds, Ireland could simply impose a regime where haircuts were imposed by democratic majority of anyone who invested in Irish Bonds governed by Irish Jurisdiction and Irish Laws.

    Of course, this would not satisfy Mr. Gros who wants to discriminate between creditors based on nationality.

    Mr Gros is simply proposing legal mechanisms (rather than principles) to implement his desired solution based on real-politik power plays, i.e. he wants the powerful countries to succeed in discriminating between nationalities of creditors to allow those powerful countries to screw the Irish people to the absolute maximum to achieve the absolute maximum gains for foreign countries and their citizens.

    Mr. Gros is engaged in casuistry. Ireland is being mugged with a gun to its head. He is the assailant’s assistant, pretending he is unaware of the gun and suggesting there is a reason for us to hand over the money voluntarily. He will of course claim later that we acted of our own volition and he made no threats.

    This is a standard commercial technique whereby a dominant powerful party menaces another party with unstated threats into doing something wholly against their interest. This is how powerful private creditors use their power improve their security/repayments to screw other creditors who rank parri-passu with the powerful party. They use their position and power to bully the debtor into acting unfairly. Later they disclaim all responsibility.

    (At lease the NAMA Act dispensed with this pretence by saying that S. 286 of the Companies Acts, which allows a creditor to challenge a charge giving an unfair preference in certain circumstances, shall not apply in relation to assets acquired by NAMA)

  21. DOCM Says:

    @ All

    I would suggest that the real issue is as outlined by Hamish McRae in today’s Indo.

    http://www.independent.ie/opinion/analysis/greeces-woes-highlight-power-shift-across-eu-2656459.html

    The simple fact is that governments generally have indulged their electorates and have funded a lifestyle by borrowing which they can no longer afford. The problem for the EZ is acute because of a shared currency which has resulted in the individual difficulties of countries with the markets becoming a shared problem. As I layman, I have been struck by the similarities between banking and bond markets as far as EZ governments are concerned. Instead of runs on the banks, we now have runs on the governments and, until a mutual insurance arrangement is put in place, the crisis will continue.

    How Greece is dealt with provides a useful interim guide to how the eventual agreement on the ESM will look. Neither the IMF or the EU any longer trust Greek politicians to do what is necessary and the establishment of an independent authority to oversee the sale of Greek state assets is now a real possibility. In this game of chicken, Greece is the side with the weak hand. The same is true of Ireland.

    A Morgan Kelly solution is not the answer. But a recognition of the absolute necessity to bring the public finances back into balance is. Fiddling around with “jobs initiatives” so that a surfeit of ministerial appointees can give the impression of doing something useful - and funding it by the most counter-productive means imaginable - is not the way to go.

  22. Ahura Mazda Says:

    Can someone clarify this bit:
    “For example, governments could reduce the value of public debt held by residents by some form of lump-sum tax, such as a wealth tax. The government could just pass a law that forces every holder of a government bond to pay a tax equivalent to 50% of the face value of the bond.”

    In reference to the second sentence, is he suggesting that ‘only’ residents would be taxed on Gov bonds?

  23. grumpy Says:

    @zhou, ahura

    Not using Irish law to alter the bond repayments is a way he suggests to avoid annoying foreigners by what would be labeled a “default”. Limiting the effects to the Irish by using taxation, would concentrate the effects of the default within the country and avoid some of the reputational damage to gilts wrt international investors that John McH often raises.

    You could probably more sensibly default domestically on things like Bertie’s pension and actually get round to reading the clause in Croke Park that means it no longer applies because the state is insolvent.

  24. Aidan R Says:

    @ Grumpy

    Very fair point. But, the incentives in Ireland over the last ten years were not to channel savings into productive activity but speculative activity or real estate. It would have made sense to adopt fiscal policies to avoid both or at least tame their worst effects (i.e. a property tax).

    @ Hugh Sheehy

    I wonder how we will finance the deficit when the deflationary spiral we are currently on runs the economy into the ground. Capitalism by design is based on a compound rate of growth. Policies aimed at raising revenue such as the pension levy or a wealth tax will have less impact on growth than cutting public spending.

  25. The Dork of Cork Says:

    @Zhou
    Excellent breakdown of D. Gros clear loyalties in this regard.

    I hate guys who project a image of the so called European Ideal but behind it all they are clearly of a nationalist mindset - there is nothing wrong with this viewpoint but his advice is clearly duplicitous.

    This fake Europeanism is clearly toxic for the remaing few who actually believe this horse manure.
    If people want to solve this mess a bit of honesty would not be inappropriate.

  26. hoganmahew Says:

    @Aidan R
    “It would have made sense to adopt fiscal policies to avoid both or at least tame their worst effects (i.e. a property tax).”
    It would if there was any evidence that it would work. Instead the US, France, Hong Kong, the Netherlands, you name it with property taxes, have experienced property bubbles, some of which have burst, some of which have not.

  27. DOCM Says:

    @ All

    FYI

    http://www.reuters.com/article/2011/05/25/us-standardpoors-ireland-idUSTRE74O2P720110525

  28. Aidan R Says:

    @ Hoganmahew

    True, but they did not have the same aggressive pro-cyclical policies we adopted. (Charlie McCreevy cut capital gains tax in half in the 1999 budget). The closest comparison is the US and what we both share is a) lax financial regulation b) low levels of tax as % of GDP (and GNP in Irish case). The Netherlands are currently experiencing the possibility of an emergent property bubble but given a tradition of counter-cyclical tax policies they will not experience the chaos of our economy.

    If Ireland had introduced a property tax in the 00’s our tax base would not have collapsed in 2008. Taxes would have decreased but not on the same scale. Presently our overall tax intake as a percentage of GDP is equivalent to Estonia and Lithuania - this, in my humble opinion, is the core of the public finance crisis.

  29. zhou_enlai Says:

    @grumpy

    “Not using Irish law to alter the bond repayments is a way he suggests to avoid annoying foreigners by what would be labeled a “default”. Limiting the effects to the Irish by using taxation, would concentrate the effects of the default within the country and avoid some of the reputational damage to gilts wrt international investors that John McH often raises.”

    That is it in a nutshell. The prospect of being labelled a “default” is the non-legal real-politik gun. You’re point is we should go along with the mugging because it is in our interest not to get shot. You may be right. However, I think we should insist on the principle that we won’t pretend this isn’t a mugging. We should tell the mugger’s assistant that we don’t differentiate between him and his colleague.

  30. zhou_enlai Says:

    “You’re point”? Where is that edit function again?

  31. zhou_enlai Says:

    @DOCM

    “The simple fact is that governments generally have indulged their electorates and have funded a lifestyle by borrowing which they can no longer afford.”

    That has not been the problem in Ireland. The problem was private banking, private borrowing and systemic risk in the international financial system exacerbated by synthetic credit default swaps.

    Who has to pay if we default? Geithner’s gang?

  32. grumpy Says:

    Slightly off-topic, but hey, economists ought to be interested in sovereign defaults. Excellent article on Reuters here:

    http://www.reuters.com/article/2011/05/25/us-greece-shadow-ifr-idUSTRE74O2VM20110525

    Lots of straight talking insight among which:

    “One potential tactic might be to delay any default or restructuring as long as possible. With every year that passes, exposure to such an event is decreased as bonds mature and are paid off in full. Of the estimated 270 billion of Greek bonds currently in existence, about a third will mature by the end of 2013.

    But while that might lessen the blow for the banks, politicians are likely to find such a solution less palatable than a full-blown restructuring. That’s because EU and IMF loans will have to fund those redemptions — essentially a government-sponsored bailing out of private bond holders. Insurance companies, pension funds and central banks hold a further 170 billion of Greek paper.

    Indeed, an added complication is the exposure of the ECB, which stepped into the market to buy Greek bonds last year. Under a default or restructuring situation, it would have to be recapitalized. Indeed, advisors say some clients see the ECB’s exposure as a reason such an event will be delayed.

    “These banks know they are in good company — the ECB is in the same position and they too are unhedged,” said the first banker. “There is the presumption that it doesn’t really matter for the Landesbanken, they know they will get rescued. For them, this isn’t an immediately pressing issue.”"

  33. grumpy Says:

    @zhou

    “You’re point is we should go along with the mugging because it is in our interest not to get shot”

    Not really fair that. I have been trying to get the message across that the smart, if potentially sub-optimal thing to do, it to stop giving the muggers the impression you consider it a disaster if you end up having to as get your suit dry cleaned, and make it credible that there might be a cost to the mugger also.

    I know I am wasting my time though.

  34. Ahura Mazda Says:

    Grumpy,

    I find Dan Gros’ suggestion to penalise any type of Irish private wealth very odd and a good bit stupid. I’ve given out about him on a previous thread. My recommendation would be the exact opposite of what Gros puts forward. Ireland would be much better placed post default if some wealth remains in the hands of residents.

    Although quite different, there are some countries in European looking at taxing foreigners/non-residents http://www.ft.com/intl/cms/s/2/550d48b6-82fd-11e0-85a4-00144feabdc0.html#axzz1NMQTditd

  35. hoganmahew Says:

    @Aidan R
    “True, but they did not have the same aggressive pro-cyclical policies we adopted.”
    So what you are saying is “don’t have pro-cyclical policies”… I’ll remember to put that nugget aside for when I’m dictator.

    “The Netherlands are currently experiencing the possibility of an emergent property bubble but given a tradition of counter-cyclical tax policies they will not experience the chaos of our economy.”
    The Netherlands are currently experiencing the possiblility of a bursting of an already apparent property bubble. You don’t know your Dutch history if you think it will not cause chaos in their economy.

    “If Ireland had introduced a property tax in the 00’s our tax base would not have collapsed in 2008.”
    Well, it’s a good think all those states in the US haven’t had collapses in property tax revenue.

    Property tax is:
    1. Pro-cyclical - it follows asset prices, not sets them. Look at the ineffectiveness of stamp duty and that was just a tax on transactions. High rates of stamp should, by your logic, have stopped the boom dead. They didn’t and they contributed to pro-cyclical spending.
    2. Regressive - it takes no account of income.
    3. Inefficient - it costs more to collect than income tax does.
    4. Pro-cyclical - it hurts more when people have least money (in a downturn) and generates more when asset prices rise.

    I don’t see any justification for a property tax that does not relate to increased government revenue. As such, it is a poor way to raise revenue.

  36. zhou_enlai Says:

    @grumpy

    I was commenting on that individual post - it wasn’t an analysis of your overall view!

    I have been making the same point, insofar as we should draw up contingency plans for implementing the Morgan Kelly solution even if we don’t intend doing it. The mugger has to know there is a limit.

  37. Tom Costello Says:

    @John McHale

    I might be misreading Auerbach et al.s paper as I am used to significantly more formality, but it seems that there are strong assumptions that the government spending has no effect on utility, and government spending has no effect on the economies production function.

    I do not know what the spending analogue of Ricardian Equivalence is, but is seems natural that should government spending be just as efficient as private spending (on utility), then we can substitute government spending for consumption. The obvious examples are each of us keeping a group of armsmen, or alternately paying a tax to the state to keep an army. If the benefits and costs are equal, then the effect on utility is the same, and the amount we each work remains unchanged. Our consumption is lower, and thus under A et al.s theory the output of the economy is lower, but if the production function includes government consumption, then we are back exactly at the same output.

    Obviously, if government spending is more efficient than each of us raising our own private armies, then taxation is actually a net positive.

    The assumption that government spending is always completely inefficient - both in terms of economic growth and in terms of personal utility is common in America, but I would have thought that Berkeley was immune, so I presume that I am missing something.

  38. Kevin Walsh Says:

    @hoganmahew

    A tax that raises more money in good economic circumstances is anti-cyclical. Aidan R. was presumably referring to the cuts in income tax and capital gains tax, the increase in public sector wage rates, and so on, all of which were pro-cyclical. The austerity measures introduced in the last few budgets are also pro-cyclical.

    It’s a basic principle of good economic governance to tighten your finances when things are doing well and to loosen them when things are going badly. This is part of why progressive income taxes and social welfare payments are so valuable, they do it automatically. Hence the term ‘automatic stabilisers’.

  39. DOCM Says:

    @ Zou_enlai

    You must be joking! Two FF governments indulged in a massive splurge of spending on its own members, the public service, FAS, social welfare, “front line services”, consultants’ exorbitant contracts; you name it, all funded on the back of income from a false boom based on borrowed money, and notably stamp duty from the biggest property bubble seen to date in terms of its excesses. Indeed, one member of one of said governments had such little grasp of basic economics that he opined that the government did not even need the revenue from stamp duty.

    The players you mention facilitated the borrowing but the Irish people spent the money. And now it has to be paid back. It is no more complicated than that.

    Hunting around for scapegoats of every hue - a very popular occupation on this blog - will not change this reality.

  40. The Dork of Cork Says:

    @DOCM
    They had no choice but to spend it (remember saving in this monetory system is also spending as fiat has no intrinsic value and so therefore when hyperinflated needs a yield - hence the spending via saving)

    IT IS IMPOSSIBLE TO GO INTO NEGATIVE FISCAL DEBT

    Goverment did not create the money Baby.

    Keep progressing - you will get it eventually but by then……
    http://www.youtube.com/watch?v=bFt71GNd0i8

  41. hoganmahew Says:

    @Kevin Walsh
    “A tax that raises more money in good economic circumstances is anti-cyclical.”
    I said:
    1. Pro-cyclical - it follows asset prices, not sets them. Look at the ineffectiveness of stamp duty and that was just a tax on transactions.

    That is procyclical - it is positively correlated with the overall state of the economy.
    (This is assuming that the tax is a percentage either of asset value or imputed rent).

    I also said:
    4. Pro-cyclical - it hurts more when people have least money (in a downturn) and generates more when asset prices rise.

    Even though the amount collected rises, the strain it causes at the bottom of the economic cycle on those with lowered household income - falls in taxes tend to lag changes in asset value) - it increases the requirement for welfare payments or decreases disposable income by more than income tax.
    (Whether it is a fixed property tax or a variable one).

    No? :?

  42. hoganmahew Says:

    @Kevin Walsh
    “It’s a basic principle of good economic governance to tighten your finances when things are doing well and to loosen them when things are going badly. This is part of why progressive income taxes and social welfare payments are so valuable, they do it automatically. Hence the term ‘automatic stabilisers’.”
    Um, yeah, that worked our really well for us, didn’t it? Insufficient funds in the Social Insurance fund, every penny in excess income tax blown as soon as it came in, the huge amounts of property taxes peed away, massive tax breaks and reductions in income taxes. But hey, the budget was balanced, so I guess that fits your definition of tightened finances? Until the machine stopped…

    The trick is not to earn it differently, the trick is not to spend it all…

  43. DOCM Says:

    @ All

    A link to an article in Voxeu of somewhat more relevance to Ireland than the one under discussion.

    http://www.voxeu.com/index.php?q=node/6521

  44. hoganmahew Says:

    @DOCM
    From the voxeu link:
    “First, the Eurozone is not an optimum currency area, because it lacks two necessary requisites, i.e. price and wage flexibility and labour and capital mobility.”

    Oh come on, anyone coming out with that tired canard about lack of capital mobility. Capital mobility is precisely the problem. Effectively the eurozone is a gold standard. If capital flows into your country (you are not allowed to stop it and nobody else will) and into local assets, you can only pay it back on a 1-1 basis. You can’t devalue your way out of a capital crisis. You are not permitted to default, because that would both grind you back into the stone age and ensure a loss of face for the ECB.

    There are no hedges against the euro for a eurozone country. If you get a large, unstable capital flow into your country in the eurozone, you are stuffed. Totally and utterly. There is nothing you can do about it, there is no way you can stop it and, because the besuited chimps that run the banks will fritter it away, you won’t be able to pay it back when it unstably flows back out.

    “As the Eurozone does not comply fully with either of the two, it needs to have a very large common or single budget to face potential asymmetric shocks affecting some of its members, as has happened now.”
    This is also rubbish. I don’t see that having a federal budget has helped bail California out. I don’t see that the Irish state is going to prevent job losses at Galway CoCo because they’ve overspent. It is a political argument based on a desire and not much else.

  45. zhou_enlai Says:

    DOCM - the government did not borrow recklessly. There is a big difference.

    It is a complex problem. People sometimes over-simplify things when they don’t want to have to explain the truth of a situation. Don’t let them fool you.

    Law, morality and the principles of political unity and fairness underlying the EU are our greatest weapons. If people intend trampling on little catholic Ireland then we may not be able to stop them but we can hold the light on them while they do it. Little catholic countries have a good record in that regard.

  46. zhou_enlai Says:

    FYI - from twitter…

    @Nouriel (Nouriel Roubini)

    “The new free RGE Economonitor web site is now live at http://www.economonitor.com. Hundreds of contributors. Check it out.”

  47. Hugh Sheehy Says:

    @Aidan R
    We’re not in a deflationary spiral. Inflation is increasing and interest rates are likely to increase. Borrowing more money isn’t helping do anything much except push the potentially productive parts of the economy into the ground for longer.

  48. Kevin Walsh Says:

    @hoganmahew

    I would appreciate it if you stopped redefining well known economic terms. A tax or policy is pro-cyclical if it aggravates/enhances the prevailing economic trend. Any tax whose returns are significantly positively correlated with economic growth is anti-cyclical because the increased revenues in good times are a drag on growth and the reduced revenues in bad times help to foster a recovery. This is basic stuff.

  49. Yields or Bust Says:

    @hogan

    Slightly off piste but in reference to your property tax summary I thought the details of DSKs New York living quarters in NYC whilst under house arrest warranted a mention.

    He’s renting a 4 bed house in Tribeca, Manhattan, NYC. For those who know NYC they’ll also know that Tribeca is none too shabby a locality to lay ones head down at night.

    The house is costing DSK $50k a month to rent.

    It, according to reports, has a home theater, a gym, waterfall showers, Japanese paper walls and renovations featuring the finest materials and craftsmanship. It has 5 bathrooms, a large terrace and is located on a cobblestone street.

    What’s interesting is that it’s on the market for $13,995,000. At $50k a month and assuming the normal net yield deduction of 1 month for costs the net yield is 4%.

    The average market yield for Irish property quoted by Daft.ie in their latest residential yield survey was also 4%.

    Now here’s the thing should it be equivalent in rental terms to live in Trim or Tribeca?

    Answers on a postcard to Frank Daly @ NAMA.

  50. hoganmahew Says:

    @Kevin Walsh
    I agree it is not the best source, but wikipedia says:
    http://en.wikipedia.org/wiki/Procyclical
    “In business cycle theory and finance, any economic quantity that is positively correlated with the overall state of the economy is said to be procyclical.[1] That is, any quantity that tends to increase when the overall economy is growing is classified as procyclical. Quantities that tend to increase when the overall economy is slowing down are classified as ‘countercyclical’.”

    It then goes on to say:
    “Procyclical has a different meaning in the context of economic policy. In this context, it refers to any aspect of economic policy that could magnify economic or financial fluctuations. An economic policy that is believed to decrease fluctuations is called countercyclical.”

    Property tax does not decrease economic or financial fluctuations. If it did, countries with property taxes would not have property bubbles. As I said above , property taxes lag the economic cycle, so they are pro-cyclical (in the sense you mean it) at turning points. They will be too low when the next bubble starts, they will be too high when the next bubble bursts, and they take no account of ability to pay.

    You may like to shoehorn them into an anti-cyclical tax bracket, but you have provided no argument that property taxes are generally anti-cyclical. Taxes are generally procyclical in that they are positively correlated to the economic cycle. They are only anti-cyclical where they attempt to modify behaviour. In that regard, stamp duty was anti-cyclical, before it was reduced to meaningless levels.

    Far better, I reckon, to remove both capital exemptions on PPRs and vastly reduce inheritance tax thresholds. This would be both anti-cyclical and suppressive of property prices as well as raising a consistent stream of revenue. Additionally, stamp duty should be increased and should apply to all purchases.

  51. Joseph Ryan Says:

    @Yield

    Never been to Trim. Wonderful place. I must go to see the castle.
    I wonder is NAMA the seller! Better get out quick. I suspect many of the fellow tenants won’t be too happy with the attention the building is getting.
    And DSK has no helicopter usage, a bit like Frank Daly’s new rules for the developers. Well they might get the odd ride. On the helicopter.

  52. grumpy Says:

    @Kevin W, hogan

    If revenue from tax increases with either or both of gdp or asset prices the question is - what do you do with the revenue. If you essentially use it to feed through into the economy via spending or wage agreements then it is pro-cyclical. If you know the difference between an elbow and a backside, and you use it to contribute sufficiently towards a budget surplus then it is counter-cyclical.

  53. Taxes drive Money but not quite in the way Daniel Gros thinks – Smart Taxes Network Says:

    [...] McHale in the Irish Economy blog picked up on yet another piece by Daniel Gros on the Eurozone and the Irish problem.  Gros sees an important link between [...]

  54. George Says:

    It is interesting to me that printing money and default are the only solutions available. During the Mexican debt crisis changes to US manufacturing were made to allow shifting of jobs that were likely destined for Asia to relocate to Mexico, the so called Maquiladora factories. Germany seems to be doing the complete opposite selling their share of their partially owned Greek Shipyard at Skaramanga, instead of increasing their investment there. Maybe instead of arguing about the relative merits of default vs money printing as a way around austerity the argument should be about how the PIIGS can do useful work by adding value to products people need.

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