Brexit Flu?

The latest exchequer returns are in, and are a bit down relative to trend and to target month-on-month. From the release:

July 2016 Outturn
July 2016 Target Excess/Shortfall (€m) Excess/Shortfall (%)
Income tax 1519 1522 -3 -0.20%
VAT 1766 1830 -61 -3.30%
Corp. Tax 116 139 -23 -16.50%
Excise 482 507 -25 -5%
Stamps 114 111 3 2.30%
Capital Gains 14 8 6 67.40%
Capital Acquisitions 19 17 2 13.80%
Customs 26 29 -4 -13%
Levies 0 0 0 0.00%
LPT 21 23 -2 -6.60%
Unallocated 9 0 9 0.00%

The two numbers everyone will focus on are the 13% drop in customs taxes and the 16% drop in corporation tax.

In terms of money in the door up to July, the State is still up 8.5% on last year, so we shouldn’t be too worried about the supply of sweeties come Budget day just yet. The other important thing to note is just how volatile these data are–they bounce around a lot, and you can read very little into one month’s data. So please, before everyone runs off saying Brexit is killing the Irish economy, it isn’t. Or perhaps more accurately, it isn’t just yet.

Another interesting piece of data shows Irish consumers are a bit put off but unlikely to develop Brexit flu from contact with their nearest neighbour.

While UK PMI data is nose-bleed inducing, the recently-released KBC consumer sentiment index shows that Irish consumer sentiment declined in July, but the scale of the drop was relatively modest when measured beside its UK equivalent, as the chart below shows.

csijul16d02So what do we see? We see a bit of concern, and bit of a wobble, but that’s all, up to now. Hold fire on the pronouncements of doom for a few more months at least.

By Stephen Kinsella

Senior Lecturer in Economics at the University of Limerick.

11 replies on “Brexit Flu?”

A few points on the Exchequer returns:

1) Almost all of the tax collected relates to activity pre-Brexit vote.
2) Do not focus too much on the monthly profiles . They are not ‘targets’ as you suggest but forecasts which date from last October and are based on monthly patterns and (likely) specific events. They are often quite out. More useful to look at YTD compared to profile which is still looking healthy.
3) No one will focus on a €4m drop in customs taxes. It is a tiny drop in the bucket.

Exchequer returns have been ahead of profile for about 18 months now. This is most likely a slowdown in that pattern (second derivative turning negative), the year-on-year growth still leaves the public finances in a very healthy position.

A slightly bigger (structural) issue is that taxes seem to be showing a high elasticity to economic activity again. Great in good times but not in bad times as we all know.

This feature was supposed to have been dampened with the tax reforms of 2008-12 (reduction in stamp duty, introduction of USC and LPT) which should have made the tax base more stable. The flyaway performance of the last two years or so suggests to me that the tax base is still quite pro-cyclical.

Perhaps I am wrong however and economic activity really is growing the way the CSO say it is!

Some caution is required in interpreting the UK PMI (purchasing managers’ index) survey data which are bleak for July.

The manufacturing and construction sectors have been slowing for months while the survey response rates (not disclosed) are likely to be slow in summer months.

Markit, the compiler of the data, discloses the sample for manufacturing but not for services (suggesting that it’s small) — the latter would be big firms in transport (airlines, freight firms), financial services, business services, IT, hotels and restaurants.

The main index is based on one question on actual business activity and these typically big firms in the services sectors are unlikely to have seen cancellation of existing orders because of Brexit.

PMI surveys can be useful in showing a trend and the French Treasury found that measuring services via surveys underestimates French growth.

Good analysis.

There may be a psychological effect from Brexit, but I’d be surprised if this was reflected in tax receipts as early as July.

And, its possible (although not certain) that the U. Kingdom could already be in the early stages of a short-lived and shallow recession, which would be bound to affect Ireland somewhat.

More important than either of these is the 15% fall in the value of sterling.

This is bound to have significant and almost immediate short-term effects but, contrary to media hype, there are positives as well as negatives. And both are temporary. What’s needed is some in-depth analysis (say from ESRI) on the effects of the 15% fall in sterling, that highlights both these positives and negatives, rather than the usual simplistic media sensationalism focusing on cross-border shopping and such like.

On the negative side:

It could well affect VAT as import prices to Ireland fall significantly and it could well affect CT as export prices from Ireland fall significantly. This may well have happened in July.

And, it could slow export growth for a time.

And there could be an increase in cross-border shopping, although nowhere near the level of 2009 as inflation in the U. Kingdom has been far higher than in Ireland since then.

However, the PMI for services in July just published this morning shows strong economic growth continuing – it was 59.2, which is extremely high by international standards, but not as high as in previous months.

On the positive side:

Consumers in Ireland are now richer. Their real incomes will have risen as a result of the 15% fall in sterling. Pressure should be put on retailers to pass on the cost savings. If they do (and assuming no huge surge in oil prices), inflation in Ireland should go sharply negative early next year (implying sharply positive growth in real incomes).

In addition, government spending can now be reduced as a significant chunk of government expenditure will be on imports from the UK (e.g. many medications) and these are now 15% cheaper. And public sector salaries and welfare benefits will now go further as a result of the fall in import prices. There is no excuse for the government not adjusting spending to match the new reduced cost base.

Both effects are short-term:

Both effects will gradually melt away as price inflation in the U. Kingdom takes off. It may be some months before the fall in sterling filters through, but I’d be surprised if inflation in the U. Kingdom does not hit 5% next year (compared with likely negative inflation in Ireland). Over the course of 2-3 years, this higher inflation will wipe out the competitiveness benefits of the 15% devaluation.

I’m already being hit by higher costs as a result of the 15% fall in the value of sterling. I was on holiday in Iceland last week and the trip had a surcharge of over £300 added to it from what I paid when I booked it. My trip to Croke Park this Saturday will cost me 15% more than my last trip to Croke Park a few months ago. All Tyrone fans will be similarly hit, while those from Dublin, Donegal and Mayo won’t. They are relatively wealthier than Tyrone fans as compared with a few months ago.

In short, the effect of the 15% fall in the value of sterling is to make consumers in Ireland wealthier and consumers in the U. Kingdom poorer. None of this would be economically justified if Ireland was in balance-of-payments deficit and the U. Kingdom in balance-of-payments surplus. But, exactly the reverse is true, so it is economically-justified. Based on past history, I’d say there is little chance of the U. Kingdom achieving a permanent improvement in its cost competitiveness as a result of the 15% devaluation. Sterling has been repeatedly devalued throughout my lifetime. Always, the result is the same – a short-term improvement in cost competitiveness which is then rapidly eroded by higher inflation, then back to square one. It was to get away from this long-term currency decline that Ireland broke with sterling and joined the EMS in 1979 and then the Eurozone in 1998. The main losers are those who were mug enough to purchase UK government bonds (at < 1% interest) earlier this year. They are now taking a huge and well-deserved hit. The fall in sterling could have been seen a mile off and was inevitable, Brexit or no Brexit, because of the UK's huge balance-of-payments deficit.

What is striking about the media commentary is its usual superficiality. The IT refers, for example, to a reduction in the government’s “room for manouevre” or, as the SK accurately puts, “the supply of sweeties come budget day”. This, and the apparent reversal of the drive for a broader tax base, are ominous omens.

The lack of even a medium-term focus in budgetary planning has been rightly criticised by IFAC and others. Planning for the longer term seems to attract no consideration whatsoever cf. the lack of debate of the IBEC/CBI paper on long-term investment.$file/Ibec+CBI+all-island+report+WEB.pdf

The re-introduction of border trade controls of some kind seems inevitable. The UK must leave the Customs Union if Brexit is to have any logic, Maybe this will concentrate minds.

Re Sterling:

There does not appear to be any great empirical support for the idea that a change in the exchange rate has a significant impact on trade volumes. A currency appreciation, as JTO notes, boosts the purchasing power of domestic consumers while a currency fall reduces it. A big FX change also has an impact on company margins, which may, of course , have knock-on effects.

On the broader issue, if one excludes the surge in corporation tax receipts, which are nor related to anything happening in Ireland, tax revenue is €164mn ahead of profile, or 0.7%. It is also worth noting that the unemployment rate has remained unchanged for 3 months, retail sales fell in q2 and external trade, as captured in the monthly merchandise data , has slowed sharply.

What you say about the unemployment rate is correct. But, its happened several times in the past two years with the new monthly unemployment series and the figures have invariably been revised down some months later. There are now two monthly series tracking unemployment. The other one is the Live Register.

The Live Register figures published yesterday show the fall in unemployment accelerating (not just continuing). The numbers signing-on fell by just over 12k between April and July compared with just over 6k between April and July last year. The y-o-y decrease was at a record high of just over 44k. The decrease in July alone was a near-record 5k. In the past when the monthly unemployment rate figures diverged from the Live Register figures they’ve invariable been revised down. Last year the monthly unemployment figures actually showed an increase of 300 in July, but this has since been revised to a fall of 4k. I expect similar this time.

To summarise:

Lots of stats this week, but some related to June, (i.e. pre-Brexit). I can identify six that were for July (i.e. post-Brexit). Of these some were very good, some not so good.

Very good:

Services PMI (59.5 in July, which is again by far the highest in the EU)
Live Register figures (a near-record fall as described above)
KBC Sonsumer Confidence Index (as described by Stephen Kinsella above)

Moderately good:

New car sales up 8.5% in July compared with July last year

Not so good:

Manufacturing PMI
Tax receipts

There is no doubt that there is little air escaping from the balloon, but it was rising too rapidly for it to ring true.

One of the more interesting figures in the alternate exchequer presentation is the PRSI intake.
This is up 2.2% on 2015, and exactly on profile for YTD July 2016. PRSI intake should mirror wages in the economy more closely than income tax.
[Income tax up 5.4% on 2015, Vat up 4.2% on 2015] [Alternative presentation]

I had a look at the figure for July 2011, as against July 2016 and the tax take has risen as follows:
Tax Heading 2011 2016 % rise
Income tax (BN) 18.6 26.6 43%
VAT 7.3 10.3 41%
Excise 2.6 3.6 38%

These are big, big, rises and may explain, to some degree, why people do not feel the recovery.

Your are correct that a 15% stg depreciation in Sterling is very important, but then you downplay its importance, in particular by saying that Irish consumer are richer! Perhaps globe trotting well to do people are richer, but it is doubtful if very much of the drop in sterling will find its way into the pockets of most consumers.

*On a small point, I don’t think VAT on imports will fall, as ‘imports’ in the VAT sense are imports from outside the EU, and the largest exporter to Ireland from outside the EU, is probably the US, whose currency (and presumably prices) will have appreciated.

PS: You will have only two more trips to Croke Park, so your pocket will be saved one trip at least!

Michael the graphic in that article illustrates that France and Belgium (the one where the EU is based) are the clear centres of popular hostility towards Britain after the Brexit vote.

I’m sure everyone in Britain will be appropriately shocked to discover that the French have it in for them.

Mark Carney gave a five minute interview this evening on Channel 4. He gave a very good interview, leaving this listener in no doubt that Mark Carney believes troubled times are on the way, and his own determination to do his bit to combat that trouble.
[Click on photo/video to play:]

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