From the frontiers of knowledge (yes, it’s grading time again): “Fiscal contraction was first noticed in the 1960s by a man by the name of Fiscal and it was him who derived the short, medium and long run effects of it and how they would occur and the reasons for it…”
Social solidarity is clearly highly desirable during a period of severe economic and fiscal distress. Accordingly, it is important that the government works out a fiscal adjustment programme that is rigorous but still perceived by the general electorate as distributing the burden as fairly as possible. Of course, fairness is in the eye of the beholder to some extent but a primary political objective should be to successfully achieve fiscal stabilisation while avoiding social disruption that is now evident in some other European countries. See this article in The Times (London) on the upheaval in Iceland and Greece.
Paul Krugman discusses the problem facing those EMU member countries that are currently suffering from a lack of competitiveness (note, by the way, his use of the word competitive!) and accepts that nominal wage reductions are a necessary part of the adjustment: you can read his discussion here.
He also links to a posting by Edward Hugh that probes the difficulties involved in engineering nominal wage reductions: you can read it here.
I have written an article for today’s Sunday Business Post on the economics of public sector pay cuts: you can read it here. Although Karl is correct in saying that public sector pay cannot be the sole factor in the fiscal adjustment, it is clearly the most contentious issue in terms of the range of views that are being expressed.
In my discussion at Monday’s conference (slides here), I raised the question of where Ireland’s tax burden was going to settle down once the public finances have been stabilized. The Addendum to the Stability Report published last week by the Department of Finance shows how the Gross Budget Balance can be brought back to a deficit of 2.5% by 2013 through an adjustment process in which the revenue share of GDP stays roughly stable so that almost all of the adjustment occurs on the Revenue side. The document itself does not comment on the composition of the adjustment described in this table, so perhaps this isn’t an actual plan but instead an illustrative example. Still, it’s worth starting with as a baseline for discussing where we are heading.
I noted on Monday that the plan projects a government revenue share of GDP of 34% in 2013 and that this is well below the equivalent share for EU15 countries, which has been stable at about 45% for a number of years. A number of observers at the conference questioned this calculation on the grounds that the calculation should be done relative to GNP. In particular, since GDP has been about 17% higher than GNP in recent years, one might want to adjust the tax share upwards by this amount. Doing so would give a figure for 2013 of about 41.5%. This is still a reasonable amount lower than the EU15 average but not nearly as much as the figures I quoted
However, I do not view this higher GNP-based figure as a useful one, for two reasons.
First, I believe that GDP rather than GNP should be viewed as the correct tax base when making calculations of this sort. GDP represents all the income generated in this country and, technically, all of it is available to be taxed by the Irish government at whatever rate it chooses. Of course, profit income generated by multinational corporations is likely to move elsewhere if we tax it at a sufficiently high rate but this is an issue faced by all governments, not just our own.
Second, if one is going to exclude the substantial factor income repatriated abroad (€28 billion in 2007) from the tax base it is not consistent to then include the taxes earned on this income in the measure of the tax burden. Assuming that the €28 billion figure represents corporate profits repatriated after paying the 12.5% corporate tax rate, one comes up with a figure of €4.1 billion in taxes paid by multinationals on repatriated profits. Excluding tax payments of this magnitude would give a 2013 (adjusted) tax share of GNP of 39%. So, even if one agreed with the idea of GNP as the tax base, an internally-consistent calculation of the Irish tax burden would still leave it well below the European average.
The broader and more important point here is that we need a wider debate about the shape of future fiscal adjustment than the one currently taking place, which focuses almost without exception on the need to reduce public sector pay.