Category: Fiscal Policy

Posen on stimulus

Last week’s news was terrible, but I felt even more depressed the week before. If we enter a spiral in which we get worse news on GDP and GNP than expected, and then conclude that we will have to push through even more deflationary budgets than previously planned, then we have entered a doom loop from which there is no escape.

Unless.

(Unless what?)

Unless the cavalry comes charging to the rescue, is what. Unless Ireland is bailed out economically by the rest of the world, via a world trade boom that allows us to export our way to recovery.

Unfortunately, there are lots of question marks hanging over this scenario right now. The cavalry is uncertain as to where it is headed, and for every piece of good news we get from overseas, there is a corresponding piece of bad news (and vice versa). Any honest forecast of where we are headed in the immediate future will have extremely wide confidence bands associated with it, which in the Irish case will surely straddle the zero axis.

This is why it is so utterly in Ireland’s interests that policy makers overseas listen carefully to Adam Posen (short version here, longer version here). I strongly urge people to read the full speech. It is a carefully argued (and, for a central banker, passionate) plea for further stimulus measures, as well as for a certain way of thinking about the macroeconomy. It is nice to know that some central bankers, at least, understand how serious are the downside risks facing the world economy right now.

I am sure that our political leaders enjoyed their moment in the sun this spring as poster boys for austerity. But insofar as they contributed to a feeling that austerity was the right policy everywhere — and not just in basket cases like Greece and Ireland — they did their country a disservice. Far better to have a quiet word with their colleagues in more solvent states, pointing out to them our nine successive quarters of shrinking real GNP, and to say to them: this is what austerity can do, even in an economy as small and open as ours. Are you really sure you want to follow suit?

More on Taxes

The debate on taxation policy has heated up in recent days.   Readers might find KPMG’s Income Tax and Social Security Rate Survey 2010 of interest.   It is available for free download here.  The Economist has a piece on the survey, but does not include Ireland in its main comparison figure for the effective tax rate at an income of USD 100,000 (gross).   The effective rate for Ireland is 30.3 percent, which puts us in the middle of the pack (pages 11 & 12). 

Some other tables and figures in the survey show that we should not exaggerate the extent to which Ireland is a low tax country for middle to higher earners.   See the table for the highest rate of income tax (2003-2010) on pages 9 & 10; and also the figure showing the US dollar income at which the highest rate kicks in on page 28.   I’m sure our tax experts will have some quibbles with the calculations.   But it does help to put tax rates for higher earners in a useful comparative context. 

Corporation Tax and the EFSF

There has been a lot of discussion over the past few days about the implications of Commissioner Rehn’s comments about Ireland not being a low tax country in the future. While the comments didn’t explicitly mention the 12.5% corporate tax rate, many have inferred from the comments that the removal of that rate would be part of the price of an EFSF bailout for Ireland.

Two points on this issue seem worth discussing. The first is: What would be the effect of an increase in the corporation tax rate? The take from this tax this year is projected to be €3.2 billion (actually it’s running ahead of target but let’s stick with the original projection.) A purely mechanical extrapolation would see an increase from 12.5% to 15% raise an additional €640 million in revenue while keeping Ireland’s corporation tax rate low by European standards.

Of course, that assumes no negative effects on declared profits. So the €640 million figure may be too high. That said, I don’t think there’s reason to think that 12.5% is a magic Laffer-curve point whereby revenues decline when the tax rate is raised.

Over the longer-term, however, there may be more serious repercussions from a decision to raise the 12.5% rate. Even a small increase would represent a significant departure in policy from the line-in-the-sand approach that has been taken up to now. The real risk may be to that those considering future FDI projects in Ireland (or perhaps making decisions about whether to keep current operations here or consider further investments in them) see an increase to 15% as potentially being the first of a number of increases. Rhetoric about how we’d never change the rate again would not be too credible. On balance, I think the arguments for keeping the rate as it is win out.

The second point worth discussing is whether indeed access to the EFSF bailout would require changing the corporate tax rate. As I understand it from the facility’s framework agreement, the dispensing of funds from the facility does not require each Euro-area parliament to approve. Instead, agreement on a plan must be reached with the Eurogroup of finance ministers.

I’m not prone to anti-European conspiracy theories, so the idea that the Eurogroup finance ministers will be happy to hike Ireland’s corporate tax rate substantially, even if it would have negative effects on our economy and possibly lead to sovereign default, doesn’t strike me as correct. More generally, my sense of IMF-style rescue packages is that the package negotiations usually feature lots of nasty options but that the government can pick which areas it wishes to prioritise for protection. So (and these could be famous last words) I don’t think access the EFSF funds would imply changing the corporate tax rate.

Death by a Thousand Cuts

Pat Kenny’s Frontline made for depressing watching last night.   The first segment focused on the level and composition of the fiscal adjustment for the next four years with an emphasis on next year.   Credit to Dan O’Brien and the others on the panel for being brave enough to be specific about where they would cut. 

But given the size of the needed adjustment, I worry that this formula of focusing on specific adjustments one-by-one is just not going to work.   For each proposed adjustment – means testing child benefit, cutting public–service pensions, introducing a property tax – the affected group will focus on the negative effect on them and will inevitably try to shift the burden. 

Recognising the size of the overall adjustment, I think it is better to start with a plan for the overall distribution of the burden across the income/wealth distribution.   The pain will need to be spread broadly but progressively.   After recent budgets, the ESRI has provided an excellent analysis of the distributional implications of tax and benefit adjustments using its SWITCH model.   This tool could be available prior to the budget to evaluate alternative four-year plans.   The key is to make people think about the overall effect on them in the context of how the overall burden is being shared.   My sense is that there is recognition a large adjustment must take place and most are willing to play their part — but only if assured that others are bearing their fair share.   The alternative of arguing about specific cuts in isolation of the overall distribution of the pain is probably doomed to failure. 

Child Benefit Payments Cut for UK High-Rate Taxpayers

The BBC report on the UK Chancellor’s decision to axe child benefits from top-rate taxpayers. Rates in Ireland are approximately 150 per child per month (but vary with family size) and are paid universally regardless of family income for each child aged under 16 or under 18 and in full-time education. Like any universal payment of this nature, there is the obvious question as to why people on higher incomes should be receiving a transfer payment from the state. A less obvious question is what we mean by higher incomes and where the threshold should be set. Expenditure on this scheme is approximately 2.3 billion euro in Ireland. Those arguing to keep the benefit as it stands might question why we will end up subsidising John Terry’s wages (see Karl’s post below) while cutting benefits from mothers and children. I am not sure I have an answer to that one either. If we do have to cut, then I would rather it be from people like me with above average salaries and for schemes like child benefit that don’t have an obvious reason to be universal rather than from well-targeted schemes.