The FT outlines some of the elements of the new fiscal austerity budget in Spain – especially noteworthy is the hike in VAT rates. Although the Spanish fiscal deficit is not as large as ours, the unwinding of unsustainable boom-period tax cuts and spending increases is qualitatively similar.
Category: Fiscal Policy
Today Thomas Conefrey and myself publish a working paper entitled “Managing Housing Bubbles in Regional Economies under EMU: Ireland and Spain”. It is available here .
With the advent of EMU, monetary policy can no longer be used to prevent housing market bubbles in regional economies such as Ireland or Spain. However, fiscal policy can and should be used to achieve the same effect. This paper shows that the advent of EMU relaxed existing financial constraints in Ireland and Spain, allowing a more rapid expansion of the housing stock in those countries to meet their specific demographic circumstances. However, the failure to prevent these booms turning into bubbles did lasting damage to the two economies, damage that could have been avoided by more appropriate fiscal policy action.
The failure to tighten fiscal policy in Spain and Ireland in the early years of this decade laid the ground for the housing market bubbles in the two economies. The Stability and Growth Pact proved a distraction: government budgetary balance was not an appropriate fiscal target for those two economies. By contrast, Finland, having learned from its mistakes twenty years ago, ran substantial government surpluses to prevent domestic overheating. Specifically in relation to overheating in the housing market, we consider that a temporary tax on mortgage interest payments (first suggested in 2001) should have been used to target overinvestment in housing, investment which seriously crowded out the traded sector of both economies. This tax would have mimicked an increase in interest rates. Obviously it will be a very long time before such a tax might be needed in either Spain or Ireland to limit overinvestment in housing.
The paper shows that demographic circumstances in both Spain and Ireland meant that it was appropriate that investment in housing in those two economies should have been somewhat higher than in their neighbours. Even after the housing bubbles have burst, the relatively low endowment of housing infrastructure in the two economies (relative to adult population) means that there will be a need for additional investment in the next decade, when the current excess supply has been worked off.
In the paper we also include a graph taken from our paper “Recovery Scenarios for Ireland” published in May which, inter alia, considered likely housing demand over the coming decade. Our model included estimated 2009 population numbers which were quite close to the latest estimates published by the CSO. We assume that between 2009 and 2015 there will be cumulative net emigration of up to 120,000. Our analysis would suggest that the underlying population increase would lead to somewhat higher demand for housing than Brendan Walsh has estimated in a recent post for the period to 2015. In addition to the pure “demographic” effect we also factor in some increase in headship on the basis of the recent rise in the number of households, which possibly reflects falling rents.
In a paper just published in the ESR, Verde and Tol study the implications of a carbon tax across the income distribution. The paper by and large confims previous work (Callan and others being the most recent). A carbon tax is markedly regressive. It disproportionally hits poorer households. That said, the scale of the carbon tax is modest (euros per week) and small relative to income taxes and benefits. That means that the distributional damage can easily be repaired (should our dear leaders be so inclined).
The paper adds to previous research by also quantifying the indirect effects of a carbon tax. (This was last done by Cathal O’Donoghue for 1987.) A carbon tax increases the price of energy (direct effect) and thus of everything else (indirect effects). The paper shows that the indirect effects are small relative to the direct effects, and thus hardly affect the regressivity of the tax. The paper also shows that a carbon tax abroad would have a similar impact on Irish households again.
The new edition of the Economic and Social Review is now available online. The edition contains two policy papers. One is this paper by Eilish Kelly, Seamus McGuinness and Philip O’Connell on public sector pay rates. I think Richard Tol is going to open a thread on the other paper which focuses on the carbon tax.
The three regular papers in the edition (David Audretsh on entrepreneurship, Ken Benoit and Michael Marsh on political science in Ireland, and Vahagn Galstyan and Philip Lane on fiscal policy and competitiveness) are also, in my opinion, very interesting contributions.
Here‘s an article I wrote for today’s Irish Times on tax. The article was slightly edited in a way that might obscure one of the points I wanted to make. I understand that the Commission on Taxation were not really given a mandate to think about what is the “correct” level of taxation but the fact is that we are going to have make serious Boston-versus Berlin-style decisions over the next few years and this issue will come up time and again.
I don’t favour raising income taxes in the upcoming budget and I do favour full implementation of the McCarthy report. But after that point, a decision to keep income taxes at current levels will have major implications for spending. I heard the Minister for Finance on the radio yesterday say that there is was “no further room” for income tax increases. It is possible he is referring only to the upcoming budget but the idea that income tax has hit some very high level that can’t be increased doesn’t strike me as correct in light of the facts.