L’Homme est instinctivement protectionniste et seule la raison le pousse au libre-échange.
(Celso Amorim, Brazilian foreign minister, in today’s Le Monde.)
Fitch said….
“Fitch Ratings has today placed the Republic of Ireland’s ‘AAA’ Long-term foreign currency Issuer Default Rating (IDR) on Rating Watch Negative.
The rating action reflects recent disappointing news on government revenue performance which points to very sharp declines in tax receipts across the board in January and February. This will intensify the policy challenges facing the government as it seeks to tighten fiscal policy further than anticipated in the midst of a steep recession and raises the risk of fiscal slippage.
In the first two months of this year revenues were again below the already low expectations built into the government’s January forecasts. In response to these forecasts Government took action designed to produce savings this year of EUR2bn and thereby reduce the government’s deficit to 9.5% of GDP. The latest information suggests, in the absence of any further Government action, the 2009 deficit could be increased by another EUR4bn, equivalent to over 2% of GDP, implying a revised deficit of 11.5% – 12%. The Prime Minister has said that new tougher measures on both taxation and public expenditure to rectify the further slippage in the fiscal position will be announced and a supplementary Budget is scheduled for the first week of April.
Fitch will re-assess the medium term prospects for Ireland’s public finances in light of the deterioration in revenue prospects, forthcoming policy announcements and worsening economic conditions, which could raise the potential call on government funds to support the Irish banks. A Rating Watch Negative is typically resolved within three to six months.”
As a reminder, there are 2 stages in the process of changing ratings with S&P and Fitch (Moody’s is a bit different).
“Rating Watch Negative”
This means action imminent in days (max 4 weeks), and is typically almost certain.
“Negative Outlook”
This means action possible within months (sometime years for sovereigns).
(Ireland is still AAA/Aaa neg outlook with S&P, Moody’s)
The worst damage to spreads is done with the Outlooks… but if the day wants it, any statement is as good an excuse as any to sell risk…
Irish – Bund 2013 and 2018 back to near their highs in terms of yield spread, at 262bp and 284bp respectively.
Athough I don’t detect that much interest in the expansionary fiscal contraction hypothesis, I think it is important we don’t try to reinvent the wheel. The determinants of successful fiscal consolidations was the subject of a large research effort in the 1990s. The following passages from a paper by Alesina, Perotti, and Tavares give a flavour of the findings:
“Empirical work on the effects and sustainability of fiscal adjustments has consistently reached two conclusions. First, long-lasting adjustments rely mostly (or exclusively) on spending cuts, in particular, in government wages and social security and welfare; by constrast, short-lived adjustments rely mostly on revenue increases. Second, fiscal adjustments are not always associated with reduced growth, or with a deterioration in the macroeconomic environment in general.” (p. 200)
“Fiscal adjustments that rely on cuts in government transfers and wages and are implemented in periods of fiscal stress are long lasting and not contractionary. On the demand side, the expansionary aspect of such fiscal adjustments works through an expectation effect, which is stronger the worse are initial fiscal conditions. On the supply side, the interaction of certain types of adjustment — those without tax increases but with cuts in government employment and wages — lead to wage moderation, reduced unit labor costs, and increases in profitability, business investment, and production.” (p. 214)
The Minister for Finance might be interested in this:
“Furthermore, governments do not seem to be systematically punished at the ballot box for engaging in fiscal adjustments, nor do they lose popularity, as measured by opinion polls. In principle, one can think of two explanations for this result. One is that voters do not like fiscal profligacy. The other is that governments are particularly skillful at choosing the appropriate moments to implement unpopular policies While it is difficult to decide definitively, we conclude in favor of the first interpretation.” (p. 241)
Alesina, Alberto, Roberto Perotti, and Jose Tavares. (1998). “The Political Economy of Fiscal Adjustments,” Brookings Papers on Economic Activity, 1998.1, pp. 197-266.
“Indeed it was entirely through increases in taxation that the reduction in the primary deficit was achieved. This also weakened the credibility of the government. The failure to reduce public expenditure, or indeed the growth in the share of current expenditure in GNP, was a result of three factors. First, the operation of automatic stabilizers, especially through a mushrooming of income support resulting from the sharp rise in unemployment. Second, a conscious decision to maintain (and even, to improve) the real value of income support payments in an attempt to shelter the worst off from the fiscal adjustment. Third, the inability of the government before 1987 — a coalition of trade-union and middle class interests without a parliamentary majority — to agree on the elimination or curtailment of any significant programmes [fn. Other than the deferment of some public investment plans] or to implement real wage rate reductions in the public service. This last factor had a most debilitating effect on confidence in the government’s determination to set things right, especially considering the repeated government announcements that such retrenchment would be inevitable.” (p. 205)
Honohan, Patrick. (1989), “Comment on Rudiger Dornbusch, Credibility, Debt and Unemployment: Ireland’s Failed Stabilization,” Economic Policy, 4(8), pp. 202-5.
In my post on income tax of a few days ago, the sample structure that I presented went part of the way back to the rates and bands in effect in 1996, a good year.
One feature of the mid-1990s income tax structure was the much lower exemption levels effectively achieved nowadays through tax credits. Should this trend be reversed?
Two comments on my earlier post point to problems in lowering the effective threshold. Colm McCarthy worries about incentive effects given the interaction with social welfare. Aedin Doris finds it difficult to justify taxing a low income single mother with two kids.
I have sympathy with both views, and this is not a make or break issue for revenue (though there is some revenue potential even at the low end).
I also note counterpoints. The more revenue we seek from the system as a whole, the more a high exemption threshold/general tax credit pushes other workers into higher marginal tax rates; bad for incentives. And, depending on their family/household circumstances, not all low income part-timers have low consumption.
Then there is the political/ideological view that as wide a range of citizens should feel involved in the national housekeeping by paying some income tax (though all pay expenditure taxes anyway).
The impact of a lower exemption threshold on low income tax payers could be considerably eased, as has been suggested, by re-introduction of a third low income tax rate.
My guess is that, for a Minister of Finance, lowering the effective threshold (by lowering personal tax credits) offers too big a hostage to fortune to be worth the revenue it would raise.
What do others think?
(Update: the first version of this posting used misleading language about thresholds, I have modified it without changing the intended sense).