Tuesday 21 October 2014

The 'budgetary situation' will lead to rises, not the anticipated tax cuts

Published 20/02/2014 | 02:30

TAX cuts are a priority in the next Budget, the Taoiseach says – provided, of course, that the budgetary situation allows it. A more pertinent question is whether the budgetary situation will be allowed to stop it.

It is a bit depressing to have this debate running in February, when the Budget is not due until October. Apparently there are some elections between now and then. It is also depressing that the debate is already running along well-worn tracks – excessively well-worn tracks.

The employers, via IBEC, along with the employment minister, want an increase in the lower-rate tax band so that employees do not enter the top rate at less than the average industrial wage – itself significantly below the average national wage.

Social Justice Ireland is already complaining. It says that band-widening is of more benefit to high-earners. By definition, anyone earning less than €32,800 gets nothing from an increase in the band, because all their relevant income is taxed at 20pc.

SJI would like to see an increase in tax credits, where everyone gets the same reduction in their tax bill. Unless, that is, their taxable income is so low that they don't get the full value of a credit. In that case, says the organisation, they should be refunded the difference in cash. That would certainly benefit the lowest earners, but it is not what the politicians are talking about.

The difficulty now, just as it was 25 years ago, is the sudden jump from a 20pc tax rate to 41pc, with levies bringing the actual deduction to more than 50pc. The difficulty about changing that is that widening the band is expensive, precisely because everyone earning more than €32,800 benefits.

Ministers have been talking glibly about other countries where the top rate kicks in at €80,000 a year or more. It is glib because no such band widening is remotely affordable here, short of wildly ambitious radical reform of the entire tax system.

The evidence is that the budgetary situation does not allow for any overall reduction in tax revenues at all. And in the longer run, it looks like taxes will have to rise as a proportion of the economy, not fall.

Some of the pressures were outlined in a new research note by two economists from the Economic and Social Research Institute (ESRI) and the OECD which compared the long-run budgetary pressures in different countries.

Researchers Rossana Merola and Douglas Sutherland say Ireland is particularly vulnerable to the rising bill for pensions; a problem it shares with several EU states, plus Switzerland and Korea. Pension costs will add almost €200m to public spending this year and that trend will continue. Interestingly, recent pension reform in Greece and Spain has lifted them out of the vulnerable group. More will have to be done here.

The national plan – don't forget – aims to have the government debt ratio down to 90pc of GDP in the next seven years. The implications of that plan often seem to have escaped government politicians, if you take what they say at face value.

Which, of course, you shouldn't. But a lot of people will try hard to do so, by way of seeking higher wages, lower taxes and more spending. None of which is compatible with the task the country has set itself.

It's all there in black and white (actually with helpful coloured blobs) in the medium term framework from the Department of Finance. The underlying budget deficit is meant to finally disappear in 2018, by which time tax revenues must exceed public spending on goods and services by 5pc of GDP.

That's about €3.5bn which has to be found. Most of it is meant to come from a 20pc growth in the money value of the economy over the period. Analysis presented to a seminar on EU budgetary rules at the Institute for International and Economic Affairs (IIEA) showed just how tight things will be, even if we get that kind of growth.

In separate papers, economists Pat McArdle, who chairs a major committee of the European Banking Federation, and Donal de Buitlear, director of Publicpolicy.ie, emphasised the limits on basic public spending, excluding interest costs, to which the government is officially committed. There has been very little debate on those. It is not enough just to balance the budget; there are specific targets for expenditure.

The economists calculated that spending will have to fall again next year and rise by little more than 1pc per annum in the following three. If that were achieved, spending could then rise in line with economic growth from 2019 onwards.

If the economy does grow at 5pc a year, as in the plan, that looks quite a pleasant life for the next government. But even 5pc a year could hardly satisfy the demands for more spending and higher wages – still less if accompanied by cuts in taxation.

Not that anyone wants to wait until 2019. Michael Noonan referred to this at a meeting of the Irish Association of European Journalists last week. If he could be sure that the economy would grow like that, he might be willing to bring forward some of the benefits. But of course he cannot be sure and, if it did not happen, the targets would be missed by a wide margin.

It is hard to know what to make of these new EU rules. They are so cumbersome and complex – often overlapping – that they will probably never enter popular political discourse. That casts doubt on the EU's ability to enforce them.

The real enforcers are in the bond markets. The plan envisages the national debt falling by about ten percentage points to 95pc of GDP by 2020. Interest costs, currently 5pc of GDP, will drop to 4pc. Those are affordable levels by past international experience, but allowing for the inflated value of Irish GDP, they are near the limits of affordability.

It is impossible to know how the markets will react to the evolving situation in the euro area but it would be wise to assume that lenders will have little tolerance for an increase in Ireland's debt ratio – or even a failure to bring it down.

Plenty of people recommend a debt default to escape from this bind. That is like the old economist joke about assuming you have a can opener when faced with a can. We can be sure that default will never be Irish government policy. The question is whether government could stumble into such a crisis by accident.

The chances of such an accident will be all the greater if politicians cannot find a way to move public debate into the real world circumscribed by fearful bond markets and EU creditor countries. There is room for policy differences even within those narrow parameters. Current talk, along with existing promises to reverse many of the unpleasant actions of the past four years, does not even come close.

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