Tuesday 21 October 2014

Government's giveaways will end in disaster

The Troika is gone but 
we simply cannot afford to dispense with a policy 
of fiscal caution

Published 13/07/2014 | 00:00

The final visit by Troika officials took place today at the Department of Finance. IMF official Peter Breuer (left), Craig Beaumont (centre), IMF Mission Chief for Ireland, and other members of the delegation are pictured leaving the Department of Finance

The Troika has departed, so it is time to get back to the core business of Irish politics, namely the purchase of the electorate's votes with their own money. The Cabinet reshuffle will be forgotten quickly but the policy measures announced by the Government on Friday are ominous.

The Government, which took over in February 2011 tasked with the restoration of national solvency, has gone into pre-election mode and seems to be proceeding as if the financial problems of the country have magically been resolved. There are to be tax cuts for low- and middle-income earners, which, in practice, means just about everybody; a programme of social housing; free GP cards for the 50,000 over-70s not currently eligible, an enhanced household-benefits package and a review of the minimum wage. The first four measures will worsen the State finances, which this Government was elected to fix while the final measure, if it results in an increase in the minimum wage, will raise costs for business.

The Government is behaving as if the elimination of the budget deficit, and hence the postponement of stabilisation in the national debt, can now safely be deferred. With the winning post looming into view, it is time to loosen the reins and ease up. The announcements add up to a programme of cutting taxes while expanding expenditure commitments. If this is to be the policy framework, the date when government borrowing is eliminated (the winning post) recedes indefinitely into the future.

The recent improvement in tax revenues, which could prove to be temporary, is to be devoted to financing a permanent reduction in direct taxes on income. Irish Government revenue remains so far below government spending that the gap will hardly close on its own, even if economic activity expands.

So a policy of using any improvement in revenue as a trigger for giveaways runs the risk of extending indefinitely the period of fiscal exposure.

Given Ireland's enormous debt overhang, any policy of continuous budget deficits is risky. Last week's events in Portugal, where the discovery of fresh problems in the banking system induced immediate pressure on government borrowing costs, should serve as a sharp reminder that Ireland is extremely vulnerable to adverse shocks at home or abroad. The impression created by the change in policy is that, with the Troika's surveillance ended, the political class are now free to revert to type.

As to the specific measures, it is simply not the case that direct tax burdens in Ireland are exceptionally high. If the populace were willing to curtail expenditure under various headings, of course taxes could ultimately be cut. But the Government position is that social expenditures are to rise, while taxes on income are deemed too high. There is no indication that alternative taxes are to be raised in compensation for the proposed direct tax cuts. The Funny Money show is back in town.

Construction of local-authority housing will add to the cost of the capital programme, while the decision announced earlier last week, to extend free GP care to all over-70s will add further cost to the overshooting health budget.

Approximately 1.7 million citizens are entitled to medical cards on the basis of medical need or inadequate means. Entitlement to free GP visits has already been extended to all under the age of six. Their ranks are now to be swelled by 50,000 over-70s, hitherto excluded on the grounds of income which exceeds the threshold. There are about 390,000 people aged over 70 in Ireland, of whom 340,000 already qualify for free medical cards or GP cards. The lucky 50,000 to whom 'free' GP cards have now been extended are, by definition, the elderly with the highest incomes. The services of GPs are, of course, not free, but will be an increasing charge on the Exchequer. The household-benefits package ('free' electricity, 'free' travel, 'free' TV licences and 'free' telephones) regardless of income for those who qualify is to be enhanced by €100 per annum, explicitly to compensate for the cost of paying for water, hitherto 'free'. Government spending on a universal programme is to be increased in order to compensate the public for an increase in government revenue!

Politicians regularly assert their commitment to protecting the weak and vulnerable, which points to targeted social-service entitlements, from which the better-off are excluded. Meanwhile they expand universal benefits, available to all regardless of means. The latest extension of universal entitlement to health services is, moreover, just an instalment on the way to 'free' GP care for all, a Fine Gael/Labour commitment in their Programme for Government. Other universal entitlements, bestowed independently of any means assessment, include free university education (regardless of cost as well as means), child benefit, free travel on public transport, free TV licences for the elderly and several other costly programmes.

This proclivity to universalise benefits means that, if the State is to deliver some free or subsidised service to the bottom half of the income distribution, it must be delivered to the top half as well, which doubles the cost. Curiously those on the political left, supposedly most devoted to targeting at the poor and disadvantaged, seem most wedded to universal benefits. The inevitable result is high levels of public spending with blunted redistributive impact, necessarily accompanied by high levels of taxation now, or later.

In many developed European countries, the state spends up to 50pc of all national income. There is only limited re-distribution to show for it, due to the prevalence of universal entitlements combined with numerous taxes which are regressive in their impact, which is true of most indirect taxes. Financing universal benefits with taxes paid by everybody sends the public's money on a pointless merry-go-round intermediated by politicians. It has more to do with the re-distribution of votes than with the re-distribution of income.

Should the minimum wage be increased as a result of the work of the new low-pay commission, the cost will not fall on the State budget. It will, however, fall on the payroll bill of businesses. If the current rate of €8.65 (higher than the UK figure) is increased only a little, the impact should be modest. But any substantial increase runs the risk of discouraging employment prospects for the low-paid. Policy changes which offer benefits to some social group without apparent cost to the Exchequer are particularly seductive for vote-hungry politicians. The prospective increase in the minimum wage will be modest, precisely because the same politicians know that it is not 'free'. Increase it by any appreciable amount and reality intrudes.

In his speech to the Dail last Friday, the Taoiseach referred, yet again, to Ireland's emergence from the three-year Troika lending programme last December. This promises to become the most misunderstood event in recent Irish history. What actually happened was the following. Mainly through Irish mismanagement, with a little ill-treatment from European 'partners', the Irish State became insolvent for the first time in its history in the autumn of 2010 and could not borrow to fund the large budget deficit and to re-finance maturing debt. Had there been no substitute lenders when market funds dried up, the State would have had to default on its debts.

International official lenders, mainly the EU and the IMF, came up with a three-year programme of loans, totalling the enormous sum of €67.5bn, and duly disbursed these loans up to the planned horizon of the programme at the end of 2013. They did not announce that these loans were to be forgiven. They simply departed, with the full debt outstanding, and will lend no more. It is rather a large confusion to interpret the departure of the only people who would lend money to the Irish State as the signal that said State had entered the Promised Land and that fiscal constraints could now be relaxed. The exit of the Troika means only that future borrowing will be on market terms. As Portugal discovered last week, the market can turn.

The Government has chosen to gamble that economic growth has returned and that the improvement in tax revenues can safely be dished around to what they hope will be a grateful electorate. Since nobody can predict with confidence, this is a pure roll of the dice, highly imprudent and against the advice of their own Fiscal Council. Fasten your seatbelts.

Sunday Independent

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