Friday 28 October 2016

ECB rate rises and tax hikes: it's the doomsday double whammy

Having put money into our pocket for the last five years, the ECB will change tack writes, Marc Coleman

Published 25/08/2013 | 05:00

Richard Bruton
Richard Bruton

Richard Bruton says the marginal rate of income tax must come down. Some of his colleagues disagree: how, they ask, can tax cuts be justified for those on higher incomes when spending is also falling?

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Apart from the fallacy that marginal income taxes affect only those on higher incomes – the average Irish industrial worker is now subject to the highest marginal taxes in the eurozone – the premise of their question is false. From €57.3bn when the crisis began in 2008 to €60.8bn by the end of this year, gross current spending will, during the first five years of the crisis, have risen, not fallen, by 6 per cent. Household incomes, by contrast, are down 8 per cent since 2008. Marginal income tax rises, the Universal Social Charge, health levies and various indirect taxes are just some of the reasons why.

So, tempting as it is to see this in ideological terms with tax-cutters on the right championing higher earners and tax-raisers to the left championing the poor, it is those on lower and middle incomes who are most in need of tax cuts. But there is an even more powerful argument for tax reductions. One that cuts across the ideological divide and makes the case for cuts – at least temporary cuts for the next few years – crystal clear.

Basically it runs like this. In this life there are takers and there are givers. There are also those who do a bit of both. For all the austerity talk, in terms of overall current spending, the State has been a taker and not a giver in this crisis.

Yes, current spending rises would have been bigger but for various cuts including those to public service pay and pensions.

But in net terms, current spending is up, not down. The only "giver" in the crisis by far is the poor taxpayer. But the really crucial thing to focus on is that unique institution which both gives and takes over the economic cycle.

Yes, the tax rises of the last few years have been painful. But ask yourself how much more painful they would have been had the ECB not been in giving mood during the last five years. Since September 2008, it has brought its key policy rate – the so-called "main refinancing facility" – down by three-and-three-quarters of a per cent. What that means for the average punter – someone paying off a 25-year €250,000 mortgage on a tracker – is savings of €600 a month or €7,000 a year. "But my variable rates have been rising," I hear you say. And for many, that's true. But it's also true that had the ECB not cut its policy rate, those variable rates would have risen by even more. So whether you're on a tracker or on a variable rate mortgage, the ECB has been putting money in your pocket these past five years. Lots of it (fat lot of thanks it got for it).

Had the ECB not been, as I put it, in a "giving" mood, the share of our people at risk of poverty would not be the 16 per cent identified in a recent CSO report but probably closer to one-third. The high home ownership rate compared to Mediterranean countries has, incidentally, played a key role here. In Greece and Italy, ECB rate cuts have had a less significant impact on incomes. Now here is the trouble: compared to the Government, which just taketh, the ECB giveth. But it also taketh away. And judging by financial markets, it is likely to start making that shift before the next election.

There will be one further rate cut between now and 2015 and that will most likely come in the next two months. But thanks to a raft of positive indicators published last week, movements in Euribor futures – derivatives whose value reflects where financial markets think ECB rates will move over the next few years – are pointing to rates rising by the end of 2015.

And more evidence of recovery in coming weeks could bring that date forward to the middle or start of that year. Of course, if another relapse happens all bets are off. But if eurozone recovery takes wing, then the Government would be wise to reckon with interest rates on election day being around a full per cent higher than at present.

An even-worse-case scenario would be a eurozone recovery pushing up ECB rates while Ireland remains in recession. Worse still would be something many economists fear: a rapid rise in inflation and the ECB making up lost ground in double-quick time, raising rates rapidly. If on the way up the ECB raises rates even half as quickly as it brought them down between the autumn of 2008 and spring of 2009 then a rise of one-and-a-half per cent could be on the cards in the year leading up to the election.

With €150bn in mortgage debt and a further €30bn in personal debt outstanding, according to Central Bank figures, that could take between €2bn and €3bn out of an economy already reeling from more tax cuts. Unless, that is, the Government changes tack.

During the last five years the ECB gaveth. But from 2015 and for at least two years thereafter, the ECB will be in "taketh away" mode. As the ECB put money into our pockets, the Government took the money out. Even with the ECB's helping hand, the effect of those tax hikes was awful, politically, economically and socially. New figures show mortgage arrears hitting crisis levels. Against this backdrop, further tax hikes occurring as the ECB begins raising rates could be simply unbearable.

Sunday Independent

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