The last year of the Irish Bubble was 2007. Government revenue had already begun to weaken as the world financial crisis intensified with the collapse of Northern Rock in the UK in September 2007, followed by the Bear Sterns bank in New York in March 2008.
Serious concerns had also begun to emerge about the Irish banking system and bank share prices were sinking rapidly. It was pretty clear that Ireland was headed for a sharp rise in the budget deficit and the first expenditure cuts were introduced in July 2008 following Mr Ahern's departure as Taoiseach. The banking system began to implode in September and policy has been dominated in the period since by austerity budgets and efforts to rescue the banking system. The combined task exhausted the credit-worthiness of the State and Ireland had to resort to official lenders, the EU and the IMF, at the end of 2010.
It is hard for people to accept that after almost four years of expenditure cuts and tax increases so little progress has been made in eliminating the budget gap. In 2012, the deficit will still be at the quite unsustainable level of 8.6 per cent of GDP. The gap has failed to close partly because the level of economic activity, and hence of tax revenues, has weakened so much. Total employment is down almost 300,000 from the peak.
In the construction sector, over 60 per cent of those employed in 2007 have lost their jobs and employment is down, thankfully by lesser amounts, in almost every other sector. The sole exceptions are public administration, health and education, where job numbers have been sustained. The volume of consumer spending has fallen by about 13 per cent from the bubble peak. Government revenue comes mainly from taxes on income and from taxes on expenditure: both have been treading water, despite increases in the effective rates of tax.
Meanwhile, government spending has been subject to two sources of upward pressure. The numbers relying on unemployment pay have almost trebled and the cost has soared, despite reductions in rates of payment. The annual interest bill has rocketed as the national debt increases year by year. The early stages of a fiscal crisis usually follow this pattern. The problem tends to get worse initially as the tax base narrows and these two expenditure items surge. The first milestone in a budget adjustment is when the deficit stops rising, and this often takes a few years. In Ireland's case, that first milestone will be achieved in 2012, and the result should be a deficit below the 2011 level. If economic growth were to return, further steady progress could be expected; the Eighties fiscal crisis in Ireland was eventually resolved in this manner.
It is a myth that the big factor in the recovery of the public finances from 1987 onwards was the programme of expenditure cuts. The cuts were modest by comparison with what has already occurred on this occasion. The restoration of budget balance eventually came through a resumption of economic expansion and the consequent boost to government revenue.
Unfortunately economic growth is not a policy instrument. The government cannot instruct the economy to expand, nor would it be wise to assume a resumption of growth in current circumstances, since the external environment is unfavourable
and the Irish economy remains uncompetitive. Following the sharp contraction after the bubble burst, economic activity in Ireland has been essentially flat and there is no realistic prospect of rapid growth for quite some time. With debt already excessive and a deficit remaining stubbornly high, balance must be restored through further expenditure cuts and further tax increases, without, in all likelihood, any early assistance from a return to growth.
When the public finance correction got going in the late Eighties, the economy was not suffering the competitiveness handicap which still remains, notwithstanding some improvements on this front over the last few years. Importantly, the banks did not go bust during the Eighties, just the government. On all counts, the current crisis is deeper and more difficult to manage.
It is not correct to attribute the imposition of fiscal correction to the country's reliance on the EU and IMF for emergency finance. Ireland was embarked on austerity before access to the credit markets was lost. Without EU and IMF support, there would have been a crash-landing in late 2010, since nobody else would lend. This nightmare scenario may be about to play out in Greece. There is one thing worse than having to rely on official lenders, and that is having no official lenders to rely on.
The Irish budget deficit will be zero in four or five years time. This will happen either as an explicit condition of continuing support from official lenders, or as a re-entry test for access to the bond markets. It is difficult to envisage any circumstances in which this will not happen. If the prospects for economic growth are unpromising, it follows that balance must be achieved mainly through further expenditure cuts and tax increases.
The two principal elements in current spending, apart from interest, are the public service payroll and the social welfare budget. On public service pay, government has committed itself to the Croke Park agreement, which ruled out further pay cuts and compulsory redundancies. Job security is a precious concession in today's Ireland, and no significant price was extracted by the government's negotiators at Croke Park. Rather than another across-the-board cut in pay rates, would it not be fairer to conduct a fresh benchmarking exercise, in full public view this time, comparing pay rates across the public services with rates in the private sector in Ireland and in public employment in other European countries?
There is a widespread belief that, particularly when pension entitlements and job security are taken into account, public employees in Ireland are still better off than their private sector neighbours. Moreover it is regularly asserted that Ireland's public officials are better paid than their counterparts in countries on which we now rely for emergency finance. If these beliefs are inaccurate, as the public service trade unions maintain, would it not be best to get the evidence out in the open? If there is substance to them, the government would have a practical case for re-opening Croke Park.
Social benefits can be either targeted (means-tested) or universal. In the good times, there is a temptation for politicians to universalise: the middle and upper income groups have votes too. Means tests are unpopular and an administrative burden. But insistence on universality means that fair cuts are harder to achieve. The alternative to ending free medical cards for the better-off elderly, or free university education for the better-off young, is across-the-board cuts in benefits which affect everyone. The social welfare safety net was built up over the decades to provide an income floor for the less fortunate, not an Exchequer dividend for one and all.
Government revenue must also be supplemented. Rates of income tax in Ireland, when the universal social charge is taken into account, have risen significantly already, and it would be a pity to have to push them too much higher. But a blanket exclusion of the option is unwise. Some indirect taxes remain below the levels prevailing north of the border and can be increased further without fear of revenue leakage.
The Commission on Taxation advised in 2009 that residential property be taxed and that all householders should pay for water, as of course many already do in rural areas. There are very few countries where householders enjoy free water as well as exemption from property tax.
The generous treatment of residential property in Ireland was a contributory factor in the credit-fuelled bubble which has created such economic and social devastation. The system included mortgage interest relief, exemption from capital gains tax, free water and non-imputation of income from owner-occupation. A plethora of additional tax breaks for residential development was provided during the bubble years. The gimmicky extra tax breaks are largely gone, but there is widespread resistance to the Government's proposals for a residential property tax and for water charges.
There has been extensive coverage, including a week-long series in The Irish Times, of the squeeze on Middle Ireland. Job loss, negative equity and tax increases are exacting a heavy toll. It is not possible to exempt the broad mass of the population from further impositions: the challenge is to choose the fairest path for an unavoidable further cut in living standards.