Saturday 18 January 2020

Brendan Keenan: Spending surgeon emerges as the economists' favourite

Lenihan may shy away from tax hikes in the forthcoming Budget, but going after property cannot be discounted

SPENDING cuts, rather than tax rises, was the official message from the Cabinet brainstorming at Farmleigh. The economists will like it, but will the voters?

It is never too early to think of the electoral cycle. It may be that professional politicians never stop thinking of it. John FitzGerald, senior research professor at the Economic and Social Research Institute (ESRI) certainly thought it was time to take it into account.

There are, after all, two Budgets at most between now and a general election, and €5bn more to be found in Budget corrections, according to the Great Plan.

The figure is supposed to break down into €3bn this December and €2bn the next. Prof FitzGerald wondered if it was realistic to expect a €2bn correction in a 2011 Budget just months before an election.

Perhaps the Government might consider doing more in this Budget, he mused. None of your stimulus stuff for Prof FitzGerald. He agrees with the trade unions that the fiscal corrections are choking the economy. He even gave them a number to put on it. Two per cent of GDP (output) will be lost -- €3.5bn in this year's money.

He differs from the stimulators in thinking that it would not actually do any good to ease up on the corrections. The cost of the extra accumulated debt, plus any rise in interest rates because of the borrowing, would undo the stimulus.

Not everyone is treated the same in this unfair world. The Americans can borrow for 10 years at 3 per cent. It makes a deal of sense to borrow and support the economy at those rates. Even the British can raise funds at 3.4 per cent, although David Cameron thinks they have raised enough.

But the Irish National Treasury Management Agency (NTMA) had to pay 5.6 per cent for a small amount of 10-year money last week. There is no way to stimulate an economy with money as expensive as that. Indeed, there is a limit to how much money one country could borrow at all.

We are not at that limit yet, and a lot of the existing debt carries a lower interest rate. But something will have to give over the next year or so. Even if the annual deficit comes down, and there are no big fresh demands for cash from the banks, interest rates will have to ease back for there to be any chance of achieving stability in the public finances.

For now, the Cabinet seems to have bowed to Brian Lenihan's arguments that it must be €3bn on Budget Day. He would have told them that this is the minimum to stay on the track that gets the finances back within EU rules by 2014 (growth and interest rates permitting).

He may also have told them that any sign of backsliding or slippage could send even that 5.6 per cent borrowing rate sharply higher.

Two bitterly contrasting pieces on Ireland appeared on the same day last week: one in the Financial Times 'Lex' column and the other on Bloomberg News. The former took the view that Ireland's fiscal correction did not seem to be working; the latter that it was a shining example to everyone.

Take your pick, or go for something in the middle, but the consequences of a perception that the political will was beginning to slacken, or that political popularity was taking precedence, only lead one way.

Which leaves the question: would spending cuts be more popular than tax rises? The reason economists prefer them is that there is some evidence that cuts do less damage to an economy. Only some evidence, mind you; but one can see why it might be so.

The main one is that high income taxes can deter people from taking work, or prove counter-productive because more work is done under the counter. Ferocious poverty traps between work and welfare were created during the corrections of the 1980s.

The boom gave us just about the most work-friendly income tax system for an average-earning family in the developed world. Many are not liable for income tax at all. That generosity can hardly continue, but care must be taken. Unlike the 1980s, there appears to be no commitment to maintain the real value of welfare, or pensions.

The politics of more tax on the bottom 20 per cent of earners and none on the top 20 per cent do not look very appealing. Making the better-off pay more by cutting their tax breaks -- which is Mr Lenihan's stated approach -- could play better.

Property tax moves in and out of the speculation like a drunk doing the conga. Nothing provokes more fury. The rage of those who paid large amounts of stamp duty, and now have large negative equity is understandable. If it does not happen now, it can hardly happen in 2011, but it is too common a tax in other countries ever to disappear off the agenda entirely.

Sunday Independent

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