March 5th - Helping Out the Brians: The Recession Diaries
So, the Brians are asking for advice. We should not begrudge them. It is time for all ‘good patriots’ to step forward and give our faltering government a helping hand. For we are now, effectively, looking into the third budget in five months. So where do we start?
No better place than with Sean O’Riain’s piece on TASC’s progressive-economy blog. His message is simple, his analysis irresistible:
‘The crux of the matter is that this gap is too huge to close with cuts and tax increases, even though those will play a part. We have scope for borrowing, given our low debt ratio but this will give a few years ‘breathing space’ at best.
What can close the gap is growth.’
ICTU would be well advised to hire loudspeakers and drive down every street, avenue, road and boreen of the nation, repeating this message until people say it aloud in their sleep: what can close the gap is growth.
Let’s take this as a starting point but keep in mind Alec’s comment on a previous post on this blog:
‘ . . at what point will the deficit become too large?’
For clearly the deficit has all the appearances of being out of control (and under current deflationary policies it will continue to be) and there is a point at which the deficit will so widen it will squeeze out resources for a stimulus programme. It may have reached that point already. Can we stimulate the economy while bringing the deficit under control? Let’s try.
Financing the Stimulus
We need to get our hands on some cash quick and start turning it into jobs, economic activity, consumption and investment in a reasonably short time without exacerbating our deficit. Well, the Central Bank has about €20 billion sloshing around in its vaults. €4 billion of that is committed to redeeming a bond issue in April leaving €16 billion. That’s a darn good start. We can supplement that by diverting the €1.5 billion contribution to the Pension Reserve Fund.
So, without going any further than the Central Bank’s ATM machine, we already have over €17 billion to put into an economic stimulus and investment programme.
A second source is the state’s Pension Fund. Without getting into the thorny debate over whether pre-funding is the most appropriate way to finance future pension liabilities, we can transform the Fund in a way that meets investment needs while ensuring it’s still around in 2050 when the Celtic Tiger cub start retiring. The Fund could finance a range of infrastructural and capital projects with a long-term commercial rate of return here in Ireland.
And we’d better start doing this soon or we won’t have much of a Pension Fund left:
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Pension funds are getting hammered on the equities market. Last year, pension funds saw over a third of their value wiped out. In the first two months this year, over seven percent was wiped out. The Pension Fund used to have assets of over €20 billion. Now it’s worth only €15 billion. Every day it gets less.
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The Government is draining the Pension Fund to blow it on recapitalising our banks. Talk about throwing good money after bad, really bad.
Redirecting Pension Fund investment will not only pay long-term real dividends back to the Fund; it will get people back to work as well.
So we have two sources for an economic stimulus package - immediate, in the form of Central Bank cash; and medium-term, in redirecting billions from the Pension Reserve Fund. While I don’t intend to go into detail here I will suggest two areas as examples (there are, literally, hundreds more):
- ICTU’s No Child Left Behind. ICTU proposes that every child under the age of four be guaranteed an early education / childcare place. This would be an invaluable investment in our future in addition to addressing the inequities in our current lack of support for early education. And the thousands of jobs it would create - this is win-win today and tomorrow
- The Irish Exporters Association has called for a €1 billion intervention - a combination of state and EU-aid - to save 45,000 jobs in our critical export sector. The IEA, noting that other countries have introduced such measures, stated:
‘Here in Ireland we have not responded to the deepening economic crisis with any enterprise/export stimulus measures. As a consequence we are now falling further back in the international competitiveness race, while the Government dithers on the issue. . . . An Enterprise Sustainability Fund of approximately €1 billion, rolled out in line with the EU’s recently released State Aid scheme of up to €500,000 per company between now and the end of 2010, is what is now needed. This would have the impact of saving markets and approximately 40,000 jobs over the next two years.’
This is a persuasive argument - even if the details need to be worked out.
Realistic Targets
The fiscal deficit is analogous to someone who has binged for years:
If I can survive on a diet of one pea and one grape a day, I can lose five pounds a week and within three months I’ll have shed over four stone.
Guess what - that diet won’t last the day. The unfortunate individual will get depressed and return to bad habits: lounging around all day in their underwear drinking beer and eating chocolates while watching Star Trek reruns on obscure digital channels.
The Government first planned to close the gap within three years. Then they revised that to five years (the EU didn’t buy that one either). Now they’re coming forward with a new three-year plan and a third budget. And the situation just gets worse.
We need targets, working within a stimulus programme, which are rooted in the real world. Realistic targets that can be reached will provide not only a credible process but create a positive psychological effect going forward - one of the best assets one can have in recessionary cycle.
But setting targets requires two things: first, a grasp of the dynamic relationship between deficits and GDP; and, second, a forensic deconstruction of that deficit.
For instance, let’s take a deficit that remains the same in nominal terms.
- If GDP grows, the deficit is reduced.
- If GDP declines, the deficit grows.
- If GDP remains static, so does the deficit.
The deficit itself hasn’t changed but the relationship with GDP has. Trying to cut the deficit through general tax increases and public spending cuts will accelerate our economic decline, so that while we cut the deficit, the gap closes only marginally. This is the proverbial ‘running up a down escalotor’.
A stimulus programme, on the other hand, attempts to, first, slow the decline in the GDP and then get it increasing quicker and, ultimately, faster than it would have without the stimulus. In this way, the deficit reduces. However, we must set a ceiling on the nominal deficit (otherwise we have the reverse effect of the cuts - we grow the economy but the deficit grows too) and this requires an examination of its three main components:
- Capital budget expenditure: currently this stands at 40 percent of the deficit.
- The cyclical deficit: the portion of the deficit that should disappear when growth, employment and output returns to normal (whatever that might look like on the other side of the recession). This is considered temporary.
- The structural deficit: the portion of the deficit that will remain even when our economy is back to the full strength. That is because we relied for years on tax sources that will not recover (e.g. property / construction related revenue in VAT, capital gains, stamp duties, income tax, etc.).
The structural deficit is the key element. The EU would not have launched an excessive deficit procedure against Ireland if they found the deficit to be (a) resulting from an emergency, and (b) temporary. We passed the first test - a collapse in output is an emergency; we failed the second, owing to the structural nature of the deficit. That the EU didn’t have confidence in either the Government’s projections or strategies only sealed the deal.
Let’s take the capital budget off the table for the moment. We will need a long-term, sustained investment budget - well above EU norms - to raise our physical and social infrastructure to the European benchmark.
Our priority, in setting the ceiling, is to tackle the structural deficit while letting the stimulus programme tackle the cyclical deficit. If we can get a positive interaction between these two, which are themselves fluid (for every job created/retained we decrease public expenditure and increase tax revenue - thus reducing both elements within a growing GDP) we can:
- End the cyclical deficit within five years
- End the structural deficit within seven years
- Bring the total deficit - structural and cyclical, inclusive of capital investment - under the Maastricht guidelines within ten years
Much will depend on what proportion of our deficit is structural (the latest projections suggest it is 70 percent of our overall deficit). This is the tougher nut to crack, and will take longer.
This is realistic and do-able. Too long, you say? What about the EU, you ask? Remember two things - the dieter’s dilemma is that it takes longer to remove excess weight than put it on; and second, the EU is more interested in process and credibility. Establish that, and we might find the deficit withering away faster as the economy grows in quicker time.
Tackling the Deficit(s)
So where do we start tackling the structural deficit while we launch a stimulus programme to tackle the cyclical? Let’s remember two principles from a previous post:
- Do not load tax increases on low-average income groups who have a higher propensity to spend - if we do, we will only deflate the economy and make it more difficult (and expensive) for the stimulus to work.
- Identify, instead, three sources: unearned income, unproductive capital and high income groups with a greater propensity to save.
This will have a lesser effect on consumption and do less harm to those sectors and firms reliant on domestic demand. Only when the economy, consumption and wages returns to growth should we begin the long-term process of increasing general taxation and social insurance contributions.
Here are some sources(among many, many more) from which we can take tax without doing much harm to consumption:
- Double the tax rate on inheritances and gifts and apply PRSI and Income levies.
- Apply a 1 percent tax on the market value of all ‘second homes’ (with a reduction for rented accommodations that are listed and audited for health and safety compliance).
- Remove the exemption of the sale of principal residences from Capital Gains tax, taking into account mortgage repayments and inflation (it’s more equitable to tax a house when it’s turned into an asset rather than tax it while it is being consumed).
- Reduce tax expenditures by a minimum of 10 percent by phasing out all non-productive reliefs for income groups over €100,000, ending tax shelters and reforming tax expenditures that are regressive.
- Abolish the income threshold for PRSI levies, phased in over four years.
The main element, however, would be to adopt the principle contained in the Framework Document:
‘ . . .that those who benefited most from the economic boom should make a particular contribution to the adjustment required.’
So here’s the particular contribution: a once-off 5 percent levy on all assets over €1 million to be paid for over seven years. With the top 75,000 households holding an average of €4.2 million in assets, according to the Bank of Ireland, Private Banking (2007), there’s a considerable asset base to tax. Even taking into account write-downs and exempting productive assets (businesses, farms, etc.), we would be capturing a significant proportion of wealth that has been accumulated over the last decade.
This would raise billions but would take some time to get off the ground. So even discounting income from this levy, the other measures (and these are just a sample) could raise between €2.5 billion and €3 billion a year - and this doesn’t even include new tax rates or levies on high incomes.
We could also transfer expenditure to more productive and socially equitable programmes: the €100 million in subsidies to private fee-paying schools could go to our debt-ridden primary school system or help fund computerisation in the classroom; the €400 million Early Childcare Supplement expenditure could be phased out and transferred to the No Child Left Behind Programme.
Such tax revenue and expenditure efficiencies could start us on the path of getting rid of the structural deficit without undermining the stimulus programme and the phasing out of the cyclical deficit.
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There. The two Brians now have a plan - or, at least the outline of a plan.
- Launch a stimulus starting with Central Bank funds and redirecting Pension Fund assets
- Establish realistic targets based on the dynamic interaction between growth and the deficit
- Go after, in the first instance, revenue sources that won’t adversely impact on domestic demand
It’s not without its problems - no proposals are. But it is better to deal with the problems thrown up by a growth strategy than those associated with managing deflationary policies.
For only one of those provides us with an exit from the recession room.
Discussion
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Comment by: marie murphy .
Apr 1st 2009 at 20:04
hi, first of all can i say that we irish are great patriots and now lets show it .
1- instead of singing and crying lets get united like the indians.
2 - each county should appoint a successful business person , give them so much money to tackle the roads ,unkept farms , house auctions , car auctions ,find out who made the real money and get them to pay 1 euro each time they use there credit card and this money be held by this apponted business person and start getting the economy moving in each county .
THE GOVERNMENT IS NOT ABLE TO DO IT ALONE SO LETS GET REAL INSTEAD OF CONTINUOUS TALKING AND BICKERING ,ITS NOT THE WAY FORWARD.
SINCERELY,
MARIE
Comment by: Donagh
Apr 2nd 2009 at 10:04
Hi Marie,
Thanks for your suggestion. It’s a cracking idea. I suggest though that you send it the Ideas Campaign. They’re always saying that people are sick of the ‘whingers’, so why don’t you see if they’re interested in it.