The Better-Off Shall Be First: The Recession Diaries – August 25th

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John McHale of NUI Galway has produced an outline for a fiscal plan. It is well worth reading. It’s a serious treatment. It’s also an unnerving treatment. For it has the capacity to wreck the Exchequer’s finances with little ‘stimulating’ effect on the economy.

On the way to presenting his fiscal plan John makes some highly contentious statements. He claims that falling investor confidence last year meant the Government had no choice but to engage in large fiscal adjustment (i.e. cuts). Of course, last year the National Management Treasury Agency launched the biggest bond issue by any borrower in Europe since 2004. Indeed, such was the level of demand for Irish debt that the NTMA was able to build up a war chest of €20 billion in free cash balances. And in the first few weeks of this year, the NTMA raised nearly 40 percent of all the money we needed to fund our debt this year. So much for slipping investor confidence.

John states that current expenditure cuts are less contractionary than tax rises. The ESRI simulation suggests just the opposite – that tax increases are less deflationary and fiscally more beneficial.

He also states that it would be better for wages to fall than to let unemployment rise. However, beyond the supply/demand curves of textbook models we find that office and factory floor workers are taking pay cuts (in the process subsidising substantial management pay rises) and at the same time find themselves being laid off as well.

On such shaky premises, we are now ready to examine John’s plan.

Step 1: Implement the McCarthy plan over two years. Never mind that it contains horrendously deflationary recommendations with the centre-piece proposal – cutting 17,000 public sector jobs – having been road-tested by the ESRI and found wanting; implement them. John seems to think the Report provides ‘a useful focal point for shared sacrifice’. 40 percent of the ‘savings’ comes from reducing social transfers, impacting most on low income groups. That’s a lot of sharing by one particular income group in society.

Step 2: Cut public sector wages by 5 percent. But of course. It won’t save much, mind you – only about 0.3 percent of the borrowing requirement, while cutting consumption by nearly a full 1 percentage point. John suggests the savings would be €700 million. The ESRI projected savings of €671 million but that was before the April budget and the imposition of additional levies. The net gain would be, as a consequence, somewhat less.

So far, pretty standard deflationary fare.

Step 4 (yes, I’m jumping ahead here – building the drama so to speak): Postpone the 2010 and 2011 cuts in capital expenditure for two years. John rightly points out:

‘Cutting capital expenditure as the economy falls into a deep recession just continues the pattern of pro-cyclical fiscal policy.’

It’s unfortunate he doesn’t see that cutting current expenditure is similarly pro-cyclical and more deflationary than capital expenditure cuts.

But, now, the piece de resistance.of Step 3:

‘. . a significant roll-back of the income and health levies. These levies have brought the marginal tax rates facing many workers to over 50 per cent. The Government was correct to put the burden on the better-off in the first phase of the adjustment. But continued increases in marginal tax rates will damage incentives and hold back growth. The tax-cutting package should also include temporary reductions in employer PRSI to the extent affordable.’

So the real game is revealed:

  • Cut public services, wages, health card entitlements, social welfare recipients living standards, and at the same time
  • Reduce taxes and levies – in particular, the marginal rate in order to provide relief to the better off John puts some numbers on this proposition.

John wants the Government to reduce taxation by as much as €3 billion nest year (some of this would be directed to cutting employers’ PRSI – an ineffectual deadweight proposal). He seems to go further. He wants the Government’s planned tax rises next year to be postponed (though I’m not sure if this is in addition to the €3 billion or is inclusive).

Why? What is the point of this ‘plan’? I can’t believe it’s a crude ‘take from those who don’t have enough and give to those who have more than enough’. John states:

‘This may be as close as Ireland can come to real economic “stimulus” in the current circumstances.’

So we have stimulus for the ‘better off’ and hard times for those at the lower end. This might be worth considering if John had put forward any argument that such an approach would actually stimulate the economy. But he doesn’t. And it won’t.

Recessions are marked by many things – loss of money to the economy, falling living standards, reduced consumer spending, rising unemployment and falling investment. It’s hard to see how giving money back to the ‘better-off’ will address these issues.

Would it result in a rise in investment? I don’t see how. There are few investment opportunities. Enterprises are retrenching from lack of demand while banks are a basket case. The history of investment in this country is that it has either been led by multi-nationals or the State. The investment of choice for the better-off has been property – both here and abroad. With this route of investment cut-off, is it really being suggested that this money will end up in productive investment?

What about boosting consumer spending? Better-off individuals are more likely to save a larger proportion of their income than spend it. If they do spend it, it’s more like to be import-dense. If you want to boost consumer spending, you find ways to put cash in the pockets of those groups with a higher propensity to spend – those same income groups that John wants to hammer with the McCarthy proposals.

This has to be one of the more peculiar ‘stimulus’ proposals I’ve come across. It could end up wrecking the Exchequer finances. John is hopeful that the €3 billion in tax cuts next year would be financed by implementing half of the McCarthy proposals and the public sector wage cuts.  However, the net savings from these deflationary proposals would struggle to reach €2 billion, while undermining economic performance (cutting consumption, increasing unemployment).  This would leave at least a €1 billion hole for next year.

All in the hope that the better off would do something productive with that money that they’ve been gifted.

That’s not so much a plan as a leap of faith.

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