Why Cuts Don’t Work
The economist Michael Burke has an article in Tribune Magazine which makes the point, for a UK audience being sold the Conservative Party line, that austerity measures are economically counter-productive, and that during a period which has seen such a significant decline in private investment and consumer spending the last thing a government should do is ‘join the savers’.
In the wake of the financial and economic crisis, the private sector has significantly increased its savings by paying off debt. For both individuals and companies, this makes sense, especially if they have falling incomes or their debts are high - or both. But the more they save, the less they are able to spend. For individuals, this means cutting back on consumption. For companies, this means cutting back on investment. Both these components of demand have declined, but the most severe decline has been the collapse in investment - as is the case in Britain.
Under these circumstances, it is economically disastrous for a government to join the savers. The net result is to depress activity even more, leading to further declines in incomes for companies and individuals, who respond by making further savings. And so the cycle continues. It is a death-spiral for the economy that is familiar from the Great Depression.
Instead, and just like the businesses which currently cannot or will not invest, government can invest to achieve a return that lifts both economic activity and the taxes emanating from it. In this way, not only does the economy grow, but also the deficit actually falls.
However, this process also works in reverse. In the latest Budget announced in the Dail, there were cuts of four billion euros, mainly in public sector pay and welfare. The Department of Finance accepted that pay cuts for public sector workers means lower taxes from public sector wages. However, there was no estimate of the impact on demand for goods and services. Nor had the ensuing effect on tax revenues from the private sector been taken into consideration. Further, there was no impact assessment made of the effects on other areas of government spending. This is to ignore a crucial aspect of austerity measures. Increasing numbers of low-paid workers or unemployed inevitably place greater pressure on government welfare spending, especially where benefits are means-tested.
He also mentions that when taxation is based on consumption, that revenue declines when the engine of that consumption is undermined further by wage cuts and increasing unemployment.
One of the reasons that Ireland is so admired by George Osborne - and one of the reasons its government finances deteriorated so sharply - is that it is a low-tax economy. So, how can it be that falling activity led to such a high proportionate fall in taxation? The answer, in the jargon, is that taxation is elastic. If various economic activities are subject to thresholds or exemptions or are untaxed at all, the burden of taxation falls on a narrow part of overall activity. If that activity declines - and Irish investment has declined by 53 per cent - the taxes on it will fall disproportionately.
Some further points worth highlighting…
However, the money wasted on the bailout of bank shareholders in both Britain and Ireland, not included in these data, dwarfs the economically useful spending on the poor and low-paid.
And
Austerity has also led to an increase in interest payments compared to those countries which have engaged in reflation. Yields on Ireland’s 10-year government debt have been more than 1 per cent higher than the eurozone countries which tried to stimulate their economies. Bond markets, for all the Thatcherite cheerleading of most of their participants, are above all focused on repayment of their loans to governments. Repayment requires tax revenues. But Ireland’s tax receipts have experienced the biggest falls in the euro area, aside from Greece, because of its austerity policies. As a result, it has been obliged to borrow 55 billion euros in the past two years. Because of both higher borrowing and higher interest rates on government debt, the additional cost to Irish taxpayers amounts to approximately one billion euros a year for the entire lifetime of that debt.
However, you should read the whole thing.
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