Now Let Us Plot the Great Social Expansion

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Are we getting into election mode?  We have Government Ministers promising every tax cut possible while warning of the pestilence that will descend upon us if anyone else gets elected to office.  No doubt, parties are preparing their election manifestos, poster and leaflet designs, and candidate strategies.  Good luck to some of them.

We know what the Government parties intend to do – pursue real spending austerity as identified here.  They will cut primary expenditure (excluding interest) by 9 percent, public services by 8 percent and investment by an incredible 15 percent in real terms; that is, after inflation.  They will do this in pursuit of an economically reckless, socially callous and fiscally irresponsible and unnecessary goal:  eliminate the deficit by 2018. In fact, they intend to run a small surplus.  We have an investment crisis, a poverty crisis, an enterprise crisis (in the indigenous sector), and a public service infrastructure degraded after six years of irrational austerity.  Yet the Government intends to stand idly by while it pursues budget fundamentalism.

Fiscal Space 1

However, while they have outlined what they intend to do with expenditure (cut it in real terms), they have not revealed their taxation policies. They’re projections are based on ‘no change of policy’.  If they reduce taxation – and maintain their deficit elimination target – they will have to cut spending even further.   But they’re hiding that little scenario.

The Government hopes to trap progressive parties and independents.  They will say ‘if you want to increase expenditure, you will have to raise taxes’.  They will accuse progressives of wanting to increase taxes on workers.  Given that workers have suffered falling real wages while at the same time seen the effective tax rate increase by nearly 25 percent since the start of the crisis (never mind the cuts in income support such as Child Benefit) any hint of increased taxes is not likely to be met with hurrahs.

There’s a way out of this trap.  It’s quite simple.  Change the fiscal (budgetary) framework.   If we do that we will have billions more for investment, public services, and social protection without raising taxes on workers.  How?

A progressive fiscal policy should target an average of 2.5 percent deficit for 2016 – 2018.  How much would this give the government for economic and social investment?

Fiscal Space 2

Within three years a future government would have an extra €6 billion available to it.  That’s a considerable amount.

But this is only a static measurement.  Readers of this blog will know that when the government invests, the money doesn’t disappear into a black hole.  Instead, tax revenue rises, public spending (unemployment costs) falls and growth accelerates.   So the net impact on the deficit– after you factor in all these elements – is far less.  Let’s take 2016 for example.

Let’s assume that the future government spends the additional €1.4 billion in 2016 on capital investment.  Using the Nevin Economic Research Institute’s fiscal multipliers, what is the impact?

Fiscal Space 3

As seen, if we just take a static view, spending the extra €1.2 billion under a progressive fiscal framework would bring the deficit to 2.5 percent of GDP – the target mentioned above.  However, when we factor in the economic impact (higher employment, etc.), we find the deficit only rises to 2.1 percent – below our target threshold.

Therefore, even after the €1.2 billion investment, we still have an additional €800 million that can be invested back into public services and social protection which, in turn, will produce more growth and tax revenue while further cutting unemployment costs.

This is the point of a progressive fiscal framework – expansion creates room for more expansion.  We can start creating a virtuous cycle to free us from years of deflationary austerity policies.

But what about those rules – you remember, the Fiscal Treaty and all that.  You will hear a lot about them, mostly from people who claim ‘oh, no, you can’t do that – that’s breaking the rules.’  We’ll be snowed under with a blizzard of acronyms:  MTO (Medium-term Objective), EB (Expenditure Benchmark), SBB (Structural Budget Balance).  We’ll get into these in a subsequent post (hint:  the Expenditure Benchmark is not actually a rule).

Let’s look at one rule:  the Debt/GDP rule.  This requires Governments to reduce the debt (as measured as a percentage of GDP) by 1/20th of the difference with the Maastricht guideline target of 60 percent of GDP until that target is met.  A progressive fiscal framework of keeping the deficit at 2.5 percent for the medium-term would meet this rule – which actually doesn’t kick in until 2019. (For a more detailed account of this rule – see the Fiscal Council’s explanation).

Fiscal Space 4

The debt doesn’t fall as fast under a progressive policy but it still falls – fast enough to keep in compliance with the EU’s debt rule.  However, my admittedly back-of-the-excel sheet calculation for the debt under a progressive policy is over-stated.

While the above estimates a modest multiplier for increased public spending, using the Minister’s estimate (using NERI’s detailed multipliers would show a higher GDP and, so, a lower debt), it doesn’t include the increased tax revenue arising from the fiscal expansion nor does it include the reduced unemployment and related costs.  So the debt would probably fall even faster than presented above under a progressive fiscal policy.

The other rules we’ll get into later.  Just to note:  the big one that will be thrown at us is the unobservable structural budget balance.  Measuring the structural budget balance is tantamount to alchemy.  Economists and statisticians put away their calculators, don black robes and chant incantations from the Necronomicon by candlelight.

And none of the above factors in a progressive tax policy – one that seeks to leverage in provision from sectors that have made little contribution to the economy to date.  A wealth tax is small proposal; increasing the social wage (employers’ social insurance) is a big one.  Reform of the tax system does not mean tax cutting; rather it is about creating a more efficient and equitable tax platform to facilitate economic growth and social prosperity.

So progressives can prepare up their manifestos in the full knowledge there is considerable fiscal space.  And this space should prioritise investment; investment creates considerable short-term budgetary gains (which can be used for public services and income supports) while boosting long-term growth.  More research on the best balance of economic and social investment is needed but as the IMF points out – investment boosts growth while actually reducing debt.  It is not a cost.

The Government parties are pursuing regressive tax cutting strategies.  Progressives must counter with pro-growth and pro-living standards strategies.  This will not be an easy debate – but at least we know we have the resources.

Now we have to fashion the winning arguments.

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