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Where to now (Post-Troika)?

Posted on December 14, 2013 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

A very strong narrative is gathering pace abroad and at home:

  • There was ‘absolutely’ no alternative to ‘austerity’ in the case of Ireland once the storm broke in 2008;
  • Ireland displayed remarkable and exceptional resilience, consensus and passivity in accepting the ‘tough’ decisions that ‘had to be made’ to restore public finances;
  • The ‘tough’ decisions made and implemented were as fair and as equitable as they could have been within the parameters of the politically possible;
  • Ireland has one of the most progressive (income) tax systems in the world and most people (including the ‘middle squeezed’ and the richest 10%) already pay far too much (or as much as can be extracted without causing damage to entrepreneurship, investment and recovery)
  • We are now moving on to a new phase having passed with flying honours the ‘adjustment programme’ which was ‘imposed’ by the Troika.
  • The immediate future holds out the prospect of growing confidence, restoring competitiveness, ‘leaning’ the public services and ….. cutting taxes for ‘hard pressed middle-income people’.

The vision Post-Troika could be summed up in the following pithy sayings:

  • ‘the best small country in the world in which to do business’
  • ‘a fairer and more competitive country once again’
  • ‘a better governed place having learned the lessons of the past’
  • ‘no return to the bad old days of cosy deals, lax lending and spending and property craze’

The narrative is persistent, strong, coordinated, widespread and effective. It might even be believable given the positive, if tentative, news on employment growth, the falling cost of borrowing on international capital markets and the deliverance from the Troika adjustment process. It is said that even the ‘markets’ believe the narrative (and it hard to fool them although they are a poor guide to economic fundamentals as evidenced by the period 2007-2008). Who knows, may be the ‘best is yet to come’ as one writer observed in pre-Crash Ireland?

The best is yet to come?

And yet the best is not to come yet because the journey to economic prosperity with fairness and sustainability is is going to be a long and arduous one with many uncertainties and unseen shocks along the way. In human living, as in political economy, it is often the case that the development most feared doesn’t quite happen (remember the Y2K scare in the late 1990s or the lack of any break up in the Eurozone – at least not yet) while those things few people were paying attention did happen and happened with a fierce vengeance (like the ‘Celtic economic miracle’ of the 1993-2007 period which wasn’t all bad or the subsequent crash which was very bad for most people).

There ‘was no alternative’? (from TINA to TWNA)

That austerity was ‘absolutely’ unavoidable is not the case. There were strategies based on fiscal consolidation which involved less economic damage and that put the emphasis on domestic demand and growth as an efficient and fairer way of fixing public finances. That the adjustment was ‘fair’ is not supported when, in practice, those who did not cause the crisis suffered severe reductions in real income, hours of work, employment opportunities and public services. Even if some of the budgets in the 2008-2010 period were statistically more progressive than regressive when narrowly measured by impact of specific tax increases and spending cuts on the income of each group this did not stop a rise in the degree of income inequality between 2007 and 2012. Recent research by the ESRI suggests that the hardest hit – as measured by % reduction in income as a result of some specific and measurable welfare and tax changes in the various budgets from 2009 to the latest one for 2014 – were the top income decile and the bottom income decile with the ‘middle’ faring relatively not as badly. But the differences are marginal and when one considers the impact of a given cut (say 13%) on a family already in poverty with a family on ten times the poverty income threshold (say 16%) then it is clear that we are not comparing like with like and the impact of a given percentage reduction entails much more hardship for the poorer family.  Moreover, the negative impact of budget on the ‘social wage’ not captured in budget modelling by the ESRI and other analysts needs to be considered.

‘Best (little) progressive tax country?’

That Ireland has one of the most ‘progressive income tax’ systems in the world (because ‘the OECD says so’) is not the case. What the tax wedge data published by the OECD show is that there is a steep rise in both the average effective and marginal headline rate of income tax paid as you move from just below average income to just above average income – at least up to 2011. This is also confirmed by a recent paper by Patrick MacCloughan to the Statistical and Social Inquiry Society of Ireland. However, the particular interpretation placed on these statistics by some commentators (namely that ‘you can’t tax the rich any more’) is based more on a particular perspective on taxes as a ‘burden’ on individuals and a potential impediment to growth and effort than a rounded consideration of all the evidence. It must be asked:

  • In what sense is it the case that taxation is ‘progressive’ when we include both direct and indirect taxes as a percentage of income? Evidence reviewed by Collins and Turnbull indicates a ‘U-shaped’ curve with the poorest and the richest paying the most as a % of income.
  • How is it valid to claim that income taxes (as distinct from all taxes) have become more ‘progressive’ over time when, in the decade prior to 2008, many low to average income households were removed entirely from the personal income tax net – thus creating a sharper wedge between the average effective tax payable by households at the (i) 67% of median, (ii) median and (iii) 167% of median levels of income. This was an unwise and unsustainable fiscal policy at the time and was a (bad) substitute for raising wages rather than subsidising employers through reduced income taxes (and increased supplementary welfare payments).

Comparisons of income tax paid in international studies such as those cited above are based on case examples with standard tax reliefs for a given household classified by numbers of adults and with/without children. They do not factor in the actual tax paid when all tax reliefs are taken into account. These latter are strongly skewed towards the top third of income earners. To be fair, the paper by MacCloughan does include actual income tax paid by tax cases. However, it does not include PRSI or  the income levies preceding the USC.

‘tax cuts’ – here we go again!

General elections (with the possible exception of the 1981/82 elections) from 1977 up to and including the 2007 (those 30 glorious years…) were characterised by promises or hints of tax cuts in one form or another. 2016 promises to be no exception. Parties are advised to get in early and promise something. This seems to apply from far left to far right and the centre in between. After all, who could be against ‘putting more money’ into your pocket? Sure it would be good for the local economy, foreign investment and enterprise? And as for corporate tax – we would rather perish than compromise on that?

As Ireland exits the current bailout calls for, and promises of, ‘tax cuts’ for the ‘squeezed middle-income working households’ are ill-judged and ill-timed. How is it possible to discuss tax cuts for anyone when the government deficit is still double the EU target of 3% and €20 billion has already been cut from public spending with more to come? How is it possible to suggest tax cuts any time soon (even before the next general election) and, at the same time, proceed with a further fiscal shock of well over €1 billion in cuts to social welfare, health and public programmes in Budget 2015 not to mention the continuing decline in capital spending? If the Government wants to ‘to put more money back in the pockets of hard-pressed workers who bore the brunt of the downturn’ as reported in last Saturday’s Irish Independent then the fairest and most effective way is to stop causing further damage to both public services and domestic demand by cutting into the ‘social wage’. ‘Social wage’ is a term and concept that deserves to be used much more in Ireland. It means the total flow of ‘social goods’ to households and individuals in the form of public service and income including the wages earned from work and other sources. A bit of moderate wage increase especially in the low-pay area would also help where profitability is on the increase again.

We must not confuse ‘tax reform’ with ‘tax cutting’…

It is important, however, not to confuse ‘tax reform’ with ‘tax cutting’. The case for changing the bands or thresholds at which some households on fairly average to just above average incomes (between €32,000 and €65,000) pay the higher income tax rate of 41% does need careful consideration.  However, this should be done as part of a package of tax reform that:

  • Addresses many anomalies between self-employed and PAYEE workers, single and married and earned income and other income.
  • Avoids cutting the total tax on income (personal, USC and PRSI) for any category.

The idea of everyone paying something is good and the idea that an average effective rate of tax paid of less than 20% for households on average income is too high is not acceptable. Citizens should contribute in accordance with their means to a modern, streamlined and adequate public service from ‘craddle to grave’. This is good for economic productivity, social cohesion and sustainable public finances as various studies of the Nordic world have illustrated.

In summary, Government should consider applying the highest marginal rate at a higher income threshold than is presently the case while, at the same time, reforming tax relief and integrating various components of taxation on income so that the system is more transparent, adequate to the task of funding local and central government services and progressive. Taxes on income need to be planned in such a way that the total tax payable by households through consumption, income and capital (including  taxes on housing) is proportionate to social need and ability to pay. Currently, our system of taxation is overly-complex, fragmented and unfair with the lowest income households paying almost as much as those in the highest income bracket.

Plotting a Vision ….

In plotting a course into the future we need to understand why we got here. The story is complex and multi-faceted. Growth in GDP was driven by a number of factors including a good level of skills and initial education among the young entrants to the labour force in the 1990s, a booming international economy for most of the period from 1993 to 2008 and a positive impact from EU membership and European Social Fund support. However, growth was also driven by a credit-fuelled boom some of which was highly speculative and risky in nature. Light touch regulation, continuing tax avoidance and tax evasion together with highly damaging policies of cutting the wrong taxes at the wrong time meant that the Republic of Ireland was hugely exposed to a sudden downturn in 2008.  While real incomes and wages increased significantly over the years prior to 2008 the share of wages in national income underwent a long-term downward trend. Ireland was being driven forward by a combination of high-profitability multinational corporations, speculative investment in property and a credit-fuelled consumption and housing boom linked to lax rules and low interest rates. While the fundamental problem resides in the nature of how global capitalism evolved over the previous decades the local manifestation was expressed in the transformation of institutions, public finances and social investment which left Ireland exposed on many fronts.

The key to rebuilding Ireland is fourfold:

  • Jobs (decent paying, quality)
  • Incomes/wages (the 'living wage')
  • Public services (the ‘social wage’)
  • Enterprise (public& private&not-for-profit)

Failure to reach a much higher level of employment (close to 80% of the ‘working age population’) will leave Ireland exposed to the social and fiscal implications of an ageing society and, in all likelihood, a diminished cohort of young people born in the 1980s and 1990s through involuntary net outward migration in the immediate years ahead.  Failure to recover the real value and purchasing power of incomes and wages – especially for those in the bottom third of the income heap would ensure deepening poverty and inequality in the context, also, of diminished public services as we can expect a very iron lid on public spending into the coming decade. Failure to generate sufficient-scale Irish enterprise – innovative, export-orientated and equipped to produce new products and services will leave us in a position of continuing excess dependency on footloose foreign direct investment. A strategy founded on competing against other countries on low corporate tax will not succeed in the long-run.

An honest debate is needed…

Moving from failure to success means that we need an honest debate about choices informed by the evidence. It will also mean a long-term vision and strategy that encompasses many electoral cycles and many programmes of government and not just one or two. Rebuilding, re-equiping and re-energising Irish society will require strong cooperation among civil society organisations. But, it will also require deep and critical analysis based on human values as President Michael D Higgins often reminds us.

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