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Some questions about the Programme of (new) Government

Posted on May 22, 2016 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

The recent Programme of Government has set the scene for policy priorities for the coming three years. Clearly, much will depend on international events as well as developments closer to home in shaping the success of economic policy.  The Programme is long on aspiration and light on detail – as inevitably most long-term plans are. However, it is clear that in so far as public expenditure is concerned the plan to increase discretionary spending by €6.75 billion over the coming 5 years is a very modest one representing as it does an increase of less than 10% over 5 years or 2% per annum on average.  It is very unlikely that such a pace of increase will meet two main drivers of public spending: (1) a growing population (and a slowly ageing one) and (2) cost inflation in public services.  In this blog I focus mainly on some specific commitments under the chapter heading ‘Creating a Social Economy’ (pages 32-40)

Establishment of a ‘rainy day fund’

In principle this is a good idea. However, how will it be financed from cuts in public spending, tax increases, borrowing or repackaging of existing NTMA assets and portfolios?

The wording of the spending increases/tax cuts formula (remember all the debate about 50:50 and 2:1 last year) has been carefully crafted as follows:

To address unmet needs, we will introduce budgets that will involve at least a 2:1 split between public spending and tax reductions.

The reference to ‘at least’ is significant reflecting, as it does, political pressure from various quarters prior to the final programme agreement. Yet, it must be asked how is a commitment to tax cuts within a very narrow technical fiscal space achievable given that:

  1. Ireland is already a low-tax economy (refer to Chart 1)
  2. According to research by the Fiscal Council the size of demographic impact on public spending may very well be under-estimated by the Department of Finance (see here )

Demography, cost inflation and the needs to improve our inadequate social infrastructure are not compatible with a continuing low average effective tax rate. In short, Government should be planning to increase the average overall revenue proportion from 31% of GDP in 2016 – gradually – to something closer to 38% in the short-term just to begin to meet some of the pressures on health, education and pensions. Beyond that there is scope for an even higher level of overall tax to fund an efficient and reformed public service as well as move towards mainland European standards of public service (never mind Nordic ones).

On a no-policy change scenario (see Table A2.1 in the Stability Programme Update April 2016 ), the Government expects total spending to decline from 35% in 2015 to 26.6% in 2021. Stripped of interest costs, ‘primary spending’ (spending on public services excluding debt service costs) is expected to be 24.7% in 2021 compared to 32% (refer to Chart 2). Add in tax cuts – any discretionary tax cuts – and the level of spending is even lower. Such an outcome is not compatible with what we know about demographic change and the needs to upgrade many areas of public service and infrastructure.

Commitment to additional spending of €6.75 billion over 5 years (or just under €1.4 billion) per annum (page 33).

Going on demography and a modest annual inflation rate of around 2% such a level of planned increase is woefully inadequate to meet future needs never mind improve services as they are after half a decade of intense fiscal austerity.

Commitment to ‘the continued phasing out of the Universal Social Charge’ (page 34)

This comes as no surprise given pre-election commitments. However, it must be asked if this should be done instead of merging USC (which has many attractive features not least its progressivity) into a reformed social insurance scheme where employers and employees pay taxes to cover some of the costs of sickness, parental level, unemployment, continuing education and training as well as pensions? The idea of trading various taxes and charges such as non-indexation of personal tax credits, a sugar tax, etc. for a phasing out of USC begs the question – why not transform USC into PRSI (which everyone accepts is very inadequate to fund long-term social insurance demands) while going for tax increases as listed in the Programme of Government anyway?

The following text found on page 37 of the Programme is incoherent and not evidence based:

High personal tax rates in Ireland discourage work and jobs. To make Ireland’s personal taxation system more competitive, we will ask the Oireachtas to continue to phase out the USC as part of a wider medium-term income tax reform plan – to be published for consultation with the Oireachtas Committee on Finance by July and for approval by the Oireachtas in October – that keeps the tax base broad, reduces excessive tax rates for middle income earners, and limits the benefits for high earners. Reductions will be introduced on a fair basis with an emphasis on low and middle income earners

First of all, there is no evidence that personal tax rates, in the Republic of Ireland, ‘discourage work and jobs’. Secondly, the idea of phasing out USC entirely is incompatible with the notion of keeping ‘the tax base broad’.  The fact that the bulk of USC is paid by high earners means that the abolition of USC (or, at least, its non-transformation into a progressive PRSI add-on) will be regressive and not progressive. For a consideration of these matters including the literature on the impact of tax on growth and productivity readers may refer to a number of research papers by my colleagues Dr Micheál Collins and Dr Tom McDonnell and which can be found on www.NERInstitute.net

Commitment to raise ‘Band A Capital Acquisition Tax Threshold’ to half a million Euro  (from €225,000) is deeply unfair given that such a tax does not impact on work, enterprise, business or access to a home. CAT is like a windfall tax when a parent dies and bequeaths the value of a large estate or home whose value greatly appreciated over the decades.

Commitment to partial sale of publicly owned banks?

Again, this is hardly surprising but begs the question of what sort of vision do we have for banking and how a diverse and competitive banking system with elements of public and Irish ownership can best serve savers, borrowers and investors?

Commitment to implement the recent public sector pay agreement with restoration of pay and pensions. However, it may be asked if such restoration will match the cycle of fast growth now (with GDP outstripping wage growth in both the private and public sectors) likely to be followed by an economic slowdown at some point in the medium-term and not impossibly during the term of the new, incoming administration?  Just as there were ‘get out clauses’ in previous deals under Croke Park and Lansdowne Road there is a need for faster ‘get in clauses’ in agreements made in the recent past, I suggest.

An additional 200,000 jobs by 2020

The goal is achievable if current trends in GDP, productivity and employment continue. The commitment to a more regionally balanced growth in employment is welcome. However, it remains to be seen how the Government will deliver on this especially at regional level where, in the absence of state aid due to EU rules, a programme of investment in public transport, broadband and other facilities is urgent.

Action Plan for Jobs

Here in this sub-section there is a lack of specific detail and costed and time-bound commitments. There is a commitment to :

Support a leap forward in the capacity and performance of our enterprise sector …. Excel in getting the basics right, and deliver a job-fit business environment which ranks in the top tier globally

Keeping corporate profit taxes low

The commitment to the 12.5% headline rate is sacred given and it would be astonishing if any Irish Government appeared to signal a shift on this in the future. Yet, there must be scope to raise average effective tax rates which fall well short of 12.5% in the case of some specific companies. Would this be such a deal-breaker as to drive away investment?

More investment promised

The commitment to additional investment is welcome. However, it is not at all obvious that additional investment will be genuinely additional to what is already planned. The Programme refers to an additional €4 billion of exchequer capital spending over 5 years as a result of the relaxation in the structural deficit of target (which goes from 0% of GDP to -0.5%)

Social welfare commitments

The commitment, among others, to increase ‘income disregards for lone parents’ through a new Working Family Payment scheme is welcome. However, firm, costed and time-bound commitments to training as well as public childcare facilities are missing. There is no mention of reversing any of the age-discriminatory cuts to first-time job seekers under the age of 26.

Increased minimum wage

The proposed increase of 2.7% per annum in the national minimum wage between now and 2021 (from €9.15 to €10.50 over five years) is welcome and may compensate for increases in the cost of living facing low-paid workers (provided that hours of work are not reduced). However, this scale of increase could fall short of increases in the median hourly wage rate over the same period implying a further erosion in the relative position of low-paid vis-à-vis other workers. Moreover, a rate of €10.50 falls well short of a ‘living wage’ rate especially when the likely cost of living increases over the coming years are factored in.

Other areas

Health

Extending in phases, and subject to negotiation with GPs, we are committed to the introduction of free GP care to under 18s. This will require a substantial increase in GP numbers to support the additional workload. Promoting oral hygiene is important and early intervention saves the taxpayer later. We will introduce a dental health package for the under 6s. Together with existing dental checks at 6, 9 and 12 years, every child under 12 will be entitled to a comprehensive preventive dental health programme. We are committed to timely access to orthodontic care.

Transatlantic Trade and Investment Partnership (TTIP)

There is only one indirect mention of TTIP and that is under a heading on agriculture (page 117):

We will work with the European Commission and colleagues across the EU to ensure the best possible outcome for Ireland in any future negotiations. In particular, we will work to ensure the principle of equivalence is maintained in negotiations in terms of food safety, traceability and production standards to ensure that producers are operating on a level playing field.

Education

We are committed to investing an extra €500million in education by 2021 through measures including childcare subventions, HSE Speech and Language Therapists, to bring the number up to 1,102 (a 25% increase) additional National Educational Psychologists (NEPs) to the bring the total to 238 (a 25% increase), reducing the pupil teacher ratio in junior and senior infants, annual increases in primary and secondary capitation rates, additional teacher CPD, a new School Excellence Fund, pay increases in accordance with the Lansdowne Road Agreement and extra third level investment. (page 86)

An annual average increase in exchequer funding of €100 million (representing an increase of 1% per annum) is surely not adequate to cover the costs of commitments in the above paragraph. An additional €100 million per annum would not even adequately cover the cost of single of the areas mentioned above. Yet, an increase of €100 million is probably just within the limits of fiscal space which will amount to just over €1 billion on average each year.

I n short, there is a simple conclusion to be drawn:

Even with strong economic tailwinds the new Government has not got a chance of meeting its ambitions from housing to health to education without raising taxes in one form or another. That the Government could cut taxes, expand spending to meet demands, make a significant impact on the housing crisis and do this within the fiscal rules is just not possible.

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