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Much ado about little

Posted on October 13, 2017 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

The draft budget for 2018 to be yet approved by the European Commission has arrived. Still, some working out of detail in the Finance Act and various other legal measures remains.  The build-up, the leaks, the drama, the instant analysis, the soundbites and the slowly emerging aftermath is part of the annual cycle of media news and lobbying by various interest groups. 

Thankfully, recent years have seen a greater supply of background documentation, analytical papers, budgetary oversight hearings not to mention the annual National Economic Dialogue held in June.  However, the debate, such as it is, is highly staged, framed, managed and brought to a conclusion.  The very term and notion of ‘fiscal space’ has served to close down debate on the bigger issues and challenges (like climate change, demography, Brexit, the need for a radical reorientation of Irish enterprise policy, the need to reconfigure local government financing and to reform the management, accountability and delivery of public services).  The draft Budget 2018 was notable for its lack of any major changes or impacts.  Steady as it goes with very modest increases in spending more or less across the board and very modest cuts to income tax for some (although there is a twist to this – read on…).

Overall, the budget maintains a steady course in terms of maintaining Ireland as a low tax economy with a very under-developed social insurance model and a huge reliance on state transfers and tax to even out what would otherwise be a very unequal distribution of income. This is the matter of political choices made decades ago and made again every year in the Budget. 

Some commentators and economists worry that the Irish economy is near to over-heating (and the European Commission think it is already over-heating).  The implication of this, according to the neo-over-heaters is that the Government should start putting the brakes on in terms of spending and taxation especially as dark clouds are visible on the international horizons threatening possible storms in the next few years (by contrast, meteorological forecasting is much more solid in the very short-term).  The combined evidence in relation to unemployment (which is falling but is still elevated and particularly so among particular groups and in particular regions and places) suggests that we are not at risk of over-heating. That said, Ireland is hugely vulnerable to external shocks given the make-up of our economy. Moreover, indebtedness (personal, corporate and governmental) remains very high even if – for now – interest rates are exceptionally low.

Draft Budget 2018 was close to neutral and possibly took a little bit more out of the economy depending on various technical assumptions and ways of measuring. One way of assessing the impact is to consider the overall impact of the Budget on household disposable income. In a preliminary analysis of the Budget by Tim Callan and other researchers at the Economic and Social Research Institute published last week in the Irish Times (“ Budget 2018 will lead to small losses in income at all levels ”). Their analysis indicates that the Budget took more money out of households than put money in. The reason is twofold. While welfare rates were increased (above but close to the expected consumer price inflation rate) they fell short of the 3% wage increase benchmark assumed by the ESRI. The second reason is that the small cuts to income tax (including USC) were not sufficient to counter-act what economists call ‘fiscal drag’. In other words, a single person earning €35,000 a year saw an increase of €750 in the threshold at which they paid a higher income rate but may end up paying more income tax because, in the meantime, their income has increased by just over a thousand a year. So, whatever gains were made due to changes in USC and income tax and these were modest, the expected modest increase in incomes will probably more than cancel out these gains in terms of net income.

In a telling table (page 12) in Tax Policy Changes published on Budget Day, we read that a single worker on €25,000 a week gains €1 a week while the worker on €75,00 gains €6 a week before account is taken of fiscal drag.  This suggests that these relatively minor tax adjustments favoured the higher paid both in absolute and percentage terms (+0.7% compared to +0.3% in this example).  Confirmation that Budget 2018 was, on balance, likely to be regressive comes from the ESRI response shown in Chart 1, below.  It shows bigger drops in net income for the lowest income households and the smallest drops for the higher income groups (note that these drops are relative to a benchmark of 3% wage growth used by the ESRI). 

Ironically, all the talk about helping ‘middle Ireland’ with changes to income tax bands and rates means that the Exchequer is worse off by close to €400 million in a full year (see page 3 in Tax Policy Changes ) while there is a likelihood that many of the beneficiaries of these very modest cuts to income tax will see the gains partially or entirely wiped out by hikes in private health insurance, car insurance and other price increases over the coming year. Such is life for ‘Middle Ireland’: Ministers and Governments promise relief for 'the hard pressed and deserving middle income groups' when we continue to foolishly narrow the tax base and leave Ireland vulnerable to future shocks by underinvesting in services and infrastructure to the detriment of lowest, middle and highest income groups (and in that order).

I am afraid that in regard to personal taxation we have not learned the lessons of 1997-2007.

 

 

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