Thursday, August 13, 2009

Economics 14/08/2009: Irish welfare rates and the tragedy of poverty

On last night's RTE Prime Time I referred to the OECD 2007 report that shows Ireland having the second highest welfare rates in EU27 (and the third highest in the OECD).

Here is the link to the report.

Here is a chart from the report:
Here is an excellent article on the report.

And here is my follow up analysis.

The OECD data was in the range of 2005-2006. Since then:
  • Taxes on work in Ireland increased substantially
  • Wages have declined in 2007-2008
  • Earnings other than wages (overtime, bonuses, commissions) also have fallen
  • CPI has dropped in July 5.9% yoy and HICP fell 2.6% yoy
So after tax returns to work have declined rather significantly in real terms - a good deal 10-15% for an average wage earner, depending on the sector.

In the mean time,
  • Welfare rates have gone up (since January 2009) by 3% nominally, or between 5% and 8% in real terms;
  • Indirect benefits rose in real terms, as rents fell off the cliff and not all these savings were passed on to the Exchequer - some of these savings could be easily 're-distributed' between assistance-receiving tenants and the landlords;
  • Black /gray cash economy is thriving, providing additional earnings to some welfare recipients; and
  • Costs of services to those of us in employment that are free to welfare recipients have gone up, implying a rise of benefit to the welfare recipients.
But let us be clinical about this. I did an balance-sheet analysis before on current (post-April 2009 Mini-Budget) after-tax earnings here.

Our replacement net of tax wage - equalizing the value of benefits obtained by the welfare recipient (in the case of my model - single parent with one kid) to make them even with the wage earner - now stands at €31,102.

The above figure is not inclusive of Income Taxes, Income Levies, PRSI and Health Levy contributions exacted by the state off those working. So let us add this to the numbers above.

For PAYE:
  • Health levy adds 4% on all earnings below €75,036;
  • PRSI levy adds another 4%
  • Income tax and Levies (here) - €31,102 after tax is consistent with the pre-tax earnings of €39,870pa
Replacement wage for PAYE (inc PRSI and Health Levy): €43,059.60.

For Self-Employed person:
  • Health levy adds 3.333% on all earnings below €75,036;
  • PRSI levy adds another 5%.
Replacement wage for Self-Employed (inc PRSI and Health Levy): €43,191.17.

If we are to recognise that a self-employed person has to cover some of the costs of their work out of pocket, say 25% of the net revenue received in income (a conservative assumption if you need to operate some equipment, run a van etc), a self-employed person working in this country would have to generate around €54,000 in revenue in order to come close to breaking even with a welfare recipient!

Comparatives: Pre-tax average wages by sector (for All workers and for lower grade of P&M Workers):
  • Industry: All employees = €42,078 pa (-€981pa relative to a welfare recipient), Production & Manual Workers = €34,507 (-€8,552pa);
  • Mining & Quarrying: All = €40,435 pa (-€2,624pa), P&M Workers = €36,878 (-€6,181pa);
  • Manufacturing: All = €41,184 pa (-€1,875pa), P&M Workers = €33,675 (-€9.384pa);
  • Electricity, Gas & Water Supply, Waste: All = €55,286 pa (+€12,227 pa), P&M Workers = €46,592 pa (+€3,533pa);
  • Financial & Insurance Services: All = €56,742 pa (+€13,683pa), P&M Workers = €34,445 pa (-€8,614pa).
  • Minimum wage earners €17,992 pa (-€25,068pa worse off working than being on welfare).
So here we have it - our incentives to work or choose welfare.

Now, there are many studies out there doing international comparisons of pensions and other benefits across the EU.

Majority of them count a particular benefit alone and disregard in-kind payments and other assistance, such as housing allowances, rent supports, bills assistance, lack of apartment maintenance fees, etc. Majority of them disregard the fact that a working family has to pay its own healthcare costs in this country on top of paying taxes to cover our public health services. Or that we pay for child care, while our welfare recipients do not. Or that we pay to commute to work, that we also pay more for our food, because we do not have the luxury of eating all our meals at home. This makes these comparisons extremely stylized.

Another example is Eurostat adjustments of welfare supports for PPP differentials. This is suspect practice because PPP refers to HICP inflation adjustments and exchange rates differentials. However this presents several problems in comparing welfare benefits baskets in Ireland with the rest of EU:
  1. We have many more non-rates benefits (housing assistance, healthcare cards, etc) not reflected in HICP;
  2. We have larger relative share of imports in welfare consumer basket of goods than larger countries of the EU, so stronger Euro here buys more for our welfare recipients than it does in the rest of the EU, even after we adjust for nominal exchange rates;
  3. In most of the EU there are caps and declining scales of benefits. Not in Ireland, where a life-long benefit is available at a flat rate irrespective of the person's ability to work, health status and duration on benefit; and so on.
Methodology is important.

The real tragedy of Irish welfare system is that we tend to lump together people on unemployment benefits with:
  • long-term welfare recipients (often generational ones) who are able-bodied working age adults; and
  • long-term disability aid recipients.
This is simply immoral and wrong economically. They are not the same. Unemployed seek employment. Welfare recipients do not. Elderly and disabled have a real claim to make on the society for help - they deserve it and they should not be stigmatised for this assistance. Those who can work, but choose not to have no such claim to make.

Our unemployment assistance rate is below our long term welfare rates. This is farcical. It is an incentive for some to move off unemployment roster and out of the labour force. But it also fails to recognise that people who find themselves in unemployment have some consumption commitments that are reasonably based on their prior income (so these commitments are not some extravagant spending of the past) and have to be met. The long-term social welfare recipients have a steady income instead.

From my point of view, the real problem is that we are paying a number (no one can tell us how big it is) of people who made it their career to milk the taxpayers. I have no problem with helping those in real need of help - the elderly and those with severe disabilities. And I have no problem with providing a safety net for those who pay for it through taxes.

But I have significant issue with seeing perfectly healthy individuals not working, while many people with real disabilities are leading productive lives, ordinary families taking their hard earned cash and sending it the way of those who never intend to contribute to the society.

High cost of social welfare is economic (lost jobs and lost investment due to high tax burden, discouraged younger workers and so on), but first and foremost it is social. The latter manifests itself in a culture of entitlement developed in the mindset of our long term welfare recipients and their advocates.

How many times do we hear that welfare recipients are
  • poor (see figures above to show that they are not);
  • never gained from the Celtic Tiger (welfare provisions increased between 97% and 110% since 2000 alone);
  • neglected by the society (welfare costs have risen from 8% of our GNP in 2000 to over 13% in 2009 and this does not include massive indirect transfers from the private sector through schools allocations, sports grounds, community facilities etc); and
  • ignored by private sector growth (there is a deeper question to be asked here in return: Why should someone who never worked in their life be entitled to benefit from the wealth and income created by the sweat and labour of others?)
Welfare spending now accounts for over 70% of the annual Exchequer tax intake. It is more than 37% of our current expenditure bill. This is not sustainable.

An argument that NAMA funds can be better spent on social welfare supports is a fallacy, for there are no NAMA funds. We will have to borrow to finance both. If we are to borrow to retain current welfare spending, some €5bn per annum in fresh debt will have to be added to our own and our children's obligations.

A simple math - through 2013, doing nothing on Irish social welfare spending will cost us additional €23bn in debt we will have to pay down in the future. Scared? If unemployment remains at the levels we are seeing today through 2015-2018, this bill will rise to €44-61bn, once interest payments on the requisite bonds are factored in.

That is a disaster on the same scale as NAMA.

Instead of strengthening the fabric of our society through providing a real safety net and real help to those who cannot contribute to this society through work due to age or health reasons, by having this lavish welfare system with a maze of benefits supplied on the unlimited life-long basis, we are actually destroying the moral state of Ireland. That is the real cost of our welfare-as-entitlement industry that is still thriving in this recession.

What should be done?

We need serious reforms of the welfare system in the long run. I will write about this at some point in the future. In the immediate term, we need:
  • a cut in welfare rates of 12% for all able-bodied long term welfare recipients, bringing the rates below the unemployment assistance rate;
  • a system of two-tier old-age pension: one basic rate for all, set at 1/2 of the current rate, and a second, top-up rate for those who pass means testing (the second rate to be set at 1/2 of the current rate) - on the net, poor pensioners will be guaranteed current level of benefits with no change, while wealthy pensioners will see a cut in their rate of 50%;
  • ensuring that no public worker retired on full public pension benefits is in receipt of the old-age pension allowance - at either rate stated above. There should be no double pension allowance;
  • a 3% reduction in unemployment benefit to reflect the fall in HICP;
  • enforcement of the rent support scheme to extract savings, generated in the private sector on falling rents;
  • introduction of co-pay on hospital visits for welfare recipients to reduce use of emergency rooms as their primary care physician access.
This really is a basic starting point for restoring sustainability to our public finances. No matter how you turn the arguments about welfare system around, it has to be done!

6 comments:

kirghiz said...

Great analysis. I didn't realise it had become so distorted, but it certainly explains a lot of the large cars around the (largely unemployed) neighbourhood I live in.

One question: do you have an estimate of the size of the black/gray economy? Any ideas for clearing this up?

Donagh said...

The "excellent article" you refer to on the Finfacts site is a press release from the OECD site, which is published to coincide with the publishing of the report. This post Constantin is a political and ideological rant. The press release also refers to the Wages and Benefits calulator. Here's a different perspective using that as a way of finding out how Ireland's social welfare payments ranks in the EU. http://www.irishleftreview.org/2009/03/23/open-letter-sarah-carey/


When Ireland was at "full employment" there was still 4% of the workforce in long term unemployment, as there is in many EU countries.

Dr. Constantin Gurdgiev said...

Kirghiz,

it is very hard to estimate the size of black/gray economy in Ireland. We have anecdotal evidence. For example, people in certain non-national communities purchase alcohol and tobacco from unlicensed vendors. Parts of city markets operate on cash only basis and there are illegal vendors of restricted goods there as well. Large shares of cash economy are completely unaccounted for. What is clear, however, is that this economy operates.

To legitimise it, bring it into the fully open economy, you need to reduce taxes and other barriers. High taxation of alcohol and tobacco is driving sales there. High income taxation is driving other activities. Welfare income supplementation is probably another factor.

You will always have some gray markets around, but the heavier the regulation burden and the heavier the tax burden, the larger will be this quasi-legitimate and illegitimate economy.

Dr. Constantin Gurdgiev said...

Donagh,

I generally use this space to argue points raised.

Unfortunately, your post raises not a single valid point. This is quite an achievement for this blog and for you having expanded 5 sentences on it.

Accusing me of going on an ideological and political rant would be insulting if it were not simply daft.

I do not support (and never did) any political movements or parties in this country. I never stood for an office, nor have any intention of standing for one. I am clearly not aiming to gain some Government commission either.

What political motivation do I have in running this blog?

As per being ideological, my post is not ideological, but I am ideological, that is true. You should really spend some time to think about the difference between two.

I do have philosophical belief in the primacy of individual liberty and freedom. From these two core principles stem all my arguments. So yes, you've got me, I am ideological and by corollary, my blog posts can be informed by ideology, though I always try to consult evidence, both in forming my beliefs and in my analysis.

Let me ask you a question here. Are your own views fully detached of ideology? Do you see lack of ideology as a virtue?

Are you so depraved in your ethics that you cannot tell ex ante what is right (e.g that an able bodied adult of working age should work or at the very least make an honest effort to work for living before they demand entitlements from those who do) from what is wrong (e.g spend ones lifetime demanding that other work for them - for that is a definition of an able bodied adult of working age who does not work and not attempting to find work - aka welfare recipient - yet expects to be paid handsome living allowances)?

Or are you simply stupefied into believing that the world is a battle ground for ideologies to understand the concept of forming your views from the basic principles?

Your post doesn't really permit any other options or choices here. Sorry - check and mate, or rather 'own goal'.

Now, I am ideological, as I said above. But the post you attempt to dismiss draws on factual evidence. Dispute that.

If you were to attempt to study logic - the tool that separates demagoguery from philosophy - you would know that arguments against person or on the basis of pure authority are fallacious. You commit both in the space of two sentences. That is pretty darn remarkable.

Let me explain in case you fail to grasp this.

I refer to OECD report and then show separately that our welfare system is simply perverse. Your respond by citing a single letter from one observer to another citing secondary evidence only. You argue from their authority. I argue from my facts.

You gotten so far as to even fail to read my post in your desire to smash my argument. I actually distinguish welfare payments from unemployment benefits. I also address the fallacy of Michael Taft's response to Sarah Carey (and numerous other 'counter arguments' based on the same fallacy). In post I state that my estimates include in-kind benefits and payments under multiple subsidy programmes awarded to our welfare recipients. Taft only uses cash payments under single programme.

Next time, read thoroughly both, what you would like to criticise and what you advance as a counter view.


Now, Donagh, I never censor anyone on this blog, unless uncalled for language is involved. And I am not going to censor anyone in the future either. But for your own sake, try to offer real arguments

- not 'ideological/political rant' stuff;

- not a 'full employment' vs 4% long term unemployed stuff, which is really economically illiterate and irrelevant to my post you chose to critique;

- not irrelevant references to Wages and Benefits calculator...

Thanks for the comment and come back for more anytime...

MK1 said...

Hi Constantin,

I fully agree with you that we have created a social welfare dependent cohort. Some call it a 'poverty' trap but for many it is a 'lazy benefit'. It also supports the black market. Maybe I am an idealogue by calling such non-tax-measured activity 'black'!

The problem has developed over many generations, not only by FF governments but also FG and Labour. There is generational social welfare dependance which is passed on from one generation to the next. They actually see it as a right. Indeed when the state was the British the Irish became particularly good at it.

Indeed, in these current climes there are cases of people taking their redudancy packages and looking forward to going on benefit and getting housing, etc. The incentive to work is gone.

Like many problems, it only comes back to bite us as an econmic nation when other problems exacerbate, so it appears ugly like a rock when the tide goes out.

On Prime Time, you were right by agreeing with Joe O'Flynn from Siptu that some of those dont deserve to be hit by social welfare cuts if implemented as suggested by McCarthy's Snip. We do have to protect the vulnerable. But untangling those that have become dependent by choice is another matter.

And the 4% who remained unemployed during the boom when we were flying in workers on planes is a gauge on the size of the numbers of people that dont want to work.

As for ideologies, I guess we all have them, whether they can be categorised or not. My one is right and wrong and fairplay. And how do we setup an economic system which is fair and can 'beat' through Human frailities of greed and one-up-man-ship, etc.

I do think at times that you are perhaps overboard against the likes of Brian, Brian and Mary, as not all is their fault. But if you are open to persuasion by measured argument, then any person's ideology is at least not entrenched but evolving. I know I learn something new everyday.

MK1

John Pardway said...

MK1 brings up a valid point, referring to when we were governed by the British. I think this is where the social welfare dependency comes from. There is a sense in Ireland that the government is some sort of extraneous entity, and the more money you can get out of them the better. This has been further exacerbated by farmers etc who look on the EU as something to take from, not to contribute to. Payments are considered to come from the government, not from the taxpayers. Ireland needs to change that psychology. We are not a colony anymore.