3/5/18: Irish Exchequer Returns: April 2018

My article on Irish Exchequer returns for April 2018 is now available on Sunday Business Post site: https://www.businesspost.ie/business/no-fiscal-panic-yet-figures-highlight-tax-uncertainty-spending-weaknesses-415535.

21/7/17: Professor Mario: Meet Irish Austerity Unsung Hero

In the previous post covering CSO's latest figures on Irish Fiscal metrics, I argued that the years of austerity amount to little more than a wholesale leveraging of the economy through higher taxes. Now, a quick note of thanks: thanks to Professor Mario Draghi for his efforts to reduce Government deficits, thus lifting much of the burden of real reforms off Irish political elites shoulders.

Let me explain. According to the CSO data, interest on Irish State debt obligations (excluding finacial services rescue-related measures) amounted to EUR 5.768 billion in 2011, rising to EUR7.298 billion in 2012 and peaking at EUR 7.774 billion in 2013. This moderated to EUR 7.608 billion in 2014, just as Professor Mario started his early-stage LTROs and TLTROs QE-shenanigans. And then it fell - as QE and QE2 programmes really came into full bloom: EUR6.854 billion in 2015 and EUR6.202 billion in 2016. Cumulative savings on interest since interest payments peak amounted to EUR2.65 billion.

That number equals to 75% of all cumulative savings achieved on the expenditure side (excluding capital transfers) over the entire period 2011-2016. That's right: 3/4 of Irish 'austerity' on the spending side was accounted for by... reduction in debt interest costs.

Say, thanks, Professor Mario. Hope you come visit us soon, again, with all your wonderful gifts...

21/7/17: Ireland: a Poster Child for Austerity through Taxes

Ever since the beginning of the Crisis in 2008, Irish policymakers insisted staking the claims to the heroic burden sharing of the post-Crisis fiscal adjustments across the entire society, the claims closely mirrored by the supporting white papers, official state-linked think tanks and organizations, and even the IMF.

Time and again, independent analysts, myself included, probed the State numbers and found them to be of questionable nature. And time and again, Irish political and policy elites continued to insist on the credit due to them for steering the wreck of the Irish economy out of the storm's path. Until, finally, by the end of 2016, Ireland officially was brought to enjoy falling official debt burdens and drastically declining deficits. The Hoy Grail of fiscal sustainability, delivered by FF/GP and subsequently (and especially) the FG/LP coalitions was in sight.

Well, here's a new instalment of holes that the official narrative conceals. CSO's latest data for full fiscal year 2016 on headline fiscal performance metrics was published earlier this month. It makes for an enlightening reading.

Take a simple chart:

Here, two figures are plotted against each other:

• General Government Expenditure, less Capital Transfers (the bit that predominantly is skewed by 2011 banks resolution measures); and
• Taxes and Social Contributions on the revenue side.

The two numbers allow us to compare the oranges and oranges: policy-driven (as opposed to one-off) revenues and policy-driven (as opposed to banking sector's supports) expenditures. Fiscal discipline is the distance between the two.

And what do we see in this chart? 

1. Gap between tax revenues and non-capital transfers spending shrunk EUR899 mln in 2012 compared to 2011 and proceeded to fall EUR2.698 billion in 2013, EUR 4.22 billion in 2014, EUR 4.416 billion in 2015 and EUR1.815 billion in 2016. So far - good for 'austerity' working, right?
2. Problem is: all of the reductions came courtesy of higher tax take: up EUR 1.567 billion in 2012 compared to 2011, EUR2.107 billion in 2013, EUR4.525 billion in 2014, EUR4.724 billion in 2015 and EUR2.713 billion in 2016.
3. All said, over 2011-2016, cumulative reductions in ex-capital transfers tax deficit were EUR14.05 billion, but tax increases were EUR15.66 billion, which means that the entire story of Irish 'austerity' was down to one source: tax take increases. The Irish State did not cut its own spending. Instead, it raised taxes and never looked back.
4. In fact, ex-capital transfers spending rose not fall, even as labor markets gains cut back on official unemployment. In 2011, ex-capital transfers Irish State spending was EUR71.403 billion. This marked the lowest point for expenditure in the data set that covers 2011-2016. Since then, 2015 expenditure was EUR72.113 billion and 2016 expenditure was EUR 73.011 billion.
5. So there was no aggregate spending austerity. None at all.
6. But there was small level of austerity in one category of spending: social benefits. These stood at EUR28.827 billion in 2011, rising to the cyclical peak of EUR29.454 billion in 2012, then falling to EUR28.526 billion in 2013 and to the cyclical low of EUR28.076 in 2014. Just as the labor markets returned to health, 2015 social benefits spending rose to EUR28.421 and 2016 ended up posting expenditure of EUR28.494. So the entire swing from peak spending during the peak crisis to the latest is only EUR418 million. Granted, small amounts mean a lot for those on extremely constrained incomes, so the point I am making is not that those on social benefits did not suffer due to benefits cuts - they did - but that their pain was largely immaterial to the claims of fiscal discipline.

So what do we have, folks? More than 100% of the entire fiscal health adjustment in 2011-2016 has been delivered by the rise in tax take by the State - the coercive power whereby money is taken off the people without providing much a benefit in return. That, in the nutshell, is Irish austerity: charging households, many struggling with debt, loss of income, poorer health and so on, to pay for... what exactly did we pay for?.. I'll let you decide that.

22/10/16: Watering Down Budget 2017 Promises?

My article on the Irish Finance Bill for Budget 2017 is now available on Sunday Business Post website: https://www.businesspost.ie/opinion/constantin-gurdgiev-2-key-budget-promises-watered-finance-bill-367627.

21/6/16: Real Ireland and the New 'Fiscal Space'

My comment for the Sunday Business Post on the Summer Statement by the Irish Government, covering fiscal space for 2016-2021 is available here: http://www.businesspost.ie/comment-sorry-real-ireland-youre-low-on-list-of-government-priorities/.

15/10/15: Budget 2016: Tech & Entrepreneurship Perspective

My take on the Budget 2016 from the perspective of tech sector: https://www.siliconrepublic.com/video/dr-constantin-gurdgiev-on-budget-2016-stimulating-consumption-by-taking-credit-card-on-future

And more of the discussion of the Budget from technology sector and entrepreneurship perspective here: https://www.siliconrepublic.com/video/dr-constantin-gurdgiev-on-budget-2016-stimulating-consumption-by-taking-credit-card-on-future

Thanks to @iia for hosting the event and to the Silicon Republic for putting the discussions into broader public domain.

I covered the Budget in broader setting of economy-wide entrepreneurship and start ups formation here: http://trueeconomics.blogspot.ie/2015/10/141015-there-isnt-ireland-without-mnc.html.

14/10/15: There isn't Ireland without MNC Inc.: Budget 2016

Budget 2016 went in like a circus convoy entering a sleepy town: all pomp and all the excitement with little substance of change in tow.

Budget 2016 is a political budget and not an economic one. The point of all the smaller taxation measures in it, relating to people working for living, is simple: get those voters, vulnerable to swing Left to stay Centre. Sinn Fein got punched, few independents too; Labor got cookies to hand out. But even on this count, Budget 2016 was a fizzle of a firecracker with mostly smoke to show in the end:

1. Much lauded idea of exempting from USC all earners
2. Virtually all net gains for low income earners from this Budget do not accrue from Michael Noonan spending tax revenue or Government cash, but from minimum wage increase. Just how exactly does minimum wage hike (a mandated cost imposed onto employers - rightly or wrongly is not the point here) qualify as a fiscal policy measure (aka, Government fiscal management of the economy) beats me. Proper economics have no room on fiscal policy side for the scenarios where Government spends not its own money on stimulating its own votes. Note: Employer PRSI change is virtually immaterial, costed by the Department of Finance at only EUR7 million over full year. Where this might help somewhat is in alleviating pressure on employers to cut working hours.

Besides the above aberrations, the Budget was a net positive for current consumption spending, and was a net zilch for investment. Now, here the Government logic is completely off the charts. We are borrowing money to fund the Budget 2016 measures. And we are channeling this borrowed cash into activities that are not expected to generate a return, since these are non-investment activities. Multipliers for current consumption are miserable - most of the stuff we will be buying with the few quid we got in Budget 2016 is stuff made elsewhere and all we can collect in this economy from it is a small gross payout on labour in the retail and logistics sector. Whatever the social imperatives can be for such a 'stimulus' (and they are quite sound in some cases), it is poor economics and poor strategy.

When it comes to economics: Budget 2016 continues with a well-established theme of doing everything possible to demolish productive entrepreneurship spirit in the country. This time around, it is doing it with a flavour of simultaneously pretending that we are pro-entrepreneurs. 

Take the following post-Budget 2016 numbers:

1. Income tax: What maters here from entrepreneurship and modern economy activity is the upper marginal tax rate, not the base rate. Why? Because people do not choose to become entrepreneurs to earn EUR34,000 a year. It is that, brutally, simple. So in Ireland post-Budget 2016 we have a 40% upper rate kicking in at EUR33,800. Across the pond, in the UK, this happens at EUR59,900. Get it? Forget entrepreneurs, we are talking about school teachers being high earners according to our tax codes.
2. Dividends taxation: You get dividends on your investments (rare, but happens in normal economies). Your upper tax on these is 55% here in Ireland, whilst in the UK it is 38%. Darn, those rich retail investors who carefully select better quality long-term non-speculative shares (majority of which pay dividends). Whack them hard, shall we?
3. Capital gains Tax: We are a basket case. We have general rate of CGT of 33% which is higher than UK's 28%. We have now a new measure that allows for some reduced CGT on the first EUR1 million at 20%. Minister Noonan thinks that is a great way to reward successful entrepreneurs. In the UK, they think a reward should involve 10% CGT for such investors. For investment returns of up to EUR13 million 'entrepreneurship Island' reserves an effective (reduced by Budget 2016) rate of 32%. In the UK it is 10%. There is no CGT exemptions for qualifying investors and no CGT rollover for reinvestment in Ireland, whilst both measures are available in the UK. Case closed.
4. Capital gains structural incentives: For years Irish policymakers and Enterprise Ireland have been struggling with the fact that majority of Irish entrepreneurs opt for early exits from companies - in other words, instead of building large Multinational Enterprises, our entrepreneurs too often opt for a sale of company early on. It has been an explicit objective for Irish development agencies to stimulate growth of companies beyond certain thresholds in size in the past. And Budget 2016 just created an added (albeit small) incentive to exit earlier, rather than later (the cap on preferential rate being set at EUR1 million). Classic example of incentives contradicting objectives.
5. VAT: in Ireland, post-Budget 2016, this stays 23% and the crazy situation of charging VAT on services provided to non-VATable entities remains in place. In the UK, VAT is 20%. Thresholds: in Ireland VAT accrues for traders with revenue of >EUR37,500, but in the UK the threshold is Stg82,000. Get that, all of you self-employed and sole traders.

Of course, there is one, just one, area where Irish Government continues to impress the world: Multinationals-linked Tax Optimisation schemes. Ireland now has a Knowledge Development Box bestowing 6.25% corporate tax rate on... err... we don't quite know what. Promise is - it will apply to 'certain' patents and software copyrights. Which is just a tiny sub-set of actual business innovation and knowledge acquisition. And it is the subset that MNCs dominate. The Department of Finance estimate this measure to cost the Exchequer EUR50 million. Which really tells you just how much real activity this Knowledge Development Box is going to generate (answer is: very little) as opposed to how much of the old tax optimisation loopholes it is expected to absorb (answer is: plenty).

NY Times headline from yesterday says it all, really:

Our Knowledge Development Box is 'boxier' than that of the UK - our 6.25% tax beats their's 10% one. Case closed: MNCs win, and there is no economy beyond that which matters.

Anyone noticing that the world around us and the world inside Ireland is shifting toward supporting human capital-centric growth (yes, not labour or PAYE or specific sector, but Human Capital-centric)? Well, over 40 submissions from various bodies and individual analysts to Budget 2016 did. They also spelled out that this shift entails two key things:

• The need to recognise the risks assumed by workers and entrepreneurs working in this New Economy; and
• The need to recognise the fact that human capital-endowed workers are higher earners (not the rich, but well above the average).

People like myself have been drumming this beat for ages now. Still, Budget 2016 does nothing to resolve discriminatory taxation of human capital under the USC system, discriminatory taxation of human capital in self-employment under the USC system and broader income tax system, and it has done nothing in terms of even considering asymmetric risk loadings that entrepreneurs and self-employed carry compared to PAYEs. The Budget does help by introducing Earned Income Tax Credit to offset, partially (by 1/3rd) the glaring discrimination against self-employed inherent in the PAYE tex credit system. But this is hardly a measure to fully address the problem of the taxation system vastly out of tune with realities of modern economy.

Time to ask that pesky question, thus: Does this Government understand modern economy or do we still have leadership that thinks in terms of early 20th century proletarian world?

The sop of the 'entrepreneurship' measures unveiled in Budget 2016 is illustrative to the above question:

• Corporation tax exemption for start ups for the period of 3 years has been extended. The measure 'costs' the Exchequer EUR2 million per annum (per Budget 2016 estimates) same as the estimate for the measure in Budget 2015. Apparently, even by Department own figures, there is zero growth in uptake of this measure year on year. 
• The Knowledge Development Box - which is for all intents and purposes is about useful for entrepreneurs and start ups as the Beats by Dre headphones are to the donkey.
• The EIIS scheme to incentivise investment into start ups has been 'fixed' (by increasing company limit from EUR5 million to EUR15 million). Except, the fix addresses non-existent problem and the real problems remain not tackled. You see, you gotta be a fabled unicorn (in Irish market terms) to raise EUR15 million as a start up. Majority of entrepreneurs need far less capital than EUR5 million. So the old ceiling was not a barrier in EIIS scheme. However, EIIS is excruciatingly  bureaucratic and difficult to navigate, which it remains such after Budget 2016. And EIIS is not suitable for raising small funding that majority of start ups really need up front - EUR100,000-200,000. Which, once again, Budget 2016 left unaddressed.

And that's it. Entrepreneurs and the self-employed, high Human Capital-endowed workers, start ups, their directors and advisers, as well as their key employees - all can now send their 'Thank You' cards to the Minister for all the love and support extended to them yesterday. Or they can continue to send their business to the UK and Northern Ireland, where quietly, without labelling themselves to be the 'Best ... Country to Do Business In' the fiscal powers are trying to run a more benign environment for investors, entrepreneurs and start ups.

4/6/15: Irish Fiscal Spring: Village, April-May

My recent article for the Village Magazine [April-May edition] on Irish economy is now available on-line: http://www.villagemagazine.ie/index.php/2015/05/spring-unsprung/ 

28/4/15: There is a Spring... There was a Statement...

This Spring Statement was a lengthy and over-manned delivery of the vintage "A Lot Done. More to Do." 2002 FF slogan. As such, it is inevitable that the Statement ended up sounding like a self-congratulatory pre-electioneering platform announcement with some promises for the future. And you can read the Department document here: http://budget.gov.ie/Budgets/2015/Documents/SPU%20for%20Web.pdf in its full glory.

'Entrepreneur' or 'Entrepreneurship' are words not mentioned in the document. Self-employed are cited only once, in reference to timing of tax receipts the Government expects from them. Part-time workers - the crucial category that can drive up ranks of early stage entrepreneurs and can be a source for huge gains in productivity if their skills are increased forward - deserves only two mentions, both relating to the unemployment reductions trends to-date. Quality of jobs creation is un-addressed. And so on...

In his speech, Mr Noonan said the government is in a position to implement another expansionary Budget this year and every year out to 2020 “if this is deemed prudent and appropriate.” The "if" part - crucial as it may be - is hardly enforceable, once the train of spending rolls out into the station.

The Government deserves credit. The national deficit was reduced from €15 billion to €4.5 billion over 2011-2015. This was achieved with less tax increases and expenditure cuts than forecast at the onset of 2011. Minister Noonan is correct. But much of this was down to good fortunes from abroad. And still is. And, based on the Department of Finance projections still will be, if one to trust their outlook for the exchange rates, exports growth and jobs growth.

Per Minister Noonan, the state has, this year “fiscal space of the order of € 1.2 billion and up to € 1.5 billion… for tax reductions and investment in public services." So, “the partners in Government have agreed that [this] will be split 50:50 between tax cuts and expenditure increases …in Budget 2016.”

Does that make much sense? Well, no. 2014-2015 cumulated decrease in deficit can be broken down into:
- 50% from increased tax revenues,
- 14% to GDP growth,
- 9% to reduction in net Government expenditure and
- 27% other factors.
Jobs creation and wealth creation both require reducing burden of State and taxation on self-employed and early stage entrepreneurs. Who, both, went totally unmentioned in the Spring Statement. Domestic demand growth - that supposed to contribute 2/3rds of 2015 growth and more than 3/4 of 2016 growth - requires reducing household and corporate debt and stimulating domestic investment - preferably not in property sector. These too went un-mentioned in the Spring Statement.

Instead, we got Minister Howlin watershed discovery that the Government creates wealth.

Which is scary and even scarier in the context of missing real wealth creators in the Statement: the Government's role in wealth creation should be to remove itself from managing it as much as possible. But see more on this below.

Minister Noonan warned that returning to the days of “if I have it I’ll spend it” or the “even if I don’t have it I’ll spend it” policy stance taken by the opposition over the past four years, was by far the biggest risk to economic growth and job creation. He might be right, but his plan for expansionary Budgets into 2020 is more of a policy stance consistent with "I might have it, so I'll spend it".

“We must never again repeat the boom and bust economic model. Over the remainder of this decade we expect all sectors of the economy to contribute to growth and employment.”

He is right on this and the Government said much the same over and over again. But it is hard to see any coherent strategy emerging from the Government's numerous reiterations of Jobs and Growth plans and white papers on how broad growth can be delivered. To-date, the Government projected the same policy approach to growth as its predecessor - targeted supports and tax incentives. Not levelling the playing field, getting rid of state inefficiencies, political interference and tax-and-spend redistribution of resources. Note: this is not about redistribution of income. It is about allowing the economy to grow without political meddling and favouritism.

The Spring Statement was not much of a departure from the same. In the statement, the Minister mentions just one 'red line' policy item - the 12.5% corporation tax. Everything else is more of an IOU based on "if - then". Which suggests that this Government has little in terms of new economic growth ideas beyond corporate tax measures.

Mr Noonan said the mistakes that left the country on the verge of bankruptcy in 2010 must never again be repeated. Which begs a question: does Minister Noonan recognise the mistakes, linked to 2010, that this Government also participated in - willingly or not? Banks recapitalisations were carried out in 2011 on foot of 2010 policy decisions. Troika MOU - shaped in 2010 - was implemented by this Government. Bondholders bailouts were completed by the present Government on foot of mistakes made by the previous one.

Minister Noonan also referenced a promise to "give people security around their income and their pensions". But it is very hard to see how this can be achieved, given lack of any serious progress on dealing with legacy debts and the 50:50 split between tax reductions and expenditure increases in Government budgets forward. And on the point of debt, we do have a massive Government debt, now being augmented by the quasi-Government non-Government debt of the likes of Irish Water et al. Remember, expenditure increases do not improve people's incomes and pensions, except for the select few in State employment and contracting. Nor do they improve Government ability to deleverage its own debt.

And on that note, the Department of Finance says little about actual interest rates, but does project relatively benign debt-related costs through 2020. Which might be tad optimistic, given we are currently scraping the bottom of the historical rates barrel. The Department says that "While unlikely in the short term, higher policy-induced interest rates would have a dampening impact on Ireland’s economic activity. Simulations suggest that a 1 percentage point increase in policy interest rates could reduce the level of GDP by almost 2½ percentage points by 2020. This effect is especially pronounced given the large debt overhang. Such a deterioration in the economy would add almost 1 percentage point to the budget deficit by 2020". I know we all 9ok, not 'we' but almost 'all') expect the current interest rates to stay here forever, because, obviously the ECB is not going to raise them any time in the future under the 'new normal' of complete oblivion to the reality. But here's a bad news: current ECB rates are some 300bps below the pre-crisis average. And if we are moving out of crisis, that average is moving closer and closer in time. So for testing that 100 bps rate rise that the DofF did in the Spring Statement: try 300 bps next. And see the whole promise of the golden future go puff in a cloud of smoke.

Moving on through the Statement: it is also hard to spot any serious momentum for pensions reforms that can really be productive in restoring some capability of the private sector workers to secure pensions. The Government has all but abandoned the idea of pensions reforms in the public sector - the biggest drain on pensions resources in the country.


In summary, the Spring Statement is a call to the voters to support the status quo based on the idea that 'our continuity is less painful than opposition's change'. Which, of course, is an equivalent to giving a granny a choice of being mugged by the "Thank you, Mam" lads with school ties or by the rude villains in clowns' wigs. It is a choice. Just not the one many would order on their elections' menu after six years of economic and social bloodletting. 

Irish Times summed this up as "The spring statement can be seen as a political exercise in which Fine Gael and Labour adopt a common fiscal plan for the election campaign to come." (see http://www.irishtimes.com/business/economy/spring-statement-analysis-assumption-nothing-goes-askew-1.2191971?utm_content=sf-man) and my favourite political analyst in this country, summed it up much better: http://thejacktrack.blogspot.ie/2015/04/michael-noonans-2-billion-return-to.html?spref=fb who says: "there was a haunting echo of Bertie Ahern and Charlie McCreevy resonating through the halls of his Department, and with it the emergence of a disturbing - if hardly, at this stage, surprising - sense that in Ireland there is no such thing as a lesson learned, only a lesson observed."

25/11/2014: Irish Fiscal Council: More of Troika Speak, Less of Original Insight

The Irish Fiscal Advisory Council [an independent body of sort with some relevance of sorts, if only as a 'check' on the Government] has issued its assessment of the fiscal situation in Ireland. Just in time after the Troika review. Unsurprisingly, the Council mirrors the IMF (and the Troika analysis - covered here: http://trueeconomics.blogspot.ru/2014/11/21112014-latest-troika-report-risks-no.html.

Per Council:
"The Government will likely accomplish the important milestone of reducing the deficit to below the 3 per cent ceiling in 2015. The debt to GDP ratio is beginning to fall, albeit from a very high level. At the same time, economic recovery appears to be taking hold and risks to the Government’s balance sheet have subsided considerably as the outlook for both NAMA and the banking sector has improved." They wouldn't notice that debt/GDP ratio and deficit/GDP ratio were both helped quite a bit by the switch to new National Accounts classification in 2014. See Eurostat data here: http://trueeconomics.blogspot.ru/2014/10/21102014-of-statistics-ireland-and.html. Then again, Troika too 'missed' that point, so predictably, everything is down to the miracles of growth (see: http://trueeconomics.blogspot.ru/2014/11/23112014-half-of-irish-growth-miracle.html).

The Council shows some teeth, however, pointing the obvious: "…Budget 2015 reflects a missed opportunity to move the public finances more decisively into a zone of safety by following through on previous plans. The deficit is projected to be more than one percentage point higher in 2015 than could have been achieved if previous plans had been implemented. All else being equal, the larger deficits result in the debt level being roughly €10 billion higher in 2018 than if previous plans had been adopted."

And then there is the risk of pro-cyclicality - the new boggeyman  of European fiscal policy. In this context, "…Budget 2015 was marked by an absence of a well-specified plan for the public finances beyond 2015. Published tax revenue projections assume no change in policy despite Budget commitments to lower taxes in the coming years. Moreover, the Budget spending profiles assume unchanged expenditure after 2015, despite higher figures being set out in the Comprehensive Review of Expenditure 2015-2017 (CER 2015-2017). Expenditure ceilings have been raised again, however, the CER 2015-2017 does not adequately address how well-known expenditure pressures will be accommodated in the coming years."

Oh dear, that stuff is almost entirely Troika-speak and hardly much new. All in, this makes the Fiscal Council report if not outright redundant, at least repetitive. Which might be the point of the exercise, to keep the pressure on in hope that politically-expedient boom and bust spending and tax cutting are not making a return in Ireland ca 2015.

Good luck to all ye, hoping.

3/4/3014: Tax or Not: Sunday Times, March 9, 2014

This is unedited version of my Sunday Times article from March 9, 2014


Speaking at last week's Fine Gael Ard Fheis, Minister for Finance, Michael Noonan, T.D. noted that "As a Government, we know that there are further opportunities in the years ahead for us to build upon the initiatives that have worked.  It is in this vein that …I will consider the introduction of targeted tax reductions that have a demonstrable effect on employment growth."

With these words, Minister Noonan finally set to rest the debates as to the Government intentions with respect to core policies for 2015 and thereafter. Whether you like his prior policies or not, he makes a good point: Ireland needs a tax-focused policy intervention. And we need an intervention that simultaneously addresses the declines in after-tax household incomes endured during the current crisis, and does not trigger rapid wage inflation and jobs destruction that can be associated with centralised wage bargaining. The window for an effective intervention is now, in part because as recent evidence shows, fiscal policy effectiveness is greater at the time of near-zero interest rates. But beyond an intervention, Ireland needs a longer-term reform of taxation system.


In general, any economic policy can be judged on the basis of two core questions. Firstly, does the policy offer the most effective means for achieving the stated objective? Secondly, is the policy feasible in economic and political terms?

Reducing income tax burden for lower and middle class earners yields an affirmative answer to all three of the above questions. No other alternative proposed to-date – a cut in VAT rate, a reduction in property tax burden, or an increase in public spending on core services to alleviate cost pressures on families – fits the bill.


Starting from the top, cutting income-related taxes in the current environment makes perfect sense from the point of view of economics.

The three stumbling blocks on our path to the recovery are anaemic domestic consumption, high burden of household debts, and collapsed domestic investment. All of them are interlinked, and all relate to low after-tax disposable incomes. But the last two further reinforce each other. High levels of household debt currently impede restart of domestic investment by both households and firms. They also act as partial constraints on our banks ability to lend. Meanwhile, low domestic investment implies depressed household incomes and high unemployment. In other words, reducing private debt and simultaneously increasing domestic investment should be a core priority for the Government.

On the other side of the national accounts equation, stimulating private consumption offers a weak alternative to the above measures. Due to high imports content of our average consumption basket most of the discretionary spending by Irish households goes to stimulate foreign exporters into Ireland. And it is this discretionary imports-linked spending, as opposed to consumption of non-discretionary goods and services, that has taken a major hit during the Great Recession. Beyond this, higher domestic consumption will do little to raise our SMEs exporting potential, in contrast with increased investment.

Take a quick look at the top-line figures from the national accounts. Based on data from Q1 1997 through Q3 2013, cumulative decline in personal consumption of goods and services over the current crisis amounts to roughly EUR5 billion, when compared against the already sky-high 2004-2008 trend. For gross fixed capital formation - a proxy for investment and capital spending - the cumulative shortfall is EUR50 billion against the 2000-2004 trend, which excludes peak of the asset bubble period of 2005-2007. Put differently, compared to peak, private consumption was down 12 percent in 2013 (based on Q1-Q3 data), while gross investment was down 65 percent. If in 2013 our personal consumption is likely to have returned to the levels last seen around 2005-2006, our investment will be running closer to the levels last witnessed in 1997-1998.

More significantly, lending to Irish non-financial, non-property SMEs has fallen 6.2 percent year-on-year at the end of 2013, as compared to 5 percent for the same period of 2012, according to the latest data from the Central Bank. Meanwhile, value of retail sales was down only 0.1 percent in 2013, according to CSO. Things are getting worse, not better, in terms of productive investment.

It is, therefore, patently clear that an optimal policy to support domestic growth in the economy should target increases in the disposable income of households and incentivise investment and savings ahead of stimulating consumption. It is also clear that such increases should be distributed across as broad of the segment of working population as possible.

To achieve this, the Government can reduce the burden of personal income taxation.

Alternatively it can attempt to target a reduction in the cost of provision of non-discretionary services, such as childcare, health, basic transport and education. In fact, the main arguments against lower taxes advanced by the Irish Trade Unions and other Social Partners are based on the idea that such costs reduction is possible were the state to invest taxpayers funds in further development of these services as well as provide subsidies to supply them to the broad public.

Alas, in practice, Irish public sector is woefully poor at delivering value-for-money. Since 2007 through 2013, inflation in our health services outpaced the general price increases across the economy by a factor of 5 to 1, in transport sector by 3 to 1 and in our education by 12 to 1. Pumping more money into provision of public services might be a good idea when it comes to achieving some social objectives. It is certainly a great idea if we want to stimulate public sector employment and pay, as well as returns to various consultancies and state advisers. But it is not a good policy for helping households to pay down their debts, increase their savings, investment and/or consumption.


Which brings us to the questions of economic and political feasibility of tax reforms.

This week, the Finance Minister confirmed that he will "try to begin the process of making the income tax code more jobs friendly" starting with Budget 2015. Most likely, the next Budget will consider moving the threshold for application of the upper marginal tax rate, currently set at EUR32,800. Minister Noonan described this threshold as being "totally out of line with the practice effectively all over the world, but particularly in Europe." And he's got the point. Across a sample of twenty-one advanced economies, including Ireland, the average effective upper marginal tax rate, inclusive of core social security taxes, currently stands at around 44.4 percent. In Ireland, according to KPMG, the comparable upper marginal tax rate is 48 percent. But an average income threshold at which the upper marginal tax rate kicks in is EUR136,691 in the advanced economies, or more than four times higher than in Ireland.

Widening the band at which the upper marginal tax rate applies to double the current Irish average earnings will mean raising the threshold to EUR71,500 per person per annum. This should be our policy target over the long-term, through 2019-2020.

However, given current income tax revenues dynamics delivering this target today will trigger significant fall-offs in income tax revenues. Data through February 2014, admittedly a very early indicator, shows effectively flat income tax receipts, despite large increases in employment in recent months. In other words, brining our upper rate threshold closer to being in line with the advanced economies average is, for now, a non-starter from fiscal sustainability point of view.

But gradually, over 2015-2016, increasing the 20% tax rate band to around EUR38,000-40,000 should be fiscally feasible, assuming the economy continues to improve as currently projected. This will leave those at or below the average earnings outside the upper marginal tax rate. But it will also provide relief to all those earning above average wages. In other words, widening the lower rate band will generate a broadly-based measure, with likely support amongst the voters.

At the same time, it will also yield significant gains in economic stimulus terms. At the lower end of the targeted band, such a measure would be financially equivalent to a tax rebate of around double the average residential property tax bill.

More importantly, widening the lower tax band will provide for an effective stimulus to the economy compared to all of the above measures. The reason for this is that unlike property tax and VAT, income taxes create economic disincentives to supplying more work effort in the market place. This effect is most pronounced for second earners, self-employed, sole traders and small business owners – all of whom represent core pool of potential entrepreneurs and future employers.

In addition, reducing income taxes, as opposed to consumption and property taxes provides both financial and behavioural support for investment, and savings for ordinary families. A number of studies of consumer behaviour show that savings achieved from the reductions in consumption taxes are commonly rolled up into higher consumption. On the other hand, higher after-tax labour incomes are associated with greater savings, investment and/or faster debt pay-downs.


Beyond widening the standard rate band, the Government can do little at the moment to stimulate disposable income of the households. Yet, in the longer term, we face the need for a more comprehensive and deeper reform of our tax system. Critical objective of such reform is to achieve a new system for funding the state that relies less on income tax and more on direct user-fees charges for goods and services supplied to consumers, plus taxes on less productive forms of capital, such as land, property and speculative assets. Changes in the underlying drivers for growth in the Irish economy will also necessitate tightening of corporate and income tax loopholes. This should lead to increased reliance by the state on corporate tax revenues, while freeing some room for the reduction in tax rates. In targeting these, the Government should focus on the upper marginal tax rate itself.

Designed with care and delivered with caution, such reforms can put Irish economy on the path of higher growth well anchored in the underlying fundamentals of our society: indigenous entrepreneurship, domestic investment and skills-rich workforce.

Box-out:

This week, the EU Commission published its 2014 Innovation Union Scorecard showing comparative assessment of the research and innovation performance across the EU. The good news is that Irish rankings in the area of innovation have improved from 10th to 9th over the last twelve months - not a mean task given our tight economic conditions and scarcity of funds across the economy. The bad news is that we are still ranked as 'innovation follower' and that our performance is still weak when it comes to developing a thriving innovation culture in the SME sector. As experience from the UK shows, just a couple of simple changes to Ireland's tax codes can help us enhance the incentives for SMEs to develop a more active innovation and research culture. We need to reform our employee share ownership structures to make it easier for smaller companies and entrepreneurs to attract key research personnel and promote innovation within enterprise. For example, in Ireland, employees securing an equity stake in the business employing them currently face an immediate tax liability, irrespective of the fact that they receive zero financial gain from the shares until these as sold. This applies also to smaller start-up ventures, particularly the Universities-based research labs. Thus, a researcher working in Ireland's high potential start-up or a research lab can face a tax liability on owning the right to a yet-to-be-completed research they are carrying out. This is not the case across the Irish Sea and in the Northern Ireland. In 2012-2013, the UK Government adopted 28 new policies aimed at promoting various forms of Employee Financial Involvement (EFI) in the companies that employ them. The UK has allocated £50 million through 2016 to promote public awareness of the EFI schemes and is actively working on reducing the administrative burden for companies and employees relating to EFI. It is a high time we in Ireland have followed our neighbours lead, lest we are content with remaining an 'innovation follower' in the EU for years to come.

26/12/2013: Strategy for Growth 2014-2020 - A Fruitcake of Policy?

This is an unedited version of my Sunday Times column from December 22, 2013.


It is a well-known fact that virtually all New Year’s resolutions are based on the commitments adopted and promptly abandoned in the years past. Our Government’s reforms wish lists are no exception. Like an out-of-shape beer guzzler struggling to get out of the pub, our State longs to get fit year after year. Most of the time, nothing comes of it: bombastic reforms announced or committed to quietly slip into oblivion. Smaller parts of resolutions take hold; bigger items get buried in working groups and advisory panels. Thus, over the last decade, we have seen promises of reforms across the domestic sectors, protected professions, pensions and health systems, quangos, social welfare, government funding, tax systems, and so on. Virtually none have been delivered so far.

This week’s Strategy for Growth: 2014-2020 is the latest in the series of Governments’ ‘New Year, New Me’ resolutions. It is a lengthy list of things that have already been promised before. With a sprinkling of fresh thinking added. All of it is based on a strange mixture of pragmatism in fiscal targets, resting on economic forecasts infused with an unfunded but modest optimism. Giddy exuberance in confidence concludes the arrangement: confidence that the reforms which proved un-surmountable under the Troika gaze will be feasible in over the next seven years. The entire exercise promises a lot of reforms, but delivers little when it comes to realistic costings and risk assessments of the promises made.

In brief, the new Strategy is a disappointingly old fruitcake: pretty on the outside, inedible on the inside and full of stale trimmings, held together by the boisterous dose of potent optimism.


On Monday, the National Competitiveness Council unveiled its own version of a roadmap to the proverbial growth curve. The 32-page document on the New Economy contained no less than 65 references to the building and construction sector and 39 instances of references to property sector. No other sector of the economy was accorded such attention.

In the footsteps of NCC, on Tuesday, the Government launched its own multi-annual post-Troika policies roadmap.

The core point of the glossy tome is that Ireland needs a combination of policies to get its economy moving again. No one could have suspected such a radical thought. Majority of the policies listed are of ‘do more of the same’ variety. Some are novel, and a handful would have been even daring, were it not for the nagging suspicion that they represent political non-starters.


The plan has three pillars. Pillar one: fiscal discipline to keep Government debt under control. Pillar two: repairing the credit supply system and the banks. Pillar three: create an economy based on innovation, productivity and exports, and… building and construction. If you find any of this new, you are probably a visitor from Mars.

The document fails to provide any risk analysis in relation to all three pillars. Instead, it fires off pretty specific and hard-set targets and forecasts. Normally, the forecasts reflect the impact of policies being produced. In the Strategy 2014-2020 normality is an inverted concept, so forecasts enable targets that justify proposals.

There are two scenarios considered: the baseline scenario (better described as boisterously optimistic) and the high growth scenario (best described as wildly optimistic). None are backed by an analysis of sources of growth projections. No adverse scenario mentioned.

For the purpose of comparison, based on IMF model, Irish GDP, adjusting for inflation is forecast to expand by less than 12.3 percent between the end of 2013 and the end of 2018. In contrast, Government latest plan projects GDP to grow by over 16.1 percent in the case of high growth scenario. Nominal GDP differences between the high-growth and baseline scenarios amount to just 0.1 percentage points on average per annum. In other words, the distance between boisterous and wild optimism in Government’s outlook for the next seven years of economic growth is negligible.

By 2020 we will regain jobs lost during the crisis. But unemployment will be 8.1 percent under the baseline scenario and 5.9 percent under high-growth projections. Both targets are above the pre-crisis levels of around 4.7 percent. Which means that the Grand Strategy envisions jobs creation to lag behind labour force growth. The only way this can be achieved is by lowering employment to labour force ratio. This, in turn, would require increasing labour force more than increasing employment. In other words, the numbers stack up only if we simultaneously reduce emigration and push people off welfare benefits and into the jobs markets, and do so at the rates in excess of the new jobs creation. How this can be delivered is a mystery, although the Strategy promises more reforms to address these.

We will also transition to a fully balanced budget by 2018, eliminating the need to borrow new funds. Of course, we will still be issuing new debt to roll over old debt that will be maturing. Government debt itself will decline to below 100 percent of GDP by 2019. Per IMF latest estimates released this week, our General Government deficit in 2017-2018 will average around 1.5 percent of GDP and Government debt will end 2018 at around 112.2 percent of GDP. By Governments baseline scenario, we will be running a deficit of 0.25 percent of GDP on average over 2017-2018 and our debt will fall to 104 percent of GDP by the end of 2018. Optimism abounds.

To make these achievements feasible, let alone sustainable, will require drastic reforms far beyond what is detailed in the strategy documents. Instead of detailing these, Strategy for Growth: 2014-2020 leaves the major reforms open to future policy designs by various working groups.

For example, the Government Strategy talks high about the need to ensure sustainability of pensions provision. In an Orwelian language of the Strategy, having expropriated private pension funds before, the Government is now congratulating itself on achieving positive enhancements of the pensions system.

Yet, we all know that the key problems with current pensions system in Ireland are two-fold. One: we have massive under-supply of defined contribution pensions plans in the private sector. Two: we have massive deficits in defined benefit schemes that are predominantly concentrated in the public sectors. The Strategy documents published this week simply ignore the former problem. With respect to the latter one, the Government plan amounts to hoping that the problem will go away over time. Overall, going forward, the magic bullets in the State dealing with the vast pensions crisis are exactly the same as before: higher retirement age, gradual closing of defined benefit schemes and more studies into “setting out … long-term plans in this area”.

Another complex of Augean Stables of economic policies left untouched, potentially due to the influence of Labour is the tax system. Current income and social security taxes de facto penalise anyone considering an entrepreneurial venture. The Strategy puts forward no income tax reforms proposals. The document brags about the ‘progressivity’ of our income tax system and promises to retain this feature of the tax codes. Unions will be happy. Entrepreneurs, self-employed, higher-skilled workers, innovators, professionals, younger and highly educated employees, and exporting sectors workers will remain unhappy.

The Strategy admits that “Traditionally in Ireland starting and growing a business is considered less attractive by many than working in larger employers.” It goes on to stake a bold policy claim “to find innovative ways to encourage an entrepreneurial spirit.”

Stripped of fancy verbiage, the ‘innovative ways’ amount to a call to educate us all, toddlers and pensioners alike, about the goodness of entrepreneurship, and develop unspecified policies to make business failure more acceptable. Given the shambolic nature of the personal insolvency regime reforms designed by the current Government, there is little hope the latter objective can be met.

For intellectual gravitas, key marketing and PR words were deployed in the Strategy, promising more assistance, subsidies and supports to entrepreneurs, and more “clusters”. The same Strategy also promised to cut the number of business innovation assistance schemes and streamline business development programmes.

Taken together, these changes suggest that the Irish entrepreneurship environment will remain firmly gripped by State bureaucracy and will continue churning out state-favoured enterprises with clientilist business models. The fact that the said platform of enterprise supports, having been in existence for some 12 years, has failed to deliver rapid growth of innovation-focused high value-added indigenous entrepreneurship to-date seems not to bother our policymakers.

Other elephants in the room – some spotted by the very same Government years ago, while in opposition – are mentioned and, predictably, left unchallenged. One example: the Strategy promises yet another Action Plan to “identify ways to use Government procurement in a strategic way to stimulate … innovative solutions.” Back in 2011, this Government has already promised to do the same.

Overall, the fruitcakes of economic policy planning by the Government and NCC both lack vision and details. The two documents do contain some good, realistic and tangible ideas, but, sadly, these are buried beneath an avalanche of unspecified promises and uncontested figures. Risks to implementation of these policies may outweigh incentives for reforms. Lack of realism in expectations may overshadow the potential impact of the proposals.

More fruitcake, anyone? There’s loads left…

Box-out: 

In the latest report published this week, the European Banking Authority (EBA) analysed data from 64 banks with respect to their capital positions and the underlying Risk-Weighted Assets (RWA) holdings. Overall, capital position of the EU banking sector “continued to show a positive trend,” according to EBA, with Core Tier 1 capital holdings rising by EUR 80 billion. This, “combined with a reduction of more the EUR 800 billion of RWAs” means that the EU banks are building up risk buffers at the same time as pursuing continued deleveraging. The latter is the price for the former: higher capital ratios are good for banks’ ability to withstand shocks, deleveraging of assets is bad for credit supply to the real economy. On the net, however, as capital ratios rise, the system is being repaired so the price is worth paying. The improvements, however, were absent in one economy. Per EBA, Irish banks (Bank of Ireland, AIB and Permanent TSB) are unique in the EU in so far as they are experiencing simultaneous reduction in capital ratios and a decrease in Risk-Weighted Assets, which only partially offset the drop in capital. Put simply, Irish banks deleveraging is not fast enough to sustain current capital ratios: we are paying the price, but are not getting the benefits.

EBA chart (click to enlarge):

7/10/2013: Taking an Easy Road Out of Budget 2014? Sunday Times, September 22

This is an unedited version of my Sunday Times column from September 22, 2013.


The upcoming Budget 2014 will be one of the toughest since the beginning of the crisis in terms of the overall levels of cuts and tax increases. It also promises to cut across the psychological barrier of austerity fatigue. The latter aspect of Budget 2014 is more pernicious. Two other factors will add to the national distress, comes October 15th. Reinforcing our national sense of exhaustion with endless austerity, this week, the IMF published a staff research paper on fiscal adjustments undertaken during the current Great Recession. According to some, the IMF study reinforces the argument that Ireland should have been allowed to spread the austerity over a longer period time. In addition to this, Ireland’s planned 2014 cuts are set to be well in excess of the deficit reduction targets for any other euro area country.

The superficial reading of the IMF statement, the nascent sense of social distress brewing underneath the surface of public calm, and the tangible and very real pain felt by many in the society suggest that the Government should take it easier in 2014-2015. The policy option, consistent with such a choice would be to cut less than committed to under the multi-annual fiscal plans agreed with the Troika. This is being proposed by a number of senior Ministers and TDs, the Opposition and the Unions.

Alas, Ministers Noonan and Howlin have little choice when it comes to the actual volumes of fiscal adjustments they will have to implement next year. Like it or not, we will need to stick very close to the EUR3.1 billion deficit reduction targets irrespective of the IMF working papers conclusions, or the volume of outcries coming from the Government backbenchers and the opposition ranks.

Here's how the brutal logic of our budgetary position stacks up against an idea of easing on deficit reductions.

If everything goes according to the plan, Ireland will end 2013 with a second or a third highest deficit in the EU, depending on how we account for the one-off spending measures across the peripheral states. We will also have the second highest primary deficit (that is deficit excluding cost of interest payments on Government debt) in the euro area. In 2014 this abysmal performance will replay once again, assuming we meet the targets. Greece and Italy are set to finish 2013 with a primary surplus. Portugal is expected to post a primary deficit of less than one half that of Ireland's. Should Ireland deliver on the targets for 2014, our gap between the Government revenues and spending will still stand at around 4.3-4.6 percent of GDP at the end of December 2014. Not a great position to be in, especially for a country that claims to be different from the rest of the euro periphery.

In this environment, talking about any change in the course on austerity or attempting to enact a fiscal stimulus will be equivalent to accelerating into a blind corner on a one-lane road.

In order to stabilise government debt, Ireland will require cumulative deficits cuts of 11.6% of GDP between January 2013 and December 2018 with quarter of these cuts scheduled for 2014-2015. This is the largest volume of cuts for any economy in the euro area - more than 20 percent greater than the one to be undertaken by Greece and more than 50 percent in excess of Spain’s requirement.

Any delay in cuts today will only multiply pain tomorrow with higher debt to deflate in 2016-2018. As things stand under the agreed plans, Ireland will be spending 4.9 percent of its GDP annually on funding debt interest payments from through 2018. This is more than one and a half times greater than what we will be allocating to gross public investment. The interest bill, over the next five years, will be at least EUR46 billion. Lowering 2014 adjustment target by EUR1 billion can result in the above cost rising to over EUR50 billion, based on my estimates using the IMF forecast models.

The reason for this is that any departure from the committed fiscal adjustment path is likely to have consequences.

Firstly, with the ongoing sell-offs of bonds in the global investment markets, it is highly likely that the cost of funding Government debt for Ireland will rise over the medium term even absent any delays in fiscal adjustments. The long-term interest rates are already showing sharper rising of yields on longer maturity bonds compared to short-dated bonds. Year to date, German 10-year yields are up 64 basis points, UK are up 105 bps and the US ones are up 111 bps. The effects of these changes on Irish debt and deficit dynamics are not yet fully priced in the latest IMF forecasts. A mild steepening of the maturity curve for Ireland can significantly increase our interest bill. This risk becomes even more pronounced if we are to delay the Troika programme.

Secondly, failure to fulfill our commitments is unlikely to help us in our transition from Troika funding. Ireland will require a precautionary standby arrangement of at least EUR10 billion in cheaply priced funds. The European Stability Mechanism (ESM) funds to cover this come on foot of good will of our EU 'partners'. These partners, in turn, are seeking to redraft EU tax policies, as well as banking, financial and ICT services regulations. In virtually all of these proposals, Ireland is at odds with the European consensus. Good will of Paris and Berlin is a hard commodity, requiring hard currency of appeasement. Whether we like it or not, by stepping into the euro system, we committed ourselves to this position.

The long run financial arithmetic also presents a major problem for those who misread the latest IMF research on austerity as a sign that the Fund is advocating easing of the 2014-2015 adjustments for Ireland. The IMF clearly shows that Ireland has already delayed required fiscal cuts more than any other euro area economy. In all euro area peripheral economies, other than Ireland, fiscal adjustments for 2014-2015 are set at less than one fifth of the total adjustment required for 2010-2015 period. In Ireland they are set at one third. Which means that, having taken more medicine upfront, Italy, Greece, Portugal and Iceland can now afford to ease on cutting future primary imbalances.


With this in mind, there is not a snowballs chance in hell that we can substantively deviate from the plan to cut EUR3.1 billion, gross, from 2014 deficit without facing steep bill for doing so. Which leaves us with the only pertinent question to be asked: how such an adjustment should be spread across three areas of fiscal policy: Government revenues, current expenditure and capital expenditure.

This year, through August, Government finances have been running ahead of both 2012 levels and we are perfuming well relative to what was planned in the budget 2013 profile. However, the headline numbers conceal some worrying sub-currents.

This year's current primary expenditure in 8 months through August stood at over EUR36.6 billion, more than targeted in the 2013 profile and ahead on the same period last year. This deterioration was caused by the one off payment made on winding down the IBRC, plus the increase in contributions to the EU budget. Nonetheless, while tax and Government revenues increases in the 8 moths of 2013 were running at almost EUR3.4 billion compared to the same period of 2012, spending reductions are down only EUR823 million.

To-date, only 17 percent of the entire annual adjustment came via current voted spending cuts and over 57 percent came from increases in Government revenues. The balance of savings was achieved by slashing further already decimated capital investment programmes.  Given the overall capital investment profile from 1994 through forecast 2013 levels, as provided by the Department of Public Expenditure and Reform, this year's net capital spending is likely to come below the amount required to cover amortisation and depreciation of the current stock of Government capital. Put simply, we are just about keeping the windows on our public buildings and doors on our public schools in working order.

In this environment, Labour Party and opposition calls for undoing 'the savage cuts to our frontline services' - or current spending side of the Government balance sheet - are about as good as Doctor Nick Rivera's cheerfully internecine surgical exploits in the Simpsons.

The adjustments to be taken over the next two years will have to fall heavily on current spending side. This is a very painful task. To-date, much of the savings achieved on the expenditure side involved either transforming public spending into private sector fees, which can be called a hidden form of taxation, or by achieving short term temporary savings.

The former is best exemplified by continued hikes of hospitals' charges which have all but decimated the markets for health insurance. The result is a simultaneous reduction in health insurance coverage, an increase in demand for public health services and costly emergency treatments. The 'savings' achieved are most likely costing us more than they bring in.

The latter is exemplified by temporary pay moderation agreements and staff reductions in the public sector. This presents a problem to be faced comes 2015-2016: with growth picking up, many savings delivered by staff reductions and pay moderation measures will be the first to be reversed under the pressure from the unions.

In short, the Government has no choice, but to largely follow the prescribed course of action. Like it or not, it also has no choice but to cut deeper into current spending. This is going to be an ugly budget by all measures possible, but the real cause of the pain it will inflict rests not with the Troika insistence on austerity. Instead, the real drivers for Ireland’s deep cuts in public spending are the internal imbalances in our public expenditure and the lack of deeper reforms in the earlier years of the crisis.

Via @IMF

Box-out: 

Recent data from the CSO on Irish goods exports painted a picture of significant gains in one indigenous economy sector: agri-food exports. The exports of Food and live animals increased by EUR101 million or 15 percent in July 2013, compared to July 2012. In seven months from January 2013, agri-food exports rose to EUR4,911 million, up 8.8 percent. Most of the increases related to exports of animals-related products, live animals, eggs and milk. The new data caused a small avalanche of press releases from various representative bodies extolling the virtues of agri-food sector in Ireland and posting claims that the sector is poised to drive Ireland out of the recession. Alas, the data on agricultural prices, also covering the period through July 2013, released just three days after the publication of exports statistics, poured some cold water over the hot coals of agri-food sector egos. From January through July 2013, the main driver for improved exports performance of our agriculture and food sectors was not some indigenous productivity growth or innovation, but the price inflation in the globally-set agricultural output prices. On an annual basis, the agricultural output prices rose 10.7 percent in July 2013. Over the same period of time, the agricultural input price index was up 5.2 percent in July 2013. This means that Irish exports uptick in 2013 to-date was built on the pain of consumers elsewhere. So good news is that our agri-food exports were up. Bad news is that we have preciously little, if anything, to do with causing this rise.

12/8/2013: Sunday Times August 4, 2013: Troika Programme Exit vs Fiscal Reforms

This is an unedited version of my article for Sunday Times August 4, 2013.


Irish political leaders are not exactly known for making logically consistent policy pronouncements. The current budgetary debates are case-in-point. On the one hand, minister after minister from both sides of the coalition benches are repeating ad nausea the tired cliches about their successes in managing the economy. On the other hand, the very same ministers are talking tough about the need for more pain, more adjustments, and more 'reforms' to secure the said recovery and deliver us from the clutches of the Troika. Only to turn around and start praising Troika support as the source of our recovery.

In reality, there are good, if only rarely voiced, reasons for these exhortations: seven hard budgets down, we are not really close to shaking off past legacy of wasteful fiscal practices. The state is still insolvent. The structure of the state policies formation is still dysfunctional. The legacy of pork barrel party politics continues unreformed.

Nothing exemplifies this better than the stalled structural reforms of social welfare and the resulting temporary, risk-loaded nature of much of our fiscal adjustments to-date.


Take a look at the top-line data coming from the Merrion Street.

In the first six months of 2013 tax revenues collected by the Government were EUR3.17 billion ahead of the same period three years ago, while the total voted current expenditure by the Exchequer was up EUR391 million. In other words, the only difference between the current budgetary approach and that practiced by Bertie Ahearn is that today's tax collections are starting from the low levels. Aside from that, current spending continues to ride well ahead of our economy’s capacity to fund it. The 'boom is not getting “boomier”, but the two main current spending lines: social protection and health, are still running at 65.2 percent of the total voted current expenditure, up more than 4 percentage points on 2010.

Things have changed, over the years, to be fair. There have been reductions in current expenditure during the crisis, overshadowed by tax hikes and dramatic cuts to capital spending. Thanks to tax hikes, in H1 2013, Ireland marked the first half-year period when the current spending by the Super-3 Departments: Education and Skills, Health and Social Protection, combined, was below the total tax revenue collected by the State. A significant milestone, but hardly a salvation, as three departments' current expenditure in January-June 2013 still counted for 95 percent of total tax receipts. Thus, even with all the cuts to-date, shutting down all current voted expenditure, excluding the Super-3, will only half our Exchequer deficit from EUR6.59 billion to EUR3.31 billion.

Which exposes once again the five-years-old policy dilemma: to balance the books, Ireland will require at least a EUR2.7 billion worth of further cuts on the spending side on top of what is being planned for 2014-2015. Most, if not all of these will have to come from the Social Protection and Health

Sustainability of savings achieved to-date presents a further risk. So far, cuts to the Exchequer spending that dominated the last five years were heavily concentrated on the sides of capital expenditure and public payrolls. Both are at a risk of reversal in the future.

Any return to growth will require heavier capital investment in public infrastructure, schools, medical equipment and facilities and so on. In other words, capital savings are an illusion on the longer time scale.

Meanwhile, much of the current spending cuts fell onto the shoulders of temporary and contract staff, leaving permanent and more expensive staff protected. This protection came at a cost of increased demands on their productivity. With staff feeling the bite of higher taxes and pensions contributions, while being forced to work more and outside their comfort zone of life-long assignments, public sector unions are already itching to get a new wave of wages increases going.

Back in December 2012, the Troika has pointed out that the savings delivered in public sector pay bills under the Croke Park Agreement cannot be deemed sustainable in the long run. The Haddington Road Agreement for 2013-2016 further confirms this assessment. The insolvent state is now fully committed to more rounds of increments payments, no matter what happens to the economy or exchequer finances. Virtually all ‘savings’ to be delivered under the Haddington Road Agreement are to be automatically reversed at the end of the agreement term or earlier.

The risks of policies reversals on capital and public sector pay, relating to the above measures, are non-trivial. IMF forecasts through 2021 showed the current path of fiscal adjustments taking us to a debt to GDP ratio of just over 95 percent in 2021 from the peak of 2013. Using IMF assumptions, my own estimates suggests that reversing budgetary policies to 2013 levels after 2015 can result in our Government debt to GDP ratio stuck at 108 percent in 2021.


All of which points to a simple but uncomfortable fact: to achieve long-term sustainability of our fiscal policies, Ireland requires a longer term reduction in public spending well in excess of what can be delivered without significantly cutting into current health and social welfare expenditures. Given the fact that health spending is already stretched, the above cuts will have to happen on welfare side.

The reforms, to be undertaken across a period of, say 2015-2016 will have to be sweeping and permanent, building in part on some of the piecemeal changes already in place.

To reduce the risk of replay of the devastating 2008-2010 effects of unemployment shocks on exchequer and economy at large, we need to separate unemployment benefits from other welfare supports.

Unemployment Insurance (UI) should provide a temporary, but generous safety net, sufficient to sustain reasonable family commitments to mortgages and children- and health-related expenditures. Thus, UI should be paid as a percentage of the end-of-employment salary, starting with 2/3rds of the salary up to a maximum of the median wage, with payments declining with duration of unemployment. Payments should terminate after 9 months.

Social welfare payments (SWP) to able-bodied adults can kick in following the expiration of the UI scheme on a means-tested basis. A low monthly personal SWP rate should be supplemented with access to childcare and healthcare, as well as educational grants for children, but only in the cases where recipients engage in training and/or active job searching. A recipient cannot turn down a reasonable offer of a job without facing a financial penalty. All benefits should be subject to a life-time cap of 6-7 years to prevent formation of permanent welfare dependency, while providing a broadly sufficient safety net..

All benefits payments above the monthly personal SWP rate, benchmarked for provision under the scheme, such as health, public services and transport allowance, should be cashless to reduce potential misuse of funds. To encourage better health attitudes and more careful utilisation of public services, a share of unused allowances, say 10-20 percent, accumulated in the account at the end of each year can be paid out as an annual bonus.

We also need to reform our state pensions. Given the fallout from the property bust, large numbers of Irish families are facing the prospect of pension-less retirement. They will require significant state supports - something we cannot afford while carrying the burden of unfunded state pensions.

All statutory state pensions should be means-tested to generate immediate savings and remove absurd subsidisation of the better-off at the expense of those in genuine need. Ditto for age-linked medical cards.

Automatic benchmarking of legacy public sector pensions should end and all current public employees’ pensions should be converted into defined contribution schemes. This will require a legislative decision to alter employment contracts. It will also require recapitalization of the public pensions fund, which can be done gradually over the period of, say, 10 years.

Savings to be targeted in the above measures should apply gradually, over 2014-2017, to generate new substitutes for temporary measures adopted in previous budgets.

However, even with gradual improvements in the labour markets and economy from 2014 on, implementing the above reforms will be nearly impossible. Current political system, with policy decisions based on consensus of the interest groups, is subject to stalling on big reforms and the risk of future reversals by governments seeking popular mandates. This means that we need to take a National Unity approach to structuring and enacting the new legislation dealing with reforms of the social welfare and pensions. Such a consensus is feasible, once all political parties in the Dail realise that Ireland will continue to face subdued economic recovery, elevated unemployment and anemic asset markets well into 2020-2021. With these headwinds, the pressure to carry on with prudent fiscal policies will remain. Thus, the only way of avoiding the contagion from the current long-term economic crisis to the political and state balance of power is to enact irreversible, legislatively protected structural reforms of the social welfare on the basis of bi-partisan legislative engagement.

Box-out:

A note from Davy Research on Mortgages Arrears, published this week, represents a good summary of the current crisis and draws some sensible and well-argued policy conclusions on the subject. Alas, the report commits one common, unnecessary and unfortunate error. Strategic non-payment of mortgages debt is cited in the report eighteen times. Yet, there is no direct evidence presented in the report, or in any study cited in the report, as to the true extent of the problem in Ireland. Instead, like all other analysts, Davy team references unsubstantiated statements by the banks and banking authorities, and simplistic extrapolations of other countries’ studies to the case of Ireland as evidence that "mortgage delinquency has continued to grow despite better-than-expected labour market  conditions” and that “strategic default is now a problem." Like other researchers, Davy team cites increases in employment in Q1 2013 as the evidence of a 'growing problem' with strategic non-payments.  Alas, in Q1 2013, seasonally-adjusted full-time employment (jobs that can sustain payment of mortgages) dropped 4,500 year on year. Broader measures of unemployment reported by CSO also posted increases. This hardly constitutes a material improvement on households' ability to fund mortgages repayments and it certainly does not support the thesis of significant and growing strategic defaults. Of course, absence of evidence is not evidence of absence; the employment data cited above does not prove that there are no strategic defaults in Ireland. It simply shows that absent real, direct evidence, one should take care not to fall into the trap of convincing oneself that an oft-repeated conjecture must invariably be true.

15/2/2013: Loose Lips of Brendan Howlin & Jens Weidmann's Bother

Strong words today on the Irish Promo Notes deal from ECB's Jens Weidmann via Bloomberg (link to full interview here):

"It’s important that we draw a clear line between monetary and fiscal issues. The transaction in Ireland demonstrates how difficult it is for monetary policy to free itself from the embrace of fiscal policy once you’re engaged. The Irish government in its very own statements underscored the fiscal elements in this transaction.

"I’m rather strict when it comes to the definition of monetary financing. It’s important to draw a clear dividing line and accept the limitations of Article 123 for our actions. It’s not difficult from that to guess what my position is. [I would guess he is 'troubled' by the deal]

"The Irish government liquidated the IBRC. That has repercussions on net financial assets and has to be assessed against the background of Article 123. Of course the Eurosystem has to make sure that its actions are in conformity with its rules and statutes. [Widemann here clearly links NPV from the deal (small but positive by my estimates at EUR4.3-6.5bn, with some other analysts getting their estimates out to EUR8bn or roughly 25% of the original Promo Notes issuance or 30% of the remaining outstanding amounts) to the issue of whether the deal is legitimate.]

"I’m not passing a legal judgment on a particular transaction, but I think it is clear from what I said that I’m very concerned about monetary policy being too closely intertwined with fiscal policy and crossing the line to monetary financing. That’s why I was very skeptical about some of the decisions in the past, and you can be sure that I apply the same benchmark to this transaction.

"Once you cross a certain line, setting a precedent, it’s very difficult to come back and argue against the next similar transaction. That’s why it is important to define our mandate narrowly, so we’re not drawn into fiscal policy matters. There is a reputational issue, there’s a credibility issue. It might make it more difficult to focus on our main objective credibly. If governments had wanted to provide additional funding to Ireland, they could have tapped the ESM.

"We took note of this issue in the Governing Council. Our deliberations aren’t public. Apart from that, the transaction is out there, it’s known, it’s very transparent. Everybody has his own judgment on this -- I have mine.

"The transaction as such is technically a bit complex but it has a fiscal nature as stated by the Irish government. That’s clear enough." [Oh, here we come: Irish Government and senior Ministers have gone out talking about the 'social' dividend on the deal 'savings' etc. This might just bite the Government back. Rhetoric about Government spending (in any way) at least a share of the deal short-term cash flow savings will clearly signal that the Irish Government has pulled ECB into monetary financing and thus opens up the whole affair of the deal to legal challenge in Germany. As they used to say in WWII: 'Loose Lips Sink Ships'... care to listen, Minister Howlin?]

4/9/2012: Six Key Facts About Irish Government Spending: August 2012

In the previous post I looked at the receipts side of the Exchequer returns for January-August 2012. Now, let's take a quick tour through the expenditure side.

In January-August 2012, the Government total Net Voted Expenditure stood at €29,593 million or €244 million (0.8%) above the same period of 2011. In other words, the Government is spending more in 2012 than it spent in 2011 on the expenditure side that it actually controls. In July 2012, the overrun was €138 million or 0.5%.

Fact 1: things are getting worse month on month, not better, on the spending side

Fact 2: things are getting worse year on year, not better, on the spending side

Current Net Voted Expenditure rose €444 million (+1.8%) y/y in January-July 2012 compared to same period of 2011. In August, this figure went up to €659 million (+2.4%).

Fact 3: the core driver for rising Government spending is Current Expenditure, and the increases in spending in this area are getting worse, not better, with time. 

On the total expenditure side, the Government is now exceeding its target for 2012 (these are revised targets published in May, so the overruns are compared for just 4 months running) by 1.1%, and on current expenditure side these overruns are at 1.6%. In July 2012 the same figures were +0.8% and +1.3% respectively.

Fact 4: even by revised targets the Government is already behind its set objectives, just 4 months into running and the set-back is accelerating month to month.

In July 2012, five departments exceeded their targets on current expenditure side, including (as expected) Health (+1.0%) and Social Protection (+4.4%). In August 2012, six departments were in breach of their targets on current spending, with Health performance deteriorating (+1.5%) while Social Protection performance showing shallower miss on target (+4.2%).

Fact 5: More departments are slipping into underperformance relative to target in August than in July.

In August, five departments posted increases y/y in Current Net Voted Expenditure, in July there were seven departments in the same position.

Fact 6: year on year cuts in spending in smaller departments are not sufficient to offset increases in spending in larger departments. 

Capital expenditure has fallen €415 million (down 20.9%) y/y and is now €120 million (7.1%) below the target. In an ironic twist, these 'savings' will be totally undone through the Government capital expenditure boost once privatization process gets underway. 

However, annual estimates assume 13.4% or €562 million reduction in capital spending. With 74% of thse already delivered on, it is hard to see how the Government can extract more savings from this side of the balancesheet to plug the widening gap on the current expenditure side.

To summarise, therefore, the Irish Government continues to increase, not decrease the overall Exchequer expenditure year on year and is now behind its own targets. 

Neither the receipts side of the fiscal equation, nor the expenditure side are holding.