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.

13/9/2014: Irish tax System: Less Balance, More Burden

Remember the booming tax receipts and corporate tax returns? So what is really booming in the Exchequer accounts in Ireland?

Chart above shows that:

1. As proportion of total tax receipts, Income Tax and Levies now account for 42.84% of all tax receipts (data for January-July 2014) against 42.52% in 2013. This is the third highest proportion (in 1987 it reached 43.48% and in 1988 it was 43.62%) on record since 1984.
2. VAT, also predominantly paid by consumers (or households) now accounts for 31.76% of the total, up from 27.34% in 2013.
3. Meanwhile, booming corporate tax receipts accounted for just 9.48% of total tax take in the seven months of 2014, down from 11.30% in 2013. Controlling for timing of taxes, and thus excluding the result for 2014 to-date, 2013 marked the second lowest year for corporation tax receipts since 1995 (the lowest was 2011 at 10.34%). So far, through July, 2014 corporation taxes as a share of total tax paid in the country are at their lowest levels since 1992.

So as Irish media lauds Government efforts to rebuild the Exchequer balancesheet as some sort of a great achievement for the economy, keep it in mind - mortgages arrears, anaemic domestic demand, low household investment, pensions under-provisions, health insurance drop outs, utilities arrears, defaults on car and road taxes, and a myriad of other problems are being made worse by the fact that we have prioritised taxing families as the means for achieving the necessary objective of 'fiscal stability'.

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.

Economics 19/05/2010: Euro rescue and tax burdens

So the Euro has hit 1.219 against the USD last night and has been bouncing erratically throughout today. The markets are flashing red across pretty much entire listings on the back of German 'talking tough' to the speculators. Rumors of Greeks contemplating an exit from the euro are swirling across the forex traders'-frequented blogs. ECB has abandoned all caution and previous policy mandates and is now pumping euros out of FX markets. Sterilizing Europe's economy into a liquidity crisis, before the insolvency crisis is resolved.

In short, there is a clear lack of conviction in the markets about the Euro area plans for more fiscal discipline, as well as a general apprehension about the bans of naked shorts. This is a direct corollary of the 'rescue' package and the political rhetoric that surrounded German Government decision to back the PIIGS - or more aptly BAN-PIIGS - debts. Yesterday, John Cochrane of UofC, my old professor - had a superb analysis of the whole circus (here).

Of course, banning naked shorts for their alleged role in causing market panics is like banning oxygen for its role in causing fires. Short sales positions are about the last bastion of transparency in the murky waters of sovereign finances.

But take a look as to why the entire package of 'fiscal oversight' proposed by the EU has no legs.

First there is an argument to be made that the 'new package' is really 'old news'. In effect it simply front-loads the Stability Programme Updates reporting (currently submitted to Brussels for approval ex post adoption of the budgets). In theory, supplying SPU statements prior to the budget is supposed to provide for (1) time to adjust budgetary positions in response to the Commission criticism; and (2) a chance for 'peer-review' of the budgetary proposals. Apparently, no individual lines of either spending or taxation will be considered, but instead, the headline figures (macro side) will be looked at.

What's wrong with this picture? A lot.

1. Stability & Growth pact already tasks the EU Commission with such oversight and with tools to fine serial abusers. Yet, countries like Greece have been in an obvious violation of the SGP criteria since at least the late 1980s and nothing was done to enforce the existent compliance mechanism. France has been in violation for about 8 out of 11 years of SGP application. Italy - since the foundation of EMU. The list can go on.
2. Peer-review by fellow countries does not work in international policy processes. Look no further than heavily edited (by Member States) 'consultative' documents from the IMF, the OECD, the World Bank and so on. States do not criticise states and there is no real mechanics for ensuring that euro area peer review is going to have any more integrity than the 'business-as-usual' Brussels approach to policy making and analysis.
3. Creation of a formal Eurozone-wide supervisory mechanism will de facto guarantee future bailouts, thus inducing a massive moral hazard on future Governments and fueling risk appetite for the markets. After all, if the budgets are approved collectively, there is at least an implicit collective responsibility when things go wrong. As rightly argued in John Cochrane's article linked above, such a guarantee will be an open invitation to continued unsustainable risk-free lending to the reckless sovereigns from the bond markets.
4. With peer review mechanism having no real power, the power to police deficits will fall with the Commission. Does anyone have any serious belief that the Commission has whereabouts to enforce the restrictions it cannot adhere to itself? After all, the Commission has failed, repeatedly, to clear its own budgets in the past. And very little positive can be said about the Commission historical ability to produce high level macroeconomic policy analysis. Do we need to be reminded of the Lisbon Agenda or the Social Economy or the Knowledge Economy or the latest pie-in-the-sky Agenda 2020?
5. Lacking specific powers to go through the member states' budgets line by line - covering all of the expenditure and revenue measures - the oversight process will simply be out of power to either alter anything in response to adverse findings, or to even understand the nature of and risks involved in each headline budgetary projection.
6. Front loading SPU reporting will do nothing to the Budgetary outcomes, as SPUs, alongside the Budgets are subject to built-in assumptions/expectations. Are we really saying the Commission will be able to tell, for example, Irish Government: 'Boys, you are assuming here economic growth of 4% in year X. That's not going to happen. Revise?' I doubt it.
   

Notice, I am disregarding the longer-term economic side of the proposal. The EU Commission, as well as many peer states in the review process will have a heavily pro-tax Government spending-favoring and economic growth retarding policies. The Commission, alongside many peer member states consistently believe that budgetary / fiscal health is assured when tax revenue equals tax expenditure (roughly speaking). And they believe that more expenditure is a good thing. Thus, the process is likely to be biased heavily in favour of high-tax, high-spend economic development model. Of course, there isn't a country on earth that has been able to deliver such a model while maintaining dynamic economy. Are we settling Europe into a slow decay model that suits declining demographics of the Continent?

Here is the comparative table on tax revenue collected by the various advanced economies in the boom year of 2007. Notice that the countries currently in trouble - the BAN-PIIGS (Belgium, Austria, Netherlands + PIIGS):
What does this analysis tell us?

• Tax revenues as a share of economy is well above average for BAN-PIIGS. So low taxes are not a problem that caused their bankruptcy.
• The structure of taxation - the spread over various tax heads, is pretty much even across various heads, suggesting that over-reliance on a specific tax head is not a cause of excessive deficits.
• The deficits, at least on revenue side, simply could not have been caused by the adverse recessionary shocks.
  

All of this means that the deficits are structural. And that the debt accumulation was not only visible well before the crisis (which of course means that SGP supervision has failed) but was also caused by the expenditure side of the Government balance sheets.

Remember, these figures are from the boom-time 2007! And take a look at Ireland, expressed in GNP terms. The table below is self-explanatory:
So we do live between Boston and Berlin, folks? And we do have exceptionally low tax burden? We really do need more the Brussels-styled fiscal discipline?

Economics 28/12/2009: Irish Earners - amongst highest taxed

Ireland now has some of the highest tax rates in the developed world, and this tax burden shows one of the highest rates of progressivity when it comes to the state dipping into higher earners incomes. Table below illustrates (source here):
Note how dramatic is the tax burden for higher earners in Ireland.

Now, give it a thought. We want to build a 'knowledge' economy. The main input into such an economy is individual skills of the employees. This high skills-intensity of production in the 'knowledge' economy means paying key employees more than in the 'dumb' traditional economy, where physical capital takes up much larger share of total value added. In other words, 'knowledge' economy must compete globally for human capital. The higher the quality of the talent, the greater is the intensity of competition and thus, the more important are the tax rates charged on such labour. Our tax rates simply are inconsistent with such competitiveness.

Funny thing is that most of our media - especially the Irish Times and RTE - keep on banging about the need for creating a vibrant 'knowledge' economy, while at the same time calling for higher taxes on top earners in the private sector.

Given that both papers have absolutely no real economics analysts on board, this contradiction is not surprising - it takes a real economist, with a wide knowledge of economic theory and empirical analysis, to understand the complex nature of productivity and returns to various forms of capital. Ex-banks folks and ex-political correspondents simply won't do here.

Economics 22/11/2009: News Flash - our taxes are already killing FDI

If you missed my today's article in Sunday Times, here is the unedited version below.

Before that, a quick news flash - my source close to DETE has informed me last week that in September-October this year three large multinational companies currently not present in Ireland have told our international investment development agency that they have no interest in locating in Ireland. These statements came after several months of negotiations to attract these companies into Ireland. Significantly, all three indicated that the upper marginal tax rate in Ireland, which inclusive of levies and charges rises to a whooping 56% of individual income was the main reason for them not to locate their European headquarters here, as they deemed this level of tax on executives' earnings to be prohibitive.

As Ireland is facing the prospect of one of its toughest Budgets in history, the debate about what to cut and by how much has firmly displaced all other issues on the news agenda. Different views, arguments and policy proposals abound. Virtually all side one way or the other with the idea that any reduction in public spending will be deflationary in this economic environment. Cut public deficit financing, say proponents of tax-and-spend or borrow-and-spend policies, and you will be cutting consumption, triggering a decline in GDP, and more layoffs.

This argument is not new. Many economists, let alone policy pundits, subscribe to it. But is it really true? If the Irish Government were to reduce public consumption or state wage bill today, will the Irish economy crash?

The debate centres on the question as to how large is the fiscal policy multiplier. To understand it, suppose that the fiscal multiplier is greater than 1, say 1.5. In this case, a €1.00 increase in government purchases raises the aggregate demand for goods and services in the economy by more than one euro, or in example above, by €1.50. If the original euro was borrowed at 5% per annum, then the net return to the economy is 42.9%. Sounds magical? If this indeed were true, economic prosperity for all can be achieved by simply endlessly running ever-rising deficits to finance more and more public spending. Enter SIPTU/ICTU/CPSU programmes for State spending. Clearly something is amiss in this logic.

But forget the theory, perhaps fiscal policy alchemy works in practice?

Well, even in the case of the US – the most thoroughly researched economy in the world - there is confusion as to what exactly deficit financing of public expenditure does in a recession.

In a recent research note Professor Christina Romer, Chair of President Obama’s Council of Economic Advisers, asserted for each $1 spent by the Federal Government in a recession, US economy grows by $1.95. So far so good – borrowing at, say 5% per annum and getting 51.3% return makes sense. So much so, that her own employer – the said Council of Economic Advisers – thought this paper was a grand candidate for publicly justifying President Obama’s stimulus package.

The problem, of course, was that Professor Romer’s estimates did not fully for the fact that the largest part of President Obama’s stimulus came in the form of tax cuts, not spending increases. The former accounted for roughly $66bn of the total spending of $151.4bn in March-August 2009, while conventional public spending accounting for just $30.6bn. The rest of stimulus was taken up by aid to the states ($38.4bn) much of which went to offset earlier local tax increases and Government investment ($16.5bn).

In response to Professor Romer, Professor Robert Barro of Harvard University argued in January 2009 that historically, US fiscal multiplier was very close to 1, suggesting that deficit-financed spending earns no real economic return. And Barro’s findings are echoed by an earlier study by Roberto Perotti of Bocconi University, Italy. Perotti looked at fiscal multipliers for the OECD countries between 1960 and 2001. His main conclusions were that post-1980 there is no evidence of fiscal multipliers being in excess of 1. Over time, with a 5% coupon on a 10-year Government bond, deficit financing for Ireland Inc today, under Perotti’s findings will end up costing our economy at least 62 cents on each euro spent net of any benefits we might receive from growth. Furthermore, Perotti found evidence that government spending stimuli hurt private consumption and investment, whereas tax cuts do not. This suggests that cutting taxes, although not necessarily more productive than a fiscal stimulus in the short run will at the very least be less costly to the economy in the longer term.

So dynamic effects of deficit-financed fiscal stimulus over time do matter. And here lies the crux of our debate: dynamic effects depend on country characteristics. Majority of studies on the matter of fiscal multipliers were carried in the US – a country that hardly resembles Ireland for several reasons. Firstly, it is a large and a relatively closed economy. Secondly, it has independent monetary policy, prints its own currency and has a global market for its bonds. Ireland, in contrast, is a small open economy, with no monetary policy independence, extremely tight and saturated markets for its bonds and with exchange rates that are flexible vis-à-vis its main trading and investment partners (the US, UK and the rest of the non-euro world).

And this brings us to the last point of our tour de force through the world of fiscal multipliers and deficit-financed state spending programmes. To make the most accurate assessment of the potential effects of the public sector cuts proposed for the Budget, we must consider empirical evidence for countries similar to Ireland. A recent (October 2009) study published by the Centre for Economic Policy Research looked at 45 countries (20 high-income and 25 developing), spanning 1960 through 2007. What the authors found confirms the results attained by Romer and Perotti, and paints a picture of just how dangerous the deficit financing myth can be for a country such as Ireland.

For a small open economy, like Ireland, the study found cumulative total fiscal multiplier starts with a negative (yes, a negative) -0.05 effect on economic growth and in the long run (over 6 years) reaches a negative -0.07. In no time does the average cumulative multiplier exceed 0.4%. Now, add to this a realisation that Irish economy operates in the world where the Euro is in a virtual free-float against the Pound Sterling and the US Dollar. The same study estimates that for economies with flexible exchange rates, the impact effect of fiscal stimulus is -0.04 and the cumulative long-run effect is -0.31.

This means that were we to pursue a policy of higher fiscal spending based on deficit financing, as the Men of the Liberty Hall suggest, we would be facing immediate losses of at least between 4-5 cents on each euro of the entire stimulus. Over time – say by around 2013-2015, these losses will accumulate to something in the neighbourhood of 31-40 cents on the euro per annum. And this is before the cost of financing these deficits is factored in.

Even were ICTU/SIPTU were right on our ability to raise funding without any cost to the real economy (although their proposals would imply severe tax hikes for ordinary men and women of this country), Irish economy would still be wasting money if transferring wealth from the so-called rich (aka pretty much everyone with a decent job) to public expenditure.

Love it or hate it, but real world economics simply has no room for our Social Partners’ latest ideas on fiscal management.

Box-out:

At a recent conference, a French colleague asked me if Ireland is a low tax and low public spending economy.

The only way to answer this question is to consider the overall size of the Government expenditure in Irish economy. Back in 2008, Irish Government spending accounted for approximately 48% of our GNP, or one percentage point above the EU average and about half a percentage point above the UK. Forget for a moment that the UK has a functional and a sizeable military.

Focus on 2009 numbers. Due to continued increases in public spending throughout
this year, and to a rapid decline in our GNP, Irish Government spending is likely to account for between 53% and 54% of our domestic economy. In other words, over half of all goods and services supplied in Ireland is being swallowed by the State.

To put this number into perspective, the heaviest taxed economy in Europe in 2008 was Sweden, where the ratio of public spending to domestic economy was just over 53%. Yet, navigating through the recession, Swedes cut their taxes in 2009 as we raised our. Thus, by December 31 this, Ireland will be the holder of the dubious title of the heaviest taxed economy in the EU.

Now, give a thought another fact. Top personal income tax rate in Denmark in 2008 was 59%, in Sweden - 56.4%. In Ireland it is 56% after April 2009 Budget. Thus, we now have the third highest income tax band in Europe.

All of this means that Ireland is heading for a grim Christmas sales season shackled not by low consumer confidence, but by a lack of after-tax disposable income.

Economics 10/11/2009: Our Unique Path to Solvency

Updated: FX outlook (below)

And so two things come to pass in the last few days that will have a significant bearing on Ireland in years to come.

Issue 1: the ECB has firmly set its sight on exiting from money printing business sooner rather than later. Per ECB's statement last week, the bank will close off its 1 year discount window, cutting maturity of the loans available to the banking sector in the euro area from 1 year long term maturity to 3 months traditional maturity. This will mean two things for Irish banks who are the heaviest borrowers from the ECB by all possible measures (see here):

1. Irish banks will face much faster transmission of any rates increases into their cost of borrowing increases;
2. Irish banks will see higher cost of borrowing directly due to them being unable to access 3-12 months maturity instruments outside the interbank lending markets (currently they are collecting a handsome subsidy from the ECB’s discount window by borrowing at rates well below those offered in euribor).

And all of this will mean that our banks will once again see their margins squeezed by the credit markets, implying an even greater incentive for them to go after their paying customers with higher mortgage rates, credit cards rates and banking fees and costs.

Issue 2: earlier this week, the EU produced an estimate that the Union members’ total public debt could reach 100% of GDP by 2014 up from 66% in 2007. Last month, the Commission forecast that EU debt levels will rise to 84% in 2010 and 88.2% in 2011. Now, it says that not only the debt will top 100% of GDP in 2014, but that it will keep on rising after that. And the Commission named the row of culprits most responsible for fiscal debacle: Greece, Ireland, Latvia, Spain and the UK. This is linked to the earlier paper from the Commission that looked at long-term demographic challenges to deficit financing, where Ireland and other countries were presented as basket cases in terms of pensions liabilities and expected healthcare costs associated with ageing population.

This, of course means the following two things for Irish economy:

1. Despite all extension for 2013 deadline for Mr Cowen to deliver SGP-compliant budget for Ireland, the EU is going to put more pressure on Ireland to bring its house in order. Not doing so will risk derailing of stimulus exits and deficits rollbacks by the likes of Italy, followed by Austria, Spain, Portugal and France. This simply cannot be allowed for the fear of undermining euro’s credibility and with it any plans Brussels might have for the tidy earnings from reserve currency seignorage in the future;
2. Brussels will be pushing harder and harder for own tax revenue source – some sort of a unified federal tax – in order to divorce itself from the precarious and uncertain (i.e volatile) sources of state-level revenues.

The net effect of all of this – taxes will go up. To put this into perspective, should the EU allow us the deadline of 2014 to sort out our deficit, this will mean our debt will be up by another €20-22bn and our cumulative interest bill will rise (by the end of 2014) by another €5.5-7bn.

Alternatively, consider the annual bill for this debt – at 4.7-6% per annum (a reasonable range starting from today’s low rates and reaching into rates consistent with ca 1.75-2.0% base ECB rate), the new, shall we call it ‘delay the pain SIPTU’-debt, will cost us every year something to the tune of €940-1,320 million, or just about what Mr Cowen is now promising to shave off the public sector pay bill.

So do the math – accumulation of liabilities (interest only) of up to €1.3bn per annum and political process delivering promises of savings of €1.3bn after two years of the crisis… Path to solvency indeed.


Now, per one reader's request, here is my view on what this means for the euro:

Macro side: unwinding of deficits will mean a steep fall off in Government consumption and investment, so both - short term and longer term demand for euro will fall. This will be offset by the simultaneous unwinding of quantitative easing, so supply of euro will also decline. Three scenarios and paths are possible from there:

1. If the two offset each other, we are down to interest rate differences to drive currency pairs against the euro (more on this below);
2. If monetary tightening will be lagging fiscal constraints, then euro will be heading south vis-a-vis dollar but not by much as it is highly unlikely that Obama Administration will be able to sustain its own deficits for much longer;
3. If monetary tightening leads fiscal tightening, then euro might head further north vis-a-vis the dollar.
4. Interest rates effects are most likely to drive euro up for several reasons: the US Fed is likely to continue easing as fiscal stimulus runs out; the ECB has reputation building (re-building?) to do; US has higher tolerance for inflation.
5. Last issue to watch over is the financial sectors demand for liquidity. Here, the US is more likely to face smaller demand for liquidity than euro area and this will imply a net positive to the dollar upside.
   

So my view is that dollar-euro pair will remain volatile over some time, with some limited upside to the dollar in the medium term. Carry trades in dollar will be continuing especially as the BRICs and the rest of the world launch into a new investment cycle in early 2010. Depending on whether this will coincide with monetary/ fiscal tightening in the euro area, we might see temporary testing of $/€1.65 barrier.

Euro-sterling story is a different story. The UK will be unwinding fiscal stimulus, while continuing monetary easing (banks are still in need of capital and writedowns will remain pronounced), which means we shall see plenty excess supply of sterling. The pressure is to the downside here and parity can be approached once again (remember that 0.98 moment in December 2008?).

Economics 09/10/2009: A small win for free trade?

Per our stockbrokers report this am: government commissioned report from the Tourism Renewal Group stated that Minister Lenihan should repeal the Air Passenger Departure tax because of its damage to the tourism industry.

In what was termed, by the Irish Times editorial a 'Gurdgiev-Ryanair' (Irish Times editorial term) campaign (see here) sane economists and industry participants have waged consistent analysis-based factually grounded argument against the tax-driven protectionist scheme that was conceived to support domestic tourism. The scheme, harking back to the dark age of protectionism was aiming to force more Irish people to stay at home instead of traveling abroad. It did not work. Instead, the numbers of Irish people vacationing at home has continued to decline, while the number of foreign visitors to this country has collapsed - tourism is now down 20% in Ireland, while tourism is down under 10% across Europe. More businesses clawed back on international travel amidst recession. All decisions, on margin, were not helped by a completely gratuitous Departure tax.

The Tourism Minister (I am not sure why even have one) now says that the government “will consider its response within the wider context of fiscal sustainability”.

Bloxham's description of the tax effects: "the domestic tourism industry has been disemboweled by a consumer recession, strong euro and this Monty Python air tax... Someone replaced their brain with an abacus to invent this moronic tax (aping the UK) for an island economy dependent on tourism. It requires an adult to stop it. Instead of considering, fiscalising and consulting the Minister needs about one minute to conclude that this regressive tax, that harms lower income passengers most, deserves the boot. It might even re-ignite services to Irish airports, some of which (Cork ?) appear to have been hit by a neutron bomb (undamaged and pristine buildings, no people)."

One fact: the BAA reports a -5.7% year-to-date decline in volume in September at its seven UK airports, compared to 15% decline in Dublin Airport traffic to August 2009 (here).

'Gurdgiev-Ryanair' campaign check-mate to a ridiculous tax policy? One hopes.

Economics 21/08/2009: Commisions and Taxation

Per Irish Times report today:

"Despite the significant Exchequer deficit the (Commission for Taxation) report does not recommend a rise in income tax rates and says that the combination of taxes and levies mean that anyone earning €75,036 is paying 53 per cent in taxes and levies to the State." You can almost hear the tears dropping from the eyes of the Times staff as higher income tax would be a favourite pet project for the paper.

41 per cent is tax, 4 per cent is PRSI, a further 4 per cent is a health levy and an income levy of 4 per cent. Well, we almost forgot other taxes and rates. All meaning that less than about a 1/3 of Ireland's productive (private sector employed= population supports the entire economy, with some 400,000 overpaid and under-worked public sector employees... Now, Irish Times wouldn't have anything to say about that would it?

A property tax will be introduced which will eventually replace stamp duty and while a new carbon tax on energy has been proposed. Now, what does this mean? We can only speculate, but eventual replacement of stamp duty implies that the two new taxes will coexist. My sources tell me that

• the new property tax will be based on self-assessment, which means it will yield huge rates of tax evasion, will retard even further property resale markets (as under-taxed properties will be held back from the market) and thus will lead to a renewed property crisis over time;
• the new tax will be a double tax with no credit given for recent payments of stamp duty, so in effect, it will be a new additional tax.

You'd wonder if the Irish Times actually cares about these small details.

Well, obviously, another Times pet projects are artists’ exemptions. These should and will be scrapped, so Bono & Co can fully move out of the country. I wonder if that will make them preach less about doing good at the expense opf the ordinary taxpayers. I doubt.

Reliefs on union subscriptions and bin charges will be phased out. Hmmm - wonderful stuff. Union subscriptions relief was an honest admission by the state that it is so deeply in bed with the unions that even a tax amn can't separate the two. Now, let's pretend they no longer are... Does this change the reality of this state doing absolutely everything possible to appease the bearded men of the Liberty Hall? Not a chance.

Another rumoured proposal is a SSIA-type pension for those on lower wages with the State contributing €1 for every €2 saved by employees. Funny thing. Of course it raises two issues:

1. Who will pay for it? You can imagine a family just above the margin threshold for such a subsidy that will have to provide tax payments for this pension scheme and at the same time pay for own pension. Fair?
2. How will we pay for this? Assuming you have to save ca 40% of your income in order to afford a public sector-level of benefits at retirement, how can a country afford paying an additional premium of 40/3=13.3% on lower wages in taxes at the time when we can't afford to cover our current account deficit.
   

This Taxation Commission report is starting to look like a clock made of jello, as PMD like to say...

Economics 16/08/2009: A tax too far?

Here is a nice one from the Sunday Papers. Sunday Times "In Gear" supplement is featuring tow different cars: a Devon Motorworks GTX, 8,354cc V10 650bhp super-car that goes 0-60 in 3.5 sec and costs £300K (pages 4-5) and Mazda MX-5 1,999cc 4-cylinders, 158bhp ordinary bloke/gal car, priced at estimated €37,000 pages 14-15. Guess why am I writing about them?

Well, Devon's in the UK road tax band M, which sets you back £405pa, or €470.06pa, Mazda is in Ireland's rod tax band E, which sets you back €630pa.

Assuming that

• a 'sensible' consumer would tend to purchase a car for about 7-12% of their income;
  
• hold it for 7-10 years;
• sell at the end of the holding period of 50% or 20% of the value, then
  

the following table shows just how close our road tax policy comes to highway robbery:
Yes, you are reading it right -

• a buyer of a small middle class car in Ireland will pay between 1.4 and 2.1 percent of their annual income per annum in road tax;
• a buyer of a large super car in the UK will pay between 0.14 and 0.315 percent of their income in annual road tax.

And I know what you are going to say - the UK is closer to meeting its Kyoto Protocol commitments than we are, and it has better roads than we do.

Where is our National Consumer Agency in all of this? Oh, well, busy counting Government payoffs for staying quiet on the rip-off culture of our public policies...

Finance Bill 2009: Economically-illiterate and jobs-destroying

Finance Bill 2009 published yesterday confirms a simple fact Lenihan and Cowen are hell-bent on pillaging this economy and destroying private growth and wealth.

I will focus on far less-discussed Explanatory Memorandum:

• confirms that "the income levy rates in force in the first four months of the year will apply to redundancy payments made up to 30 April 2009" - so DofF has venally gone after people who lost their jobs and was forced to step back. No worries, they'll get you in some other ways. But this means that the DofF projections for €754mln in 2009 due to be raised out of income levies is now looking more like my predicted (here) €714mln.

How? Well, we had some 384,400-268,600=115,800 people joining the Live Register since November 2008, this is probably ca 80% of those laid off in the period and so the numbers of those getting redundancies since January 1 (there is a lag in redundancy payments for quite a few workers due to cash flow problems in many businesses) are close to the above number. Statutory redundancy is 2 weeks pa, so say on average we have around 4 weeks of pay pa of service, for median salary of the laid off of, say €35,000 pa. Average tenure in the job is 5 years. Redundancy total paid since January is around €1.55bn mark. At 1% foregone levy, flat, that is €15.5mln. Annualized - €46.5mln. Ouch! Yet, it does not stop there - those 115,800 workers aren't going to get a job any time soon, so their income taxes (and levies) are now NIL. Foregone levies? Ouch, €41.5mln odd for the rest of 2009 income... And that is before we get to factor in the Laffer Curve effect of levies on the rest of us...

Yes, Brian, you should have sent Lenihan to Economics 101...

• "Section 5 amends section 97 of the Taxes Consolidation Act 1997 in relation to the extent to which interest on borrowed money used to purchase, improve or repair a rented premises can be deducted in computing the amount of taxable rental income. Where the borrowed money is used to purchase, improve or repair a residential premises, 75% of the interest on the borrowings can now be deducted instead of the normal 100%".

Now, I am not the biggest fan of buy-to-let investors, but... this is absolutely arbitrary. If I invest in a business - to increase that business' earning capacity, I can write it off against my earnings. Well, rental properties are business too. This measure is arbitrary in so far as it applies to a relative penalty to specific businesses. It is also idiotic, for it discourages improvements in properties, or in other words reduces efficiency of the existent housing stock in the country.

Yes, Brian, you should have sent Lenihan and DofF to Economics 101... preferably not taught by Alan Ahearne...

• "Section 6 amends section 644A of the Taxes Consolidation Act 1997 (which deals with the income tax treatment of income arising from dealing in residential development land) by providing for the abolition of the 20% incentive rate of income tax on such income, with effect from the 2009 tax year. From 2009 onwards such income will be taxed under normal income tax rules. The section also inserts a new section 644AA into the Taxes Consolidation Act 1997 [on] certain trading losses arising from a trade of dealing in residential development land where if profits had been earned the profits would have qualified for the 20% incentive rate of income tax. Under normal income tax rules, a loss sustained in a trade may be set ... against the person’s other income. In the case of losses sustained in a trade of dealing in residential development land, ...such losses (sustained in a trade in which if profits had been made would have been taxed at 20%) could be set against the person’s other income taxable at the higher 41% rate. The new section provides that such losses must first be converted into a tax credit, valued at 20% of the loss, and then allows the tax credit to be set sideways in the year the loss is sustained
  against tax payable on the person’s other income."
  

Brian-the-Genghis-Khan of Irish finances is now doing the following: you can earn income and pay a tax of 41%, plus levies, but if in the process you incur a loss, you can only write it off at 20% tax rate. This is patently business retarding. Application of this Zimbabwean-like measure to residential development land is not the point. The point is that the tax charge is more than twice the loss write-off charge. Of course, Zanu-FF will never pass this onto the entire economy - because our MNCs and large domestic vested interests will never allow this to occur, but... drop-by-drop he will start extending this in the next Budget to other parts of business.

But again, an added here is a bonus insight into Brian's economic illiteracy. The banks and corporates are overloaded with bad loans at this time. Much of it is collateralized on or lent on development land. If we were to force the banks to take serious writedowns and to see developers do so as well, why are we introducing a 50% penalty for them to do this? Brian is creating zombie land banks in return for a couple of hundred of euros he might claw back from a handful of forced sales of land. This is (a) going to haunt us for a long period of time, and (b) bodes poorly for the prospect of NAMA not generating the same...

• Finally, where a claim for terminal loss relief (i.e. on the permanent cessation of a trade) has not been made to and received by Revenue before 7 April 2009, the new section restricts the relief so that any part of the terminal loss that relates to a loss sustained, before 1 January 2009, in a trade of dealing in residential development
  land is ‘‘ring-fenced’’ and can only be set against income arising in that trade, or in that part of a trade, in prior years.
  

So no booking of losses after January 1, 2009 on development land. This is a penalty on those going bust in 2009 - a venal act, given that some developers tried their best to stay afloat before then and are now facing back taxes on business losses. Again, not being enamoured with land speculation myself, I just don't think this is a good way of reducing such activity in the future, but rather a way to kick in the sensitive area those who are already down. Well done, Brian.

In contrast, Section 8 allows for a close-off period for nursing homes incentives scheme phase-out. Why not for development land, Brian? After all, what's more toxic and needs to be written off faster and in a more orderly fashion?

In further contrast, here is a fair treatment:

• Section 11 abolishes the effective 20% rate applied to trading profits from dealing in residential development land with effect from 1 January 2009. An accounting period that straddles that date is treated for this purpose as two accounting periods. Profits or gains on dealing in residential development land will now be charged at the general rate of corporation tax that applies to dealing in land, which is 25%.

The only question to be asked here is why on earth did we have this exemption in the first place?

• Section 7 amends section 372AW of the Taxes Consolidation Act 1997 which relates to the Mid-Shannon Corridor Tourism Infrastructure Investment Scheme. One of the conditions of this tax incentive scheme is that the Mid-Shannon Tourism Infrastructure Board must grant approval in principle for investment projects in advance of expenditure being incurred. At present an application for such
  approval in principle must be made within one year of the commencement of the Scheme, i.e. by 31 May 2009. This amendment extends the period during which such applications can be made from one year to two years so that the latest date for the submission of applications is now 31 May 2010. Under the Scheme, the current period within which expenditure must be incurred for capital allowances purposes is the three-year period commencing on 1 June 2008 and ending on 31 May 2011. To cater for any projects that may avail of the new date for the submission of applications for approval in principle, this period is also being extended and will now end on 31 May 2013.
  

So all is fine in the land of wasted resources - Mid-Shannon development incentives scheme is being extended... Typical FF regional subsidies waste before the local elections.


Down to the part where Brian extorts the money out of the ordinary folks:

• Section 9 increases Deposit Interest Retention Tax by two percentage points with effect from 8 April 2009. Section 10 increases the rates of tax applying to life assurance policies and investment funds by two percentage points with effect from 8 April 2009. Section 14 gives effect to the proposal announced in the Budget statement to increase the rate of capital gains tax from 22% to 25% in respect of disposals made from midnight on 7 April 2009. Section 15 confirms the Budget increase in the rate of Mineral Oil Tax on auto-diesel which, when VAT is included, amounts to 5 cent on a litre. Section 16 confirms the Budget increases in the rates of Tobacco Products Tax which, when VAT is included, amount to 25 cent on a packet of 20 cigarettes with pro-rata increases on other tobacco products.
  

• Section 22 provides for an increase in the current non-life insurance levy by 1 per cent to 3 per cent and for a new 1 per cent levy on life assurance policies. The increase in the non-life levy applies to premiums received on or after 1 June 2009 in respect of offers of insurance or notices of renewal of insurance issued by an insurer on or after 8 April 2009. The new levy on life assurance policies applies to premiums received on or after 1 August 2009 in respect of life assurance policies whenever entered into by an insurer.
  

As expected, the issue of legality of these measures didn't phase DofF. I certainly hope insurers are going to take this state to the ECJ and trash these measures as an arbitrary infringement by the state onto the conditions of the private contracts.

• Section 23 gives effect to the proposal announced in the Budget statement to reduce the current tax-free thresholds from \542,544 (Group A — broadly speaking, from parent to child), \54,254 (Group B — broadly speaking, between siblings, from children to parents, from grandparents to grandchildren, and from uncles and aunts to nephews and nieces) and \27,127 (Group C — all cases not covered by Group A and Group B) to \434,000, \43,400 and \21,700 respectively. The section also increases from 22% to 25% the rate of tax in respect of gifts or inheritances taken after midnight on 7 April 2009.

This is clear hand out to the trade unionists - you work all your life, you save and invest, you pass it over to your children and you get milked by the state on assets which were acquired from after-tax income. This is a signal that Brian Lenihan wants to send to us, wealth-creators, and to the rest of the world.

I certainly hope that during his ''road show' selling Ireland Inc, at least one prospective foreign investor stands up and asks him: "Minister, if you can raid your own peoples' wealth in an arbitrary and unilateral fashion such as this, what guarantees can you give us, foreigners, that you will not turn Ireland into a Zimbabwe, where property rights are adhered to only as long as it is convenient for your Government?"

And watch him avoid your gaze...

Daily Economics 23/04/09: That place called Dublin

Irish Wholesale Price Index, March 2009
Available (here) from CSO: "Monthly factory gate prices decreased by 1.0% in March 2009. This compares to a decrease of 1.6% recorded for March 2008. As a result, the annual percentage
change showed an increase of 4.5% in March 2009, compared with an increase of 3.9% in February 2009. In the year there was an increase in the price index for export sales of 5.5% and an increase of 0.9% in respect of the price index for home sales." So we are not gaining any competitive edge on FX devaluations in exports trade, then. And there is no factory-gate deflation at home either.

In the month Office machinery and computers prices fell 2.1%, and Basic chemicals were down -1.1%. Some multinationals are taking a hit. There were increases in Pharmaceuticals and other
chemical products (+13.1%), Other food products (+11.8%), and Basic chemicals (+8.9%). SO some other MNCs are doing ok, although short-run price hikes can come back and bite these manufacturers. Building and Construction All material prices decreased by 2.4% in the
year since March 2008 and by 0.6% in March 2009. Not enough, if you ask me, and this leads to a question concerning the Government plans to achieve expenditure 'savings' on the back of cheaper capital construction costs... Year on year, the price of Capital Goods decreased by 0.6%, while there was a monthly price decrease of 0.3%.

Of course, our heroic boys of CER/ESB/EirGrid-controlled energy sector are turning out more and more price gauging as "Energy products increased by 3.2% in the year since March 2008, while Petroleum fuels decreased by 23.7%. In March 2009, there was a monthly decrease in Energy products of 0.9%, while Petroleum fuels decreased by 3.8%." Well, table below does show this in indisputable terms...
Is it time to fire CER? In my view, long overdue!


UK Budget
Some in Ireland are making 'happy faces' at the UK Budgetary numbers released yesterday. The UK forecasted that the General Government Deficit will reach 12.6% in 2009 - some 1.85% points above the 10.75% GGD built into Irish mini-Budget of April 7. A catch here is that I personally do not believe the Irish figure, having predicted (here) that our GGD will reach 12.5-13.0% this year - right about where the UK is placing its own expectations.

Going on with the misguided cheerleaders, today's Davy note says: "Moreover, gross debt to GDP is set to remain much higher in the UK than in Ireland." Hmmm... that is true only when it comes to direct public debt, excluding such 'trivialities' as financial sector commitments and guarantees (which total $641bn or 280% of our GDP in Ireland and only $375bn or 13.4% of the UK GDP: see here). Oh, yes, of course, some of the moneys on both sides of the Irish Sea is going to count as 'investment' on public balance sheet, but to you, me and the rest of the productive economy there is no difference - we will be paying the price in our taxes, investment or not. And the cheerleaders are forgetting another small point - Ireland's total debt (public and private) is actually much larger than that of the UK (see here, and the chart below - from here).
Now, I know I won't be welcomed by Davy in years to come for pointing this out, but Reality Bites!

Just to be fair, though, Davy also say that "Gross debt is a different matter: recapitalisation funds that need to be borrowed affect this metric. So the projected gross debt ratios will be quite fluid". Yeah, so fluid that we'll need buckets, not shovels to get that NAMA mess under control. UK liability under banks recaps is likely to be ca 10% of their overall guarantees commitments - taking into account the already substantial paydown of funds and the maturity of the downturn over there. So take it to be $37.5bn. Ireland's commitments are going to be around the same percentage share, or $64.1bn, of which only $9.8bn has been paid down so far. In the mean time, Ireland's benchmark yields on Gov bonds are in 420bps territory, UK's - 237bps. Shhhh... don't say it out loud, but it does look like Ireland's advantageous debt position, relative to the UK, is a quagmire. And no, this stuff is not simply 'academic'. Financing our 'low debt' position will cost us €1.83bn in interest expenditures pa. Financing the UK's 'perilous borrowings' will cost them €635mln per annum. Doughhhhh, as Homer would say it, all is grand in the Davy-world of voodoo economics...


Regional subsidies
Yesterday, ESRI published an interesting article: Who is paying for regional balance in Ireland? (available here). It is a worthy quick read if only for one reason - after hearing continuously the whingeing that passes for regional economic policy in this country and the anti-Dublin biases out in the country-side, the article puts few facts straight.

"...real resource transfers per head of population (i.e., the per capita excess of expenditure over revenue), have increased over time. In other words, redistribution across regions has increased over time. These transfers tend to flow from richer to poorer areas – a large negative correlation between the implied transfer of resources and real per capita gross value added. ...Expenditure is positively correlated with real per capita output (Gross Value Added), but tax revenue is even more strongly correlated with real per capita output, implying that the fiscal system operates to transfer resources from richer to poor regions."

Put in real (as opposed to ESRI's) terms, this means that few productive parts of the country are subsidising numerous less productive ones. Is this a good thing? Well, no.

• First, such subsidies distort returns to personal capital (physical and human) of those who receive them. In other words, people living in the parts of the country that are the 'gateways to excellence' are ripping off their productive compatriots while being deluded into believing their work actually adds value. It does not, at least not in a competitive way.
  
• Second, the transfers diminish the productive capacity of those who live where real jobs are located.
  
• Third, the subsidies continue to perpetuate the already extensive destruction of the country-side as extensive means of production are being subsidised over intensive economy.

"Overall, Dublin and the South-West region are substantial net contributors. For example, in 2004 both Dublin and the South-West contributed just over €2,000 per person while in the same year the Midlands region received a transfer of just over €3,000 per person." This is nice. As a person living in Dublin, I am apparently sending some €6,000 of my family income to the Midlands. This means that my 1,100sq ft Dublin city household is paying for some folks living in average 2,000 sq ft houses in the middle of nowhere. But should I choose to avail of the landscape and natural amenities that my money is paying for out there, I just might get a shovel-pat on my back from the subsidies-receiving locals. Hmmm...

"In 2004 just over €3 billion were transferred from the ‘net surplus regions’ Dublin, South-West and Mid-West to the other regions. Overall the tax burden (including social contributions) averages at €11,000 per person in 2004 with a high for Dublin of almost €14,000 per person and a low of €8,500 per person in the Midlands." Yes, this does account for those Midlands inhabitants working in Dublin too, so no arguments about 'We work in Dublin, so we are productive too' apply.

"In per capita terms ...Dublin is not favoured when it comes to capital expenditure. Indeed no clear pattern of ‘excess’ per capita capital expenditure can be detected in the data." In other words, we are building capital infrastructure stuff in the middle of nowhere.

But ESRI would not be itself if there was no voodoo of socialist economic dogma in the article somewhere. This comes at the end: "The finding that the system provides a significant degree of regional equity is largely the result of the centralised nature of revenue collection in
conjunction with the aim to provide similar levels of service across the full range of government activities in all regions. In order to achieve a similar level of equity with a less centralised system would require a more sophisticated system of fiscal equalisation payments across regions. Thus, while many have argued that the Irish system is too centralised this centrality turns out to be an asset in terms of achieving regional equity."

Run this by me again, please! 'Equity' apparently happens when younger and more productive workers of Dublin and South-West are paying older and less productive workers in the rest of the country? 'Equity' also means that we must achieve 'fiscal equalisation payments across regions'. This is the same economic illiteracy that argues that Sub-Saharan Africa can achieve growth by taxing the developed world.

One thing that was lacking in this paper, and indeed is lacking in overall research on regional transfers is how much more dependent on subsidies are specific areas. One that comes to mind is the area covered by the patchwork of various Gaelic ethnic enclaves sponsored by the Government. Another one - the patchwork of useless 'gateways' we have created across the country.

Yes, folks, ther eason we are forced to accept gang crime in Limerick and parts of Dublin, roads gridlock in the capital, lack of proper public transport, poor broadband services, horrific quality of landline phone services, overstretched schools and universities infrastructure in Dublin and the rest of the mess we call urban living in the Capital City is because we want 'equity' and 'equality' between those parts of the country that work and those that collect subsidies. Regional policy indeed...

Mini-Budget 2009: A 'Fail' Grade

To summarize, mini-Budget failed to deliver the substantial public expenditure savings promised. As a result of destroying private wealth and failing to cut public sector waste, instead of reducing the Gen Government Deficit to 10.75% of GDP as claimed in the Budget (Table 5), Minister Lenihan has left a Deficit of -12.5% to -13.0% of GDP in 2009. Details below.

The mini-Budget 2009 Part 1 is in and the Government has done exactly what I've expected it to do - soaked the 'rich'. This time around, the 'rich' are no longer those with incomes in excess of €100K pa, but those with a pay of €30K pa. We are now in the 1980s economic management mode, full stop.

Microeconomic Impact: Households

• The heaviest hit are the ordinary income earners and savers: Income levies up, thresholds down. Impact: reduce incentives for work at the lower end of wage spectrum and generate more unemployment through adverse consumption and investment effects. Before this budget, it would have taken a person on welfare living in Dublin ca €35-37,000 in annual pre-tax wages to induce a move into job market. Now, the figure has risen to over €40,000. PRSI ceiling is up a whooping 44.2% to €75K pa. This is jobs creation Lenihan-style;
• DIRT is up from 23% to 25% and levies on non-life and life insurance are up. CGT and CAT are up from 22% to 25%. The CGT is a tax stripping off the savers/investors protection against past inflation, so Mr Lenihan is simply clawing back what was left to the investors after his predecessors generated a rampant inflation. This is savings and investment incentives Lenihan-style;
• Mortgage interest relief is cut and will be eliminated going forward (Budget 2010) - I hope people in negative equity losing their jobs will simply send their mortgage bills to Mr Lenihan. Let him pay it;
  
• Interest reliefs on investment properties and land development are down. The rich folks who bought a small apartment to rent it out in place of their pension (yes, those filthy-rich Celtic Tiger cubs who saved and worked hard to afford such 'luxury' as a pension investment) are getting Lenihan-styled treatment too.These measures, adopted amidst a wholesale collapse in the housing sector, are equivalent to applying heavy blood-letting to a patient with already dangerously low blood pressure.

Microeconomic Impact: Businesses

• Providing no measures to support jobs creation or entrepreneurship, Lenihan managed to mention only his Government's already discredited programme for 'knowledge and green' economy creation from December 2008 as a road map for what the Government intends to do to stimulate growth;
• No banks measures announced or budgeted for, implying that an expected budgetary cost of ca €4-5bn in 2009 due to potential demand for new banks funds is simply not factored into our expenditures. Neither are there any costings or provisions for the 'bad' bank;
• No credit finance resolutions, PRSI cuts for employers, minimum wage reductions etc;
• CAT and CGT taxes up, income of consumers down, insurance levies up... Lenihan-styled treatment for business support is so dramatic that it is clear we have a Government that only knows how to introduce pro-business and pro-growth policies for their own cronies.

Microeconomic Impact: Public Sector
The only clear winners in the Budget were public sector workers. They face no unemployment prospect, no imposition of any new levies or charges, no cuts in salaries or indeed no changes to their atavistic, inherently unproductive, working practices.

Yet, they can retire earlier with a tax-free lumps sum guaranteed. And no actuarial reduction for shorter work-life, implying that the cost of the Rolls-Royce pensions to all of us has just risen by a factor of at least 1/3! Happy times skinning the taxpayers to pay the fat cats of the public sector elites? Lenihan-styled sharing of pain.

Pat McArdle of the Ulster Bank in an excellent late-night note on the Budget said: "Our main quibble with the Budget is with the split of the burden between tax and spending. ...contrary to the recommendation of practically every economist in the country, they opted for a 55% to 45% split in favour of taxes".

This is correct. On the morning of the Budget day, Mr Lenihan told the nation that not a single economic adviser was suggesting that the Budget impact should fall onto expenditure side. Clearly, he was either incapable of listening or simpy arrogantly ignorant.

Adding insult to the injury, Lenihan also ensured that majority of cuts were to befall the already heavily hit middle classes. Microecnomically speaking, Minister Lenihan has just dug the private sector grave a few feet deeper. It was at 6ft before he walked into the Dail chamber. It was at 10ft once he finished his speech.

Macroeconomic Impact: When Figures Don't Add Up
In Macroeconomic terms, we are no longer living in Ireland. We are living in Cuba where numbers are fudged, forecasts are semi-transparent and the state knows better than the workers as to what we deserve to keep in terms of the fruits of our labour. Mr Lenihan has torn up any sort of social contract that could have existed between the vast majority of Irish people and this Government.

All data is from DofF Macroeconomic & Fiscal Framework 2009-2013 document.
More realistic assessment of the GDP collapse in 2009 is being met with a relatively optimistic assumption that GDP contraction will be only 2.9% in 2010. Even more lunatic is the assumption that Ireland will return to a trend growth of ca 4% in 2012-2013. So my assumptions are: -8-8.5% fall in GDP in 2009, -3.5-4% fall in 2010, +1% growth in 2011, +2% in 2012 and +2.2% in 2013. This will be reflected in my estimate of the balance sheet below.

Another thing clearly not understood by the Government is the relationship between income, excise and import duties. Imagine a person putting together a party for few friends. She had before the Budget €100 to spend on, say, booze. Now she has €90. Her VAT, excise, import duties on €100 of spend would have been ca €66. Now she goes off to Northern Ireland with her €90. Does the Government lose €66? No. It also looses other (complimentary) goods shopping revenue. Say that the cost of party-related goods is €250 worth of purchases at 21% VAT, 10% duties. Total cost of a €10 generated by Lenihan in income tax levies is a loss of over €140 in revenue. Good job, Brian. Your overpaid economic policy advisers couldn't see this coming?

Notice investment figures in the table above? Other sources of GDP growth? Well, DofF did apply a haircut on its projections in January 2009 update, but these corrections are seriously optimistic on 2011-2013 tail of the estimates. This again warrants more conservative estimates.
Judging by the inflation figures estimates, the DofF believes that the era of today's low interest rates is simply a permanent feature of the next 5-year horizon. Again, this is too optimistic and should it change will imply much deeper economic slowdown in 2010-2013 period.

Now to the estimates Table below summarizes the estimated impact of the measures.
Per DofF estimates, the Exchequer deficit drops, post mini-Budget-1, by ca €2.7bn in 2009 or 2% of GDP. This is rather optimistic. In reality, this estimation is done on a simple linear basis, assuming no further deterioration in receipts and a linear 1-to-1 response in tax revenue to tax measures. This also assumes the macro-fundamentals as outlined in the Table 2 discussed earlier.

Now, building in some of my outlook on the budget side and GDP growth side, Table below reproduces DofF Table 5 and adds two scenarios (with assumptions listed): From the above table, we compute the General Government Deficit (the figure that is the main benchmark for fiscal performance) as in the following Table:
This speaks volumes. The Government promised in January 2009 the EU Commission to deliver 9.5% deficit in 2009. It has subsequently reneged on this commitment, producing an estimated Gen Gov Deficit of 10.75% today. However, stress-testing the DofF often unrealistic assumptions provides for the potential deficit of 12.5-13.0% for this year.

But there is a tricky question to be asked. Has Lenihan actually gone too far on the tax increases side? Note that the estimated gross impact of the overall budgetary measures is €3.3bn for the remaining 8 months of 2009, implying an annual effect of €4.95bn in fiscal re-balancing. This is ca 2.9% of GDP - a sizable chunk of the economy. From that figure, per Table 5 above, the implied net loss to the economy from the Government measure (estimated originally at -1% of GDP) should be closer to 1.5-1.7%. This in turn implies that instead of an 7.7% contraction in GDP, the DofF should have been using a 9.2-9.4% contraction. In today's note, Ulster Bank economics team provides a revised estimate of GDP fall for 2009 at 9.5% for exactly this reason.
Mr Lenihan and his advisers simply missed the point that if you take money out of people's pockets, you are cutting growth in the economy. Of course, our Ministers, their senior civil servants and advisers would not be expected to know this, given they lead such sheltered life of privilege.

If the above estimates were to reflect this adjustment, we have: 2009 GDP of €168.2bn;General Government Deficit of 11% for DofF estimates, and 12.7-13.25% for my scenarios. I will do more detailed analysis for 2010-2013 horizon in a separate post, but it is now clear that the Government has not achieved its main objective of an orderly fiscal consolidation to 9.25% deficit. Neither has it achieved an objective of supporting the economy through the downturn.

Conclusions
Today's Budget delivered a nuclear strike to the heart of the private sector economy in Ireland. It furthermore underscored the Government commitment to providing jobs and pay protection for public sector workers regardless of the cost to the rest of this economy. We are in the 1980s scenario facing years of run-away, unsustainably high public spending and no improvements in public sector productivity amidst severe contraction in demand and investment at home and from abroad.

Minister Lenihan has promised to go on a road show selling Ireland Inc. I wish him good luck and I wish his audiences a keen eye to see through the fog of demagoguery this Government has produced in place of sensible economic policies. If they do, their response to Mr Lenihan's approaches is likely to be "Thank you, Minister. We don't need to invest in the economy that taxes producers, savers and consumers to protect public sector waste. Thank you and good by."
From an investment case point of view - they will be right.

PS: As the first fall-out from the Budget, Moody's downgraded Irish banks (here)... More to come.