The TASC letter: Fiscally consolidating what?

Michael Taft10/03/2010

Michael Taft: The TASC letter raised the prospect of ‘restructuring taxation and expenditure in a progressive and expansionary manner’. This begs two questions – what does this mean for fiscal consolidation; and around what level do we fiscally consolidate. The phrase ‘fiscal consolidation’ is used as if it had some final meaning. It doesn’t. It doesn’t assume any level of tax and spend, just a relationship between the two. Everyone knows we have to achieve the latter. But there has been almost no debate about the former.

The Government has indicated the level they want this re-balancing to occur by 2014 – at the lowest level possible. There is a problem, though. By 2014, we will be paying out a higher level of interest on the debt – nearly four times as much as a percentage of GDP over recent historical levels (by 2014, 3.9 percent of GDP will go on interest payments compared to 1 percent pre-recession). There’s not much that can be done about this in the medium-term. So maintaining a low level of taxation has to factor in this rising cost.

The Government intends to maintain revenue levels pretty much where they have always been. Factor in debt servicing and by 2014 taxation levels will be lower still.

Where does that leave the Government’s spending plans? Little short of slash and burn – despite the Finance Minister’s assertion that the budgetary worst is over. Excluding interest payments, the Government intends to cut public spending and investment in real terms by over €5 billion – or nearly 8 percent – between 2010 and 2014.

The Government’s emphasis on public spending cuts (and the general conflating of ‘fiscal consolidation’ with such cuts) can be seen in a new light – not so much to bring public finances under control, but to maintain a low-tax model whereby spending and investment cuts are inevitable.

Progressives in Ireland have generally argued for a higher tax take – to invest in public services, infrastructure, indigenous enterprise, etc. As the saying goes – you can’t have European-level of services or living standards without paying European levels of taxation. So, what is the optimal level of taxation? The ESRI’s John Fitzgerald has put forward a suggestion that deserves discussion:

‘It is essentially a political question as to what level of public services and investment is likely to be “desired” by the public in the next decade. . . .My own preference would be to target a level of expenditure and revenue in the medium term equivalent to 45 per cent of GDP. However, every government has to make its own mind up on this issue. Whatever that target is should inform the composition of the next budget.’

Fitzgerald’s preference is essentially for an EU norm. If this ‘political’ goal were achieved then it would radically transform the fiscal dynamic.

It would certainly mean higher tax levels – on profits, capital, property, wealth and income. It would also mean a profound debate about what kind of taxation system we want. For instance, as the TASC letter points out - in moving towards a European model, this may mean greater emphasis on social insurance to deliver services and social protection that is now delivered through central funds. It may also mean moving towards higher local taxation – where greater accountability and transparency will hopefully translate into greater efficiencies and higher output.

Nor is it a matter of taking a crude slide-rule approach (a 20 percent increase in tax levels translate into a 4 percent increase on the standard rate). Higher, sustainable growth itself creates higher tax revenues. Even Government acknowledges this when it shows, without raising taxes or introducing new ones, current tax revenue (excluding social insurance and local taxes) will increase by 27 percent – all because of growth.

Even slow progress towards EU norms will give us considerably more resources for investment; a 40 percent tax level would provide an additional €6 billion. To reach Fitzgerald’s preference/EU norms would provide an additional €16 billion. I suspect the higher level will not be possible within four years – after all, restructuring takes time. But anywhere on the way will allow a reversal of spending cuts and a platform for investment.

And this is key – for investment itself will invigorate the economy towards even higher levels of output, which in turn will increase tax revenue. This is the virtuous circle of investment, growth, revenue and lower unemployment costs. And this is before we sit down to the hard work of debating a new taxation architecture.

When the Government says TINA (‘there is no alternative’) they are right: there is no alternative if you want to degrade taxation levels and maintain, despite the economic costs, a low-tax model. But if we move towards European norms, breaking free from a failed model that contributed so significantly to our massive economic and social deficits as outlined in the TASC letter – then more alternatives open up.

Posted in: Fiscal policyInvestmentTaxation

Tagged with: fiscal consolidationtaxationinvestment

Michael Taft     @notesonthefront


Michael Taft is an economic analyst and trade unionist. He is author of the Notes of the Front blog and a member of the TASC Economists’ Network.



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