Taxation and its place in the coming election
The years 1979 and 2002 are very similar in a number of respects, as far as the Irish economy is concerned. Both years were/are watersheds. Let’s hope that what happened to the Irish economy subsequent to 1979 is not to be repeated. It certainly need not be repeated but can we be sure?
In 1979, the economy was just coming off an economic boom, with falling unemployment rates, net immigration, and sharply rising property prices. This was fuelled by an expansionary fiscal policy, and was on the back of buoyant world economy and a benign interest rate outlook, Ireland had just entered the nascent euro system the EMS.
Abruptly, the forces propelling the economy turned off the world economy went into a recession (the second oil crisis), and, faced with rising world interest rates, a spiralling debt and a borrowing requirement that threatened to run out of control, the Government was faced with the need to implement corrective action. There are obviously several parallels with today here the major difference, fortunately, is that we are starting from a better place than we did in 1980 in that the public finances are in balance.
What happened next in 1979 was disastrous, and led to Ireland experiencing a fiscal induced recession, and an economic slump that was unparalleled in any country in the OECD area in the post-war era. In the early 1980s, faced with the need to cut the fiscal deficit the response of Governments of all hues was to raise taxation, rather than cut expenditure the economic orthodoxy then prevailing in Ireland was still Keynesian seeing a cut in expenditure as being potentially deflationary, and therefore ‘harmful’, and not properly crediting the role of taxation as a deflationary force. This realisation, ironically was gradually dawning elsewhere at just the same time with the rise of ‘supply side economics’ in the US and the UK.
The relentless squeezing of the Irish economy in the early 1980s through taxation aimed at curbing the fiscal deficit had the effect of severely damaging the confidence of participators in the Irish economy the most important of which were members of the labour force, who in their thousands voted with their feet in those years by emigrating (some to return later in the 1990s).
By the mid 1980s, with the economy flat on its back, there was only one choice left - to cut expenditure as a proportion of national income and output. This would enable taxes to be cut. However, most importantly of all, it would restore confidence. That action was taken, and the rest is history. The similarities with 1979 have now returned, as they inevitably would some day, to haunt us again. The fiscal engine, following a public expenditure rise of an amazing 20 per cent plus is now set on a course to crash (into deficit) sometime in 2003 and, somewhat worryingly, the tax burden is set to rise this year, for the first time in a long time (on this occasion, achieved fairly invisibly through the, nevertheless still economically damaging, device of a 1 per cent hike in the VAT rate).
Corrective action now will have to be taken. This is not necessarily a bad thing, and there are a few grounds to be optimistic the absolute fiscal position is far, far stronger than it was in 1979; there is a confidence momentum, carrying on from the ‘tiger’ years, and, perhaps most important, there is the hope that Ireland’s economic policymakers have learnt the lessons of the past, and the gloomy years of the 1980s.
That lesson was simple. The way to correct the deficit will be to curb expenditure. The wrong and damaging way to do it will be to raise taxation. A rise in taxation now would undermine confidence at the very moment it needs to be boosted, while a curb in expenditure could be achieved fairly painlessly, especially since the unemployment rate is so low. Governments today, unlike the Governments of the early 1980s, do not have to worry about the jobs impact of public expenditure curbs.
The other good news is that the economic cycle is coinciding quite neatly with the political cycle; on this occasion the new Government of whatever hue it is will have four or five years to implement the needed tough curbs in its early years, and that is opportune.
What parties do following the coming election will be crucial to the next few years. The taxation issue is more important than ever, as they prepare to woo us with their manifestos. |
