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Why we need to increase taxes to ensure economic stability #budget2018

This article first appeared in RTÉ BRAINSTORM here.

In 2003, the 1995 Nobel Prize winner in Economics Robert Lucas, stated at an address of the annual meeting of the American Economic Association that the “central problem of depression-prevention has been solved, for all practical purposes”. Similarly, Governor of the Federal Reserve Ben Bernanke in 2004 declared we were in a time of ‘the great moderation’. Consensus was starting to circulate that the business cycle of booms and busts was a solved problem. This idea was also reflected in policy circles, for instance Gordon Brown, chancellor of the United Kingdom from 1997 to 2007 repeatedly declared that there would be no more ‘boom and bust’. We know now, following the great global crisis of 2008, that such claims of a great moderation and no more boom and bust were grossly incorrect.

The famous work of John Maynard Keynes came back to the forefront of economic thought with a bang, following the 2008 crisis. Keynes was a key advocate of the premise that government intervention is necessary to minimize downturns and promote growth. Governments can control business cycle fluctuations with monetary and fiscal instruments. When the economy is surging ahead like a steam train, the government should put on the brakes to ensure there is not a misallocation of resources. And conversely, it can put on the gas when the economy is struggling to ensure that there is economic and employment stability. The Irish government has no control over monetary policy. This aspect of business cycle intervention is under the management of the European Central Bank. This means that the area we do have control over – fiscal policy - is even more important in ensuring economic stability over the Irish business cycle.

The decisions on fiscal policy are made on budget day. Principally, these decisions relate to how much the government intends to spend in the following year and how much taxes it needs to take in to cover this spending, plus financing our historical debt. Students in first year Economics learn that when the economy is going along nicely, governments should broadly decline spending and increase taxes to effectively put the brakes on. And, when the economy is struggling, the government should use the money they saved in good times to reduce taxes and increase spending, which in turn should propel economic and employment growth. Basically, fiscal policy should be counter-cyclical and thus ensure economic stability. This year, the Irish GDP growth rate is expected to be around 6% and the unemployment rate also to be about 6%. In all, this indicates the economy is growing rapidly and we are not far off full employment. So what advice would a first year student suggest we do in this year’s budget? Well, very simply they would advise you reduce spending and increase taxes. The Irish Fiscal Advisory Council, the body that independently assesses, and comments publicly on each budget and stability programme outlined in their