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 recent pre-budget statement that Ireland is still vulnerable and warned against extra budget spending. Specifically it outlined that “it would be conducive to prudent economic and budgetary management for Budget 2018 to stick to existing spending and tax plans within the available gross fiscal space for 2018 of around €1.7 billion”. Basically, the council is warning the Government not to lose the run of itself.

But the reality of the present economic situation is much more complicated than just a question of balancing the books and sticking to plans. The housing crisis is no doubt one of the major challenges for the present government and it needs to be tackled immediately and that means a significant increase in spending on infrastructure. The allocation of capital expenditure per annum for transport has declined dramatically since the height of the boom from 2.5 billion in 2008 to 900 million in 2017. The fall in capital expenditure per annum for transport has been substantial from about 655 euros per citizen in 2008 to 187 euros per citizen in 2016. A similar pattern is evident in the area of housing, planning, community and local government. We have chopped our spending on expenditure in these areas for almost a decade. And during this time, the Irish population has increased substantially. The fiscal council are warning against spending, but the reality is we should be spending on infrastructure and housing. This is one of the most pressing needs of our generation.

But, increasing capital spending at this time is a problematic conundrum for fiscal policy. The economy is surging and even showing signs of overheating. Increasing spending will add fuel to an already burning fire. But we must do this, if we are to solve the housing crisis. And, this is the ultimate political challenge because, in turn, if the Government want to exhibit sound and prudent governance at this time – they must increase taxes. But, all the comments coming from the Department of the Taoiseach are the opposite. Taoiseach Varadkar has recently announced his willingness to freeze property taxes and earlier in the year voiced an interest to actually cut income taxes. Doing anything of the sort at this time, would be pro-cyclical and to put it mildly, would represent poor governance.

Keynes concluded in his famous work on the ‘General Theory of Employment, Interest and Money’ that “Soon or late, it is ideas, not vested interests, which are dangerous for good or evil”. However, in this case, it is the interests of political survival, not ideas, which are putting our economic system at risk of instability. We need to move away from this unsustainable political mantra of consistent under spend and under collect tax model. It puts the stability of the economic system in jeopardy. Further, it disables the ability of Government to tackle crucial problems in society like providing young people with the opportunity to own a home, whilst also ensuring prudent responses to changing business cycles. The time of political parties would be better spent building trust with the public that their taxes are being spent appropriately and efficiently, than being caught up in a people-pleasing trap of promising to spend more on us by collecting less tax from us. It actually makes the average citizen worse off.