Opinion: Ireland's current economic situation, with challenges in infrastructure and housing, means the government must increase spending in next week's budget, but are they prepared to raise taxes to do so?
The end of the Great Moderation
It was the governor of the US Federal Reserve, Ben Bernanke, who declared in 2004 that we were in a time of "the great moderation". The previous year, Nobel Laureate in Economics Robert Lucas told the annual meeting of the American Economic Association that the "central problem of depression-prevention has been solved, for all practical purposes". This idea was also reflected in policy circles with Gordon Brown, the chancellor of the exchequer in the United Kingdom from 1997 to 2007 repeatedly saying that there would be no more "boom and bust".
Consensus was starting to gather that the business cycle of booms and busts was a solved problem. But we now know, following the great global crisis of 2008, that such claims of a great moderation and no more boom and bust were grossly incorrect.
The return of Business Cycle management
Following the 2008 crisis, the famous work of John Maynard Keynes came back to the forefront of economic thought with a bang. He 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.
As the Irish government has no control over monetary policy - this is under the management of the European Central Bank - it means that the area we do have control over, fiscal policy, is even more important in ensuring economic stability.
Basically the Irish Fiscal Advisory Council is warning the government not to lose the run of themselves
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. 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 five percent and the unemployment rate also to be about six percent. In all, this indicates the economy is growing rapidly and we are not far off full employment.
So what advice would our first year student have for those compiling this year’s budget? Well, they would advise the minister for finance to reduce spending and increase taxes. The Irish Fiscal Advisory Council, the body that independently assesses and comments publicly on each budget and stability programme, said in their recent pre-budget statement that Ireland is still vulnerable and warned against extra budget spending. Specifically, the Council 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 themselves.
The need for increased spending
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 one of the major challenges for the present government. It needs to be tackled immediately and this 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 per citizen in 2008 to €187 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 Irish Fiscal Advisory Council are warning against spending, but the reality is we should be spending on infrastructure and housing because is one of the most pressing needs of our generation.
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Increasing capital spending at this time is a conundrum for fiscal policy. The economy is surging and even showing signs of overheating and increasing spending will add fuel to an already burning fire. But we must do this if we are to solve the housing crisis. 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.
However, all the comments coming from the Department of the Taoiseach say otherwise. Leo Varadkar has recently announced his willingness to freeze property taxes and earlier in the year voiced an interest in actually cutting income taxes. Doing anything of the sort at this time would be pro-cyclical and, to put it mildly, would represent poor governance.
Political survival puts our economic system at risk
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. Because this actually makes the average citizen worse off.
The views expressed here are those of the author and do not represent or reflect the views of RTÉ