Where to now for austerity?

As silly season gives way to budget season, Irish citizens and politicians alike are confronted with the depressing reality that not much has changed since they last checked: the economy is flatlined, unemployment remains stubbornly high, and the government is still borrowing more than a billion euro per month.

When Francois Hollande was elected President of France in May, a Gallic counterweight to German intransigence promised an alternative to austerity in Europe. Growth seemed to be very much on the agenda.

This spring-time optimism has given way to the cold, hard reality of Autumn. Measures to stimulate economic growth have been welcome, but in short supply. The Eurozone economy is mired in recession. Europe’s core and periphery alike will get little respite from the painful process of reducing budget deficits, even as economies shrink. More than ever, the growth agenda needs to be front and centre.

Ireland can’t yet borrow sustainably on the markets. We remain dependent on the kindness of strangers – and those strangers are calling the shots. As such, Ireland is faced with little alternative but to continue meeting its headline targets. Even a significant deal on the bank debt burden would do little to alter the budget arithmetic.

To bring the budget deficit below 3% by 2015, Ireland has committed to a further  8.6bn in tax hikes and spending cuts over the next three years:  3.5bn in 2013,  3.1bn in 2014 and  2bn in 2015. This might suggest that budgets will get easier, but this is not the case for three reasons:  1) these amounts are premised on a return to relatively robust growth in the later years; 2) the ‘easy’ options, such as cutting capital spending, have been largely exhausted; 3) having cut day-to-day spending by  1.45bn in 2012, this will be ramped up to  1.7bn in 2013 and  1.9bn in 2014.

While the headline targets are set in stone by the EU authorities, how they are achieved is subject to domestic political negotiation. The balance between tax and spending measures, and their specific design, is largely a matter for the Irish government.

Budgets are about choices. There are always alternatives. When trying to bring down the deficit in a low growth environment, however, the choice is often between the disastrous and the unpalatable. The government is hamstrung by a ‘troika’ of political promises: no hikes in income tax, no cuts in basic welfare rates, and no cuts to public sector pay. Quite simply, the numbers don’t add up, and promises will be broken.

The negative social and economic impact of deficit reduction cannot be eliminated, but it can be minimized. Cuts in basic welfare rates not only hit the poorest hardest, they suck the most out of the economy because those who have least spend more of their income. Cutting capital expenditure, often the easiest political option, can undermine the economy’s productive capacity in the long term, hitting growth and jobs. Cuts in public sector pay will mean reduced tax revenue and increased industrial strife.

Nobody likes paying taxes, and nobody likes seeing their tax bill increase. Most controversial of all, however, are new taxes that haven’t been charged before. This is one of the core challenges at the heart of introducing a broad-based property tax.

What Ireland really needs is a ‘solidarity wealth tax’ along the French model.  This would help retain social solidarity and restrain the negative impact on domestic demand. Net wealth above a certain threshold, perhaps  1m, including both property and financial wealth, would be taxed at a low rate of less than 1%. As in France, the rate would increase with wealth. Loans are subtracted from the total, thereby avoiding the problem of taxing negative equity.

It would be dishonest to suggest that soaking the rich will solve all of Ireland’s fiscal problems, but there is certainly an argument to be made for starting at the top and working down.

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