Parties must spell out proposals for cuts and taxes

Political parties will debate a renegotiation of the IMF-EU bailout plan and some tweaks could be significant

WITH THE election looming, it may be useful to look at some economic issues that could form part of the debate over the next month or so.

First, all parties should publish a concise version of their proposals and assumptions; some have published copious amounts, others little or nothing.

The options are more limited than usual given that the shots are being called by the IMF and other lenders, with the result that the broad parameters of fiscal policy are pretty much set in stone and this is accepted by all the main parties.

However, there will be a debate about “renegotiating” the terms and some of the tweaks could be significant.

To me, it seems inevitable that the total package will remain at €15 billion, however, the split of this between higher taxes and spending cuts is open – with huge differences between the parties – and our spending has rocketed (see chart).

Economic theory indicates that spending cuts are less damaging to future economic activity but governments frequently find it easier to resort to higher taxes, as happened in the 1980s with disastrous consequences.

To date, there has been little enough debate on this important matter. However, the arrival of the depleted, January payslips will have focused minds and should prompt a useful debate. Candidates should have a clear position on the implementation of the remainder of the “An Bord Snip Nua” report by Colm McCarthy.

A tax on property has been promised for a few years’ time but there is surprisingly little detail on it. It is reasonable that voters should have a better idea of the size of their likely annual property tax bill when they decide on who to vote for.

The question of fairness needs to be put to bed. It is shocking that the Budget documentation leaves this critical issue to be pronounced upon by the Economic and Social Research Institute (ESRI) in an article in The Irish Timesa few days after the Budget. The result is that many believe that recent budgets discriminated against the less-well-off when the reverse is the case.

Then there is the question of what happens after 2014. The bailout package is designed to reduce the deficit to the old 3 per cent ceiling by 2014. To get to zero, which will surely be necessary in our case, a further €5 billion at least has to be found. It would be interesting to know how the different parties propose to find the extra €5 billion.

There should also be a debate on capital spending. The Budget projections show Government capital spending declining to 3 per cent of GDP by 2014 but this would still see it absorbing €5.5 billion of scarce resources annually. This percentage is close to, but still above, the EU average and well above Germany and the UK.

For example, it would be nice to have a metro in our capital city, but the outgoing Government refused to publish a cost-benefit analysis – so no one knows if it is justified, many suspect that it is not, and the Dublin Port Tunnel is underused.

Already, there is much debate about the interest rate on bailout funds. Generally speaking, the view taken is that an interest rate of close to 6 per cent is (a) penal and (b) unsustainable.

However, this assumes that all government borrowings are at the 6 per cent rate whereas some, eg Post Office savings, are at lower rates. Also, no one has explained how the IMF concluded that our fiscal position was sustainable at the rates agreed in the bailout.

In addition, many do not realise that IMF rates of 3 per cent equate to EU rates almost twice that. The reason is that the IMF rates are variable, like a tracker mortgage, whereas the EU rates are for seven and a half years and similar to a fixed mortgage rate.

If, for example, we decided to fix half of our bailout borrowings and leave the rest floating or fixed for a shorter period, the average rate would fall to around 4¾ per cent, ie equivalent to what we paid in 2009 and 2010 when no one thought borrowing costs were unsustainable. We would, however, be exposed to rising interest rates.

Perhaps the most fundamental issue facing the economy is competitiveness. True, there has been a significant improvement and exports have recovered but there is a long way to go. At end of 2010, the Competitiveness Index was still 10 per cent away from its average between 1995 and 2000, a period when the economy was close to equilibrium.

This gap can be eliminated by a combination of further falls in the euro exchange rate, increased productivity or more wage cuts. There are limits to what a new government can do about this, though further cuts in public sector pay would set a powerful headline.

We may well be headed in this direction anyway given that the Croke Park deal does not seem to be working and the threat of IMF action on public sector pay looms. It would surely help voters if election candidates were to spell out how they would reduce public sector pay if the Croke Park deal fails to deliver – the choice is lower rates of pay or reduced numbers.

The IMF deal made little or no change to the Government’s four year plan and the subsequent Budget. Instead, the focus was on the banks. After two years of procrastination, the banks now have to be capitalised by the end of February. This rushed, arbitrary date makes no sense given that it precedes the new stress tests by the regulator. It also increases the chances of a fire sale of bank assets, ultimately to the detriment of the Irish people. Renegotiating this may be just as important as dealing with the cost of borrowing and one would also expect election candidates to have views on whether Irish banks should be allowed fall under foreign ownership.

Finally, reform of the public service features prominently in the party political programmes, not surprising given what has transpired. Publication of the report of the independent review panel on the Department of Finance would add to the debate on this important matter between now and the election.

Pat McArdle was an adviser to the independent panel reviewing the Department of Finance