Excessive tax rises not the answer

 

OPINION:It is important that budget planning is not derailed by overreaction to our problems, writes PATRICK HONOHAN

THE CONTINUED slide in global economic conditions over the past few weeks can make it seem that the magnitude of the Government’s budgetary challenge is ever-shifting, making robust budgetary planning difficult. Do the worsening external conditions change what needs to be done? Should taxes be increased and spending cut even more than we thought a couple of weeks ago? In a word, no.

There can be no doubt that the Government is right to move promptly now to boost permanently the revenue-generating capacity of our tax system.

Spending, too, needs to be pared back, something that should be a lot easier now that consumer prices are falling. Considerable sums are required from both tax and spending to bring our budgetary position back to something that is demonstrably sustainable over time.

These statements were true several months ago, and they remain true now.

What has changed is the urgency of convincing the now-sceptical financial markets that a coherent and sustainable plan is in place.

But it would be a great pity if budget planning were to be reduced – as it has in previous difficult times – simply to a scramble to find sufficiently palatable tax increases and spending cuts to allow the Government to limit borrowing to a certain target for 2009.

For chasing a particular deficit target for the current year is not what should be driving this exercise.

After all, other governments are responding to weakening global demand by increasing their spending, thereby helping offset the effects of the contraction of private demand on their own economies and indirectly on the world at large.

We cannot now do the same thing, because we allowed our tax system to drift over the past decade or so into a condition that does not generate enough revenue in normal times. We have been surfing a wave of boom-time revenue that has suddenly broken. Stamp duties, capital gains tax, corporation profits tax, none of these will ever perform again for us as they did in the past decade. Not only did we ease up on other tax rates and bands, we even ramped-up our spending – especially in the past few years – on the strength of these evanescent receipts. Regardless of the international crisis, this underlying imbalance needs to be corrected.

And the correction needs to be soon, if we are to restore the confidence of foreign lenders. When they see we have adjusted our tax and spending structures to something that makes sense in the medium term, they will stop insisting on the high interest rates which the National Treasury Management Agency has recently had to pay for medium-term borrowing.

Bringing tax and Government spending back to the levels prevailing when the Celtic Tiger was roaring most loudly can hardly be questioned as unduly onerous, even if it does feel like a cold shower. With the world economy in recession, it will still mean a big Government borrowing requirement this year – as indeed is occurring across the world. But raising such funds at a reasonable cost will be much easier if lenders perceive prompt, decisive and thorough return to a sustainable tax and spending structure.

There is, of course, also the question of reassuring the markets that the costs of the banking crisis are under control. Certainly foreign investors are quite confused about the potential scale of the ultimate call that might be made on the taxpayer. Gradually specialist analysts have begun to realise that the total size of the relevant parts of the Irish banking system is much smaller than sometimes reported, that the system is largely free of contamination by complex structured products, and that even pessimistic projections of prospective loan losses seem to imply a quite manageable burden on the taxpayer. Steady, transparent and realistic communication by the authorities and the banks will be needed to convince the market on this aspect. The April budget can have little to contribute here.

Ireland’s challenges are not qualitatively unique. Right across the world, governments are seeing their tax revenues collapse and spending commitments accumulate in the face of the sharp and unexpected decline in global trade triggered by the appalling failures of banking and finance. Any that can manage to do so are accepting the resultant increase in government borrowing and even launching additional spending to help fill the gap in demand and keep people at work. At least 20 countries are also injecting funds into their weakened banking systems to help stabilise lenders with a view to ensuring that the supply of credit is not constrained by inability of banks to lend.

But our excesses of the past few years – the property bubble, the erosion of the tax structure, the unrealistic surge in pay rates – have given us a weaker starting position from which to tackle the crisis. A well-argued and front-loaded return to the kind of sustainable budgetary structure that we enjoyed a mere decade ago will go far in helping to restore our ability to cope with the crisis and to borrow – at reasonable interest rates – the amounts needed to absorb the recession.