OPINION:The so-called "boom years" were largely illusory, fuelled by an explosion in credit, writes COLM KEENA.
THE BURSTING of the property bubble has brought into sharp focus the mismanagement of the economy and the public finances over recent years by the Government.
However, a point that has arguably not received as much attention as it deserves is the extent to which government spending in the boom years was funded by borrowing from abroad, borrowing which must now be repaid as the State enters a sustained economic slump.
Many argue that now is the time for proposals for solving the crisis the State is in, rather than hindsight analyses and the attribution of blame. But an understanding of how the problem became so acute in the first place can be an essential tool when trying to plot a strategy for recovery. In particular, supporters of the low-tax policies of recent years who point to the growth and employment levels achieved during that period may in fact be making claims that do not stand up to scrutiny. The good old days they sometimes refer to were never as good as they were presented.
Foreign borrowing by Irish banks jumped massively during the period 2003 to 2008. As outlined in Patrick Honohan’s paper, Resolving Ireland’s Banking Crisis, presented to a conference in UCD in January, net indebtedness of Irish banks to the rest of the world was 10 per cent of Gross Domestic Product in 2003. By early 2008 it had jumped to just more than 60 per cent.
Naturally, the size of the banks grew at what should have been an alarming rate. The size of the Bank of Ireland, for example, went from €100 billion to €200 billion between 2004 and 2008. Not only did the banks explode in size but the percentage of their assets that constituted property-related lending grew from less than 40 per cent, in 2002, to more than 60 per cent, by 2006. The banks facilitated a domestic property consumption binge, using borrowings from abroad. Our current Taoiseach, Brian Cowen, was minister for finance for much of the period.
As a result of this massive injection of credit, property prices in Ireland continued to soar after the export-led era of growth had come to an end. There was rapid expansion in the size of the construction sector and what many were pointing to as a successful entrepreneurial low-tax economy, was in fact a credit-fuelled bubble economy. This development had an effect on Government revenues, where income from property-related stamp duty, VAT and capital gains tax, grew as a percentage of the overall tax take.
The huge rise in stamp duty receipts from the property area can be viewed in the statistical reports available on the Revenue’s website. In 2002 stamp duty receipts from land and property were €665.8 million. By 2006 the figure was €2.98 billion. Land and property jumped from providing 58 per cent of total stamp duty, to 73 per cent, over the same period. Total tax receipts in 2006 were €45.5 billion.
Capital gains tax rose from €618 million in 2002, to €3 billion in 2006. The Revenue website does not give figures for how much of that tax heading arose from land and property transactions. However, last June John Perry of Fine Gael was told by the Minister for Finance, Brian Lenihan, that the Revenue estimated that 18 per cent of capital gains tax receipts in 2006 came from residential property sales. Commercial property and land sales would come on top of that.
He told Perry that VAT receipts from residential property-related sales were €2.2 billion in 2006, and €2.4 billion in 2007. Again, no figures for land and commercial property VAT receipts were given. The increased activity of the construction sector also, of course, led to increased income tax receipts from that area, representing as it did an increased part of the overall economy during the 2002 to 2008 years.
A key point about this is that a large percentage of the Government’s tax take was from property or construction-related taxes and the people who were paying these taxes were borrowing the money from the banks, who were in turn borrowing the money abroad. The Ahern era pro-cyclical credo, “if you have it, spend it”, is considered a very unwise economic strategy by many economists, but there must be few if any on the globe who advocate a policy of borrowing abroad to pay taxes during a boom era, so you can pay off the borrowings later when you’re in a bust.
The result has been a type of perfect storm with a collapsed property market bringing with it a sharp contraction in the economy and public finances that are badly in the red. Meanwhile the people who took out mortgages and other property-related loans during the boom years are left with their long-terms debts, while also being faced with the likelihood of increased income tax rates.
As well as claiming credit for running a “can do” low-tax entrepreneurial economy, the Government also has a tendency to point out that we have a debt to gross domestic product (GDP) ratio that is low compared to other European economies, putting us in a strong position for weathering the storm in which we now find ourselves.
But this, too, is a bogus claim to some extent. Much of the more wild borrowing by builders, property developers and property speculators that occurred during the boom will most likely never be paid back. Many ordinary mortgage holders will also not be able to pay their debts. The resultant hole in the finances of our banks is a problem that the taxpayer, via the exchequer, looks likely to have to fix. No one has as yet put a figure on this black hole but it will no doubt be huge.
The national debt to GDP ratio has been declining steadily since 1993 and at the end of last year the net figure was €30.1 billion. The ratio reached a low of 25 per cent of GDP at the end of 2007 but rose, in real terms, to 30 per cent at the end of 2008, as a result of the crash in Government receipts. The growth in the ratio over the coming period will be in part due to the property/banking crisis, as private foreign borrowing by the banks gets converted into public foreign borrowing through the State.
Good old days indeed.
Colm Keena is Public Affairs Correspondent. The Revenue’s website is www.Revenue.ie
The Patrick Honohan paper can be accessed at www.tcd.ie/Economics/staff/phonohan/