Time to raise taxes not cut them
Boosting spending is wrong policy as problem is not demand but supply
Dublin’s city centre has been badly hit because it was geared towards a pre-Covid-19 economy such as entertaining foreign tourists and providing office workers with their lunch and drinks. Photograph: Stephen Collins
Just as giving the wrong medicine can harm a patient, taking the wrong economic measures can worsen the effects of the current recession. Already a growing number of economists, such as Central Bank governor Gabriel Makhlouf, are showing scepticism at government plans to boost consumer spending through measures such as through VAT cuts. Instead, Ireland should raise taxes today, or face paying a higher price tomorrow.
The Irish economy has been hit by its worst natural disaster since the foundation of the State, harming the ability of the economy to supply people with the goods and services they want. Necessary health and safety restrictions have led to bottlenecks and blockages across the economy. Construction workers are slower to build homes as they adopt new work practices; the numbers of passengers our buses can carry has been slashed; and restaurants can only serve a fraction of the customers they previously did. Other services such as wet pubs are completely out of bounds, while the health service is dealing with huge delays in elective surgery. This is in addition to the far greater tragedy of the numbers of people who have died, and the pain suffered by families who could not provide their loved ones a normal funeral.
The Government is planning to increase the amount of money in the economy and boost spending by consumers through VAT cuts, tax rebates for holidays in Ireland, and help-to-buy schemes for houses. However, this is a solution for the wrong diagnosis. We do not face a lack of demand. Boosting spending now is the equivalent of trying to clear a clogged toilet by forcing through more water. This will lead to longer queues (such as for pubs that sell food) and ultimately higher prices and “Covid charges”. If higher prices and inflation become embedded in the economy, they will leave Ireland poorly placed to recover economically when a vaccine or cure for Covid-19 is found. It will make it harder to attract back international tourists and export to foreign markets.
Shortages and restrictions
Instead it would be better to raise taxes today, when shortages and restrictions mean companies find it difficult to support more spending by consumers. Due to the recession, the Government has spent more, while receiving less in tax revenue. It is both necessary and appropriate for the Government to borrow to fund this. However, this will have to be paid for. Waiting until there is a cure for coronavirus will hurt people’s ability to spend just as firms can cope with their demand.
If higher prices and inflation become embedded, they will leave Ireland poorly placed to recover when a vaccine is found
It can be argued that raising taxes would hurt the economy even more. However, in contrast to the recession which followed the 2008 financial crisis, there is no lack of spending power in the Irish economy. Measures such as the pandemic unemployment payment have meant that the spending power of consumers has been largely protected. Central Bank figures show the amount of cash households hold on deposit surged by €5.3 billion from the end of March to the end of June, while deposits of firms increased by €4.5 billion. The problem is not a lack of money, the problem is a lack of somewhere to spend it.
Although Dublin’s city centre has been particularly badly hit, this is because the capital was geared towards a pre-Covid-19 economy such as entertaining foreign tourists and providing office workers with their lunch and after-work drinks. Unfortunately, it is unable to supply domestic tourists with what they expect from Dublin as the summer’s GAA matches, music festivals and conferences have been cancelled. In addition, reduced capacity on public transport makes the city centre less accessible. Tax rebates for holidays will not bring back the roar of the crowd to the Hogan Stand or Hill 16.
Western economies have been hit by an economic supply crisis before, with the oil crises of the 1970s. Then, many governments, such as the Richard Nixon administration in the US, tried to lift flagging economies by boosting demand (such as by cutting interest rates and greater government borrowing). However the problem was not a lack of demand, it was a lack of oil. As a result of policy mistakes, inflation spiralled out of control, while unemployment continued to rise, something referred to as stagflation. This led to the economic crises of the 1970s and 1980s.
Western economies have been hit by an economic supply crisis before with oil in the 1970s
The Government should not do nothing. Instead, efforts should be focused on helping businesses increase their capacity (such as facilitating outdoor eating and drinking), ensuring they will be able to reopen and get back up and running quickly (such as helping cover overheads like insurance and negotiate down rents) and providing retraining to the workers whose jobs, unfortunately, will never return.
When we eventually find the right medicine to cure or vaccinate against coronavirus, it will be a time to celebrate. Then the economy will be able to absorb an increase in spending. That will be the time to boost spending by households.
Rory O’Farrell is a former economist at the OECD