We all have to share the burden of adjustment

WHAT IS TO BE DONE?The key foundations for economic recovery are a shared understanding of the problems and an equitable distribution of the pain necessary to reverse our fortunes

IRELAND’S GDP has already dropped by 9 per cent, bringing us back to the 2005 income level. That’s still a national income that is about a quarter higher in real terms than in 2000.

However, to date, the costs of the economic crisis have been very unevenly shared in Ireland, the only losers being people who have lost their jobs or who have seen their investments wiped out. With falling prices many of those who still have jobs are actually marginally better off than in 2007. The first step to recovery will be the acceptance that, while the ordinary citizen may not have caused the crisis, we all have to share the burden of adjustment, with those on higher incomes doing most.

A world economic recovery will help lift Ireland’s economy. To maximise its impact on Ireland and to produce a sustainable recovery we must also restore our competitiveness and plug the huge hole in the public finances. With appropriate policies a full recovery may take five years, but it could take much longer if we avoid the hard decisions.

Some positive signs have emerged from the partnership talks that there is increasing acceptance of what needs to be done. There is acknowledgement that the costs of the recovery plan must be seen to be fairly borne.

Fairness requires that those on higher incomes must pay substantially more. The most effective mechanism to achieve this fairer distribution of pain is through the tax and welfare code. People on higher incomes in the public and government-supported sectors (such as the banks) must take a larger-than-average cut. Professional fees, such as those of medical consultants and lawyers, must also fall.

No economic recovery is possible unless and until the world economy turns the corner. However, to restore full employment as fast as possible there will have to be a major improvement in competitiveness.

In 2000, the last time we had a major unanticipated change in prices, the national agreement was adjusted to reflect it. In the coming year, with an unanticipated substantial fall in prices, it is appropriate that pay norms should again be reconsidered. A cut in nominal pay rates can help restore competitiveness, with some of the cut being cushioned by the expected fall in prices of the order of at least 3 per cent. In much of the private sector, wages are already being cut to help maintain jobs. A matching cut in public sector labour costs, of at least 5 per cent, needs to happen.

The task facing the Government is to hold the deficit at or below 10 per cent of GDP in 2009. Because of poor growth prospects tough action will be needed again in 2010 merely to maintain the deficit at close to this level. However, once world growth returns, the deficit will begin to fall through natural buoyancy. While this buoyancy will be nowhere near enough to avoid further tough medicine between 2011 and 2013, the Department of Finance may be underestimating the extent to which a world economic recovery will improve the public finances.

The Irish public sector stands out from its EU counterparts in having below average current expenditure on public services, a dramatically lower tax take and higher capital expenditure. In order to maintain services such as education and health, we will have to close the gap in our public finances, mainly by raising our tax take, which had been artificially lowered through reliance on revenue from property.

In the short-term, there is an urgent need to cut public spending, with a cut in public sector wage rates, whatever the mechanism, playing the biggest part, while preserving key services and jobs. The OECD said that the size of our public service is not out of line, but they pointed to areas where significant efficiency savings were possible. For example, some reduction in the size of the public sector can be achieved through the sharing of back-office functions.

There should also be some reduction in provision for the national development plan (NDP) as some projects are delayed reflecting a reduction in urgency consequent on the recession. For 2010 and later years there should be substantial savings in the cost of the NDP due to the falling price of projects through lower land prices, lower tender prices and lower professional fees. It is essential that the price the State pays for land fully reflects the true price it could fetch on the open market, which will be a fraction of its historic value.

There is no scope for the Government to increase State aids to business. Rather, the Government must ensure that the EU acts to prevent other governments extending their state aids uncompetitively.

In raising taxes the Government will need to ensure that those on high incomes pay more and that the impact on the labour market is minimised. As suggested by Ictu, in the interests of equity the top rate of tax should be gradually raised to 48 per cent.

This will not be enough – the tax base will need to be broadened and more middle income earners will also need to be brought into the tax net. This could be done by reducing tax credits and bands or taxing child benefit. A carbon tax and user charges for services should be introduced as they have environmental benefits and very limited effects on incentives to work. The Commission on Taxation will provide further guidance later this year.

A property tax makes economic sense. However, as it would fall on householders across the board, rather than only on those who are moving house, it may be difficult to make it stick politically, given our history of abolishing rates, water charges and residential property tax. To be a credible solution it would need, as Obama would say, “bipartisan” support.

The most important ingredients of a successful economic recovery are a shared understanding of the scale of the problem, solidarity about sharing the costs fairly, a shared commitment to take the medicine needed to make us better, and a sense of hope that we can get there if we act on what is within our own control.

John FitzGerald is chief economist with the Economic and Social Research Institute

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