Lessons from the recession in the early 1980s could provide some survival tips, writes Garret Fitzgerald.
IN THE past governments were primarily guardians of order and guarantors of justice, but today they are mainly providers of key public services and redistributors of financial resources from richer to poorer citizens. Nowadays the justice, public order and defence functions of government absorb little more than 5 per cent of the revenue raised. Almost half of tax revenue is now used to provide public services - with two-fifths deployed to supplement the purchasing power of the less well-off.
Because governments also have to renew and supplement the infrastructure of state services, not all tax revenue is devoted to current spending. Recently our government has been devoting about one-eighth of tax revenue to such investments in our future.
When for any reason the flow of tax revenue diminishes, or even grows more slowly than inflation, governments face a choice between borrowing to fill the emerging gap, or cutting back capital or current spending, or both.
Especially at times when tax revenue becomes insufficient to meet all needs, borrowing to finance part of the investment programme may be a reasonable temporary alternative.
However our participation in the euro zone, which is important to our financial stability, has involved accepting the discipline of limiting our borrowing to a maximum of 3 per cent of our national output.
Because the rapid economic growth of recent years has hugely reduced the burden of our public debt - which is now less than half the EU average - this is a tougher limit than the Irish economy perhaps needs, and as we have also been investing far more of our annual output than our EU partners, a case can be made for our 3 per cent borrowing limit to be temporarily eased in a crisis.
But amongst our partners and in the European Central Bank there will be some hesitation about conceding this, because the fact that Ireland is being hit far more severely by the credit crunch than other EU states clearly reflects the Government's extraordinary failure to rein in a housing boom that over several years involved constructing three or four times more dwellings per thousand population than elsewhere in Europe.
Moreover, after the Lisbon Treaty vote there may not be much enthusiasm amongst our partners for extending a soft option to Ireland. In these circumstances the right course of action for the Government is to tackle energetically our financial shortfall, with a view to ensuring that this year we remain within the 3 per cent limit, and that any excess over that level next year will be as small as possible. However, because the out-turn of the next six months cannot be predicted with any certainty, it remains possible that this year's financial deficit will turn out worse than currently foreseen. But it is also possible that the deterioration in our finances this year will be less than currently foreseen - although if that turns out to be the case this could imply a delayed recovery into the year 2010.
The big question for next year is how to achieve spending cuts without imposing additional burdens on the less well-off, who are already suffering from the greater impact upon their lives of current increases in food and heating costs. In this connection it may be worth referring back to the events of the early 1980s, when the economic situation was much grimmer than it is today.
When I became taoiseach in 1981 I inherited the consequences of the trebling of the national debt by the Lynch and Haughey governments during the previous four years. This had led to a threatened borrowing rate in excess of 20 per cent of GNP, with inflation also in excess of 20 per cent, and an impending sharp fall in national output. (Between 1981 and 1983 GNP actually declined by over 3 per cent and average living standards dropped by almost 9 per cent.)
In tackling that crisis we decided to give priority in the 1982 budget to the poor, by over-indexing welfare payments, which in the January 1982 budget were increased by 25 per cent. Together with a further 12 per cent social welfare increase in June 1983, this ensured that the living standards of the less well-off were fully protected throughout the prolonged period of recession that followed, leaving the brunt of the hardship to be borne by better-off elements in the community.
The tax increases needed to finance this social policy led to my government's temporary departure from office during most of 1982.But what this does show is that, even in a recession much more severe and much more prolonged than that into which we are currently facing, a government committed to social justice can protect the less well-off. I hope the present Government will bear this in mind when preparing next year's budget in the autumn.
In that budget it may prove necessary to supplement expenditure cuts with some tax increases. Fifteen years ago, before the Celtic Tiger period, two-thirds of government revenue came from taxes on income - four-fifths of which were related to income levels, with progressive income taxes yielding much the greater part of this revenue. Taxes on spending, which bear more heavily on the less well-off, then provided only a minority of tax revenue.
However, since then a quiet revolution has reversed the pattern of our tax burden - because governments have chosen to raise the level of expenditure taxes one quarter faster than taxes on income. So, today it is these less equitable taxes on spending that yield most tax revenue.
Later this year, when deciding on any tax increases that may then appear necessary, the Government should bear in mind the damaging social effect of this trend.