NO GOVERNMENT in the State’s history has faced a greater or more daunting challenge than that presented by the December budget. And no government, in preparing for the many difficult decisions ahead, has received more advice on what to cut, and where, who to tax, and how heavily. The Organisation for Economic Co-operation and Development (OECD) is the latest to diagnose the sick state of the Irish economy and to prescribe some unpalatable but essential medicine to assist recovery.
The OECD’s advice to the Government follows the thrust of the report of the Commission on Taxation, which recommended major tax reforms, and that of the McCarthy report, which set out a €5.3 billion a la carte menu of potential spending cuts. Between all three, there is little disagreement on what needs to be done.
The Government’s particular difficulty, however, has been an inability to listen to the advice received from those whose assistance it has specifically sought. Days before the Commission on Taxation reported, and proposed a property tax, Taoiseach Brian Cowen announced he was not wedded to such a tax. Many of his fellow Ministers were openly critical of some of the suggested spending cuts outlined in the McCarthy report.
An annual property tax was expected to raise close to €1 billion in revenue and was a cornerstone of the commission’s proposals to broaden the tax base. The OECD has backed the introduction of a property tax because, as it rightly points out, it is less damaging to growth than higher taxes imposed on “more mobile or sensitive bases such as capital and labour income”.
The OECD, in its rigorous analysis of what went wrong with the Irish economy, draws a distinction between two periods of strong growth in the boom period from 1995 to 2007. In the first, 1995 to 2000, the rapid rate of economic expansion reflected strong export growth, rising productivity and improved competitiveness. In the second, from 2002 to 2007, economic growth was driven largely by strong domestic demand, particularly house-building, fuelled by cheap credit, low interest rates and reckless lending by banks.
The result was the creation of an unbalanced and increasingly uncompetitive economy as the rate of export growth declined and labour costs rose. The public finances became over-reliant on housing-related tax revenues. Households and firms became highly indebted to the banks for property loans. The banks became heavily exposed to potential losses on these loan portfolios. And the domestic economy was left vulnerable to any serious reversal in the world economy.
The international financial crisis and the global slowdown have left Ireland experiencing the sharpest contraction in economic activity of any developed country. The economic imbalances built up during the boom will have to be reversed and that, the OECD suggests, will require a “protracted period of adjustment”. And, in an implicit rebuke to the Government, it advises that “...lessons should be learnt to avoid macroeconomic imbalances arising on this scale again”.