A Tale of two Budgets…

The contrast between how the recent budgets in the UK and Ireland have been received by the markets and the general public couldn’t be greater and tells us much about where the respective economies are currently at. (Let us ignore the distinction that the UK budget was officially dubbed a “Fiscal Event” rather than a formal budget. That euphemism has uncomfortable resonance with the Russian “Special Operation” rather than the invasion of Ukraine).

In Britain £45 Billion in unfunded tax cuts and £120 Billion in energy price cap expenditures was greeted with dismay by the markets, who lost trust in the UK’s debt expansion trajectory. The Pound slumped, shares crashed, and, most crucially, pension funds were at risk of becoming insolvent as their holdings in government debt – normally the safest of investments – went underwater. The Bank of England was forced to intervene with an emergency programme of buying up £65 Billion in government debt from private investors now unwilling to hold it.

Politically, the UK budget was also a disaster for the fledgeling Truss administration. The elimination of the top rate of 45% on earnings over £150,000 p.a., the removal of the cap on banker’s bonuses, and the cancellation of planned corporate tax increases all contributed to a general sense of unfairness at increasing inequality at a time when most people are experiencing a cost of living crisis. Wages increases haven’t been sufficient to cover the inflation rate, and more and more workers are contemplating strike action leading to greater social division. In a humiliating climbdown, the government has now been forced to reverse the 45% tax rate cut – only a day after the Prime Minister defended it.

Economically, too, the UK budget faced huge criticism, from institutions such as the IMF, no less. What particularly spooked investors was the refusal by Kwasi Kwarteng to submit his proposals to the usual scrutiny by the Office of Budget responsibility – which might have disputed his claim that such measures were required to kick start the UK economy. The inflationary effect of all this extra (borrowed) cash being injected into the economy at a time of supply constraints has also forced the Bank of England to consider a rapid acceleration of already planned interest rate increases – heaping more misery on borrowers and homeowners and negating the stated intention of the “Fiscal Event” to grow the economy.

Paul Krugman, the Nobel prize winning economist was scathing in his assessment: In an article headed the UK suffers a full-scale policy zombie apocalypse, he argues that the ‘Trickle-down’ notion that cutting taxes on the rich will create an economic miracle is a classic example of a walking-dead idea — ideas that have failed repeatedly in practice, and should be dead, but somehow are still shambling around, eating policymakers’ brains. The pre-eminent zombie in US economic discourse has long been the belief that cutting taxes on the rich will create an economic miracle.

He goes on to explain:

The important point to understand is that there isn’t a serious debate about the proposition that tax cuts for the rich strongly increase economic growth. The truth is that there is no evidence — none — for that proposition.

Of course, people on the right, raised on the legend of St Reagan, believe that his tax cuts did wonders for the US economy. But the data doesn’t agree.

Reagan did drastically cut taxes on high incomes.

So what did happen to economic growth? It’s important to distinguish between the long-run trend — which was what tax cuts were supposed to improve — and business cycle fluctuations.

Underlying US growth was pretty much unchanged through the 1970s and 1980s. The economy slumped during recessions — especially the double-dip recession of 1979-1982 — and grew rapidly during recoveries, but by the end of Reagan’s reign it was more or less exactly where you would have expected it to be if you extrapolated the trend from 1973 to 1979.

Bill Clinton effectively undid the original Reagan tax cuts, amid many predictions of imminent disaster. The economy actually grew somewhat faster than it had under Reagan, and by the end of the Clinton years it was above the level it would have reached if you just extrapolated the 1973-1989 trend.

Krugman goes on to give other examples of such failed “supply side” policy experiments in the US and elsewhere.

Janan Ganesh in Liz Truss learns the hard way that Britain is not the US has a less radical take, but comes to the same conclusion:

Britain is in trouble because its elite is so engrossed with the US as to confuse it for their own nation. The UK does not issue the world’s reserve currency. It does not have near-limitless demand for its sovereign debt. It can’t, as US Republicans sometimes do, cut taxes on the hunch that lawmakers of the future will trim public spending. Reaganism was a good idea. Reaganism without the dollar isn’t. If UK premier Liz Truss has a programme, though, that is its four-word expression.

So much of what Britain has done and thought in recent years makes sense if you assume it is a country of 330 million people with $20 trillion annual output. The idea that it could ever look the EU in the eye as an adversarial negotiator, for instance. Or the decision to grow picky about Chinese inward investment at the same time as forfeiting the European market. Or the bet that Washington was going to entertain a meaningful bilateral trade deal. Superpowers get to behave with such presumption.

The UK doesn’t.

So not only was the Truss/Kwarteng budget politically inept. It was social divisive and economically illiterate. But why was the Irish budget then so well received? It’s €11 Billion increase in public expenditure is about half as big, as a proportion of the economy, as the £165 Billion budget bonanza in the UK, which seems excessive when you consider that Ireland is coming off another stellar year of economic growth and has no need to boost the economy. Growth last year was 13% of GDP with a 200,000 increase in the size of the workforce to a record 2.55 million. Will injecting a further €11 Billion into the economy not be even more inflationary?

There were a number of distinguishing factors which mean that this may not be the case.

Firstly only €7 Billion of the increase is ongoing. €4 Billion is in once off measures specifically designed to reduce the cost of living for ordinary families – not just the super-rich. There has been a particular emphasis on cutting energy, childcare, healthcare, and education costs for all and increasing social welfare payments for the most disadvantaged. Housing costs are being addressed by the introduction of tax credits for renters and a tax on vacant homes in an attempt to incentivise an increase in supply in the housing market. As a result, the rate of inflation in Ireland is expected to decline from 8.5% this year to 7% next year. Not great, but not too bad in comparison to our neighbours.

All of the above measures are open to the criticism of being inadequate to fully address the cost of living and housing crises, but at least they are a step in the right direction.

Secondly, Ireland still expects to record at least a €1 Billion budget surplus this year, followed by €6 Billion next year, and that is after it has set aside €2 Billion this year and €4 Billion next year for a strategic contingency fund for future economic disasters or a decline in Ireland’s soaring corporate tax revenues. (More anon). Ireland’s national debt is actually declining in absolute terms and has already come down from 120% of GDP in 2013 to 56% now. In contrast, the UK’s national debt has been rising and is now heading for 100% of GDP in the short term.

Thirdly, being part of the Eurozone, Ireland doesn’t have a currency to defend, and Eurozone interest rates, while rising, are not expected to rise at the precipitous rate expected in the UK.

The biggest fly in the ointment in Ireland’s budgetary strategy is that, as Cliff Taylor says: This budget was brought to you by Ireland’s five multinational ‘superstars’. He argues that the Government is looking two ways on corporate tax revenues: delighted to get them but terrified they might disappear. Ireland is very beholden to the tax planning strategies of the many major corporates who now make their EU headquarters here, and particularly the big four: Microsoft, Apple, Google and Pfizer. Corporate tax receipts have increased from €4 Billion to €21 Billion in the last 10 years, which is huge in the context of the government’s total annual spend of €90 Billion this year.

All these companies have major and expanding operations in Ireland, but undoubtedly a major (and unknown) proportion of the tax they pay here is in respect of profits they have made on sales elsewhere. The fate of Blackberry and Nokia, once pre-eminent in their markets, should also act as a warning that these companies may not always be so profitable.

In the short term, Ireland’s tax take from these companies may actually continue to increase due to a number of factors: The capital allowances these companies gained by “investing” their intellectual property (IP) in Ireland are beginning to run out which means that much more of their profits will become taxable here. Global corporate tax reform, if enacted, will also increase Ireland’s tax take from 12.5% to 15% and prevent undercutting by other countries with lower corporate tax rates. But ultimately these companies are free to locate their IP wherever they choose, and any decisions to relocate their IP would have major repercussions for Ireland’s budgetary strategy.

Reducing our national debt and setting aside even more “windfall” tax revenues as a contingency against global recession or the relocation of corporate IP is therefore the budgetary imperative for Ireland. Let us hope that this and future governments do not give in to the temptation (and opposition pressure) to fund future ongoing expenditures from what could be very temporary windfalls.

Northern Ireland, of course, also benefits from being adjacent to such a buoyant consumer, employment, and investment market. The risk that the conflict over the protocol will kill off prospective investment requiring access to the Single Market is very real. How many of those 200,000 extra jobs created in Ireland last year could have been created in N. Ireland had the policy environment in Britain and NI been less fraught? With Ireland reaching full employment and much its infrastructure operating at full capacity, the temptation to locate new investment in a cheaper operating environment in N. Ireland must be great. But who would take that risk with the UK pursuing Zombie economics and N. Ireland becoming increasingly unstable?

The opportunity cost of current unrest is growing all the time, and those opportunities may not be available again in the future. Once decisions are made to invest elsewhere, even future investments tend to follow the same route. Both parts of Ireland need to be aware that current gains cannot be taken for granted and opportunities must be grasped while they are still available.

I would like to have it recorded in evidence that I did not use the term “Brexit” once in the above analysis. Who can now doubt, however, that it is the elephant in the room?

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