Dear Prudence

Jun 26, 2018

 Sunday Business Post, 24 June 2018

The English novelist Henry Fielding was at his best when pointing out that prudence is a virtue most often exercised by those who have no choice except to be prudent. 

The word “prudent” appears 10 times in the government's Summer Economic Statement (SES) which was published this week.  It seems this government is going to be terribly careful at the next Budget.  We are not going to be lured anymore by the prospect of largesse from the fiscal space, the amount which the EU rules will allow the government to spend including new borrowing.  Instead we shall be guided by principles of debt reduction and rainy day funds.  

There can be no doubt at this stage that we live in a recovering economy.  As the SES points out itself, the state of the labour market is the best barometer of our economic trends.  The good economic news is that unemployment in 2018 should be below 6% and expected to fall further to below 5.5% in 2019.  

Fair Weather

The real measure of success of any government economic policy is how it helps sustain private sector job creation.  There is no better way of giving people an opportunity for a better quality of life, while at the same time containing the social welfare burden on the state.  So if the jobs barometer is pointing towards Fair Weather why are we being so prudent? 

Paschal Donohoe is clearly concerned about the cumulative effects of EU pressure, the increasingly real threat of a disruptive Brexit and the deteriorating trading relationship  between the EU and the US, the latter most clearly evidenced by trans-Atlantic posturing on tariffs.  Then there are domestic political constraints he has to contend with.  The current government is still bound by the confidence and supply agreement with Fianna Fáil, which means that the budget will have to be some form of collaborative effort. 

It is now reasonable to question the extent to which government policy is actually driving the recovery.  This particular minority government isn't achieving very much.  It's a crude measure of government productivity, but the number of acts passed in the Oireachtas is in decline.  In 2015, which was the last full year where a majority government was in power, there were 74 acts added to the Irish Statute Book.  In 2017, the first full year of a minority government, there were just 44.  In the year to date, there have been only 9.  

Less Auspicious

While the employment statistics are good, some of the other economic markers are less auspicious.  The one currently receiving the most attention is the corporation tax yield, where there are concerns that it is too high to be relied upon.  The influence of foreign direct investment on our economy has been so prevalent in recent years that we have introduced a hybrid measure known as GNI* alongside the traditional measure of the size of the economy, gross domestic product or GDP. 

GNI* may well be a more appropriate way of measuring the size of the economy.  It excludes some of the consequences of the relocation of foreign owned assets, notably intellectual property, in assessing the overall size of the economy.  However, because corporation tax yields are skewed by the presence of intellectual property, GNI* might not be the best yardstick to measure the impact of corporation tax receipts on the Exchequer returns.

The focus on the high level by international standards of corporation tax in the composition of our tax yield masks another outlier.  We have one of the lowest levels of income tax relative to economic size within the OECD.  That apparently does not attract the same level of concern, possibly because income taxpayers vote whereas corporation taxpayers don't. 

Conflicting Evidence

Despite all this conflicting evidence, the SES offers comforting reassurance that the economy continues to grow and the taxes continue to roll in.  That makes it hard going for people like myself who think that targeted tax incentives are needed to stimulate economic growth and ultimately a sustainable tax yield.  Nevertheless, two of the most problematic areas for government – housing and healthcare – have deteriorated over the last decade.  I think both have suffered from the elimination of tax allowances and hence the willingness of individuals to contribute more, directly or indirectly, to their provision.  

Tax relief for medical expenses and medical insurance was effectively halved.  In housing, mortgage interest relief was severely curtailed.  Tax incentives to provide rented residential accommodation were not just eliminated, but where relief had previously been granted, in many cases it was clawed back.  It would be too much of a coincidence that the elimination of these reliefs have had no bearing at all on the problems in health and housing. 

Furthermore, the indigenous business sector needs boosting if we are to reduce our dependency on foreign direct investment.  The low take-up on incentives like the Employment & Investment Incentive, designed to offer funding alternatives for small and medium enterprise, suggests a real need for reform.  Indigenous firms are only mentioned in the SES in a discussion on productivity because they are falling behind. 

Next week, the government will conduct its annual National Economic Dialogue.  Various civil society groups will be invited to share their views with Ministers on economic issues from taxation to environment to pensions and much else in between.  The SES will doubtless inform the discussions, but it will also constrain the agenda.  

The over-arching message of the SES is that we have an economy which is not broken so it is not going to be fixed.  Forget about any missed opportunities for doing even better.  With so many internal, external and political constraints it has never been easier to be prudent.

Brian Keegan is Director of Public Policy and Tax at Chartered Accountants Ireland