There will be a lot of looking back at the banking crisis this week, the 10th anniversary of the guarantee. And rightly so. But as we try to absorb the lessons we need to remember that the crisis we faced was a double whammy, caused by unsustainable public finances, as well as bust banks. The 10th anniversary of the 2009 budget is also approaching, where the first hint of austerity via a new levy on incomes and a VAT hike were announced. Little did we know then what was to come.
Some €100 billion was borrowed to bridge the gap between government spending and revenues between 2008 and 2014, before counting in the money paid to bail out the banks. This compared to the €64 billion gross cost of the bank bailout.
Yes, I know that the banking crisis made the public finance crisis much, much worse. But the collapse in growth blew a huge hole in our public finances, very quickly. In a small, open, economy things can change rapidly.
In 2008, as well as our banks being bust, our public finances were hugely vulnerable. Successive increases in government spending had been based on a tax base inflated by stamp duty and VAT payments from a housing bubble. We are still paying the price, making repayments on the huge explosion in public debt that followed. And it is now clear that other taxes back then were unsustainably low – so something has had to make up the gap and that has largely been taxes on income.
Government spending on services and investment is being fast being restored across the board to pre-crash levels – meaning that tax won’t be. Just this week further steps towards pay restoration were announced. By next year, the total amount of spending voted through the Dáil will exceed the previous 2008/2009 peak.The political choice to put the resources of growth into spending has been made.
For better or worse, 2008 has become one of our frames of reference. It is worth noting that Minister for Finance Paschal Donohoe told Ibec last week that 2008 was not a " useful benchmark or indeed one that we would look to return to" .
Housing and health
Yet the drive to “restore” spending on pay and other areas such as housing and health is strong. Getting results from this higher spending is now a key political challenge.
If spending is going “back to the future”, taxes can’t. There are a couple of reasons for this. First, we continue to pay the price of the crisis in repayments on our national debt, which exploded during the crisis. Debt repayments now take €1 out of every €13 in Government spending, compared to about €1 in every €33 before the crisis.
Second, as we saw, our 2008 position was built on the sand of transient tax revenues. Once the crisis hit , a gaping hole suddenly appeared. The underlying deficit, before account is taken of money paid in to bail out the bank, rose to almost 12 per cent of gross domestic product at its peak.
Our national debt shot up and only massive cuts – and a bit of luck – helped us to escape the doom loop which can afflict heavily indebted countries, where borrowers lose confidence, cash flees and bad turns to worse. We were perilously close to getting stuck in a Greek-style mire.
The scars remain. Servicing the national debt costs us €4 billion more now each year than it did before the crisis"
The scars remain. Servicing the national debt costs us €4 billion more now each year than it did before the crisis. That increase in debt costs is equivalent, for example, to half of all the tax we collect on corporate profits. Or as much as the annual budgets of the departments of housing and children combined.
With these debt costs and other day-to-day government spending also rising, taxes on income have made up much of the gap. Figures from the Irish Tax Institute show how most income levels are now paying more tax than before the crash, with middle earners and the better-off paying substantially more.
Sustainability doubts
Income tax and universal social charge now account for almost 40 per cent of total taxes, up from less than 29 per cent in 2008. Add in PRSI and you get to nearly half of all taxes collected coming from income, according to the institute’s data. Corporate taxes have been the other big growth areas of recent years, to the extent of creating some nervousness about its sustainability.
The straightforward lessons of the crisis here are clear. A sharp fall in growth can hit tax revenues quickly, so leave yourself some leeway. Taxes are not as vulnerable now as they were in 2008. But our tax base is still narrow enough. A hit to growth or changes in international tax law could quickly cut the incomes of better-off taxpayers and big multinationals on which we are heavily reliant and thus reduce their taxes. With Brexit coming – and the clear risk of a no-deal shock – the government budget should be put into surplus next year. In fact it should already be there.
The other lesson is that the structure of the tax system is also important. Before the crisis, we relied far too much on taxes based on property transactions, which boosted stamp duty and also VAT, levied on new house sales. Now, arguably, we rely too much on income taxes and on corporation tax. Just watch the fuss about the revaluations under the local property tax due next year to see how tricky spreading the tax base is in practice. Most people’s idea of widening the base is that someone else pays more.
In the post-crash world, with huge pressure to restore spending and the national debt to be paid, we have little leeway to cut the overall tax burden. Taxes may, with difficulty, be reformed, but they won’t be reduced .
