POLITICAL RESPONSIBILITY:THE MAIN criticism of the Government in the two reports published yesterday was that it contributed significantly to the scale of the "home grown" economic crisis because of the policies pursued over the past decade.
The Honohan report concluded: “Macroeconomic and budgetary policies contributed significantly to the economic overheating, relying to a clearly unsustainable extent on the construction sector and other transient sources for Government revenue (and encouraging the property boom via various incentives geared at the construction sector).”
This helped create “a climate of public opinion which was led to believe that the party could last forever”, he concludes.
“A less accommodating and procyclical policy would have greatly reduced the need for preventive action from the CBFSAI (Central Bank and Financial Services Authority of Ireland,” according to the Honohan report.
It points to the fact that fiscal policy did not constrain the boom. “Indeed, the increased reliance on taxes that could only generate sufficient revenue in a boom, made public finances highly vulnerable to a downturn.
“Specific tax incentives also boosted rather than restrained the overheated construction sector. And, with surging labour demand, wage rates in both the public and private sectors moved well ahead of what could protect international competitiveness.”
The report says that public sector borrowing surged quickly with the onset of the crisis precisely because of the rise in Government spending after 2004.
“The expenditure boost came at a period when elements such as the cost of unemployment payments was driving other cyclically- related spending down. However, in light of soaring tax revenues at the time, Government decided to increase autonomous spending particularly on public sector pay. But the main cause of the borrowing surge was the collapse in tax revenues in 2008-2009 which appears to have been the most pronounced of virtually any country during the current downturn.”
Dr Honahan says much of the reason for the revenue collapse lay in the systematic shift over the previous two decades away from stable and reliable sources such as personal income tax, VAT and excises towards cyclically sensitive taxes like corporation tax, stamp duties and capital gains tax.
“Government spending doubled in real terms between 1995 and 2007, rising at an annual average rate of 6 per cent. With the economy growing at an even faster rate, this implied a generally falling or stable expenditure ratio of expenditure to GNP until 2003.”
But thereafter the ratio rose, especially after output growth began to slow in 2007. “And, in a final twist, real expenditure rose by over 11 per cent in both 2007 and 2008, an unfortunate late burst of spending which boosted the underlying deficit at almost the worst possible time,” the report says.
He also notes that throughout the period, the Government made extensive use of taxation incentives aimed at the construction sector with the rates of stamp duties, which were high, lowered several times, in 2001, 2002, 2003, 2005, and 2007.
“In addition, different classes of construction investment have attracted sizeable income tax concessions extending over long periods,” it adds.
At the height of the boom, in 2004-2006, schemes existed for urban renewal, multi-storey car parks, student accommodation, buildings used for third-level educational purposes, hotels and holiday camps, holiday cottages, rural and urban renewal, park and ride facilities, “living over the shop”, nursing homes, private hospitals and convalescent facilities, sports injury clinics and childcare facilities.
After some transitional arrangements, most of these incentives were abolished by July 31st, 2008.
The Regling/Watson report also says that in crucial ways the Irish banking crisis was “home made.”
It says the overall fiscal policies were pro-cyclical during most years up to and including 2007 and that added markedly to the overheating of the economy.