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TOPIC D: PUBLIC FINANCES, DEBT & TAXATION TCD M.SC.(EPS) – RONAN LYONS – EC8001 IRISH ECONOMIC POLICY ISSUES & CONTEXT MODULE OUTLINE Topic Title EoI Ch Dates A Irish Economic History to Independence 1+ MT1-2 B Irish Economic History since Independence 1+ MT3-4 C The Economy & Economic Growth 2, 7 MT5-6 D Public Finances, Debt & Taxation 3, 4 MT8-9 E The Labour Market 6 MT10-11 F Social Justice & Inequality 8 HT1-2 G Regulation & Competition 5 HT3-4 H Competitiveness & Trade 9, 11 HT5-6 I Health & Education 12, 13 HT8-9 J Natural Resources & Real Estate 10, 14* HT10-11 OTHER READING & DATA • OECD • Taxing Wages • Tax Revenue Statistics 2013 • Government at a Glance • European Union • Taxation trends in the European Union • Ireland • • • • Dept of Finance: Ireland – Budgetary Statistics 2014 DPER: Estimates for Public Services Budget 2015 Publicpolicy.ie TOPIC D: STRUCTURE Public Finances, Debt & Taxation 1. 2. 3. 4. 5. 6. Why a government at all? Size and levels of government Spending: principles and features Taxation: principles and features Government liabilities Government assets IN CIRCULAR FLOW, GOV IS UNIQUE • Basic circular flow: households (consumption) and firms (production) • Real and corresponding monetary flows back and forth • Factor services (input into production) and goods/services (input into consumption) • Extensions • Non-consumption: saving and the financial sector • Consumption of foreign goods: imports and exports • Consumption of public goods: taxation and gov spending • Government is unique because of powers of compulsion • Gov’s aims as per last week: high(er) living standards ASPECTS OF GOVERNMENT • Regulation: the state as referee • Legal system underpins contracts that govern economic activity – property rights underpin stocks of capital/land • Public goods: the state as owner and/or manager • Funding (and thus taxation) • Direct service provision • ‘Pure’ vs. ‘quasi’ public goods PURE PUBLIC GOODS • Two key features of pure public goods • Non-rival – my consumption does not affect yours (≠ water) • Non-excludable – benefits not easily withheld • E.g. of national defence • In particular due to nonexcludable nature, market will not provide pure public goods VS. MARKET FAILURES • Not all costs reflected in market price Negative externality € • Rationale for intervention • Aligning social MC with private MC P=SMC • Externalities • Positive – e.g. education, road network • Negative – e.g. pollution, fisheries • Other market failures • Monopoly power (IRTS) • Imperfect information (e.g. BER, PRSI) P=MC D Q1 Q0 Q Without Pigovian taxes, market will over-provide (i.e. misallocate society’s scarce resources GOVERNMENT FAILURES • Small number of pure public goods • Although note their real-world importance (e.g. climate) • Large number of goods with externalities • Thus large potential scale for government involvement in the economy • Costs – as well as benefits – to government intervention • • • • • Electoral pressures and political business cycles Interest group lobbying Perverse incentives in administration Corruption Restrictive practices, inflexible procedures in public sector TOPIC D: STRUCTURE Public Finances, Debt & Taxation 1. 2. 3. 4. 5. 6. Why a government at all? Size and levels of government Spending: principles and features Taxation: principles and features Government liabilities Government assets LEVELS OF GOVERNMENT IN IRELAND 1. Global • UN: budget of ~€2bn [Ireland contributes ~€8m] • Also IMF, World Bank and WTO 2. Supranational • EU: budget of ~€120bn [Ireland contributes ~€1.3bn] 3. National/Federal • Ireland: government spending is ~€55bn (incl non-voted) 4. State level • N/A in Ireland 5. Municipal • 31 local authorities: budget of €4.2bn (€1.1bn in grants) THE GLOBAL REFEREES • Globalization of economic activity means greater need for global framework • Cf. 19th Century globalization – self-destructing? • National action can be self-defeating if L, K is mobile • WTO: replaces need for bilateral agreements • In a world with 200 countries, ~20,000 bilateral relationships • UN: global public goods • E.g. response to climate change, global inequities, geopolitical threats • Difficulties: what is correct policy? Domestic political considerations • E.g. of past emissions by developed countries CONTINENTAL GOVERNANCE • Roots of the EU in the “Coal & Steel” community • Post-war reconstruction – ‘traders must be friends’ • Elaborate institutional structure: Council, Commission, EP • Four Freedoms – the Single European Market • • • • Free movement of goods and services [+ competition pol] Freedom of establishment Free movement of persons [political pressures?] Free movement of capital [monetary trilemma] • Taxation • ~1/8 of budget funded by VAT contributions; rest by GNI • Significant freedom in domestic tax infrastructures WHO PAYS FOR THE EU? Rebates GNI VAT AT BE BG CY CZ DE DK EE GR ES FI FR HU IE IT LT LU LV MT NL PL PT RO SE SK SI UK €550 €500 €450 €400 €350 €300 €250 €200 €150 €100 €50 €0 -€50 Per capita contributions to the EU budget, 2011 Source: European Union WHO BENEFITS FROM THE EU? Per capita receipts from EU (2009) €500 EU spending by heading €400 €300 CAP €200 Regions €100 Internal €0 Admin External -€200 Other -€300 AT BE BG CY CZ DE DK EE FI FR GR HU IE IT LT LU LV MT NL PL PT RO ES SE SK SI UK -€100 Source: Deutsche Bank GROWING PAINS • Democratic accountability • Concern that decisions are too far removed from citizens • Which is worse – EU institutions or inter-governmental? • Treaty reforms… but perception counts? • Single currency • Under Maastricht Treaty, Economic & Monetary Union • Originally 11 MSs, now 18 (334m) – further 210m pegged (most in Africa) • One-size-fits-all monetary policy & Financial Crisis • ECB – mandate of price stability (German CB tradition) • Since 2009, ‘zero lower bound’ so ‘liquidity operations’ • Public debt crisis – so now EU constraints on Fiscal Policy IRELAND & THE EU • 6% of all income in fifteen years to 1997 • Much of this came through CAP • Most of remainder through structural and regional funds • Ireland now roughly ‘in balance’ • About 1% of income Ireland’s EU transfers 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Receipts (% GNP) Payments (% GNP) 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 • EU was a significant contributor to Irish incomes in 1980s,1990s Source: Dept of Finance LOCAL GOVERNMENT SPENDING • Irish local authorities spend money in six main areas • • • • • • Housing Roads Water Environment Development Recreation • This is broadly in line with municipalities in other countries Irish LA spending by heading Housing & Building Road Transport & Safety Water Services Development Management Environmental Services Recreation & Amenity Other • Cf. schools, healthcare… Source: publicpolicy.ie LOCAL GOVERNMENT RECEIPTS • Irish local authorities earn revenues in two ways • Selling goods and services, e.g. rents, landfill/refuse charges, parking fines… • Commercial rates • The remainder of Irish LA receipts come in grant form Irish LA receipts by heading Goods & Services Rates Grants & Subsidies General Purpose Grant • Ear-marked (from central voted expenditure) • General purpose Source: publicpolicy.ie IS IRELAND MISSING A LAYER OF GOV? Municipalities per million inhabitants 600 500 400 300 200 100 0 AT BE CZ DK EE FI FR DE GR HU IE IT LV LT LU NL PL PT SK SI ES CH SE UK EU • “The principle of subsidiarity is fundamental to the functioning of the European Union (EU… [it] determines when the EU is competent to legislate, and contributes to decisions being taken as closely as possible to the citizen.” EU Website • Ireland has 7 municipalities per 1m inhabitants • EU average is ~25 times this Source: Analysis of Wikipedia content SIZE OF NATIONAL GOVERNMENT 20 Korea Switzerland Australia Estonia United States Slovak Republic Canada Israel Ireland New Zealand Poland Japan Czech Republic Spain Luxembourg Germany Norway United Kingdom Greece Iceland Portugal Hungary Slovenia Netherlands Italy Sweden Austria Belgium France Denmark Finland 25 30 35 40 45 50 55 60 Receipts (% GDP) Spending (% GDP) Source: OECD ONE SIZE FITS ALL? • Is there a “correct” size for governments, relative to their overall economy? • Generally accepted that less than 10% is probably too small relative to the scale of market failures • In same fashion, presumably 75% or more leaves people hugely vulnerable to government failures • Examples of high-income and/or fast-growing economies at top, middle and bottom ends • Korea, Estonia, US: small government • Netherlands, Denmark, Finland: big government • Perhaps question is a level further down • What are principles of good government spending? TOPIC D: STRUCTURE Public Finances, Debt & Taxation 1. 2. 3. 4. 5. 6. Why a government at all? Size and levels of government Spending: principles and features Taxation: principles and features Government liabilities Government assets THREE TYPES OF SPENDING • Main spending headings 35% Gross current 30% Capital voted 25% 20% Capital other 15% VK/All voted 10% 5% 2011 2007 2003 1999 0% 1995 • Since 2007, fraction of spending on capital has halved 40% 1991 • Declined in size (relative to economy) • Switched somewhat from current (consumption + transfers) to capital 45% 1987 • In boom, Irish Exchequer: 50% 1983 • Public consumption • Public investment • Transfers Spending by type (% of GNP) Source: Dept of Finance PUBLIC SPENDING: CONSUMPTION • Consumption 2014 spending, by type • Administration, defence, education, health • Service provision vs. service funding • Funding due to market failures (including endowment effects / redistribution) • Direct service provision? • ~2/3s of all consumption is health, education DSP Health Education Other current Voted capital • More in Topic I next term Source: Dept of Finance / Budget 2015 PUBLIC SPENDING: INVESTMENT • Goals of investment • Three areas dominated by investment • Environment • Jobs/enterprise • Transport • Add health, education – €2.9bn of €3.6bn in 2014 70% 60% 50% 40% 30% 20% 10% 0% Agriculture Arts HG Children YA CENR Defence Education ECLG Finance FA&Trade Health Jobs Justice PER Social Prot Taoiseach Transport+ Total • Boost productivity of economy • Maintain assets/amenities that provide social return % of spending as investment Source: Dept of Finance / Budget 2015 Roughly 3/4s Maternity 17% Other income BTW/BTE Other emp't Rent supp't Other child Community, TUS Carers Other supp't €1,000 Admin Other illness One-parent 26% Widows €6,000 Child benefit €2,000 Disab/invalidity €4,000 Jobseekers €5,000 Pension PUBLIC SPENDING: TRANSFERS DSP gross spending by heading (& type) SIF Voted €3,000 10% 4% €0 Source: Dept of Finance / Budget 2015 PUBLIC SPENDING: TRANSFERS 6% Where series line up, 20:1 ratio (i.e. 5% interest rate 100% 80% 5% 4% 60% 3% 40% 2% 20% 1% Debt (LHS) Servicing (RHS) 2013 2011 2009 2007 2005 2003 0% 2001 0% 1999 • Roughly 5% of Irish income is spent paying off national debt • More later… 120% 1997 • No good or service is being provided, nor is any capital being formed National debt & debt servicing, as % of GNP 1995 • Repayment of national debt is also a form of transfer Source: Dept of Finance TOPIC D: STRUCTURE Public Finances, Debt & Taxation 1. 2. 3. 4. 5. 6. Why a government at all? Size and levels of government Spending: principles and features Taxation: principles and features Government liabilities Government assets WHY DOES THE GOVERNMENT TAX? • Charges versus taxation • Two reasons for taxation • Revenue collection (aim to minimise distortion of behaviour) • Externalities argument – may be revenue-neutral (aim precisely to change behaviour) • Tax breaks: form of government spending • Aim: change behaviour • Regressive? Why not subsidy? WHY DOES IT NOT TAX (MORE)? • Limits on Ireland’s taxation policies • Small open economy: what are systems in other countries? • EU member state: what are rules for Irish taxes • History: “the best tax is an old tax” • Human behaviour: “the second best tax is a hidden tax” PRINCIPLES OF A GOOD TAX SYSTEM • Equity • • • • Horizontal equity: how are those on similar incomes treated? Vertical progressiveness (or regressiveness) Transitional equity: winners and losers from changes Intergenerational equity: borrowing vs. taxation • Efficiency • What (unwanted) distortion of behaviour is there? • Deadweight loss; income & substitution effects • Simplicity • What scope and incentive is there for avoidance, evasion? MAJOR FORMS OF TAX • Consumption • Rationale: provision of market infrastructure? (Cf. EU contribution) • Income • Rationale: inequality aversion? Inability to bring in user charges for many publicly-funded services? • Wealth • Rationale: inequality? • Cf. land tax: value of land and recouping taxpayer investment THE IRISH SYSTEM IN PRACTICE All-in tax rates, by decile and source tax, ca.2010 45% 40% 35% 30% VAT 25% PRSI 20% USC 15% Income tax 10% 5% 0% 1 2 3 4 5 6 7 8 9 10 Source: Analysis of ESRI, Revenue Commissioner & CSO statistics TAXES VS. CHARGES • Unavoidable taxes: • Income tax, PRSI, USC (direct) and VAT (indirect) • Avoidable taxes (cf. P = SMC) • Duties (e.g. on cigarettes, alcohol, fuel) • User charges • • • • • Motor tax, toll roads, air travel tax, car registration Licences for gambling, liquor, TV Water charges Carbon tax, landfill levy, plastic bag levy Stamp duty, property tax LAND, WEALTH & FISCAL POLICY • Value of land is major part of overall stock of wealth in modern economies • Estimate for USA, 2006: ~$24trn in residential housing of which ~$11trn in residential land • In Ireland (2007), ~75% of all wealth in real estate – largest chunk in residential, of which land comprises largest share • Example of Jubilee Line (1999 extension) • £3.5bn invested by general taxpayer • Land values rose by an estimated £13.5bn • Full Land Value Tax (5% of capital value) means £675m in revenues foregone [vs. ~£150m in interest costs] TAXES AS PRICES OF SOCIAL SERVICES • Fiscal policy often seen as black box • “Increase spending – on something, anything – to stimulate economic activity when it’s needed” • But not all fiscal policy is the same • Recent explosion of data enables us to say with greater certainty where social return on spending is highest • Opportunity cost of austerity • E.g. of lack of social housing – now resulted in hotel bills (plus social costs) EXAMPLE OF BUILT HERITAGE • If this is minimum benefit, what is current cost? ROI Average Leinster Dublin Munster Crash • Excludes other benefits (e.g. direct revenues) Bubble • Combined effect of €3.6bn means LPT revenues due to built heritage of ~€6.5m 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% -2.5% Rent • Ireland’s 6,700 castles add ~€2bn to value of housing • Churches add ~€1.4bn • Historic homes add ~€300m Effect of proximity to castles Overall • Hedonic regression analysis Other Cities Conn-Ulster TOPIC D: STRUCTURE Public Finances, Debt & Taxation 1. 2. 3. 4. 5. 6. Why a government at all? Size and levels of government Spending: principles and features Taxation: principles and features Government liabilities Government assets DEFICITS ARE FUTURE TAXES • Not all government spending is covered by public revenues • By design – a planned deficit • By accident – economic conditions mean revenues are worse than expected • All spending must be covered, however • Thus spending is either covered by current taxes & charges or future ones • Is it (a) possible and (b) desirable if a government runs a deficit every year? • Current versus capital spending DANGEROUS SLIDE IN FISCAL POLICY? 2011 2008 2005 2002 Capital 1999 1996 Current 1993 • Concerns? 1990 • Mid-2010s: large current deficit; capital in balance 1987 • What went wrong? 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 Capital and current account balances, % GNP 1984 • Mid-1980s: sizeable twin deficits • Mid-1990s: small twin deficits • Mid-2000s: large current suplus, capital deficit WHAT EXACTLY IS OUR DEBT? • Debt has risen from ~€35bn in mid-1990s to ~€200bn now • Government Bonds mostly fixed rate • Due 2019, 2020, 2025 • Floating rate: 2038-2053 • Troika funding • IMF: 2016-2021 • EFSF: 2029-2034 • Half of debt Irish-held… • … but most of that is Central Bank Ireland's National Debt (Oct 2014, €bn) Gov bonds Troika State Savings Shortterm TOPIC D: STRUCTURE Public Finances, Debt & Taxation 1. 2. 3. 4. 5. 6. Why a government at all? Size and levels of government Spending: principles and features Taxation: principles and features Government liabilities Government assets TRADITIONAL STATE ASSETS • Cash and financial assets: • Gross debt of ~€200bn, but assets of ~€23bn • Net national debt (Oct 2014) of €182bn • Semi-states • Previously very important • Small number of SOEs currently – soon to be smaller? • NewERA • Aim is to dispose and restructure state-owned enterprises • ESB, Ervia (formerly Bord Gais), EirGrid, Bord Na Mona, Coillte • In other countries, rise of SWFs OTHER STATE ASSETS • NPRF – originally to overcome PAYG pensions • Fund worth about €20bn – of which €13bn is in AIB, BOI • Average annual return of 4% • Move from long-term to job-creating (ISIF) • NAMA – originally to save Irish banking system • • • • Buy €77bn of loans (on collateral worth ~€100bn at peak) But for how much? From ~€55bn to ~€35bn About €15bn generated in cash by mid-2014 About €20bn left in “loans & receivables” by end-2013 • NDFA (National Development Finance Agency) • Advises re public investment projects >€20m (e.g. bundles of schools or courts, DIT campus) RECAPPING… • Clear benefits of government intervention – particular for pure public goods and externalities • But costs of intervention too • Importance of equity, efficiency & simplicity (on taxes) • Health, education and redistribution make up the bulk of day-to-day spending • Taxes as the prices of social services? • Greater move towards charges, not taxes? • Balance sheets matter • Spending not covered by tax means future taxes: debt • State also has assets ESSAY & EXAM-STYLE QUESTIONS 1. Is Ireland’s taxation system equitable, efficient and simple? 2. “Ireland’s fiscal policy since the 1970s has rarely been best practice.” Discuss. 3. What is the role for cost-benefit analysis in the future of Irish policymaking?