Austerity is not the answer - NERI

25 May 2021

ledger

Paul Mac Flynn and Tom McDonnell, Co-directors Nevin Economic Research Institute

The Great Financial Crash of 2008, and subsequent recession, were thought to be a once in a generation economic event. It is truly remarkable that just over 10 years later we find ourselves faced with bringing about recovery from a deeper economic shock. Of course, the nature of our pandemic induced crisis represents a very different set of challenges to those we confronted in 2008. Even so, there are lessons from that experience that we would do well to remember.

Mercifully, the first lesson from that global crisis seems to be accepted by much of the international economic and political establishment. The lesson is that cutting back public expenditure in the teeth of a recession, i.e., ‘austerity’, does not lead to recovery. Instead, it unnecessarily prolongs economic misery and permanently scars the labour market.  The move to austerity in the wake of the great financial crash was devastating for the European economy.

The second lesson is that supporting people’s incomes during a recession is the most efficient way to stabilise the economy and return it to full productive capacity as quickly as possible. The creation of the Pandemic Unemployment Payment and the Employment Wage Subsidy Scheme was very welcome innovations in the Irish context. The evolution of these income supports over the next few months will tell if we have learnt this lesson well.

The third lesson is a more troublesome prospect. Stable economies require stable tax bases. We learnt to our cost in 2008 that becoming heavily reliant on revenues from the construction and property sector did not make for stable public finances. There are ominous signs that we may well face a similar reckoning with our corporation tax revenues, but there is a more pressing challenge on this front.

Our experience of the pandemic has shown us that threadbare public services are one of the greatest threats to the viability of our economy. We can no longer shy away from the structural underfunding that we have tolerated for decades.

In what can only be described as a positive development, a conversation has now begun about how our revenue base can be bolstered to strengthen our public services. However, there is a danger that in our enthusiasm to learn one lesson, we fall victim to another.

Seeking to raise taxes in the next budget would be premature. An economy needs time to recover. A contractionary fiscal policy will stop any recovery in its tracks and could end up putting the economy into reverse. There is no immediate concern about the sustainability of the public finances and no one should use the current budget deficit to invent a crisis. Employment and strong wages are the keys to restoring the public finances. 

We will eventually need to increase taxes and social contributions, but that moment will come when the economy and labour market have had time to strengthen. 

Moreover, when we do come to look at building our revenue base for the longer term, our gaze must not be inward, but outward. Ireland is a low tax economy, but not in the areas we think it is. When Ireland is compared with our near neighbours, the real gaps in our revenue emerge. For example, the largest of these gaps, by far, is in employers’ PRSI. In Ireland, employers pay less than 60% of the European average for social contributions.  

Ultimately there will be a choice. Do we want world-class public services in areas like education and health? Do we want a proper social insurance system? Do we want the State to be able to intervene meaningfully to directly increase the housing supply? Do we want to have the resources to help people transition to a zero-carbon economy?

If so, we are going to have to accept that some taxes and social contributions are going to rise. The question then will be how best to go about doing that.

"Some economic sectors, such as aviation and arts and entertainment won't return until the late Summer. It's crucial that we maintain the PUP until at least the end of September and that we immediately reintroduce it were there to be further lockdowns."