TOPIC D: Public Finances, Debt & Taxation

TOPIC D:Public Finances,Debt & Taxation TCD M.Sc.(EPS) – Ronan LYONS – EC8001 Irish Economic Policy ISSUES & Context

Module Outline

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 • 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 non-excludable nature, market will not provide pure public goods VS.

Market Failures • Not all costs reflected in market price • Rationale for intervention • Aligning social MC with private MC • Externalities • Positive – e.g. education, road network • Negative – e.g. pollution, fisheries • Other market failures • Monopoly power (IRTS) • Imperfect information (e.g. BER, PRSI) Negative externality € P=SMC 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

Levels of Government in Ireland • Global • UN: budget of ~€2bn [Ireland contributes ~€8m] • Also IMF, World Bank and WTO • Supranational • EU: budget of ~€120bn [Ireland contributes ~€1.3bn] • National/Federal • Ireland: government spending is ~€55bn (incl non-voted) • State level • N/A in Ireland • 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? Source: European Union

Who Benefits from the EU? 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 • EU was a significant contributor to Irish incomes in 1980s,1990s • 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 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 • 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 • Ear-marked (from central voted expenditure) • General purpose Source: publicpolicy.ie

Is Ireland Missing A Layer of GOV? • “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 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?

Three types of spending • Main spending headings • Public consumption • Public investment • Transfers • In boom, Irish Exchequer: • Declined in size (relative to economy) • Switched somewhat from current (consumption + transfers) to capital • Since 2007, fraction of spending on capital has halved Source: Dept of Finance

Public Spending: Consumption • Consumption • 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 • More in Topic I next term Source: Dept of Finance / Budget 2015

Public Spending: Investment • Goals of investment • Boost productivity of economy • Maintain assets/amenities that provide social return • Three areas dominated by investment • Environment • Jobs/enterprise • Transport • Add health, education – €2.9bn of €3.6bn in 2014 Source: Dept of Finance / Budget 2015

Public Spending: Transfers 26% 17% 10% 4% Roughly 3/4s Source: Dept of Finance / Budget 2015

Public Spending: Transfers • Repayment of national debt is also a form of transfer • No good or service is being provided, nor is any capital being formed • Roughly 5% of Irish income is spent paying off national debt • More later… Where series line up, 20:1 ratio (i.e. 5% interest rate Source: Dept of Finance

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 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 • Hedonic regression analysis • Ireland’s 6,700 castles add ~€2bn to value of housing • Churches add ~€1.4bn • Historic homes add ~€300m • Combined effect of €3.6bn means LPT revenues due to built heritage of ~€6.5m • Excludes other benefits (e.g. direct revenues) • If this is minimum benefit, what is current cost? ROI

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? • Mid-1980s: sizeable twin deficits • Mid-1990s: small twin deficits • Mid-2000s: large current suplus, capital deficit • What went wrong? • Mid-2010s: large current deficit; capital in balance • Concerns?

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

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 BordGais), 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 schoolsor 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 • Is Ireland’s taxation system equitable, efficient and simple? • “Ireland’s fiscal policy since the 1970s has rarely been best practice.” Discuss. • What is the role for cost-benefit analysis in the future of Irish policymaking?

TOPIC D: Public Finances, Debt & Taxation