Matt Yglesias on the horrors of the Irish economy.1
Today of course Ireland is a total disaster. I wouldn’t try to blame their property crash on low tax rates. But by the same token a frightening number of pundits went “all-in” on the idea that Ireland’s conserva-friendly tax policies were behind a boom that was in fact driven by a real estate bubble.
I personally would try to blame a fair chunk of Ireland’s property market crash on low corporate tax rates.
The simplified political economy story goes as follows. Ireland had low nominal and even lower effective corporate tax rates. It also had low personal taxes, both because of the belief that this would foster entrepreneurship etc, and because the government used to periodically sweeten bargains between business and labor by promising tax cuts (which of course favored the rich more than the poor), inter alia buying off unions who might otherwise have started getting feisty about organizing the unorganized bits of the new Irish economy.
The result was that even with booming economic growth, the government faced a fiscal hole. This hole was filled by taxes on property transactions which, as the property market got ever more bubbly, became an ever more important source of government revenue. This provided the government with an extremely strong incentive not to deflate the bubble, reinforcing the already considerable incentives towards inaction resulting from cronyism between politicians and property tycoons, ideological notions about not interfering with ‘free’ markets etc.
When the bubble burst and the bezzle came into full view, the results were quite unpleasant, as this ESRI graph shows.
As the ESRI diplomatically puts it.
The strength of the Irish economy in recent years contributed to healthy public finances. In 2006, a General Government Surplus of 3 per cent of GDP was recorded. However, the current downturn has seen the public finances move into deficit at an alarming pace. Taxation policy in Ireland over the last ten years has led to a structural rise in the importance of capital taxes as a source of revenue. As a result, the downturn in the property market has led to a sharp reduction in tax revenues.
The Irish government now has to deal with the effective evaporation of a major source of revenue at the worst possible time – raising taxes on either individual taxpayers or businesses will further deepen the economic hole that the country is in. But even with drastic cutbacks in government spending, it’s unavoidable. This particular bit of the Irish crisis is a direct result of the country’s grossly skewed taxation model. And it’s left the country in a pretty horrible bind.
This is one of the reasons why Irish government bond yields are so high – there is no obvious way out of this hole that is both politically sustainable and economically feasible. And this isn’t even to get into the complications of Ireland’s relationship with the EU, which plausibly is the cause for Ireland’s otherwise inexplicably generous treatment of the creditors of the banks that it has effectively taken over. There are strong and persistent suggestions that the interests of those creditors (many of which are French or German banks) are significantly influencing the politics of European Central Bank support.
There is no visible upside to Ireland’s current economic situation. And as Matt notes, there has been a quite remarkable disinclination among American pundits, who were touting Ireland as a model for Europe a few years back, to publicly revisit their arguments. He mentions several Cato scholars in this regard; I’d be remiss if I didn’t point out that Thomas Friedman also deserves calumny to be heaped upon his head for this remarkable piece of globollocks about how ‘the only question is when Germany and France will face reality: either they become Ireland or they become museums.’ Sadly for Ireland, it isn’t Germany or France who has had to face reality. Sadly for the state of American public discourse, Thomas Friedman is probably never going to have to face it. At a book launch this morning for David Lynch’s new book on the Irish economy, the author talked a little bit about how the “culture of impunity” was still thriving among Ireland’s business elite. There’s a similar culture among America’s pundit class, and it’s still going strong too.
1 This may be about to get worse – if Morgan Kelly is right, the Irish economy has only been swirling around in the toilet bowl the last couple of years, and is just now about to take the deep plunge.