The Agenda

Henry Farrell on the (Putatitvely) Tax-Starved Irish State

Henry Farrell writes:

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. [Emphasis added.]

This is certainly an interesting story, and one can see how it resonates with Henry’s priors — and I should stress that Henry is a very sharp guy, who is deeply familiar with Irish political economy. But I wonder if Henry’s ideological notions are getting in the way of sound analysis.

This year’s Global Competitiveness Report, compiled by a team led by economist Xavier Sala-i-Martin, is best known for its top-line numbers on the world’s “most competitive” economies, a ranking that I don’t find especially useful. But there are many other indicators in the GCR that are very worthwhile. One of the bundles of indicators covers the quality of public institutions, including the “wastefulness of public spending.”

According to the World Economic Forum’s GCR, the U.S. is ranked 68th in the world in terms of wastefulness of public spending. That is, 67 of the 139 countries in the index are doing a better job of channeling public dollars into productive activities, including Singapore, Rwanda, and Qatar at the top of the list and Australia, New Zealand, and Canada among our large English-speaking peers. Not surprisingly, to those of us who follow work on the quality and cost-effectiveness of public spending across countries, the northern European market democracies perform well, with Sweden at 12, Finland at 14, Denmark at 16, and Norway at 20. Switzerland is at 9, Holland is at 17, Germany is at 33. There are no real shockers on the list.

But then, as I search for Ireland, I was surprised to find that the the “Celtic Tiger” is ranked at 93.

To get a sense of how Ireland found itself at 93, I strongly recommend reading Christopher Caldwell’s 2009 Weekly Standard article on the Irish economy:

In Ireland now, there is (as an American could predict) a lot of talk about how the past few years have been an era of greed, lacking in social solidarity. But in Ireland’s case, this is not true in the slightest. There was plenty of care for the less well-off. It is just that the government got no credit for it because it delivered that care by lowering poor people’s taxes. [Emphasis added.]

This part of the story resonates with Henry’s story, to an extent. But Caldwell continues:

The fiscal emergency had its roots in the generous-sounding “social partnership” model agreed on by the country’s leading politicians in the late 1980s–a sort of Irish answer to Germany’s social market economy. The key to the social partnership was assuring “competitiveness” in international markets. Irish workers wanted higher wages, but businesses wishing to locate in Ireland wanted lower ones. How do you square that circle? Through government. In return for workers’ moderating wage demands, government would make sure they paid very little in income taxes. Half the income tax in Ireland is paid by people earning over 100,000 euros, and 750,000 people–a third of the workforce–pay no income tax at all. Where does the money come from, then? From transaction taxes (“stamp” duties, capital gains taxes, corporate profits tax) that were paid mostly by the real-estate speculators who were making money hand over fist. Everyone seemed content with this system, even the speculators. It is, after all, easier to tax people’s fake money than their real money. 

As Agenda readers know, it is right-wingers who tend to fret about excessively progressive income tax structures, and to a lesser extent northern European social democrats who understand the lessons of the Scandinavian experience Peter Lindert identified in Growing Public and that Monica Prasad identified, in the French and West German contexts, in The Politics of Free Markets.

For now, let me say that I’m quite willing to believe that an excessively progressive income tax in Ireland exacerbated underlying political economy problems. 

The government could thus stimulate consumption (and consumerism) through low income taxes without having to stint on entitlements. This explains how, for a while, the ruling Fianna Fáil party managed to become the party of both the upper-middle class and the working class–much as U.S. Republicans did by a superficially different but essentially similar shell game.

We can see now that this arrangement was a time bomb. We can also see that the politically connected developers did a good deal to wreck the economy. But there is no denying that, by golly, they paid a lot of taxes. All this meant, though, was that the state became just as dependent on the housing bubble as the private sector. When more money came in, the government just spent it. The featherbedding patronage state is about the only Irish tradition that the global economy did not kill. Government employees make 25 percent more than equivalently situated private employees, according to the Dublin-based Economic and Social Research Institute. Government employees got very powerful in the process. So over the winter, when politicians decided to cut public-sector pay, they weren’t exactly forthright–they proposed lopping 7.5 percent off the top and called it a “pension levy.”

A more granular picture of what happened in Ireland leads us to a different conclusion from Henry’s: the structure of the tax system was a problem, but it wasn’t the mere fact that top-line rates or even total revenues were relatively low. (I should make the obvious point that Caldwell could be wrong about Ireland, but I don’t get the sense that he is captive to any crippling ideological notions.) Yes, the state grew dependent on the housing bubble. But the strikingly low quality of the Irish state and overcompensation in the public sector (two sides of the same coin) were clearly relevant to the broader fiscal picture. And that raises a different set of questions.  

It’s not obvious that the cost-effectiveness of the Irish state should be dramatically less than that of the effective Finnish state, or for that matter the extremely lackluster American state. 


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