Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

Irish Economy

Construction, not rent control, the solution to the housing crisis

Today sees the publication of the latest Daft.ie Rental Report. The full report is available here, while below are my thoughts on what the latest report tells us.

Most analysis of the housing market – both sales and rental – is currently done through the lens of the last housing bubble and where it was when it burst in 2007. However, that is a point of view that is increasingly out of date. In the rental market, for example, rents bottomed out in Dublin and Cork cities in late 2010 and had actually bottomed out a year earlier in Galway city. Ireland’s urban centres are four years into a new housing market cycle – and yet there is still very little evidence that anything is being done about what is now a chronic shortage of accommodation in Irish cities.

With local and European elections just a couple of weeks away, a number of candidates – particularly in the Dublin constituency – have been talking about rent control as a necessary remedy for the ills of rising rents. However, while the desire to simply make illegal what you don’t like is understandable, it mistakes the symptom for the underlying disease.

On the one hand, tenants already have reasonable security of tenure. Since the Residential Tenancies Act 2004, once a 6-month probationary period has been passed, tenants have security of tenure in four-year cycles, something that is known as a “Part 4 Tenancy”. (To ensure this is the case, tenants who have signed one-year leases need to notify their landlord about their intention to stay – more here.) There are a certain number of conditions under which a landlord can terminate a tenancy, but getting higher-paying tenants is not one of these.

On the other hand, rising rents are caused by a lack of accommodation in urban centres and reducing rents will discourage the provision of new accommodation, thereby making the problem worse. What we have seen in both sales and rental markets is reasonably robust demand for accommodation in Dublin and other cities, which has pushed up both rents and prices. These should be acting as a signal to bring about new supply – so why has significant new building not started in Ireland’s cities?

Whether construction of new homes takes place depends on whether revenues exceed costs. Revenues come from rents and house prices, which both appear to be at the cusp of affordability given incomes in Ireland. Therefore, if rents and prices are high enough, the solution is about reducing costs in construction – not about capping rents and thus further discouraging the very construction that would alleviate the accommodation crisis.

The cost base in construction includes capital, labour, land and regulation, as well as materials, whose prices are typically set on world markets. What is needed now is for the Government to go through each element in the cost base and develop actions to lower costs. It may surprise some readers to learn that the cost of building a house is 3.3% higher now than in 2007.

Labour costs in construction fell once, in March 2011, when hourly rates were reduced by 7.5%. But in an economy where the average disposable income fell by 25% between 2006 and 2012, and where there are significant numbers of long-term unemployed construction workers, is that enough? More importantly, the minimum hourly rate for a basic operative in Ireland at €13.77 remains a quarter higher than in West Germany (€11.05, a figure which will rise to €11.30 by 2017). Department of Environment figures indicate that for every €1 of materials, €2 is paid in wages, so the wage rate in construction has a real effect on levels of construction.

Just as important is the cost and supply of land. If people are allowed to hoard land or sit on derelict or vacant sites, this imposes a cost on the rest of society. Dublin City Council’s proposed levy on derelict and vacant sites may help encourage unused land to be used, but it can do nothing to encourage land to be used better and its biggest effect may be just a clamour to have some activity – any activity – on these sites to avoid tax.

Related to this, various levels of government currently deploy a bewildering array of planning and building regulations and charges, each of which increases the cost of building. While standards of quality should not be sacrificed for political expediency, many of the regulations – such as minimum sizes – appear to very little connection to quality and instead look like the preferences of planners and policymakers trumping those of households.

How the system currently treats land and planning regulations needs, at the very least, to be streamlined. Overhauling a dated and complicated system of stamp duties, development levies, commercial and industrial rates and amenity contributions, not to mention the Local Property Tax, with a single unified Site Value Tax is clearly the best solution to join up the very disjointed Government system that underpins Ireland’s construction sector.

The Government’s new strategy for the construction sector will be published shortly. No dobut the headline measures will relate to capital, with a fund for construction projects or targets for the pillar banks featuring prominently. But capital is only one part of the puzzle. Labour, land and regulation are just as important. It is to be hoped that the new strategy will contain specific measures to lower the cost of both labour and land, as well as streamline the Byzantine system of planning and building regulations. Only a holistic approach will be good enough if Ireland’s latest housing crisis is to be stopped.

Slow and steady: Ireland’s competitiveness, five years on

One of the mantras of Celtic Tiger Ireland was that it was a rip-off Republic. And indeed, by 2006, Ireland had overtaken Finland to become the most expensive place in the eurozone for consumer goods.

Mid-2008 marked a turning point, however, and the combination of global economic turmoil and local economic depression meant that prices fell for over 18 months from until early 2010. Regaining competitiveness with our currency peers does not necessarily involve deflation, however. It can instead be brought about by more moderate inflation in Ireland than in other parts of the eurozone.

And since 2010, that is what has been happening. The first graph below shows consumer price levels (as measured by HICP, which is designed to be comparable across EU member states) in four economic groupings. In addition to the eurozone core and Ireland, also shown are the PIGS countries (the “I” here refers to Italy) and the new EU member states (largely outside the Euro for the period shown).

Consumer prices in selected EU regions, 1999-2012

In the first period, from 1999 to early 2004, Ireland acted like a new EU member state. Consumer prices increased by 22% in that period in Ireland, compared to 20% on average in the new EU states, 14% in the PIGS and 9% in the eurozone core. The second period, from early 2004 to mid-2008, Ireland actually saw more moderate growth in prices: 14%, in line with other PIGS (15%), below the new EU states (21%) but above the core (11%).

In the 50-odd months since August 2008, Ireland has been unique. Prices in Ireland have actually fallen by 1% in that period, while they have risen by almost 10% in both the PIGS and the new EU member states. In the Eurozone core, they have risen by 6% in the same period.

A direct comparison of Ireland and the eurozone core shows this competitive readjustment more clearly. The second graph below shows prices in Ireland relative to the eurozone core (=100) from 1999 on. Ireland’s price competitiveness worsened by 12 percentage points in that early period (up to 2003) and by another four percentage points (roughly) between then and 2008. In other words, it was the early years of the eurozone when the damage was done to Ireland’s cost competitiveness.

Prices in Ireland relative to Eurozone core (1999:1=100)

Of that 16-percentage point worsening in Ireland’s competitiveness, roughly half has since been eroded away. Compared to 1999, Ireland’s price levels have risen by 8 percentage points more than the Eurozone core. (This hides differences by particular categories of goods and services – a subtlety that matters a lot!)

In truth, that 8% figure probably overstates things slightly, as HICP excludes accommodation costs, which are the single biggest component of consumer expenditure.  Both rents and house prices in Ireland at currently at levels comparable to 2000, which is unlikely to be the case in any other European economy. Perhaps the only other candidate for such stable figures is Germany, but its property market has heated up the last two years, meaning costs are a good bit above 1999 levels.

In short, it has not been fun – as inflation is associated with expansion and deflation with contraction – but Ireland has put in five hard years of competitive readjustment. With prices on hold, so are wages, which boosts Ireland’s attractiveness for FDI. The sting in the tail is that with inflation throughout the eurozone so low, any further competitive gains are going to be even tougher and slower.

Another fine mess! So you want to value some properties…

Dear Government,

Well, you can’t say you weren’t warned. Yes, it was a noisy time for all concerned, with plenty of people telling you they didn’t want to pay any sort of property tax, no matter how cleverly designed. But still, there were those of us who argued all year long for a smart tax with a smart design. One that got lots of information into the system, to enable the auditing that means everyone is paying the fair amount. And perhaps more importantly one that kickstarted economic activity, rather than just another form of income reduction.

Really, the whole thing was quite messy. One of your own agencies, the Land Registry – who can tell you who owns what plot of land and what’s on the land – was apparently not consulted once. The debacle of the Household Charge shows the same happened GeoDirectory, which is a database of addresses and their physical locations, maintained by An Post and Ordnance Survey Ireland, two more of your agencies.

The mess continued on Budget Day, when people were told they had to self-assess the value of their homes – but were given no good incentive to do so well. Some of us advised giving people a tax credit in Year 1 to have their property professionally assessed and in their tax return give the Revenue Commissioners the kind of information needed for good auditing. Instead, the door was left wide open for a most unwelcome experiment in game theory, where neighbourhoods come together and coordinate their valuations at below-market rates, leaving Revenue Commissioners powerless to find any individual resident guilty of tax evasion. Which is why they have decided to value the properties themselves, apparently. But of course, not least thanks to a rather detail-sparse Property Price Register, they have none of the direct information needed to do this.

So, as you’re quite fond of saying yourself, we are where we are. Now what?

As it happens, I actually spend quite a bit of my time worrying about how best to value properties, segment the property market, etc. I’m actually just fresh from a renovation of some of those models. And the good news is that with the right information – in particular a property’s size and location – it’s quite easy to come up with reliable estimates of a property’s worth.

So, between breakfast and starting work this morning, I developed the following estimate of Irish property values. It should work in all areas, urban and rural, and for all major property types (apartments, bungalows, terraced, semi-d and detached) and sizes (one- to five-bedrooms).

So how does it work? To work out the value of a property, simply take the starting point (a 3-bed semi-d in Louth) and then multiply it by whatever factors you need. In particular, pick your county or urban area, if different; and pick your property type and size. So for a four-bed bungalow in Sligo, the €108,000 starting point is multiplied by 0.875 (prices in Sligo relative to Louth), by 1.355 (prices for 4-beds compared to 3-beds) and 1.221 (prices for bungalows, compared to semi-ds). Multiplying them all together gives an estimate of the property’s value in Q4 2012: roughly €156,000.

A rough guide for valuing an Irish property in early 2013 (see accompanying text)

Hopefully, Mr. Government, this table is of some use as you try and disentangle yourself from yet another fine mess!

Some notes on the above table:

  • Clearly, this is by no means meant to capture every last factor affecting property values. (One simple extension is number of bathrooms – roughly speaking, every additional bathroom is associated with a 10% higher price.) This model captures just under two-thirds of variation in house prices in Ireland, which – given the small number of factors included – is pretty good. But there’s still a third out there to explain. (Including effects for areas within counties would explain a significant chunk of the remaining variation, as it happens.) On average this will be right, and it will for the vast majority of cases be close but of course there are always properties that have unobserved factors that dwarf what matters for most homes. The method underpinning the figures above explicitly excludes outliers, so as to better improve the estimates for the vast majority of homes.
  • The table above is based on 60,000 listings on Daft.ie over the year 2012, and allows for the fact that prices varied throughout the year. “Aha”, a sceptic might say, “these are only asking prices and sure we all know they are [insert pet peeve here – too high, too low, etc]”. As it happens, some pretty detailed research comparing asking and transaction prices shows they move together remarkably tightly, once controls for location and size are included (as they are here). Properties that sell typically sell for about 10% less than their asking price, so for that reason the starting point of €108,000 is actually 90% of the figure returned by the model. The key thing about the model is what it tells us about relativities (prices between counties), not necessarily levels.
  • Lastly, lest there be any confusion, I offer this table as a public service but can’t offer it as any more than what it is – one academic economist’s analysis of the market.

Property tax – it’s not rocket science!

Ireland’s struggle to introduce a property tax continues, as does the public’s fixation with it. A minor bullet point in this update to the IMF-EU “troika”, confirming what was already decided – that Ireland is going to bring in a value-based property tax – is (along with that other staple of Irish debate, abortion) leading the news this morning.

The on-going poor quality of information doing the rounds is a big frustration so I’ve decided to continue my crusade for good policymaking in Ireland and post (yet again for long-standing readers) about property tax.

Why a property tax at all?

The yawning gap between what the Irish government takes in and what it spends means that both spending cuts and new tax revenues are needed in coming years. Comparing Ireland’s tax structure with other countries, the country already has among the highest marginal rates of direct (income) and indirect (VAT) tax in the world. What’s missing? Well, the third type of tax, after direct and indirect, is wealth tax.

And real estate comprises the bulk of wealth – not just in Ireland, but everywhere. Ireland’s homes are collectively worth roughly €300bn – a huge chunk of our balance sheet. What’s missing, when you compare Ireland with other developed economies, is a property tax. Those who argue against property tax are not taking a principled stand against bank bailouts. They are arguing for even higher income or consumption taxes. And thus missing the chance to tax wealthy non-residents who own property in this country.

What is a value-based property tax?

Ultimately, I’m not sure why the Government is making a mountain out of a molehill. There are basically four types of property tax out there – flat charges, bands, full value and site value – and they are fairly easy to rank. The worst kind of property tax is the flat charge, what was introduced here earlier this year. It is obviously regressive and unfair and is also just a temporary measure so little more needs to be said about it.

The next worst type of property tax is the bands system. Under such a system, if your property falls under certain thresholds, it benefits from a lower tax rate than others. This is similar to how stamp duty used to work in Ireland. It is also how council tax works in the UK. Until this morning, I hadn’t heard anyone argue in favour of it, although there had been some mumblings in newspaper reports – this morning, though, Fergal O’Rourke of PWC actually called for a bands system.

What has happened in the UK should be a salutary lesson for Irish policymakers. Bands means trouble because in any given year people want to be under the threshold, thus distorting prices, while over time unless bands change every year, they become ridiculously outdated. So in England, your property tax is based on what the value was in 1991, not today, because no-one can agree on updating them. Even aside from our preferences having changed over the last generation, this is plainly bad policymaking. Why anyone, least of all a tax expert, could think is a runner at all is a mystery!

Should we pay relative to the market value?

An improvement on bands is a full value tax – you pay a percentage of what your property is worth every year. Those with more property wealth pay more in property tax. Straight away, some of the dodgy side-effects of a bands system are overcome. If property prices rise or fall, you don’t have to worry about political will to update bands. However, a moment’s thought should point out some pretty weird features of a full-value property tax.

For example, the Minister for the Environment is a big fan of regenerating town centres, which have fallen victim to edge-of-town retail centres in recent years. However, under a full-value tax, the owner of a derelict city-centre site has no incentive to redevelop it because if he does, he’s faced with a higher property tax bill. What sounds like an issue for developers also affects households. If you make your home more energy efficient, up goes your annual property tax bill. New extension? Up goes the bill. Anything at all that involves you using scarce land in socially more useful ways is punished.

This is the major theoretical problem with full value tax: the last thing you want is for your tax system to punish those who use a scarce resource well. And then in practice, there are huge issues of implementation. Is that extra room upstairs a bedroom or a study? (Each will have a different price.) Is that attic properly converted? Is that outhouse part of the main building? All of these are prices that have to be measured and updated, creating lots of work for people like me but ultimately very little use to the taxpayer.

What is “site value” and why should we tax it?

The fairest form of property tax is the site value tax. This is not as complicated as some try to make it out. The value of your property has two components: the land and what you put on the land. Subtract the latter from the total value and you have site value. How might we measure the value of land around the country? Happily, it’s already been done and is available free of charge from smarttaxes.org. There’s even a map outlining the contours of site values in the country. Pages 14-16 of that report also go through options in relation to those on low incomes and those in negative equity, as well as a number of other issues.

There are many arguments in favour of site value tax and few against. It rewards, rather than punishes, households that make their home more energy efficient. At a deep level, site value tax is inherently fair – after all, why is land worth more in some places than in others? It is because society and nature – not individuals – have created amenities that people value and pay for. Is it too much to ask people to pay back a small part of the benefit they are getting from society? Site value tax is also really handy because it can be applied to all types of land, residential, commercial, public and agricultural land, with huge beneficial side-effects in terms of land use and – dare we say it – economic recovery.

Site value tax is also a tax on hoarding land and speculating, as residential land banks on the edges of towns would incur the same as developed estates. This also removes the incentive for people to get their land banks zoned residential on the off chance they could become millionaires. If it’s zoned residential, use it as residential or pay the price!

According to media reports, the Government is currently of the opinion that a site value tax “would throw up anomalies” such as a rundown property and a modern property on similar sites having the same property tax bill. That is not an anomaly. That is the tax system encouraging us all to use as well as possible a scarce and valuable resource, i.e. land.

I agree that a property tax should be easy to understand. A range of bands and tax rates creates a complicated system that people want to game. That is only one consideration, however. After all, it is very easy to understand a €100 household charge but that was hardly publicly accepted. A simple flat site value tax rate is well within the grasp of a population that frequently votes in referenda on constitutional and foreign policy issues.

What do other countries do?

One of the oddest arguments I have heard yet against the site value tax is “no-one else is doing it”. Even if it were true, what an odd argument! In-built bias towards the status quo means that most countries are stuck with property taxes very similar to what they had fifty or a hundred years ago. Ireland – by dint of auction politics since the 1970s – is in the oddly lucky place of being able to choose the best system without the constraints of status quo.

But even then, it is not true to say that no-one uses site value tax. There are numerous states and cities around the world, from South-East Asia to North America, that have it. Two other small open economies in the EU – Denmark and Estonia – use site value tax consistently and successfully. Rather than ape the failed system of our nearest neighbour, perhaps we could take a leaf out of their book instead.

The lack of a property tax means we have the opportunity. With Land Registry records on who owns what site where, as well as existing research on the contours of land value around the country, we have the means. And with the positive side effects that only a site value tax can bring, we have plenty of motive. Hopefully our Government won’t let us down.

The post above is based on an op-ed piece I wrote in the Sunday Business Post earlier in the month.

Sovereignty is over-rated, society is under-rated – address to this year’s Parnell Summer School

After a bit of a break from blogging for a variety of reasons (not least getting married!), an invitation to speak at this year’s Parnell Summer School provided the perfect opportunity to find my voice again. Based in Parnell’s family home, in Avondale House, County Wicklow – one of the most picturesque spots in arguably Ireland’s most picturesque county – the annual Summer School builds on the memory and works of Parnell. This year being the centenary of the Home Rule Bill, the theme was ‘Sovereignty and Society’ particularly in light of all that has happened in Ireland in the last five years.

I took the opportunity, during my lecture, to outline what an economist thinks of the concepts of (economic) sovereignty and society. In particular, I argued that I felt that the concept of economic sovereignty was one that was significantly over-valued, while society was a hugely under-valued concept.

Sovereignty is over-rated

In short, my argument in relation to sovereignty is just specialisation and the division of labour recast. People happily cede sovereignty all the time to give themselves a better future. No-one tries to build their own home or produce all their own food. They pool their sovereignty in a community where these tasks are shared and so are better done. Perhaps a clearer analogy is when an individual borrows to further their education or a household borrows to buy a new home. These are decisions that immediately subject that person or family to scrutiny, in relation to spending and lifestyle patterns and plans for the future. A lender has taken some of the borrower’s “sovereignty” – and yet, the borrower is happy to pay that price, because they want a better future. And if you put yourself in the shoes of the saver, giving your hard-earned savings over to someone else, it’s not hard to see why saver-lenders want this scrutiny.

This works at the level of the country, too. No country has ever provided a high standard of living for its citizens by abstaining from investing in its future, and investment involves large-scale borrowing. So, as soon as we want what’s best for our community, straight away we should be prepared to yield some of our “independence” to deliver it.

Quite why there is such a fuss about lost sovereignty because Ireland is currently borrowing from ‘our mates’ (the other countries that make up the EU and IMF) at preferential rates, rather than borrowing from the international capital markets is beyond me. No matter who we borrow from, mates or markets, we will need to have a fiscally responsible set-up for them to do so. And the Irish Government spending €20bn more than it takes in in revenues is not fiscally responsible by anyone’s measure.

Society is under-rated

In relation to society, it’s my firm belief that the policy-making in Ireland – and indeed in most countries – systematically under-values society, which comprises market and non-market activities. Non-market activities are sometimes free (friends and family, for example), often not (roads, coastguards and primary education cost resources, for example) but inevitably, they are not included when we take stock on an annual basis.

This is not to suggest for a minute that we should scrap GDP and measure happiness instead. This would be to subject public policy to the vagaries of human sentiment, vagaries that only just being understood by behavioural economists and psychologists. Instead of scrapping using dollars and cents to guide our decisions, we should extend the principle to include non-market activities. After all, “priceless” to an accountant means zero. Let’s replace those zeros with numbers.

The related issue with how society divides out its resources is the lack of any connection between how money is raised (in large pools such as VAT, income tax and PRSI) and how money is spent (in large pools such as health, education and social welfare). Thus, when spending cuts have to be made, they are only ever done in reference to the costs of a particular public service, never its benefits.

Changing these resource allocation decisions so that they are based on the return enjoyed by society on money spent – and not just on the amounts spent – is the single biggest challenge for public finances in the OECD over the next generation, in my opinion. There’s no reason Ireland can’t be at the forefront in developing proper accounts for public spending.

The slides I used at the Summer School are available on SlideShare and are embedded below.

What price freedom?

The lecture I gave was the preamble to a panel discussion about economic sovereignty by Richard Boyd Barrett, Paul Murphy (Socialist MEP), IBEC’s Brendan Butler and Pascal Donoghue of Fine Gael. I’ll post my thoughts on that later in the week. To give that post a bit of steer, though, I’ll finish up with a little poll.

Suppose we knew for definite that not giving up some of our economic sovereignty (inter alia, ability to choose tariffs, exchange rates, interest rates or taxes) meant we’d have a lower income than doing so (this is in fact the assumption implicit in any country joining the EU). If average income missing some sovereignty was €40,000, how much of that would you be willing to pay to retrieve that sovereignty back? Zero means you’re not particularly bothered by sovereignty – perhaps things like peace and prosperity are more your bag. At the opposite end, clearly, an answer of 100% means “freedom at all costs”!

What percentage of Ireland's €40,000 average income would you be prepared to concede to have full economic sovereignty (over things like tariffs, exchange rates, taxes, etc)?

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The Austerity Games: Ireland’s Fiscal Treaty referendum redux

A few important concepts have gone out the window as the debate in Ireland about the referendum on the Fiscal Compact has descended into political games. Perhaps the first victim was cause-and-effect, with the  mere correlation of banking debts and government deficits being translated by many into iron-cast causation.

A close second in the casualty list was the concept of opportunity cost: in other words, it’s not how bad or economically illiterate the Fiscal Compact is in and of itself, it’s about how attractive it is relative to the other options. As of now, the most important attribute of the Fiscal Compact is its ability to get Ireland the funding that it otherwise would not be able to get, to allow the country to gradually close the deficit. By 2020, that may be completely unimportant and we may want to ditch the Compact. But we are voting in 2012, not 2020.

With all that in mind, I decided to develop a flow-chart that aims to illustrate the point that this is not about absolutes, it’s about options. If you click on the image, it should open up in a larger and more legible size. Hopefully you find it useful – if so, feel free to share it. If you’ve any suggested changes, pass them on and I’ll work them in.

Ireland's austerity choices

For more text on why the IMF will not be a panacea, Karl Whelan has an excellent blog post here.

Wealth taxes and property taxes in Ireland: understanding the tax base

The end of the first quarter of 2012 saw not just the usual quarterly reports – such as the Q1 2012 Daft.ie House Price Report discussed elsewhere on the blog – but also the deadline for paying the €100 Household Charge. The charge has been the focus of a campaign of resistance that is surely more to do with the principle than its size (the increase in Band A motor tax was almost as large as the Household Charge but I don’t recall anyone complaining against that particular flat tax).

In fact that campaign has succeeded in one way already: while it had originally talked about the charge applying for 2-3 years on an interim, the Government is now not going to go through all this again and desperately wants to bring in a fairer property tax with Budget 2013 this coming December.

Where’s all the property wealth?

What sort of base is there for property tax? The latest Daft.ie Report gives county-by-county figures, which can be combined with information from 2006 and subsequent completions (or alternatively Census 2011 information) to reveal what wealth there is in residential real estate around the country.

The total amount of wealth in residential property peaked in 2007Q4, at €564bn. 37% of all this wealth (€208bn) was in Dublin (home to just 28.5% of households in 2006). A further €37bn was in the four other cities – their 6.5% being roughly in line with their 7% share of all households. Since then, the trickle of new completions has not been nearly enough to offset the fall in property values. The stock of homes as of Census 2006 has fallen in value from €525bn to €255bn, as of Q1 2012, while including the value of new completions in the years since 2006 increases the total value of all residential property to €294bn.

Households and housing wealth in Ireland

Dublin is now home to just under €100bn of housing wealth, as of early 2012, while the rest of Leinster and all of Munster are home to €70bn and €76bn in housing wealth respectively. Connacht and the three Ulster counties are home to about €48bn of housing wealth. The relative proportions that each of four regions makes up of Irish housing wealth and Irish households is shown in the two pie charts above – you can see that rural households need have no fear that any property tax will hit them hardest. Quite the reverse: any property tax will have to make sure that it doesn’t overly punish urban life, which is so crucial to subsidising the rest of the country.

Where’s all the wealth?

These are statistics that the political class would do well to heed. To recap our Econ1010, there are three main types of tax: those on incomes, those on consumption and those on wealth. Ireland is also home to some of the world’s most punitive rates of taxation on income and consumption, so hence there is increasing interest in wealth taxes.

There are four main forms of wealth: (1) cash/deposits, (2) equities/shares, (3) debt/bonds, and (4) real estate/property. In Ireland, as of 2006, deposits made up 10% of Irish wealth, equities a further 8%. Pension and investment funds – wealth holdings of unknown type but likely to be a mix of mainly equities and bonds – made up a further 11% of wealth. But it was property that was the overwhelming type of wealth in Ireland, making up 72% of all wealth. The vast bulk of this was residential property. And that picture is not likely to have changed substantially with so much of Irish equity wealth being invested in the banks, which are now all next to worthless.

So when people talk about taxing wealth in this country, they are talking principally about taxing the homes that we live in. In second place comes taxing the deposits we have in the bank. Make sure to mention this to the next person who says “We don’t need a property tax, we need a wealth tax”.

The Fiscal Compact – Vote Yes to Silliness (It’s all about the cash)

Last week, I outlined some of the many reasons why the EU’s Fiscal Compact should have been sent back to the drawing board when first seen by European leaders and their economic advisers. The experience of Spain since then sums these up pretty well. Spain had been given a target deficit of 4.4% of GDP this year. But it turns out the deficit is going to be closer to 6% of GDP.

The Pain in Spain

And with good cause. Firstly, the Spanish government doesn’t control GDP. It barely controls its own spending, let alone its own receipts. So what happens GDP should not be enshrined in laws and constitutions. The Fiscal Compact should be about government spending relative to government receipts, and not relative to some arbitrary concept of national accounting. For example, if the Government makes up about 50% of the economy, an 8.5% deficit relative to GDP actually means that 17% of spending is unfunded by current receipts.

Secondly, the Spanish government fears the effects of actually getting the deficit down to 4.4%. Halving that 17% unfunded spending down to just 9% in one year would mean cutting roughly 10% of Government spending… in one year! And all this while an economy is on the verge of recession, defeating the purpose of fiscal policy as one of the remaining tools of economic stabilisation for economies within a currency union.

However, Ireland does not have the luxury of saying no to the EU’s Fiscal Compact. The reason why is simple: cash. Until someone comes up with an alternate plan for sovereign funding as Ireland closes its deficit, borrowing from our EU partners and the IMF at what are – relative to the markets – low interest rates is the only game in town.

Bear in mind that our borrowing requirements are substantial. We’ve roughly €120bn in debt that needs to be rolled over at various intervals (although some of this is owed to Irish citizens, for example in the form of Prize Bonds) while an optimistic scenario sees us borrowing a further €14bn this year, €12bn next year, €10bn the year after… and so on meaning our national debt will be something like €170bn before it is close to stabilisation.

If not EU, who?

The plan, of course, was to go back to the markets in a substantial way next year. The question is, though, with the sovereign debt markets as they are, who would lend to Ireland at anything close to the 3% medium-term growth rate we are hoping for? (When national debt is the roughly the same size as the entire economy, the quickest way of assessing sustainability of debt is to compare the interest rate with the growth rate. If the interest rate is higher than growth, debt repayments would ultimately dwarf all other spending.)

Not only that, any institution that would lend to Ireland would attach conditions that would be effectively identical to the Fiscal Compact: i.e. Ireland’s government would need to get its spending back into balance and fast. The only alternative would be to balance the books overnight – this would be an extremely painful overnight adjustment, with public servants and social welfare recipients experiencing a dramatic reduction in their income.

Compared to that, the EU Fiscal Compact is quite attractive. The “path of adjustment” outlined in the Compact gives Ireland a full two decades upon exiting the bailout programme in 2015 to reduce the debt from, say, 120% of GDP, to 60%. That’s right – only in 2035 will the full EU Fiscal Compact and all its silliness apply to Ireland.

So, as an economist, I think the EU Fiscal Compact should be completely rewritten, this time with an understanding of fiscal policy. But it will go ahead, with or without Ireland’s assent in a referendum – the referendum is really only about whether Ireland wants to opt in for further funding from 2013 if needed. So as an Irish citizen, it has to be a yes for the EU Fiscal Compact.