Committee on Budgetary Oversight debate

Economic and Fiscal Position: Economic and Social Research Institute

Chairman

I welcome our witnesses from the ESRI, Professor Alan Barrett, director, and Professor Kieran McQuinn, research professor and head of economic analysis. They will be dealing with Ireland's economic and fiscal position.

I wish to bring to the attention of the witnesses that they are protected by absolute privilege in respect of the evidence they give to the committee. However, if they are directed to cease giving evidence on a particular matter and they continue to so do, they are entitled thereafter only to a qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and they are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person or persons or an entity by name or in such a way as to make him or her identifiable.

Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person either inside or outside the House or an official either by name or in such a way as to make him or her identifiable.

I call on Professor Barrett to make his opening comments.

Professor Alan Barrett

I wish to begin by thanking the committee on my behalf and on behalf of Professor McQuinn for the opportunity to appear today. We welcome the fact that greater parliamentary oversight of Ireland's budgetary process, as recommended by the OECD, is now becoming a reality. Before turning to the specifics of our opening remarks, I would like to wish the committee well in carrying out its important work.

While we might get to explore a broad range of issues in response to any questions, we have aimed to restrict the opening remarks to the principles on which budgetary decisions should be made while also giving a brief overview of our outlook for key budgetary variables. Some of these themes may well be familiar to members of the committee but we maintain there is value in placing the later discussion in the context of those principles.

The first question to arise in the construction of a budget is the macroeconomic question of the appropriate size of the budget package. Economists tend to disagree on many issues but on the question of macro fiscal management there is broad agreement. When the economy is growing below its potential rate, a stimulatory budget can help to move the economy back to its potential growth rate. When the economy is growing faster than potential, contractionary fiscal policy can assist in avoiding overheating.

In the current context we now believe the Irish economy is growing at its potential rate and so neither stimulatory nor contractionary fiscal policies are required. Instead, a neutral stance is required. While there are differing definitions of neutrality, a budgetary package of approximately €1 billion - the net fiscal space figure in the summer economic statement - is broadly in line with this concept. These comments on economic growth are based on a view that the economy is growing at a rate in the region of 5% and not at the headline rate as published by the Central Statistics Office recently.

When arriving at the figure of €1 billion, the Department of Finance adjusted the gross fiscal space figure of €1.7 billion by subtracting estimated impacts on spending from the Lansdowne Road agreement and demographic pressures. This is appropriate but ESRI researchers tend to go a step further by explicitly indexing social welfare payments, tax bands and allowances to projected wage growth to arrive at an opening budget position. This is not to suggest that the Department of Finance is incorrect in its approach – this approach is based on the notion that indexation is a political decision made within the budget. The ESRI approach comes from a different perspective and is based on the notion that distributional neutrality can only be achieved if welfare payments, tax bands and allowances are indexed to wages.

Whether indexation is implemented in a budget, our view is that budgetary figures and analysis should be presented with a baseline of indexation applied. In this way, any failure to index tax bands and allowances is explicitly shown to be a tax increase. Any failure to index social welfare payments is shown to be a cut in relative living standards. In this way, the policy choices become more transparent.

Even if the overall budgetary position looks healthy, we know from recent experience that the tax base can be fragile. For this reason it is desirable that the tax base is broad and that reliance is placed on the tax heads less sensitive to the economic cycle. The ESRI has been exploring this issue under a programme of research with the Department of Finance. One of the themes that has emerged is the relative stability of income taxes and hence the desirability of maintaining such taxes as a sizeable share of total revenues.

Although we aim to focus on principles in this opening statement, it is difficult not to mention proposed cuts in the universal social charge in the context of discussing the need to maintain the breadth and stability of the tax base. The USC has many desirable features as a source of revenue: progressivity, transparency and stability, to mention three. For this reason we are unconvinced that moves to abolish the USC are wise. In light of my earlier remarks on indexation, this is especially the case if the non-indexation of tax bands and allowances is used to fund any reductions. More generally, the need to protect the tax base leads us to urge caution in respect of any reduction in the aggregate tax take. This point has come into sharper focus because of the potential vulnerabilities associated with Brexit and the Apple tax decision.

I will outline three remaining principles before moving to questions. The first, drawing from our medical colleagues, is to do no harm. While this is generally true, I am making the point now partly in response to fears that there may be plans to provide support to house buyers in the budget. Depending on the design of any proposals, the potential exists for any supports to simply inject further demand into the market with direct effects on prices but no net benefit to the group being targeted. In a paper before last year's budget we analysed the potential impact of a range of tax incentives in the housing market and showed how the incentives could fail to produce an increase in supply under plausible assumptions. The lessons from that paper are relevant this year as well. In the context of taxation and the property market, however, we see potential merit in site taxes and can expand on this later in the discussion.

Second, again in the context of learning a lesson from the past, all tax incentives should be reviewed periodically to ensure they are still relevant. We are unsure whether the tourism-related incentive introduced by the last Government is still needed but the case needs to be explored.

Third, as with all policies, evidence should be used where possible to assess proposals and alternative approaches to achieving the same goal should be considered. Again, I will use the USC as an example. It is sometimes argued that high tax rates are a disincentive to work. At some point this is probably true but we can ask if there is evidence to suggest that the current tax rates are leading to widespread withdrawals from the labour market. The most recent figures show that employment increased by 56,000 in the year ending quarter 2, 2016, or almost 3%. Evidence on this issue should be gathered in a more sophisticated manner but even this simple approach raises the question of whether tax is acting as a significant disincentive to work. It could be the case that child care is a greater disincentive. If this is true, then a greater effect on labour supply could be achieved through child care subsidies as opposed to income tax cuts, including USC cuts.

Finally, we believe capital investment that increases the productive capacity of the economy to be desirable, including spending on housing. I thank the committee members for their attention and we look forward to taking questions.

Deputy David Cullinane

I welcome Professor Barrett and Professor McQuinn and I thank Professor Barrett for his opening statement. I have four quick questions and I will deal with them all at the same time, if that is okay.

The first relates to growth levels. Professor Barrett referred to the growth levels and adjusting the 26% GDP figure that came from the Central Statistics Office to determine real economic growth. The chief economist from the Central Bank was before the committee yesterday. He indicated that the preference of the Central Bank would be to develop a bespoke Irish way of calculating growth and to use a different set of economic indicators. He suggested we could then try to win support for that approach throughout Europe and potentially globally. How realistic is that?

Professor Barrett mentioned the universal social charge. Can he expand on whether he wants it to be phased out or left as it is? If he believes it should not be phased out, could he give his reasoning for this? If it is phased out, what will lose out? What will come under pressure? Is it capital investment or current spend? Where will the sacrifices be made if the universal social charge is abolished?

In the calculation of fiscal space there is a difference between gross fiscal space and the fiscal space net of the Lansdowne Road agreement and demographic pressures. In some of its previous reports, the ESRI has been somewhat critical of the amount of room provided for demographic pressures. Does Professor Barrett think it is undervalued or that it is greater than in the calculation of gross and net fiscal space?

My final question relates to capital investment. I do not think Professor Barrett intentionally set out a hierarchy of priority but a vague reference to capital investment seemed to be tagged on at the end. Given that we have very depressed levels of capital investment and that there are obvious needs in areas such as health, housing and education, there is always demand. We have had the Cassells report on the housing crisis and the Department has said there will be a need for an increase of €3 billion in capital investment in roads over the next five years. How important is investment in capital and what are the priorities in that area?

Professor Alan Barrett

I will deal with the second, third and fourth questions and Dr. McQuinn will take the first. We are taking a very cautious approach to the question of phasing out the USC. I gently said in the opening statement that we are not at all convinced that it is a good idea to phase it out, for a number of reasons. Globally speaking, we would be worried about anything that reduced the total tax take in Ireland at present. One might be able to make arguments for certain tweaks to the tax system and certain taxes that one might consider moving or substituting with other sources of revenue, but the universal social charge has a lot of desirable features. Obviously, everybody hates every sort of tax but as taxes go, it is very progressive and stable. After the crisis, the stability of tax law is something on which economists have become much more fixated. The charge is very effective from the point of view of getting in a lot of revenue. Why, therefore, would one abolish this of all taxes? Much of the political rhetoric around this is linked to the notion that it was introduced during the crisis and a belief that anything that came in as a result of the crisis can seamlessly be rolled back now that we are out of the crisis. However, we got into the crisis because we had very unstable tax revenues so it seems like a really bad idea. I use the term "we" but the ESRI never says anything. Individuals within the ESRI say things, however. The question of what might substitute for the USC or what might lose out does not arise as I do not think the charge should be reduced.

The strongest debate on fiscal space took place between the Irish Fiscal Advisory Council and the Department of Finance and they had differing perspectives. The Department of Finance does now adjust the fiscal space measure and adds in demographic pressures and the Lansdowne Road agreement. In the short term, the Department is probably doing a sufficient job in this area and I have consulted people from the Irish Fiscal Advisory Council on this, who agree that the €400 million adjustment is probably reasonable. The bigger point is that demographic projections are a longer-term issue. This goes back to the need to defend the current tax base. According to projections, demographic pressures on public finances will increase at a rapid rate beyond a certain point so anything we do now to soften or reduce the tax base will have very significant implications in the long term.

The final question was about capital investment, which has been low for a number of years. There is a lesson from history here. In the fiscal retrenchment of the 1980s, public capital investment fell to very low levels. Everybody in the room will understand that this was because it is the easiest expenditure to cut. There was an accumulation of non-spending so that, when growth finally started kicking in during the 1990s, all the talk was about the infrastructural deficit, as it was known at the time. It is clear to see that something similar could happen soon, if it is not already happening with issues around congestion. Housing is the crucial issue and with that come issues around water and other infrastructural investment associated with housing. People talk about the need to invest in housing but this implies an awful lot more besides.

We certainly see a need for infrastructural investment, given that it has been cut back for many years and still stands at a low proportion of GDP. On the question of what to do with the money in the budgetary package, one can invest and will have something to show for it, while one can decide not to invest if things get bad. The fear, however, is that we start reducing taxes and then have to raise them again or start spending money on current expenditure, for which there are otherwise, nevertheless, many good reasons to do so. With capital expenditure, one at least has something to show for it and can turn it off if necessary. There is a strong case to be made for expenditure in housing and associated areas.

While we decided in the past that we had to spend on capital infrastructure, we made the mistake of not ensuring that individual projects stood up to rigorous evaluation. The catch-all notion that capital expenditure is, always and everywhere, a good thing should not be allowed to filter into the discussion. There is a case for capital investment but projects should be evaluated on a case-by-case basis.

Dr. Kieran McQuinn

The Deputy has identified a very pressing issue, particularly for those of us working in the analysis area of the economy. The CSO has to follow the approach taken in the national accounts as this is mandated by EUROSTAT under the ISA 2010 approach to setting out national accounts. There may have been some commentary to the effect that the figures were wrong but they were not - they were correct. However, it is hugely important, for ourselves and for everybody, that we have a set of national accounts which gives us an assessment of what is going on in the general day-to-day activity of the economy that is as accurate as possible. Nobody believes that economic activity surged by 26% in Ireland last year. This is a particularly important issue at this moment because we are facing into the budget and we will address it in some detail in our next quarterly commentary. We will show that it has implications on a number of levels, such as assessing what would be the most prudent budgetary package. For example, the debt-GDP ratio is a hugely important concept for which the Commission has set a target of 60%. When GDP is inflated to the extent it was in the figures in question, it brings down the debt-GDP ratio by a huge amount. The question is whether that is an accurate reflection of the economy's ability to sustain its debt and we would argue that it is not. This is an example of where figures such as these can affect a lot of our analysis.

A hugely important concept is that of potential output, which defines the output gap and the prudence of the budgetary package. I agree with what Dr. Gabriel Fagan suggested yesterday. A committee has already been established, chaired by Professor Philip Lane and including Professor Barrett, as well as many other distinguished luminaries to look at the issue. I am sure there will be some very positive and concrete proposals. We in the quarterly economic commentary, QEC, will try out some ourselves. The CSO used another accounting methodology, the ISA 1995 approach, and one possible avenue would be for both sets of accounts to come out.

That would provide two different approaches and one could compare the differences from that. However, as economists and analysts generally, there is an onus on us to come up with indicators that better reflect what is going on in the economy. Those indicators therefore would then be accepted among the policy makers generally in setting credible standards and means by which one can assess the prudence or otherwise of budgetary packages. Another area into which this comes is that it is not just the headline GDP figure, as the investment figure, for instance, which also surged last year. Going back to the discussion about the amount of capital investment, another indicator we look at is the ratio of investment to GDP and if investment is surging in an unnatural way, it is then hard to get an indication as to what is the actual level of investment in the economy and what are the levels of investment we should be having.

If I can also touch briefly on the housing issue, as we do quite a bit of research on it, one reason we have been plugging the need for greater investment in social housing in particular over the past couple of years is that quite apart from the obvious social issue there, we also believe that greater investment on the social side could have positive spillovers through the effect it would have in addressing the private market as well. When one hears of many of the difficulties that are being experienced on the supply side of the market from listening to people on the developer side regarding access to finance and the confidence factor in the market in general, a greater involvement by the Government sector in the provision of social housing could have positive spillover effects. The other crucial reason to mention housing in the context of investment in housing is that the housing issue is not merely affecting those in the housing market, although obviously it is having a huge impact on those people. It is also potentially having knock-on effects as far as the general economy is concerned. Everybody in the economy has worked hard to restore competitiveness in the economy in recent years and rental levels surging to the extent to which they are can only put upward pressure on and cause potential deterioration in our competitiveness, particularly when we are trying to attract people to come and work in our major cities especially and in Dublin in particular.

Deputy Dara Calleary

I thank the delegation from the Economic and Social Research Institute, ESRI, for their attendance. While I wish to zero in on a couple of points, I have a follow-on question on housing. While Professor Barrett stated "do no harm", there is harm there and Dr. McQuinn has zeroed in on the current state of the private side with spiralling rents affecting competitiveness and our ability to attract inward investment, as well as a major supply issue. People are struggling to get together a deposit under the new rules but the ESRI's strong suggestion is to not do anything in the budget because of its fear that it may lead to price increases on the private side. What kind of words of comfort can Dr. McQuinn offer to people who are struggling to put together a deposit? As they may be people who might need to consider social housing if they are unable to get a deposit, there is something of a vicious circle going on there. Second, I refer to supply and the necessity to get that supply quickly in respect of social housing. I am conscious the ESRI has produced a report with the rather grandiose title, "An empirical assessment of macroprudential measures in the Irish housing and credit markets". Will Dr. McQuinn provide members with a flavour of that report as to how it may address the supply issue in the context of social housing?

Dr. Kieran McQuinn

On that point, when we said "do no harm", this was in response to certain taxation measures that were being proposed. For instance, the VAT issue was being floated with the potential to give those on the development side a possible reduction in the VAT rates. When we said "do no harm", we were addressing those kinds of specific measures. We produced a quite detailed report going through the various effects as a result. As I stated in my previous contribution, where we clearly believe there must be action on the housing market is on the social housing front. This is one area in which the State could make a significant contribution and there has obviously been the publication of the housing plan during the summer. As I stated, by addressing the social housing side, one can have positive spillover effects on the private sector side. We even went so far as to look back to the noughties and even after the financial crisis had kicked in, in 2007 and 2008, as an economy we still were building approximately 3,500 to 4,000 social housing or public authority housing units at the time. A rough metric would suggest we were spending approximately €1.5 billion on it at the time. We were putting those figures in the public domain to state this is the kind of investment needed to get that number of units up and running on a year-on-year basis. Certainly, that is one specific measure.

The site tax to which Professor Barrett referred is a measure we identified clearly in some research that was published at the tail end of last year. Basically, we looked across other jurisdictions and tried to identify measures that seemed to have an impact in triggering supply in the housing market and the site tax, particularly in the Danish case, seemed to work quite well. As I understand it, there are proposals to bring in a site tax - in 2019 I believe - and a tax rate of approximately 2% to 3% has been suggested. Our recommendation would have been that this be fast-tracked, where possible, and that the rate be considered and even possibly increased. A site tax certainly is one area that could have a quite significant impact in bringing greater supply on stream.

The Deputy mentioned the issue of the deposit, which of course ties in with the macroprudential measures. First, I should state that I was a central banker for many years and I would state without equivocation that macroprudential policy is of huge importance in an Irish context, particularly given everything we have experienced with the credit bubble that led to the difficulties in the banking sector. Consequently, it is important to have this series of measures in place to prevent us from going back down the route we took in the past. We have, however, in a series of submissions and in a series of papers, suggested that the way in which these measures should be implemented should be considered. That is part of the submission regarding the latest revision of these measures that the Central Bank is undertaking. Our point has been that we believe the measures should have what we call a counter-cyclical dimension to them in how they are implemented. This basically is just following on from what we think is best practice in every other area of major economic policy, be it monetary policy or fiscal policy, namely, that when one is triggering these measures, whether it be the loan-to-value ratio or the loan-to-income ratio, one takes into account the state of the housing market at a point in time. Consequently, one examines things like house prices, supply and the credit levels that are extended in the economy. If, on the basis of one's judgment, one thinks the measures are suggesting the market is in a contractionary phase or is in a downturn, one then may need to ease these measures. Similarly, if one thinks the market is overperforming or that too many houses are being built, one tightens the credit supply. This is a principle we believe should be at the centre of the macroprudential regime. As I stated, it is of huge importance and like any other new policy area, it is important that it gets buy-in from everybody and having that element to it would help and assist in this regard. As I stated, these three areas are, broadly speaking, greater involvement on the supply of social housing, a site tax and possibly a counter-cyclical dimension built into the way in which the macroprudential policy measures are being implemented.

Deputy Dara Calleary

I agree with the ESRI on the second lesson, namely, that all tax incentives should be reviewed periodically. To highlight specifically what the ESRI calls the tourism-related incentive, that is, the 9% VAT rate, the argument being made to retain it is that while Dublin city centre is doing particularly well, this has not spread across the regions and that to change this initiative at present would be to undermine the potential of the regions to benefit from it. What do the witnesses think of that? What is their view, after the passing of five years, on what the overall initiative has done for job creation, etc.?

Professor Alan Barrett

As we have not carried out a major analysis of it, I would be reluctant to speak authoritatively on it. The point we were trying to flag and to illustrate was again back to that theme of lessons from the past. What we learned previously is that often, tax incentives could be introduced in Ireland, for which there was a rationale at a certain point in time, but then they just stayed in place. Again, it is one of the core principles of Government expenditure or taxation incentives that there should be a market failure; there should be some issue that is being addressed. Consequently, if it is something like a weakness in an industry whereby it needs some sort of assistance or boost, Government policy can do that. However, beyond a certain point, one is not actually assisting an industry; one merely is giving handouts to the players in that industry who are doing particularly well. Again, one should remember these sorts of variations are costly and consequently should be evaluated in exactly the same way as if public money was being spent.

The point about the regional spread of these sorts of things is well taken. Whether there is scope for any regional variation in that sort of measure, I do not really know. However, it is certainly very hard to look at hotels and restaurants in Dublin, especially on a Friday night, and conclude that the owners of these hotels and restaurants need public money to help them through. The broader point is this issue of analysing and ensuring that the original rationale is still in place and really interrogating that.

Deputy Dara Calleary

Finally, we are beginning a process of review of public service pay. A commission is being established. What are Professor Barrett's views on that given that it will impact slightly on next year's budget? What principles should apply, looking at the pressures on public services at the moment, in particular in certain areas?

Professor Alan Barrett

I will make a very focused point on it again. The ESRI has made a submission to the Department of Public Expenditure and Reform in advance of the setting up of the commission. The point we have always made about this is methodological, but I will try to make it as interesting as possible. I cannot even remember what year it was but before the original benchmarking exercise all those years ago, people seemed to go into it with the assumption that public servants were paid less than private sector people. It turned out that nobody had actually measured if that was the case. Our starting point in this is that one has to have a very serious analysis of wage levels. Again, people will be familiar with the notion that because public servants generally have higher levels of education and experience, they earn more. Nevertheless, one can account for all those sort of things and try to get a sense of whether there is, genuinely, a public service pay premium or, indeed, a public service disadvantage. That exercise, bizarrely, was not actually conducted at the first stage.

After the benchmarking exercise had occurred and there were increases of the order of 12% or 15% or so, Jim O'Leary, who was then in Maynooth, did the analysis and showed that actually public servants were much better paid than those in the private sector. That did not even include the benefits of the public sector pension which was relatively generous. Our core point on this is that the analysis should be done and that any decision should be made on the basis of it. I can tell the committee that the most recent analysis is going to present something of a dilemma here. The most recent analysis showed that it is no longer a simple question of whether there is a public pay premium or a public pay gap. We have now seen that at the upper end of the wage distribution, that is higher paid people, one is better off in the private sector. However, lower waged people are better off in the public sector. The very harsh conclusion is that one should be reducing the wages of public servants on the lower end of the spectrum and increasing them at the higher end. I am looking across at a group of politicians and it strikes me that this would not be the most popular and maybe not the most appropriate thing to do.

Deputy Thomas P. Broughan

The other way around it is that the higher salaries in the private sector would be taxed more extensively and the very low-paid workers given a living wage.

Professor Alan Barrett

Indeed. My thought process was dominated by the fact that we are talking about public sector pay, but the broader point the Deputy makes is fair. Remember, however, that any tax that applies in the private sector applies in the public sector also. The broader point is that when this analysis is done, there could be complicated and tricky issues that will arise.

Deputy Colm Brophy

I thank the witnesses for coming into us today. Professor Barrett's last contribution showed one of the things that is the real problem sometimes when one looks at things economically. While one might end up with a macro viewpoint on something, it sounds absolutely absurd when one hears it out loud. If anyone was to suggest that we cut low-paid public sector workers' pay because of some macro economic perspective, it would be an example of the absurdity one can end up sometimes with economics.

Professor Alan Barrett

It is not absurd. It is just a measured, observable reality. The pay gap is that way. What one does about it, of course, is a completely separate thing, but it is not an absurdity.

Deputy Colm Brophy

A measured, observable reality can be an absurdity to other people. I have a couple of questions for Professor Barrett and I appreciate that he outlined that it was his own personal view and perspective. There are two things. I take on board certain aspects of Professor Barrett's comments on the USC in regard to some of its benefits. However, for lower and middle income workers the USC is an excessive tax that is really impacting on their earnings. It is taking money out of people's pockets. I do not agree with Professor Barrett's conclusion on it at all. While I do not agree with the abolition of the USC, I always have a problem when sentences start with, "We should not abolish the USC" but then suggest that lower, small proportionate phasing or re-tweaking of it is not good either. No one would disagree with the idea that we want a broad, stable tax base, but that does not prohibit us from gradually looking at the extent to which taxes like the USC impact on low and middle income workers in terms of actual disposable income. One of the clear and obvious problems we have is that while, as the Professor said in reference to Friday evenings in Dublin restaurants, we have people who can spend money, we have a large number of people living in the real world who cannot. They are working very hard and putting every hour they can into it, but when they look at their pay packets at the end of the week, the impact of the USC suggests that we should look at doing something for them. If that means tweaking the USC and looking at what we do elsewhere, that is something we should do. I do not accept the economics, which effectively suggests one does nothing and does not touch it.

The other thing is the "Do no harm", comment which was alluded to earlier. If the Government was doing nothing on the supply side, I could see how the ESRI could come to its argument. It did a paper last year, a lot of the assumptions of which could be looked at again. One of the huge things that has changed is the programme that is now being proposed by the Government which largely addresses the supply-side problems in housing. One does not take any one action in isolation. I agree that if no attempt was being made to adjust the supply side, we could have a tax incentive here or there. At the end of the day, however, one has to create a situation for people who are working and earning and want the opportunity to afford their own home. As well as looking at the supply side, we need to look at how we can help them. There is nothing inherently wrong with that provided it is done as part of a comprehensive package which addresses both sides of the situation. I query that.

I am interested to know why the ESRI seems to ignore the supply side of the Government's newly announced programme. It is probably something we will not agree on because I do not accept the principle that we should be a high tax economy for low and middle income earners just to preserve the stability of the tax base. That is not political rhetoric, it is just a different approach in terms of how I look at things versus, perhaps, the Professor's perspective.

Professor Alan Barrett

I apologise for interrupting earlier, but we will leave that aside. On the taxation issue and low pay, one of the defining features of the Irish taxation system is the extent to which low-paid people are excluded. If one compares us internationally, there have been substantial efforts to exclude lower paid people from the tax net. That applies in respect of both income tax and the USC. If the Deputy's concern is that we need to do more to exclude more people, that is a perfectly sane thing to suggest. Nevertheless, there are costs associated with it. The question is how far up the distribution one wants to go in excluding people. To the extent that there is a second defining feature of the Irish income tax system, it is the extent to which people start paying the higher marginal tax rate at relatively low levels of income. There was an ESRI paper on this a number of years ago which compared the Irish and the British tax systems. It made the point that one of the reasons we start taxing at a high marginal rate at relatively low incomes is that we exclude so many people at the lower end.

This is a political choice and, again, there are very good reasons we might want to do this. However, I do not understand the notion that in some sense the Irish tax system attacks lower income people and that moves are needed on the USC.

With regard to the housing issue, our opening statement was brief and we did not mean to include everything. We are fixated on the notion that the difficulties in the Irish housing market will be solved on the supply side. The likely impacts of injecting additional demand into a supply-constrained market at this stage are very clear. A number of proposals had been floating around and it was partly almost as a way, we thought, of getting over the macroprudential rules that if we could just get more cash to first-time buyers in particular, it would solve the problem as they could get deposits and could buy. For years we have had analysis, and many people in the room will remember the €5,000 first-time buyers grant. All it did was to increase the price of houses by approximately €5,000. We give the payment to one group of people but we may as well just give it straight to the developers and builders because ultimately they will get it. The analysis we carried out last year was on tax incentives in a market which is constrained in terms of supply and it demonstrated that, ultimately, tax incentive measures have very little effect on supply and, very often, their effect is to transfer money not to the people we are trying to help but to the people at the end of the line. This is not to suggest for a moment we do not welcome the measures announced on the supply side, in fact we think they are critical, but our argument is that the effort needs to be focused on the supply side and if we do things on the demand side they will not be as effective.

Dr. Kieran McQuinn

Going back to Professor Barrett's comments in the opening statement regarding how we frame and think about the budgetary package and the measures that should be taken, the crucial point for us, particularly regarding taxation or expenditure, is where we think the economy is at, whether we think it is growing in line with what we call the potential level or whether it is at the potential level. If it is above or below this, perhaps there is a requirement for measures to be taken. At present, and it is quite difficult given the headline figures announced recently, our view is the economy is pretty much at its potential level. This is an important assessment because it suggests that in terms of the overall budgetary package the Government should follow a broadly neutral strategy.

Where there is a rationale to cut taxes - looking at it from a broad economic perspective - is when one feels the economy, or the domestic sector of the economy, needs some type of stimulus and we need to put more money in people's pockets which they will go out and spend with a resultant knock-on impact on growth. However, our assessment is that all of the dynamism and growth in the Irish economy is coming from the domestic sector. This is with the understanding of the many difficulties and the households still suffering the after-effects of the financial crisis. Looking at the headline figures, consumption is very strong and increased by 4.5% last year, which is higher than what we thought it would be, employment growth is very strong and unemployment is reducing albeit gradually in recent times. All of the headline figures for retail sales this year have increased strongly and I believe consumption will increase again this year. The rationale from our perspective for cutting taxes is whether it is required in terms of its impact on economic growth and, given the strong rates of growth in the economy, particularly the fact they are coming from domestic sources rather than from external trade sources - as was the case in the initial phases of the recovery - we do not see the rationale for a cut at this point in time.

We will speak a little about the Government's plan on housing in our next commentary. In line with the comments I made earlier when I spoke about identifying the role the Government can play in terms of the greater provision of social housing, we welcome the increased commitment as outlined in the plan during the summer. The targets set out are very ambitious and they may or may not be met. However, the increase in resources in the area is clearly important. The overall package of €5.5 billion over four years must be seen in the context of the metrics we spoke about earlier regarding the spend in the noughties of approximately €1.5 billion or €1.6 billion on social housing. The measures taken, particularly those announced on the supply side, will have a positive impact.

I echo Professor Barrett's point on breaks or a stimulus on the demand side of the market. We have supply-side issues and, unfortunately, supply is relatively slow coming on stream in the current market. If we give a demand-side incentive such as a tax break, the danger is it simply just becomes embedded in the price of the house. This is the difficulty with such a measure.

Deputy Colm Brophy

Professor Barrett mentioned the high marginal rates of tax and USC is an integral part of how much tax people pay. Regardless of whether we like it, we have an open economy. We must look at how much tax is coming off starter salaries of €30,000 or €40,000 and the salaries of graduates coming out of college, be they nurses or computer programmers. They can go to the UK and be paid effectively the same amount of money but with take home pay which is completely disproportionate to what we have in Ireland. This is a disproportionate draw on our situation here. The witnesses spoke about it having no effect on employment and cited the fact employment has increased by 56,000. We had a huge unemployment crisis and it is great to see what has happened, but there is no question that there is a problem with the rates of USC and the rates of overall taxation on income when it comes to certain types of salaries and people who are highly mobile, young and want to leave Ireland. We paid for them to have a very good third-level education but they can go to the neighbouring jurisdiction and pay a fraction of the tax on their incomes they would be obliged to pay here. That is a matter to which consideration must be given.

Professor Alan Barrett

To give a quick response to that, we mentioned the 56,000 increase in employment. It is normally thought of in terms of it being wonderful that all these jobs have been created. This is absolutely true but the flip side is that these 56,000 people are willing to take jobs in the context of the high tax rates which people keep speaking about as a great disincentive to work. In terms of the labour supply figures, while we have had huge net emigration it is now moving in the other direction. I will answer the final part of the question not as an economist but as somebody who heads an organisation trying to employ people in Dublin. Every time we cannot employ somebody internationally, it is not because of the tax. It is because of the housing crisis in Dublin. This is where the difficulty lies. People have not yet said to us they will not come to Dublin because the tax is too high but they regularly tell us they cannot afford rents in Dublin.

Deputy Colm Brophy

As someone who is also in the business of employing people, I have been informed directly that people can be offered the same salary in London - where they pay the going rate for housing - but that the regime here is a disincentive for them. Perhaps we are hiring different individuals.

Deputy Joan Burton

I thank the witnesses for their presentation. The ESRI has spoken at length on a number of occasions about the need for capital investment. The committee is trying to reach perspectives in terms of the budget. The Irish rate of capital investment is low. Do the witnesses have a calculation of where we should move to in percentage and gross terms? Do we need to play catch-up with several billion euro in areas such as school investment, third-level investment, training and roads? In the context of regional development, some major and secondary road projects throughout the country genuinely need to be either completed or initiated.

If we are talking about development along the west coast, there is a need for better transport links, certainly if we want Limerick and Cork to be hubs. There are several other areas too but those two, as well as housing, are critical.

I understand the overall context for the air of caution in the Governor’s letter to the Minister for Finance but I was rather taken aback at the suggestion that the EU target for debt, the 60%, ought in the case of Ireland for reasons of risk to be much lower, by an unspecified amount. I refer to the letter released a couple of days ago. What would the witnesses' advice be in constructing the budget on where capital investment should fall? It needs to be increased. I thought a consensus was developing on that. There is a hike in construction costs but that is inevitable, given where the economy was three or four years ago, and should be expected. What would the witnesses suggest would be the appropriate figure for capital investment between now and 2021? Is the current rate very low and are there areas the witnesses would prioritise? I would certainly go for education, transport and other areas of critical investment, including regional investment, but I would like to hear their views on that.

Dr. Kieran McQuinn

In our estimates of investment, we do not specify. We have not considered it in that level of detail over a multi-annual period. Any advice we have given in the budgetary process has prioritised the housing area for the reasons I have articulated, not just because of the causes within the housing market but because of the knock-on effects of higher rental rates and the pressures that high house prices put on competitiveness. In terms of priorities, I echo Professor Barrett's comments that if we suggest investment in any area, it is absolutely critical for detailed analysis to be done on the returns from any investment programme that needs to be undertaken. Sometimes there is a danger that it can be almost built into the popular vernacular that we need more investment. Obviously, there are areas in the economy where we need that but it needs to be done in a very rigorous, well thought out fashion and a very detailed cost benefit analysis needs to be done on the types of project that will result from whatever expenditure goes in there.

In terms of the broad budgetary packages, or rules, which guide this, the Commission’s take generally on the expenditure benchmark is that expenditure can be increased in line with the potential growth rate of the economy. That is one of its basic principles or guidelines for fiscal rules. In terms of any overarching principle that should guide expenditure in this area, it is important that whatever the Government engages in improves the productive capacity of the economy and by definition leads to increases in its potential output growth, for example, in areas such as transport investment.

The other point to be made, however, and colleagues at the institute have been working on this, is that we should not be thinking about infrastructural spending in segmented components, for example, broadband. Research has shown that broadband can be very useful in terms of the economic impact on an area but only if there is a reasonably high level of educational qualification among the population in that area. Just spending the money without there being an institute of technology or university locally does not give the same bang for one's buck. Broadband now has a sort of motherhood and apple pie dimension to it, everybody is in favour of it and how could one be against it but we need to step back a bit and think in a more integrated way about how we should be spending on capital to make sure we do it well. There are good lessons analytically from the recent past on how to do it.

An issue that has come up in certain circumstances, and I am going to talk once again about my much-derided profession of economics, is that economics says when interest rates are essentially at zero, we should invest quite a lot, more than is allowed by a narrow interpretation of the fiscal rules. I think the Department of Finance is already talking to Brussels about this and Professor McQuinn has touched on it. Fiscal rules should not be so ridiculous that if there are expenditures that would genuinely add to the productive capacity of the economy, they should not be reflected in the scope we have to invest in capital. The notion of treating the productive impact, for example, of a road or houses in the same way as a reduction in the universal social charge, USC, strikes me as kind of crazy. There is flexibility and Commission officials have said that. As a country, we need to explore that flexibility as much as possible.

Deputy Joan Burton

In respect of the witnesses' commentary on the tax bands and the allowances, I think the point at which one enters the top rate of tax in the revised figures is approximately €35,500. It has gone up slightly. That is essentially an alternative tax measure. It is quite valuable to discuss that versus other options. Would the witnesses like to outline or subsequently send us the details of what they would envisage? I think it is desirable that people do not fall into the higher rate as soon as they do in Ireland. It is a really big problem for young people taking up technical jobs, as I know from my experience of working with graduates. What would the witnesses envisage, for example, in terms of a three-year cycle? I would be flexible on it.

People enter the top tax bracket relatively early on, particularly when compared with the United Kingdom and Northern Ireland. This difficulty must be borne in mind.

I will make two points on housing. With regard to the construction industry, there has been total market failure in terms of access to credit for people in the construction sector who are not in the National Asset Management Agency, in other words, small and medium sized construction companies. A builder developing a block of ten apartments cannot build two apartments and then start to build another two units a couple of years later. Dr. McQuinn referred to market failure. In this case, there has been a market failure, although many of the builders concerned admittedly have impaired credit records for reasons with which we are all familiar. Do the witnesses have any proposals for addressing this issue?

Ireland has an extraordinarily large number of empty houses, as recent figures from the Central Statistics Office have shown. While I am sure some of these houses are owned by elderly people living in nursing homes, this is a will-o'-the-wisp issue in the sense that there is never anything solid done about it. Has the ESRI or any other entity identified whether there are a large number of people with two homes? The Central Statistics Office specifically states that its figures on empty houses do not include holiday homes. Are there cases of people keeping one or two spare houses in case, for example, they have a row with someone and need to move out for a while? Intuitively, I would love to have an explanation of what precisely this is about. I understand that at any one time a number of people may be in hospital for short or long periods and others may be in nursing homes. If the witnesses do not have an explanation now, perhaps they will revert to the committee on the issue. If there is a stock of empty houses and the issue is, as the witnesses noted, one of supply, why can we not get at these houses?

Dr. Kieran McQuinn

I will first address the Deputy's second point, which related to tax. Research has been done on this issue. Brendan O'Connor in the Department of Finance did a comparison across OECD countries of the levels at which taxpayers enter the various tax bands. It was clear from some simple graphs in his paper that Irish people moved into the top rate of tax at a lower income level than in other countries. If one is looking at desirable levels, which are difficult to quantify or estimate, cross-country comparisons are often a good place to start in terms of looking at where people in comparator countries, if one likes, move into the highest rate of tax. This could provide some guidance in that area.

On the issue of market failure in construction, unfortunately there is no short-term solution to this problem. Ultimately, the solution is that the banks get their balance sheets back into a position such that they are able to lend. This is happening, albeit at a glacial speed, as we all know. This reflects the fact that the banks have taken a long time to deal with the impairment issues on their balance sheets. It is a well known maxim in banking that banks with bad balance sheets struggle to lend or do not lend for a variety of different reasons. One element, therefore, is the need for the banking sector to get its balance sheets back in order to the extent where banks are in a position to lend. The stress testing results published in the summer showed that some Irish banks did not fare terribly well on that score. There is obviously an issue with confidence in the market and this clearly impacts on credit availability.

Deputy Lisa Chambers

Housing has been debated at length. A concern of mine is the difficulty younger people face in getting into the housing market. Comments were made yesterday by Deputy Broughan about the impact of Central Bank rules on younger people. This is fuelling the rise in rents because people cannot afford to buy and it is preventing people from relocating to other areas. They may be staying at home for longer.

The witness mentioned site tax. Will he expand on how that might work? Does he have a view on the Central Bank rules and the possible or alleged negative impact on the markets in terms of rentals, housing and construction? It would be interesting to hear his views. I have a number of questions.

Chairman

We might take those few questions and come back to the Deputy.

Dr. Kieran McQuinn

On the Central Bank macroprudential measures, as I stated in response to an earlier question, I worked in the Central Bank for ten or 11 years. I always say in commenting on the macroprudential measures that it is essential, as a small, open economy with a highly globalised banking sector, to have such measures in place. That safeguards as much as possible the domestic financial sector from the kind of huge inflows of credit and exposure that we all witnessed. There were almost horrific effects in many different ways.

Macroprudential policy is here to stay as a policy tool and that is a good and positive development. In our initial submission to the Central Bank on the macroprudential measures and in a revised submission recently, we suggested some tweaks in the way in which the measures should be implemented. I was speaking earlier about comparing this, for example, to monetary and fiscal policy. In those very important policy domains, the crucial issue very often in discussing whether to increase taxes or expenditure, or in the monetary policy area to increase or lower interest rates, is how well the market or economy is performing as a whole. Is it performing very well or not so well? Where is it? In terms of implementing macroprudential policy, there is no reason those kinds of principles cannot apply.

There is a growing body of international literature suggesting that this is the way to implement policy, taking into account where one believes the market is. By that I mean embedding what we call a counter-cyclical dimension. This means that if we believe the market is over-performing, we are building too many houses and house prices are rising too fast, then those measures can be implemented and tweaked so as to tighten the credit supply, as that is what often causes bubbles. Equally, if one feels the market is underperforming, we are not building enough houses, prices are very low, etc., we could ease credit. That would not happen widely within big bands but there should be a principle in place. Implementing the measures when the bank did without a counter-cyclical dimension was unfortunate as the market was still very much on its knees, particularly on the supply side. We were only building 8,000 or 9,000 houses two or three years ago and this year we will be lucky to build 14,000 units. That must be put in the context of research done by colleagues at the ESRI demonstrating that we need somewhere in the region of 25,000 units per annum. In light of the recent census, we will probably need 30,000 houses per annum, as it found 100,000 extra people in the country. The key point is that target. This year we will be lucky to build 14,000 units so we are still a long way off that. In that context, if there is a counter-cyclical dimension, it could lead to the easing of the measures somewhat. Equally, if we start to build 45,000, 50,000 or 60,000 houses, we should be able to tighten measures and reduce the exposure of the domestic banking sector to the kind of credit bubble that we witnessed in 2005, 2006 and 2007.

The Deputy is right in that the rental issue is a by-product of many of the macroprudential measures. Research, including some involving us, has demonstrated that if credit is tightened in a market, rents tend to increase vis-a-vis prices for the reason outlined; if people cannot afford to buy but still want to live in a particular area, the only option is to rent. That drives up rents. Another related issue is that there will be a spreading of the commuter belt. For people who wish to work in Dublin, the only alternative is to buy further out, which would be another unintended consequence of the macroprudential regime. It is very important that we have this policy framework in place but there are ways in which we can tweak this to ensure we take into account where the market is.

Deputy Lisa Chambers

What about the site tax?

Dr. Kieran McQuinn

The basic idea is that it penalises people who are hoarding land that could be used for development. In research across various jurisdictions, we considered what policy measures had been used to stimulate housing supply. A site tax was used in the Danish case and seemed to yield quite significant results.

There are a number of ways in which this can operate. If there is a site tax and people hoard land, they might face the prospect of paying a 2%, 3% or 4% levy, which would encourage them to bring the land on-stream. Related to this, if developers are asked about a breakdown of cost, they will all mention that land costs are quite expensive and constitute a certain proportion of the total. Part of the reason land costs are so expensive relates to the speculative element. If a person is holding land and believes it will be worth 10% or 15% more next year, it drives up the price and people tend to hold on to or hoard the land as a result. That drives up the cost for somebody trying to develop the land. If there is a site tax, which is properly parameterised and implemented, it should cut out much of the speculation on land, which would in turn drive down the cost of the land and building a house. The site tax has much potential and it could be very influential.

Professor Alan Barrett

In discussing a site tax, the question may be asked as to whether it is constitutional, at least in the short term. I have been in discussions and some people have said that in doing this sort of measure, the argument is that people must be given time to adjust to the new tax proposal. A former Minister, Deputy Alan Kelly, was involved in an argument regarding the constitutionality or otherwise of certain elements. Mr. Edmund Honohan made the point that in Ireland we have compulsory purchase orders and a legal understanding that if a social good dominates a private interest, the State can do certain things. I raise this so if we discuss the proposal and somebody argues it is not legally feasible, I would interrogate that a little further.

Deputy Lisa Chambers

That is very helpful in putting the issue in context. My next question relates to the comments relating to labour supply. The witnesses touched on the child care subsidies and I am definitely interested in hearing more about that. Certainly, some of their research suggests that the recession hit women quite hard, with participation rates down for the first time in years. Child care is an issue for both men and women but it would be considered an obstacle more for women entering or re-entering the workplace. The point was made in the paper that it is not just about income tax acting as a disincentive, as there is also the cost of going back to work. It may not be cost-effective to have two parents working.

I would like to hear views on the gender pay gap. Sometimes women may be penalised as they are seen as the primary caregiver. Taking the burden and distributing it more evenly across both parents would probably work towards addressing the gender pay gap. I would be very interested to hear what we could do in budget 2017 and the following year in terms of a child care subsidy. Are there any other suggestions or views on how to address the issue?

Professor Alan Barrett

Child care subsidies are a fascinating area. It is unusual to have an area where one can simultaneously achieve a range of policy goals. I will develop that theme slightly. The Deputy began by addressing the labour supply dimensions of this, which is correct. There is evidence to suggest that the cost of child care is genuinely an obstacle to people's participation in the labour force. Coming back to an earlier theme, one could abolish or reduce the universal social charge for everybody in a phenomenally expensive way and there will be a limited labour supply effect. With something like child care subsidies, the issue around labour supply is seeing a much more targeted focus, with euro or tax dollars being used to try to alleviate a particular difficulty. Doing something really substantial on child care will have an impact on labour supply.

The Deputy touched on the gender pay gap which leads to the next possible benefit. Research going back years from many jurisdictions shows that by far the dominant reason for the gender pay gap is the fact that women interrupt their careers. Judging by their reaction, members probably did not need an economist to tell them that. We added the science to the gut feeling that was there. It is not just women. For people who are unemployed for significant periods, the same effect happens. They come back into the labour market. They do not even go back to where they were, they often go down and certainly never get back to where they would have been if they had an uninterrupted career trajectory. If one examines the data and accounts for those career breaks, statistically one eliminates the gender pay gap. It really is all about breaks in careers. To the extent that this is a critical dimension in interrupted female careers, child care subsidies allow one to do much on the equality agenda. It is unusual that there is a labour supply effect - which is a real economist’s efficiency effect - and that there is also an equality effect. There is this tremendous benefit for kids, on the assumption that it is good quality child care. I am conscious that the economic evidence was dismissed earlier on. However, if there is one area where economists have done evaluation after evaluation, the benefits of quality early child interventions are extraordinary.

Deputy Eamon Ryan

What about equality for someone who might want to take a break? The tax system, through individualisation, very much steers people towards working and two incomes. I agree it should be left to the mother or father. Why would we make that decision for some parents who may have a different view?

No, I will come back to that previous argument that the Fianna Fáil decision to invest in child benefit left it to the parents to decide, rather than economists, what was good for kids.

Deputy Lisa Chambers

Yes, I suppose-----

Deputy Eamon Ryan

That is a philosophical view.

Deputy Lisa Chambers

The current situation is that without adequate child care or some sort of financial break, there is no choice for the female because there is no real paternity leave available for the man in the relationship. Accordingly, it removes choice. It effectively removes the woman from the workplace without her having a choice. I was happy to hear the positive impacts across the board this one policy could have.

On regional disparities in rising employment rates, the west is the slowest to improve. It would be helpful if the delegation could pass on information as to how the committee could address this in budget 2017.

Yesterday at the committee, the Central Bank was reluctant to comment on whether the tax base is broad enough, too narrow or okay as it stands. While it claimed it was not within its remit, it was pointed out that, as it poses a risk to our economy, it is within its remit. Nonetheless, we did not progress on getting an answer from that. Is our tax base broad enough? Is it robust enough to deal with another hit such as Brexit, the Apple tax finding or problems with the Chinese or US economies? There are many international pressures bubbling away over which we have no control. What we can control is our stability and putting in place enough buffers to ensure our tax base is secure enough. Is there anything we can do in this year’s budget to strengthen the tax base?

Dr. Kieran McQuinn

We are engaged in a programme of research with the Department of Finance examining taxation matters and the stability of taxation aggregates to overall economic activity. Recently, we looked at the responsiveness of income tax to overall economic activity. I have been involved in other research with an international colleague examining the main headings of taxation receipts such as income tax, corporation tax and excise. We examined what is the most stable outcome when one works out the variances between them. Income tax in an Irish context is a stable source of tax, an area that Patrick Honohan examined several years ago. Consequently, it is seriously considered whether to reduce it in budgets. Over the past several years, corporation tax has surged.

One point I would make about corporation tax, and many officials in the Department of Finance also like to make this point, is that it gets a huge amount of attention and while there are many good reasons for this, it only counts for, on average, 12% of the tax take whereas income tax accounts for around 40% and VAT for 29%. While corporation tax is important, it is not massively important in comparison with other taxation headings. Interestingly, the real problems we encountered back in 2007 and 2008 were not as a result of a collapse in corporation taxes but a collapse in the housing related taxes and in income tax.

In the recent past, corporation taxes surged quite significantly. There was a considerable surge last year and the receipts up to July of this year indicate another substantial increase in corporation tax. However, that comes with quite an amount of uncertainty in that we do not really have a good understanding of how stable those tax receipts are. Is it the case that we may witness a dramatic fall off in corporation tax next year for some reason? We do not know. Corporation tax receipts are not as closely aligned to what is going on in the real economy as the other taxation headings like VAT and income tax. That supports the argument for maintaining a very broad tax base, as the Deputy has said, and ensuring that taxes like income tax remain a significant component of the overall tax take into the future.

Professor Alan Barrett

On the question of whether the tax base is broad and stable enough, it is very hard to answer that in an absolute sense. That said, given where we are in terms of the international uncertainties to which the Deputy referred, our perspective would be that it does not make sense to do anything at this point that would weaken the tax base. Hence, the remarks on the USC in particular. To add to that, if one takes the recent experience of trying to introduce water charges and before that, the local property tax, LPT, the lesson to be learned is that there is a difficulty with introducing new taxation measures. Therefore, if one has measures already in place that people have become used to, while not necessarily liking them, why would one unwind them if one was facing the prospect in a few years' time of having to try to reimplement certain measures? With the greatest respect to everyone in the room, we all agree that these things are tremendously difficult. I was struck by the thought that perhaps in a year's time a variety of people in this room could be coalition partners trying to negotiate budgetary packages in the wake of some international crisis and it would be terribly unfortunate if the tax base had been hollowed out in the interim.

On the issue of regional development and what can be done in budget 2017 in this area, I would urge the committee to think about this in a much more long-term way. We have touched on this already in terms of capital investment and the need to think about it in an integrated way. Dr. McQuinn mentioned the fact that the Department of housing, planning, community and local government is working on a national planning framework that will replace the national spatial strategy. We must think about these things in a longer-term context. The harsh reality of modern economic development is that it is focused in larger urban areas. Very often regional development is a fight against natural economic processes and has to be seen in that way. Doing anything about that and trying to reorganise the pattern of economic development will require some of the investment we have spoken about but we need medium-term strategies to make sure it will happen.

Dr. Kieran McQuinn

In my earlier response, I spoke about the difficulties that we face and the lessons to be learned from the crisis. Some of the research that we undertook as part of this programme with the Department of Finance updated earlier research that I had done with a colleague in the Central Bank looking at the impact of the housing market on the taxation take. In particular, the research looked at the impact of disequilibrium or the excesses in the property market - the excess supply that we witnessed, the huge increases in price and so forth - on our tax take. The key taxation headings were stamp duties, VAT and income tax. The objective was to quantify the impact of the disequilibrium in the property market on the overall collapse in taxes that occurred. There are obvious lessons to be learned in terms of ensuring the stability of the taxation system going forward.

We are working to a tight deadline here.

Deputy Richard Boyd Barrett

I thank the witnesses for their contributions. I do not want to get too involved in an historical debate but the "lessons" of 2008 have been referenced on a number of occasions, particularly the importance of having a sustainable tax base. I would like to point out that it was not just the collapse in the construction industry that was a factor, although the witnesses are absolutely correct to point to that, but also the fact that in that very year, the Government made a ruling which allowed corporations that did not see a drop in profits to write off an extra €15 billion to €20 billion as so-called charges. That was done in 2008 as a result of the tax ruling in 2007. In a year when everyone else was being creamed and we saw a drop in tax revenue under the corporate tax heading, we gave an extra €15 billion to €20 billion to you-know-who in write-offs. We have been talking about the importance of ensuring the stability of tax revenues but an important element of the discussion that is missing is that we must make people pay their taxes. The Government was very happy to chase people for property tax and water charges but was doing deals with other guys.

That has to be referenced, particularly if we are talking about the lessons of 2007 and 2008.

That brings me to my question to Professor Barrett. This will be my narrative for the budget. What about some wealth redistribution? I wonder if that is on the ESRI's radar in looking at the macroeconomic situation in this country and having stability and sustainability going forward. Is redistribution of wealth, in Professor Barrett's opinion, a priority? I argue that it should be. In the 1970s people used to talk a lot about this stuff but they do not talk about the redistribution of wealth anymore and that, in fact, is what a tax system is for. The real lesson of 2007-2008 and the global economic collapse and the real explanation underlying the incredible volatility in the world economy today generally is the inequality in the distribution of wealth. It should actually be a macroeconomic imperative. I would like Professor Barrett to comment on that.

When one looks through the figures, what one will find is that as a result of the recession the concentration of wealth in Ireland has massively increased in the hands of a small group. That is what tends to happen in recessions. At the end of the recession, a smaller group at the top has ended up with more. We see it in spades with property. What was already a highly concentrated control of the property market in relatively few hands pre-2008 has now become even more concentrated as a result of the recession. We see a small number of survivors and the vulture funds coming in and buying it all up and then effectively controlling the property rental market. That is a central question for me. Should we not be talking about, as a priority in this budget and budgets generally, the necessity of redistributing wealth?

That then brings us on to things that do not get talked about except by us which is wealth taxes and having a database of the distribution of wealth, a proper database that identifies where wealth is in the country, who has it, how concentrated it is and the trends in the concentration and distribution of wealth. We need that kind of stuff. When we are talking about tax, instead of having this artificial public-private nonsense, which Professor Barrett alluded to, we need to think far more about low, middle and high. That is what we should be thinking about in terms of tax. That should be the informing logic of looking at the USC. The people on the low and middle incomes do not need to be taxed any more. They are struggling and they cannot pay their rent or bills. They deserve relief. It would be obscene to give relief to people earning in excess of €70,000 or €100,000. Should we not start talking about that?

Deputy Richard Boyd Barrett

What about housing?

Professor Alan Barrett

I will let Dr. McQuinn answer.

Dr. Kieran McQuinn

I will touch on wealth redistribution. Professor Barrett alluded to measuring poverty in 1989. A part of the problem is that there was no wealth survey of the economy until recently, when the Household Finance and Consumption Survey, which was funded by the Central Bank, was published a little over a year ago by the Central Statistics Office. A part of our body of work with the Department of Finance involves examining that and the question of wealth taxes. Research will be forthcoming on the issue in the next three to four months. That will be interesting. If one is not measuring or estimating these factors, one cannot examine redistribution and its effects. I am sympathetic to the Piketty and Stiglitz perspective on this, namely, that inequality itself could be an engine of a lack of growth in an economy.

Regarding the overall point of view, we published a paper last year that critiqued European fiscal policy since the financial crisis of 2007 and 2008, in particular since 2010. One does not need a radical perspective to grasp the simple and mainstream economic principle that one should stimulate activity when economies underperform and remove pressure when they overheat. If so and in my opinion and that of many economists, what the appropriate fiscal response to the financial crisis should have been was clear. When economies are running large and negative output gaps by general acceptance, there are large elements of debt in the banking and household sectors and the private sector is essentially on its knees, there are compelling reasons for a government to intervene and provide a stimulus and aggregate demand. This was a major policy failure in the overall response of the EU institutions. It has led to turmoil in Greece and elsewhere where the outcomes are far from the original ideals of the European project. This is taking a mainstream economic perspective on the issue. All of this stresses the importance of having reliable and credible data sets that can be used to analyse and address these issues.

The distributional aspect of the crisis is interesting. It has been addressed in a number of ESRI papers, but we have mainly considered it from an income perspective because of the absence of a wealth survey. With the property-related impacts, it is an interesting issue, but it has never really been analysed.

The Deputy made a valid point about housing. Until 2007, Ireland was in a unique situation, in that prices and supply raged ahead. This was down to a number of reasons, but it mainly owed to a massive credit bubble in the economy. It led to the highly unusual situation of both prices and supply going off the scale and in turn fed property speculation, which was a key reason for the bizarre outcome.

From our analysis, it is clear on the basis of household formation and likely demographic movements that we need somewhere between 25,000 and 30,000 new houses per annum. One must accept that it is both a private and a public issue. The public sector cannot provide all of that housing, but there must be a strong Government involvement in providing social housing. I have articulated why I believe this to be important in terms of-----

Deputy Richard Boyd Barrett

That relates to my final question. If I understood Professor Barrett correctly, he stated that we should exploit a possible flexibility in the fiscal rules around capital investment in housing. I agree with that, as it is logical. Will Professor Barrett comment on what he believes is the situation? Are the rules open to that flexibility? Can we make an argument that would get a hearing to the effect that we should be allowed to borrow money for direct investment in housing and other key infrastructure without breaching the rules? When we argue that there should be direct State investment, the Government tells us that there must be public-private partnerships, PPPs, and that everything is being slowed down because it must do things for the private sector or else breach the rules. This is an important question and I would like Professor Barrett's opinion on it.

Will Professor Barrett comment on the fact that 85% of the housing plan is based on PPPs, with the private sector building and the State leasing from it? That seems more expensive for the State. Also, it would be more difficult for the State to make an argument to the EU that we should be allowed to breach the fiscal rules because PPPs would not generate a return to the State in the same way that direct investment would. The Government might leverage some extra money from the private sector up front, but the longer-term return to the State is not guaranteed because the buildings are in the hands of the private sector. Does Professor Barrett know what I mean? I do not know whether I am explaining it fully. Since everything will be leased, our capital stock will not increase. The housing will be built, owned and managed by the private sector but leased to local authorities.

Professor Alan Barrett

Regarding flexibility in the fiscal rules, I was in Brussels a year or 18 months ago and asked a Commission official that type of question. The answer I was given was along the lines that, if member states submitted expenditure or other policy proposals and made real cases that the effect of the proposals would be to increase the productive capacity of their economies, there would be room for some flexibility. I do not know whether that has been attempted or anyone has been successful. At one level, that is a good thing. We might grump and complain about the fiscal rules, but having an infrastructure to control the excesses of the past is good. However, if one decides that capital expenditure can be exempt, could one make the case that paying teachers more was a capital investment because better people would enter teaching? One can imagine the crazy arguments that would be made. If reasonable proposals are presented to the Commission and it reflects reasonably on them, though, my understanding is that there is scope for flexibility. From an economics perspective, the notion of borrowing for productive purposes is in no way controversial. It is exactly what one should be doing, especially when interest rates are where they are now.

I am not sure that I am qualified to comment on the broader issues. Does Dr. McQuinn wish to try?

Dr. Kieran McQuinn

Regarding the Deputy's point about the role of PPPs, we have not examined it. We have made suggestions of greater investment in and provision of social housing. The model that has been used - the 10% rule - is generally conditional on a certain amount of construction taking place. One will only get 10% of whatever is built. In terms of the rule, one needs to get 7% or 8% of actual construction. When there is no construction in the economy, one is getting 10% of nothing. Given the state of the housing market and, in particular, the provision of social housing, one needs to consider the model that existed in the 2000s. Even after the crisis, we were still building 3,500 or 4,000 social houses, even if that did not meet the requirement. In 2012, 2013 and 2014, we only built a fraction of that.

I will now come to my question. Do the witnesses think we are doing enough on climate action and, depending on their thoughts in that regard, are there any budgetary implications?

Professor Alan Barrett

I will respond to the Deputy's question on climate change. I am a member of the climate change advisory council in an ex officio capacity. There are four heads of State agencies represented on the council. I should preface my remarks by saying that I am not speaking on behalf of the climate change council. My view is personal, although it may reflect the position of some of my colleagues. When people think about climate change they very often think in terms of State subsidisation - in other words, what will the State have to pay to assist people. The real economics argument is that a huge amount can be achieved through tax system measures such as carbon taxes and so on, and that leads to a double win. In other words, it creates a revenue stream and at the same time leads to the type of environmental outcomes sought. That is something I would be enormously sympathetic towards. I believe it allows for the possibility of moving us in the direction that we need to go.

On the distribution point, the counter-argument to that sort of approach is very often that measures such as carbon taxes are highly regressive, which is true, but again, as colleagues in the ESRI and elsewhere have argued, this is rebalanced by the welfare system. It is almost in the direction of the hypothecated taxes about which we were speaking earlier. These measures are brought in and they do raise difficulties for certain people. The revenue should be moved in such a way as to alleviate the difficulties while incentivising good climate behaviour.

Deputy Eamon Ryan

Yesterday, I spoke to a civil servant with responsibility for implementing policy in this area. The Paris Accord - which I presume Europe is going to sign, or else we are just pirates - involves changing our entire energy, transport, food and built environment systems over two, three or four decades. It is change of a scale that dwarfs the changes made from the 1960s up to now in terms of the move to a sustainable economy. The view of the civil servant is that this will require great change. Changes to tax measures change stuff on the margin and not the entire system. I know from experience that political favour for introducing new taxes is not that easy. The political odds of our being able to put in place a carbon tax to achieve the extent of change within the required timeframe is zero. Are we doing enough?

Professor Alan Barrett

No, we are not doing enough. I confess that this is not an area about which I know a huge amount. One sometimes attends a committee meeting from which one learns more than one contributes, which was my experience in the early days of this committee. The scale of the challenge is something that people generally are not aware of. I am speaking in that regard of the scale of the challenge related to the measures we sign up to rather than to any notional challenge. There is a rude awakening coming down the line. I share Deputy Ryan's perception of the political difficulties but I do not necessarily share his pessimism about the possible power of significant price signals. The answer perhaps is that they would have to be pretty significant price signals to get the sort of actions that are needed, which probably supports the Deputy's point on political acceptability.

Dr. Kieran McQuinn

The Deputy made an interesting point in his original comment on how to measure some of the indicators that could be used. A similar comment was made when the measures we suggested were being implemented.

If one thinks of it in broad terms, however, it is somewhat defeatist to say we cannot measure these things or that they are too difficult to measure and we should, therefore, shy away from going down that avenue. We can point to a great deal of research, for instance, which shows clearly that some of the models we use would have highlighted in advance difficulties that were coming in the property market, including over-valuation of house prices. Those are on record and can be seen. More broadly - again, as I said earlier, it is just making the comparison between macro-prudential policy and something like monetary policy - the argument falls down a little in the following sense. When the Governor of the Central Bank, Professor Lane, or whoever is going over to Frankfurt for the monetary policy decision, he is confronted with a huge amount of data and analysis on where the European economy is at any particular point in time. Those data and analyses are then used to underpin the monetary policy decision that is reached. However, if one thinks about it, that is basically assessing the overall performance of the economy. Within the overall performance of the economy is, of course, the performance of the housing sector. By definition, if we are saying that what goes on in the housing sector is too difficult to analyse or too difficult to estimate or pin down, one could equally say that is a problem that should confront people who are looking at the broader issue of monetary policy or fiscal policy.

Deputy Eamon Ryan

Behind the crisis was the fact that we were getting German interest rates.

Dr. Kieran McQuinn

Sure, but the principle is that for efficient policy macro-prudential policy is going to be a very influential and important policy for us. In order to get buy-in in terms of general acceptance from policy makers and people generally of the policy and to ensure its most efficient implementation, taking into account whichever way one does it, the state of play in the housing market is going to be very important.

Deputy Stephen S. Donnelly

I am very conscious that I have been out of the meeting for most of the day. I am just going to ask one question and if it has already been covered, I am happy to withdraw it and take a look at the transcripts. I thank both the witnesses. My question is on the quantum of the tax base. I do not expect the witnesses to make any political judgments but I would like an economic view if they feel they can give one. There is a debate going on about whether taxes should be cut, kept broadly where they are or raised. As far as I can see, we are heading towards an ill-advised erosion of USC, which is efficient, highly progressive and brings in a lot of much-needed money. However, a sort of stealth tax will result from not indexing income taxes. That will, in essence, raise tax in other areas. How it all balances out, I am not quite sure. I note to the Chairman that it would be quite interesting to see if the committee could get some analysis on that. If USC goes down, as it appears the Government will propose, tax will go up in other areas if the indexation the ESRI has referenced does not happen. It would be interesting to see how that all balances out. I am not sure if it would be the ESRI or some other body that would do it, but it would be useful analysis to have.

My question, however, is really more around judgment. I am of the view that we should not erode the tax base either in terms of its breadth or the total quantum. The reason is that, when I look at other European countries which are broadly social democratic, we appear on aggregate to have significantly less tax take to a few percentage points and significantly less investment in public services, social infrastructure, capital and so forth. Regardless of whether USC or income tax should be touched or whatever the right mix of those things is, can the witnesses give the committee a view as to whether the level of taxation it looks like we are moving towards, according to the broad outline of what is going to come up in the budget, will be enough to maintain and progress public services and investment in productive capital infrastructure? There are lots of places where we could become more efficient in our spending, such as health care. It may be that the answer is that we have enough taxation coming in for health care and the issue is better spending of the money. However, my question is about the position in the round and bringing it all together to allow Ireland to progress to having sufficient broadband, infrastructure and public services while taking into account socio-demographic pressures. For example, good-quality health care is becoming more expensive per person as we live longer. Perhaps really high-quality education is becoming more expensive. It may be that in terms of getting back to reasonable levels of third level performance, we are €1 billion behind. There are lots of different elements to this.

In that case, I might ask the question in a slightly different way, as I appreciate that it is potentially political and I do not mean to put the witnesses in that position. Assuming our current quantum of taxes funds our current level of public services and capital investment, do we currently have underinvestment in aggregate?

Maybe Professor Barrett believes we invest too much in one area or other but, in aggregate, do we have approximately the correct level of investment, too much investment or too little investment in public services and in capital at present?

Professor Alan Barrett

If one looks historically at Ireland relative to comparable countries, it is easy to make the case that current levels of capital investment are below what they ideally would be. We touched on this in some of the discussion earlier. There is the historic lesson here that in the 1980s we cut back quite dramatically on the public capital programme. When growth really came to Ireland in the 1990s, the emergence of the bottlenecks and all such difficulties was quick and then there was a period of time where we were playing catch-up. In general, a smoother approach to this is fairly critical. One need not cite a significant amount of evidence. Obviously, the housing issue is quite acute. We made the point on earlier questions that investment in housing is not only about housing as water and roads infrastructure goes with it. There is a collection of infrastructural needs that must interact to achieve it.

I am not so much afraid of making political points. I will happily make political points if there is clear evidence to back that up. The issue of whether Irish public services are good enough is a tricky one. However, on the capital side, one can draw the comparisons, look historically and make the case that we are below where we really should be.

Dr. Kieran McQuinn

The point I was going make in tandem with what Professor Barrett stated about the USC and income tax is that we have been doing a body of research with the Department to look at the stability of the taxation system and the stability of the main key taxation aggregates. Some of the research arising out of that clearly points to the fact that income tax in an Irish context is a relatively stable source of tax. If one is looking at this notion of fiscal stability and the potential shocks to the economy which could accrue in the coming years, it is, quite apart from the fact of the total revenue it brings in, merely from a variance point of view clearly important that income tax would be a sizeable component of the overall tax take. This is emphasised in recent years with the substantial take in corporate tax. There was a substantial corporation tax take last year. This year the figures are still quite positive but, of course, we do not have as great an understanding of what exactly is driving that in terms of the sustainability of that receipt as we have in terms of other areas, for instance, income tax and VAT. It is another reason one must have a sizeable component coming from such aggregates in order to ensure the overall stability of the base.

As another argument in that regard, in other research we have pointed out one needs to dig beneath it as well. Income tax, VAT and stamp duty collapsed after the crisis because of the relationship between the housing market and those taxation aggregates. It is not only focusing on having income tax; it is obviously knowing the dimensions of income tax and the degree to which the tax returns in income tax and VAT are related to the different activities in the economy and how sustainable are those levels of activity.

Chairman

I have a couple of brief questions. Yesterday, we had a number of witnesses, one of whom was Dr. McDonnell from the Nevin Economic Research Institute. Would Professor Barrett concur with his point, which was news to me, that the Irish tax and welfare system was, according to an OECD comparison, "highly redistributive" and one of the most progressive systems that exist?

Professor Alan Barrett

In many ways, I should be careful here. I think I can claim ESRI research on this, as we are the ones who do the analysis of the redistributive component. The OECD did the study, but using the ESRI SWITCH model. It is the case that our tax and welfare system combined are highly redistributive. There is an additional point though, that one should not confuse that with the totality of the tax system. For example, we know that indirect taxes are actually quite regressive. To get a total sense one would have to factor that in, but on the narrow income tax system, it is among the most redistributive.

Chairman

On regional development, Professor Barrett stated that various policies to implement regional economic development were almost akin to holding back the tide economically and that it is a difficult task. We had this discussion yesterday with Dr. McDonnell. How does one explain the differences that exist across the country? The issue I come up against quite often is that when people talk about economic development on the east coast and in Dublin, and that Dublin is doing well, they automatically speak about the need to counteract Dublin and have a counterbalance in the west, and yet my region, the south east, was the worst performing region during the boom years in terms of unemployment, third level attendance and household income. It is still the worst performing, even though employment in the south east region enjoyed the second biggest increase proportionately, but that is because it was from such a low base. Is there anything specific to the south east region or anything that can be done in this budget, if Professor Barrett were the Minister for Finance, to redress those types of imbalances?

Professor Alan Barrett

The truth, to answer the second part, is there is not much one can do in the budget. It is a much longer term issue.

I am talking on the edges of my knowledge here. Many have looked at the modern growth processes and the importance of a major urban centre is fairly critical. If one thinks about the south east, Waterford and Kilkenny may view themselves as urban centres but clearly there is a critical mass dimension to this, and often the university issue is linked in to that as well. However, it is not only the university. There is a range of elements that cities provide that are relevant when decision makers are locating industries. It is not even about the old-fashioned notion of supply chains or anything like that. It is about how young people simply want to live and work in more dynamic centres or whatever. This is not only an Irish phenomenon. If one thinks of places with which we are familiar, for example, in Britain, there is the power of the south east region there. My understanding from discussions with colleagues across Europe is that much of the recovery post-recession in France was around Paris and Lyon. In Germany, it is in the bigger cities. There seems to be a gravitational effect pulling resources and economic activity in to the centres. That is why places such as Galway, Limerick and Cork have done reasonably well. That has always been the explanation I have been given of the difficulties in the south east.

Chairman

Chairman

That would never be the case. I understand. Thank you very much. It has been a far longer session than planned. The danger of having only one group of witnesses is that politicians expand the time of their questioning to fill the available space. Thank you sincerely for coming in. It would be great if we could get the extra information requested at the earliest possible opportunity. You can talk to the clerk afterwards about it.

The select committee adjourned at 5.05 p.m. until 1 p.m. on Tuesday, 13 September 2016.

Committee on Budgetary Oversight debate - Wednesday, 7 Sep 2016

Economic and Fiscal Position: Economic and Social Research Institute

Professor Alan Barrett

Professor Alan Barrett

Dr. Kieran McQuinn

Dr. Kieran McQuinn

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Dr. Kieran McQuinn

Professor Alan Barrett

Dr. Kieran McQuinn

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Dr. Kieran McQuinn

Dr. Kieran McQuinn

Dr. Kieran McQuinn

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Dr. Kieran McQuinn

Dr. Kieran McQuinn

Dr. Kieran McQuinn

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Dr. Kieran McQuinn

Professor Alan Barrett

Dr. Kieran McQuinn

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Dr. Kieran McQuinn

Professor Alan Barrett

Dr. Kieran McQuinn

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Dr. Kieran McQuinn

Dr. Kieran McQuinn

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Dr. Kieran McQuinn

Dr. Kieran McQuinn

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Professor Alan Barrett

Committee on Budgetary Oversight debate -
Wednesday, 7 Sep 2016