What happened in the UK in the last couple of months? The narrative took on a life of its own – the markets, we were told, demanded blood after the short-lived government of Liz Truss messed up badly and new chancellor Jeremy Hunt had to throw them some raw meat in the form of higher taxes and spending cuts. The truth looks more subtle. It is important to try to understand it and see what lessons are here for Ireland.
That Liz Truss and Kwasi Kwarteng messed up with their ridiculous budget calls – and particularly plans to cut taxes as inflation was roaring – is obvious. It was a triumph of ideology over common sense. But the next part of the story, that this then required some kind of austerity sacrifice to the markets, looks overplayed. When you see big investment fund managers quoted in the Financial Times the day before the fiscal statement warning that Hunt might risk pushing austerity too far, it is clear that this is not just a case of the “markets” calling for cutbacks.
Now the new chancellor has calmed things with a budget which postpones most – though not all – of the pain until the next parliament after 2024, which of course means a lot of it may never happen. And investors seem okay with this. By talking a more conventional game, Hunt has persuaded them that the ship has been steadied. The public will feel some of the cuts in the short-term, including the likelihood of higher energy bills after next April and the non-indexation of tax bands. But much of the worst of the medicine is delayed.
The mood music of the Truss regime seemed to have been as upsetting to investors – the dismissal of the work of the Office for Budget Responsibility in the run-up to the budget, for example. But remember, too, that a key reason why UK interest-rate markets went bonkers for a few days was a little-known issue with the way pension funds had tried to protect their financial position.
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What is more striking is the grimness of the economic forecasts, with a drop of over 7 per cent in living standards expected over the next two years, a poor and recessionary 2023, and an outlook of depressingly slow growth. The hit from Brexit – a permanent loss of some 4 per cent of GDP according to the Bank of England – long-term productivity problems and a crippled public sector are all taking their toll, alongside the inevitable hit from a world slowdown and the cost-of-living crisis. The UK is also facing a significant rise in its debt-payment burden, largely due to the unusual exposure of its national debt pile to variable interest rates, which makes the need for tax hikes and spending cuts all the greater.
The British example shows that bond markets are back as a key constraint on policy, after years when countries could raise cash at zero interest rates. And that, as well as what countries do – the messaging and the mood music – is important. Ireland’s pitch since the financial crash has been to keep the head down at all costs. Boring has worked, as Ireland has made a habit of beating budget targets and telling a story of stability.
Turning point
But Ireland’s national debt remains high – one of the most onerous internationally when the distorting impact of multinationals are discounted. And the Irish economy is now at a turning point. The jobs market is topping out, as the latest Central Statistics Office data show, interest rates are rising and a host of other indicators suggest that consumers and businesses are nervous. This isn’t a cause for panic, but it should give pause for thought.
Above all, Ireland needs to avoid being caught in the glare of the markets again, like the UK has been. The British experience shows that high-debt countries walk a tightrope, with the issue of sustainability always bubbling away in the background. High debt levels are fine – until they aren’t.
For now, Ireland’s budget figures are comforting, with a surplus in prospect and enough cash to put billions aside into a reserve fund. But like the UK, Ireland is facing chillier winds now. Here, too, living standards will fall this year – even if the budget protects many of the less well-off. Together with tremors in the tech sector, this will show up, sooner or later, in the tax figures.
Next year there will be pressure to spend more to protect living standards. But the bigger pressure will come in the years ahead. Ireland faces an ageing population – the UK is watching this playing out already – and big bills from the climate transition, healthcare, housing, infrastructure, pensions and so on. The Commission on Taxation and Welfare published proposals to deal with this, which the Fiscal Advisory Council estimated this week could, in time, raise an extra €15 billion annually.
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The political system does not want to know. Soon-to-be taoiseach Leo Varadkar said a lot of this was like a Sinn Féin manifesto. But, of course, Sinn Féin is opposed to raising taxes in many areas too, notably the local property tax. Nobody will propose lower spending, either.
This avoidance of the issue may continue as far as the next general election campaign. But sooner or later, Ireland will have to face up to how to pay the bills. Doing this in a planned way would avoid the risk of falling into a UK-style trap, hemmed in by the markets. It would also mean raising new revenues in less damaging ways than soaking middle-income taxpayers, as will happen now in the UK. It will surely happen here if we end up in a bind.
The surge in corporate and income taxes has delayed the need to make these decisions, but it can’t remove them.