November 10, 2002

McCreevy: lucky accountant or supply-side economic guru?

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According to convention, McCreevy’s choices are between raising taxes or cutting expenditure when faced with the present budgetary crisis.

It’s a pity Dunphy did not run with the cutting taxes idea, because, according to McCreevy’s own purported ideology, that’s exactly what he should be doing in the face of a slowdown in the economy. The fact that McCreevy is apparently now talking about raising taxes means that either he hasn’t got the courage of his tax-cutting convictions or that his convictions were a fraud and he isn’t a supply-side visionary but an accountant who got lucky.

Real supply-side tax-cutters respond to a slowdown in the economy by cutting, not raising taxes. Ronald Reagan in 1980/81 reacted to the worst American recession in three decades by cutting taxes, prompting growth and increasing the tax take. Margaret Thatcher did likewise in 1982 when Britain was on its knees. George W did the same in the US last year.

Their collective view is that taxation is wrong; it holds back innovation and spending, ultimately strangling the economy. The great tax-cutters argue that when faced with difficulties in the economy a government should cut taxes, prompting economic growth and raising tax revenue. This approach to economics is validated by a phenomenon called the Laffer Curve that measures increases in tax revenue coincident with falls in tax rates. The more you cut, the more revenue you get.

Ministers McCreevy, Harney and McDowell profess to be persuaded by this analysis. They regularly cite the increase in tax yield following the cut in capital gains tax from 40 per cent to 20 per cent as definitive evidence supporting their views.

In addition, all three are on record as criticising the EU for being a high-tax, slothful and under-achieving economy. If the EU economies could only see the true light and reduce taxes, the continent would have much better economic prospects.

Indeed, the triumvirate believes that our low corporation tax rate is crucial and the fact that Ireland raises a much higher proportion of our overall tax revenue from our much lower corporation tax rates supports their view. If they are right, why not cut taxes straight away?

Ireland should have an income tax-cutting not tax-raising budget in December. Forget all this defeatist talk of budget deficits. True believers should dispense with arguments expounded by Keynesian quislings and carry on with the revolution.

To increase taxes now would be to raise the white flag and surrender to the poverty lobby and the liberal lefties and pinkos in the media. This budget should be McCreevy’s Dunkirk, Stalingrad and Somme all rolled into one.

What better time than now to prove to the country that he is a veritable reformer, one who believes in lower taxes and equal opportunity for all?

Just as the going gets tough is the time to show everyone that our minister for finance is a man of principle, a committed ideologue rather than an accountant who got lucky.

Unfortunately for the disciples of the lower tax camp, the minister for finance is likely to display all the symptoms of a lucky accountant next month.

As a result, some taxes will be hiked. Unlike economists, lucky accountants are ruled by annual balance sheets. When they see a surplus, accountants spend it. Likewise a deficit prompts a hole plugging exercise, moving money from one area to another.

Accountants are terrorised by the annual return and the calendar year is paramount. This approach leads accountants to ignore the economic cycle.

Yet the economic cycle determines everything. Therefore, an accountant might be tempted to regard an annual account in isolation. An economist will always project forward. Accountants are by their nature backward looking.

Forecasting demands a comprehension of trends, peaks and troughs. In contrast, the annual return approach to running the economy exists only in the present. Therefore, accountants will make promises at the top of an economic cycle as McCreevy did with benchmarking and SSIAs.

They will naturally misdiagnose the peaks of an economic upswing as a long-term trend rather than something that will ebb.

Instead of projecting out a few years, the accountant will consider only the present and regard balancing the books as a success in itself rather than part of a process.

This approach to the economy was best summarised by the minister himself who recently stated that his policy was to spend money when you had it and stop spending when it ran out. An economist thinks in just the opposite fashion.

Accountants are really dangerous when they are lucky, and McCreevy got lucky. The great Irish credit boom just happened to occur on his watch. It was the credit boom rather than the tax cuts that drove the revenues of the state in the period 1997-2001.

Yet the apparent coincidence between tax cutting and the growth of the economy and revenues allowed ministers McCreevy, Harney and McDowell to claim that there is a direct relationship between cutting taxes and increased revenue.

However, the rising of the rhetorical stakes does not accord with the data. If we look at the figures, we see that taxes were cut in Ireland after revenue had grown, not before.

This might sound like an esoteric point, but it is crucial because it slays the myth that it was the economy responding to tax cuts alone. In fact, the data reveal that it was the tax cuts responding to the economy and not the other way around.

Unlike in the US in 1981, the boom was well underway before taxes were cut, fuelled by cheap money. Clearly, lower taxes reinforced the spending splurge that generated the explosion in indirect tax receipts allowing taxes to be cut further.

However, the catalyst was lower interest rates, more widely available credit, demographics and an American boom as well as good fortune, institutional maturity and a few very brilliant people, not simply the lowering of income taxes.

So we have the worst of all worlds, a lucky accountant masquerading as a tax-cutting ideologue. If I’m wrong, taxes will be cut in December in true supply-side fashion as Ronnie Reagan or Mrs T would have done. Let’s open a book. Time to place your bets.