April 30, 2006

PDs use Reaganomics to punch above their weight

Posted in Politics ·
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Can Reaganomics work indefinitely in Ireland? This is the open question at the heart of the electoral plan unveiled last week by the Progressive Democrats.

Not surprisingly, and true to their colours, the PDs will fight the election on the basis of a programme to cut income tax for people who change their car every three years, play golf and wear Juicy Couture tracksuits on weekends.

This means that for the upwardly mobile – which, according to the last census, was well over 40 per cent of the population – the PDs� proposition is distinct. Given that Fine Gael has thrown its lot in with the Labour Party and Fianna Fail�s manifesto will be all things to all men, the PDs are the only party explicitly saying that tax cuts are good for you. This might be appealing, but does it make economic sense?

For many who believe that cutting taxes is self evidently right, it makes eminent sense. They believe that we earn our cash and the government has no right to take it.

Equally, they contend that our money is wasted by the public sector anyway and the more tax we pay, the more waste we get.

They cite advisory fees, cost over-runs and fiascos such as electronic voting to substantiate their case. In addition, these free-marketers feel that there are certain �animal spirits� in all of us which, when liberated from taxes and government interference, drive us forward, unleash ambition and allow people to make the best of their lives.

Many commentators make the mistake of assuming therefore that, because of this get-up-and-go attitude, the PDs must be the party of the rich. This might be an easy caricature – but it is wrong. A recent study by the politics department of Trinity College, which examined the last election results, revealed that Green Party supporters were the richest in Ireland.

The Labour Party, bizarrely for a leftwing party, had the second richest supporters, while Fianna Fail, the tax-cutting, supposedly right-wing, government party, got the lion�s share of the poorest vote. The pro-business PD voters were in the middle financially.

So has the PD view of the world worked? Sociological facts of the past few years reveal a great class compression, whether it is gauged by the massive employment growth or the actual narrowing of income differentials for the majority in society who are neither very rich nor very poor but – like PD voters – lie in the middle.

The results of the last census revealed that the number of people in the top social class had increased by 22.34 per cent in the five years to 2002,while the number at the very bottom fell by 29 per cent. This constitutes extraordinary upward mobility.

But there has also been significant social compression into the middle. The number of people in the second-richest social class – which is now the biggest class, with more than one million people in total – rose by a staggering 25.6 per cent (just over 200,000 people), while the number of people in the second lowest class fell by 8 per cent. There are now more people in the second-richest class than in the four poorer strata below it.

This is the �Wonderbra� effect. In the past ten years, we have experienced Wonderbra economics, whereby we have all been pushed together, and lifted upwards and outwards.

As a counter argument to these demographic facts, it is not uncommon to hear commentators blithely claim that, while we may have got rich, Ireland is one of the most unequal countries in the world. This is not true. According to the EU, Ireland is right in the middle of the European average when it comes to income distribution.

The latest comparative figures on this are from the European Union in its excellent Eurostat publication, the Social Situation in Europe. According to this definitive account, which divides the income of the richest 20 per cent by the poorest 20 per cent in each country, the European average is 4.4 times. So the richest 20 per cent earns 4.4 times the poorest 20 per cent across the EU.

So what is the figure for Ireland, the so-called bastion of inequality? It must surely be way above this – six times, eight times or even ten times. Actually, the figure is 4.5 times. We are fractionally above the EU average and considerably more equal than Italy, Spain, Portugal, Britain, Estonia, Latvia or Greece.

Thus, so far, the facts seem to support the PDs� world view. So why is it such a small party? Why does it not reap the electoral rewards for a pulsating economy?

Well maybe it is because the low tax concept only tells half the story.

No analysis of Irish society would be vaguely accurate without reference to credit, which undoubtedly has been the handmaiden of tax cuts. Without access to almost unlimited credit, none of the social revolution exposed in the census could have been possible.

The PDs argue that this was not accidental and that the deregulation of the financial industry (which facilitated the dramatic surge in credit) was part of the same ideological package as tax cutting.

Like proponents of Reaganomics in the past, the PDs contend that the developments are self-reinforcing. Tax cuts give people the confidence to take out new loans, which increases demand. This creates more jobs, which fuels the government�s coffers. This surplus, in turn, allows more tax cuts and the positive economic cycle starts again.

Unfortunately for the PDs, this analysis is not complete. Crucial to the success of slashing income tax is the country�s place is in the economic cycle. The amount of growth and employment you can get out of each tax reduction depends on the amount of idle capacity in the economy.

So when unemployment is in double digits and inflation is low – as it was in the US in the early 1980s and here in the early/mid-1990s – each tax cut gives you a bigger bang for your buck.

Today, however, when we are up to our gills in debt/credit and have to import labour to fill our jobs, each tax cut risks evaporating into greater wage or house price inflation, because when the demand goes up and there is no capacity, prices have to rise and this extra cost has to be paid from somewhere.

In the US, Reaganomics began the process whereby it went from being the world�s largest creditor nation to the largest debtor. When you cut tax and encourage people to spend, national savings fall.

The society becomes engulfed by a consumerist inferno and the only way of keeping the whole thing going is to borrow more and more from the outside, absorb more and more immigrants and let house prices go through the roof. We are experiencing the same carry-on here.

In that context, the PDs� manifesto is more of the same. Even though their message is simple and seems to make immediate individual sense, they have been a small – but very influential – force in Irish politics.

For 40 years, Hans-Dietrich Genscher�s Liberal Party played the same makeweight role in German politics with great effect. It remains to be seen whether that remains the fate of the PDs. If so, rarely in European history will a minority party have punched above its electoral weight for so long.