Cutting public sector pay will cut the tax take

It must be dangerous to be a bird in Dublin these days.

The government that promised transparency has instead adopted a kite-flying approach. The kites pop up and, like modern-day Benjamin Franklins, a government minister hangs on as it drifts into the storm, and then gauges the lightning.

Occasionally they get singed. Sometimes they escape and withdraw for another day. And it’s not just the Government. Every other aspect of social partnership is busy with economic balls and fiscal paper and silk, constructing and testing kites.

Ibec joined in this pleasant pastime recently with the proposal that public sector increments be paused. The saving would be approximately €1bn per annum, it appears.

The problem with increments is that they are generally paid regardless — one is on a salary scale along which one advances by dint of survival. In a modern managerial environment, this doesn’t make sense. There is little incentive to excel, little disincentive to slack.

Of course, we have known this for decades and for a long time it suited Ibec, as a member of social partnership, to allow this to go on. “Peace at any price,” was the seeming mantra. Cutting €1bn from the State budget is eminently justifiable in the context of borrowing a billion. However, throughout the crisis the argument about cutting public sector wages has been notable for a lamentable lack of follow-on argument.

Cutting X does not save X. At the most basic, it saves less than X, due to the fact that yes, public sector wages are subject to tax. So 0.7X might be the post-tax savings. And then there is the knock-on effect. We have seen recent estimation from the IMF of these effects.

In economics, the effect of changing one item or another is known as a multiplier. The conventional multiplier for government expenditure was about 0.5-0.7. This would imply that cutting X would, in the end, result in a fall in overall economic output of 0.5-0.7X.

In other words, cutting wages would not have the overall effect of reducing the economic cake by the same amount as the wage cut. This may now need to be revisited in the light of the IMF World Economic Outlook Report, which suggested that, far from being less than 1 (implying that cutting public sector pay would result in a small fall in output), these short-term multipliers may be much greater than 1. In other words, cutting X will result in a decline of 1.5X–1.9X.

Whatever the attraction from a government accounting perspective of cutting, the short- and medium-term effects on the rest of the economy would be significant and negative.

In the Irish case, the effects are complicated by the GNP/GDP issue — while GDP can be growing or contracting slowly, the GNP component can be falling more rapidly.

Regarding the multiplier, some very significant work needs to be done, pronto, by a combined ESRI/DoF/ Central Bank team to ascertain the best evidence. In that context, we might want to hold fire on accelerating the pace of consolidation.

Ibec has not, to my knowledge, come up with a comprehensive set of implementable performance metrics — that, to be fair, is not their job — but one must applaud their desire to save a billion. However, why stop at a billion?

Why not save three times that much, and harm nobody? Each year, the Government spends €3.1bn feeding the IBRC (Anglo/INBS) black hole. This year, in a cunning plan, instead of real money, they issued a bond to the beast. The borrowed, or tax-derived, money, you will recall, is given to the Central Bank, which then destroys it. As far as I can ascertain, Ibec has not expressed concern about that, except in so far as the technicalities of the bond versus cash 2012 payment impacted on Government aggregates.

It is abundantly clear that there is little appetite in the ECB for a deal on this money. At the very best, we might replace this promissory note (which is not government debt) with a 40- year bond. At worst, we will be stuck with the full repayment schedule. It would cause nothing but the closure of IBRC and a technical temporary accounting headache for the Central Bank if the Government were to announce, in framing the 2013 budget, that they were not going to make the March 2013 (or any subsequent) payment.

The ECB would be unhappy but I guess we can live with that. What they would not be able to do is to “cut us off” from liquidity. It would be nice if Ibec was to advocate saving €3.1bn, but then IBRC is a member firm of Ibec.

* Brian Lucey is professor of finance at Trinity College Dublin


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