Wednesday, February 04, 2009

Economic Consequences of Pension Tax

This is a tax, not a levy

I am disappointed, but not surprised, at the uncritical acceptance by almost all media and most commentators of the Government "spin" in relation to the so-called pension levy, which is, in fact, an additional tax on public sector workers. This failure of analysis has led to widespread serious misinterpretation of the benefits - and underestimation of the damage - that the tax will impose on the economy.
This is a tax increasing measure dressed up as an expenditure reduction measure and, while it will have the effect of reducing the net cost of the public sector payroll to the government, it will not have the same effect on the wider economy for several reasons.

Payroll costs not reduced

Payroll costs, and therefore government expenditure on payroll, have not been reduced, so let us dispense with that pretence. After March, the salary of a public servant will be the same as it was before March. That is an objective fact. There are only three ways to cut payroll costs: cut numbers, cut pay rates or cut allowances and overtime; none has been done to any effect.

No real government savings

Private individuals (forget that they are public sector workers for the moment) will pay the tax, so the government, as such, has not created a new source of income from, say, innovation, efficiency improvements, creation of intellectual capital, development of new services, etc. So, overall, the government has not generated any savings or income that it can pass on to the consumer or to industry

Transfer pricing

Many (if not all) public sector organisations engage in some form of transfer pricing, whereby they provide services to other public and private sector organisations. These transfer pricing mechanisms usually consist of charges for direct payroll and non-payroll costs; employers' PRSI and pension costs, and administrative overheads. Since payroll, PRSI or pension costs have not reduced, there will be no savings between institutions.

This is fine when transfer pricing stays within the public sector, where it is just churn, however inefficient. However, utilities and local authorities, in particular, pass on significant costs to the
private sector. Examples of these services include the provision of ESB supply and services; connection of sewerage, water and other services for developers; public transportation costs; inspection and certification services, and commercial rates. Since the costs of these services include payroll-related costs, which have not reduced, and there are no balancing savings to put directly against them, the costs of the services to the private sector will not decrease because of this tax.

Reduction in personal spending will seriously affect economy

This is a very significant new tax imposition on one section of the community. Therefore, public servants will, naturally, have to look at their own spending and reduce it drastically. Add in new education fees; pay freezes; property taxes; health insurance costs, and the ill-considered VAT increase, and it is not inconceivable that public sector workers will suffer a reduction of some 20% to 30%, or more, in disposable (cash) income over the next two to three years. This will have a catastrophic effect on economic activity in the state and will lead to a deflationary nosedive, perhaps one of the worst ever seen in the history of the state.

No provision for future pension liabilities

The tax, ostensibly related to future pension entitlements, will not be put to that purpose, but will be used instead to relieve the current economic and fiscal situation. The lie and devious sleight-of-hand is clearly laid bare; despite this, it appears to be too obscure for many commentators to see.

Predictions for the future

The consequences of the Government's actions are startling and demonstrate an ineptitude and lack of foresight that is hard to fathom. Because of their actions, I predict that some or all of the
following will occur:

In the Public Sector

  1. Collapse of morale leading to reduced productivity; stifling of innovation and increased absences.
  2. Collapse of partnership leading to overall loss of goodwill; far more workplace disputes; local industrial unrest; resistance to change; lack of flexibility; withdrawal from all non-negotiated local arrangements; legalistic interpretation of existing agreements, and lack of cooperation with management.
  3. Disruption to services caused by direct action and industrial unrest; works to rule or contract; refusals to fill in or substitute for absent front-line workers; creation of backlogs that will not be dealt with except by prescribed procedures; overtime bans and refusals to work, even when overtime is available and clearly necessary.
While the above consequences might seem to be discreditable, it is simply not realistic to cut someone's pay so deeply - and so ostensibly inequitably - and expect them to perform to the same standard as they did before. This is simply human nature in evidence.

In the Personal Private Sector

As the public sector represents a sizeable portion of the workforce and, therefore, of personal spenders, the increased taxes will have several consequences that can be directly attributed to their reining in of their spending. These will include:

  1. A massive further collapse in consumer confidence that will now spread like a virus to those in so-called secure public sector employment (although many were already feeling the pinch anyway, especially the large number on short-term contracts, renewable from year to year).
  2. Huge reduction in car sales, with a knock-on effect on jobs in the motor industry, and leading to continuing catastrophic declines (already seen) in VAT and VRT.
  3. Immediate deferral or cancellation of home improvement and maintenance works (e.g. home insulation, energy saving, environmental initiatives – all pet projects of the Green Party), which will affect the smallest builder in the country, with consequent impacts on jobs. There will not be a trowel scraped, a brush dipped, a nail hammered or a brick laid by the autumn.
  4. Virtual standstill in domestic property transactions, leading to an almost complete collapse in stamp duty, and knock-on effects on the legal profession; auctioneers and estate agents; building contractors; architects; surveyors, etc.
  5. Huge defaults on mortgage repayments for rental properties, as owners fail to let them and cannot afford to keep and maintain them, leading to a further worsening of bank positions and the destruction of the housing market for the next five to seven years.
  6. Dramatic reduction in discretionary spending on meals, holidays, alcohol and entertainment, leading to widespread closures and job losses in the hotel, tourism and entertainment sectors.
  7. For the first time, perhaps, in the history of the state, the emergence of large numbers of personal bankruptcies, as people fail to meet their debts and liabilities.
  8. Continuing queues heading north to shop in the cheaper Sterling area, leading to further closures and job losses in the retail sector in the Republic. The border towns of the Republic will return to being the "ghost towns" they were in the last recession.
In the Wider Economy

  1. A multiplier effect as cash and confidence evaporate from the economy, spreading from private sector worker to public sector worker, and from there back to those few workers left in the private sector, creating a massive spiral of deflation and mass unemployment.
  2. A massive reduction in PAYE and PRSI paid into the exchequer as unemployment grows because of lack of demand and consumer spending.
  3. A consequent increase in social welfare payments to the unemployed.
  4. A return to mass emigration, even to economies with similar problems, due to the plunge in confidence created by this government.
  5. A huge increase in the black economy as people return to cash dealing, with even further losses of VAT, PAYE and PRSI remissions to the exchequer.
  6. On top of losses already made on personal pensions, which will not be recovered, there will be a reduction in personal pension contributions for the next decade. This will create an even greater ticking demographic time bomb, for which there is no Pension Reserve Fund available (having already been given to the profligate banks that got us into this mess in the first place) to defuse it.
  7. A complete collapse of inward investment, and further expatriation and closures of what are left of existing multi-national corporations, as the international community loses confidence in the Irish economy and in the government.
  8. Continuing reductions in Ireland's international credit rating until we become, after years of so-called prosperity, an economic basket case once again.
  9. External intervention in Ireland's economy by the World Bank or the International Monetary Fund and the removal from us of all control over our economic affairs.
In Politics

With the breaking of the Social Contract by the government between it and the citizens, and of the employment contract between employer and employees, anger will rise swiftly in the public sector. Public sector anger will mix with further anger, despair and despondency in the private sector, creating a dangerous cocktail of social and industrial unrest; loss of confidence; inter-class and intra-class tensions; public versus private sector antagonism, and consequent searching for blame and scapegoats. The consequences will include:

  1. The current government will not return after the summer recess, at the latest, and an election will be called, leading to further instability.
  2. Cowen, already a dead man walking, will be removed as Taoiseach and leader of Fianna Fail.
  3. Lenihan will have a very short tenure as Minister for Finance.
  4. Coughlan, ineffectual in the extreme, and clearly out of her depth in any role she holds, will disappear in ignominy from government.
  5. Harney, if she does not go voluntarily, will not be returned to the Dail.
  6. The Greens and Fianna Fail will be decimated in the national, local and European elections.
  7. There will be a return to short-term governments and unstable coalitions, with further destabilising effects on the Irish economy.
  8. The Lisbon treaty referendum will be defeated for a second time, creating more trouble for us in Europe.
Ship of state is foundering

These are black days for Ireland, brought about by a government that rode the waves of prosperity without chart or compass, ignorant of, or unwilling to prepare for, the dangers of the rocky waters ahead. Sadly, when we need real leadership, we have an inept, inexperienced,narrow-visioned and ideologically misguided crew manning the ship of state, and a weak and unconvincing captain at the helm.

While the private sector is often called the "engine of the economy", the public sector is the auxiliary power, on which we hope to be able to rely in times of crisis (for example, in dealing with the collapse, nationalisation and re-capitalisation of the banks; for being a steady hand, conservative, middle class and reliable; for responding to diseases such as foot and mouth, and CJD; for putting out fires and treating the sick; for creating a sense of continuity and social stability in uncertain times).

Having lost his main engines in stormy waters, Captain Cowen, exhausted, panicked, overwhelmed, and indecisive, has just cut off the auxiliary power in a vain attempt to save fuel. A massive, catastrophic and devastating crash upon the rocks of economic ruin is the inevitable consequence of this foolhardy action.

Will it be long before the first cries of "abandon ship" echo through the vessel and the frightened crew, finally coming face to face with their own shortcomings, don their lifejackets and race for the lifeboats?

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