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News : Irish Economy Last Updated: Oct 6, 2010 - 9:02:24 AM

Ireland: From prosperity to austerity - - Higher taxes and review of Croke Park agreement
By Michael Hennigan, Founder and Editor of Finfacts
Oct 5, 2010 - 5:32:33 AM

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Ireland: From prosperity to austerity; a research note issued by the wealth management unit of the Swiss banking giant UBS says there is room for manoeuvre to raise taxes in the December budget while the  Croke Park agreement between the Government and trade unions on public service reform should be reviewed and consideration given to reneging on some of the commitments, at the risk of industrial action.

The lead author of the note is economist Brian O'Reilly, who is head of research.

In March 2008 after the near-collapse of US investment bank Bear Stearns, O'Reilly suggested that some Irish banks may have to raise capital.

The chief executive of Anglo Irish Bank, David Drumm, dismissed this suggestion.

"Big rights issues have really been by banks with large sub-prime losses having to raise new capital to repair their balance sheets," said Drumm. "None of the Irish banks are in that position. There is no requirement for Anglo to raise capital."

Drumm was right in one sense about the sub-prime comparison; the Irish banks were in a worse position than many of the sub-prime lenders.

On taxes, the authors say that Irish taxpayers have become accustomed to a policy of low business and personal taxes. The standard rate of income tax is 20%, the top rate 41%, and corporation tax remains at 12.5%. According to government data based on last year's budget estimates, of the 2.2 million income earners, 47% are fully exempt from income tax (jointly assessed married couple considered as one income earner). Of the remaining 53%, 41% pay the standard rate, while just 12% pay the higher rate whose liability is not fully offset by tax credits.

They cite a study by the OECD and present on what is called the tax wedge, which compares the total tax paid as a percentage of gross wages in income tax and employee social security contributions for a married couple with two children, with one spouse earning the average wage, and the other earning 67% of the average wage.

On this measure, a married Irish couple pays just under 20% of their total gross wages in tax. This is the fourth-lowest in the world, with only Koreans, Mexicans and New Zealanders paying less. In comparison, the equivalent German or French household with similar income distribution pays double the percentage level in tax, above 40% of total gross income. The authors say data for 2010 is not yet available, and some of last year's changes in the budget will not be reflected, but given the sizeable gap between Ireland and other nations, particularly Germany, it again shows the Irish taxpayer pays one of the lowest rates. Based on this analysis, they say there is clearly plenty of room for manoeuvre in the upcoming budget to reduce the deficit further

The note says that the Government managed to push through some public sector pay reform last year, but it is more than likely that further cuts will be required sooner rather than later to reduce the debt figures. This is made more difficult given the fact that the government entered into the Croke Park agreement with the major trade unions, which limits the amount of cuts in the public sector in the coming years. The details included that there will be no redundancies or further pay cuts over the next four years in return for co-operation with pay cuts to the public sector implemented in last year's budget. (The accord also provides for a possible refund of the 2009 pay cuts at a later date but only after major reform of the public sector has been secured.)

The authors say if the Government is to show its determination to tackle the structural deficit, it may have to renege on some of these commitments, at the risk of industrial action on behalf of the unions. But with the private sector bearing the brunt of the downturn, the public sector must also wake up to the new reality that Ireland simply cannot afford to continue spending as it is. The majority of public sector workers enjoyed significant rises in wages, up to 60% in certain cases.

The authors say a study by McKinsey shows that between 1988 and 1994 Ireland reduced its debt by a third, and the budget deficit fell from more than 10% of GDP in 1985 to just 2% in 1994, which helped set Ireland up for the beginning of the Celtic Tiger.

"If, and we recognise this is a big if, there exists the political and social will to make the necessary adjustments, we believe Ireland will once again be well positioned to benefit from an upturn in global economic growth. Encouragingly, many of the building blocks as to why it enjoyed such a period of success are still in place, such as a well educated young workforce, good infrastructure, and high levels of productivity. We highlight two important dynamics of the Irish economy that we believe sets it apart from other troubled nations," they say.

On a positive note, the authors say Ireland continues to benefit from good export exposure. In total, 45% of exports are into Europe, 19% into the United States, 18% into the UK and 18% to the rest of the world. With the likelihood that domestic demand will not return strongly, faced with high levels of unemployment, limited credit and falling house prices, Ireland must look to export growth to improve its economic output. As recent second quarter GDP figures highlighted, to improve export growth Ireland must ensure it has a competitive cost base to compete in international markets. High wage costs including those at the lower end of the labour market, with a high minimum wage of €8.75, make it difficult for Irish companies to compete on cost any longer, and as a result should continue to build on the notable success already achieved in higher value added sectors such as pharmaceuticals, chemicals and financial services.

The note concludes that unlike many nations in southern Europe, Ireland boasts one of the most productive economies in the world. GDP per capita is among the highest in Europe at €35,000. This compares very favourably with that of Greece, Spain, Portugal and Italy, which tend to focus their economies on less-productive industries.

Finfacts has often highlighted the dependence on the foreign-owned sector which is responsible for 90% of Ireland's tradeable goods and services exports.

In 2009, employment in foreign-owned firms fell to an 11-year low and despite the rise in exports from the pharmaceutical sector, the number of jobs has hardly changed in five years.

At a global level, the centre of gravity of economic activity is moving to Asia while the conventional model of globalisation is changing.

In future we will have to compete with educated workforces in both the developed and emerging economies.

UBS: Ireland: From prosperity to austerity (pdf)

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