Corporate Tax Cuts - Do They Really Create Jobs?

In the past number of weeks, there has been a great deal of mainstream media coverage, in both Canada and the United States, about federal government implementation of corporate tax cuts in an effort to both create jobs and to remain competitive so the jobs existing in both countries don't go shopping for a more tax-friendly regime elsewhere.  Governments are trying to convince voters of the validity of their "drop the taxes and they will come" philosophy when it comes to corporate taxes and jobs.

Let's take a look at the corporate tax policy and unemployment in a country that has been in the news lately regarding its rather weak economy and its inability to manage its own debt, requiring a massive bailout - Ireland.  I'll compare Ireland's experience with corporate tax levels and employment with its fellow European Union Member States.

Let me open this posting with the observation that Ireland's current fiscal state is largely a product of an under-regulated banking sector and an over-heated housing market.  Those issues may well have affected Ireland's unemployment rate, however, one would think that if corporate taxes are low enough, that companies will continue to create jobs for non-domestic consumption; no matter how bad the local economic situation is, corporations should prefer to do business (resulting in the creation of jobs) in low tax regimes.

Let's start by looking at the corporate tax rates for all EU Member States.  From the European Union's Europa website, here is a chart showing the top statutory corporate tax rates for all EU Member States:

In the 27 countries that make up the EU, the average corporate tax rate in 2010 was 23.2 percent; this rate is down 8.7 percentage points from 31.9 percent back in the year 2000.  To compare, the average personal income tax rate in 2010 was 37.5 percent, down 7.2 percentage points from 44.7 percent in 2000.  The top three corporate tax rates are found in Malta (35 percent), France (34.4 percent) and Belgium (34 percent) and the lowest three corporate tax rates are found in Bulgaria and Cyprus (both 10 percent) and Ireland (12.5 percent).  From the average corporate tax rates noted above, you can see that Ireland's corporate tax rate is just over half of the average of all 27 EU Member States and third lowest overall.

The largest decreases in corporate tax over the past 10 years were recorded in Bulgaria (down from 32.5 percent to 10 percent), Germany (down from 51.6 percent to 29.8 percent) and Cyprus (down from 29 percent to 10 percent).  Ireland's corporate tax rate dropped from 24 percent in 2000 to 12.5 percent, a drop of 11.5 percentage points or 47.9 percent.  In that period of time, Ireland's personal income tax dropped by 3 percentage points or 6.8 percent from 44 percent to 41 percent.  Corporations in Ireland are experiencing a massive drop in taxes at the expense of individuals who have barely seen their tax level budge.  In fact, recent increases to Ireland's VAT will pretty much negate any individual income tax savings.  It's always interesting to see how much of government's revenue burden is being borne by individuals versus massive and highly profitable corporations.

Now let's look at Ireland's unemployment situation for September 2010 and compare it to all other EU Member States as well as the United States and Japan:

Here's a map showing the same thing.  The darker green colours show higher unemployment and the yellow colours show lower unemployment.  Note again, that while Ireland isn't the darkest green, it is a rather appropriate shade of green:

Here is the link for the chart that the unemployment graph data came from and here's the chart showing the country-by-country monthly unemployment data for 2010:

I'm using the statistics from September 2010 since the country data is the most complete.  For the month of September 2010, the average European Union (27 country) rate was 9.6 percent.  The highest unemployment rate was 20.6 percent in Spain, second highest was Lithuania at 18.3 percent and third highest was Latvia at 18.2 percent.  Ireland comes in with the 6th highest unemployment rate of 13.9 percent after the aforementioned Spain, Lithuania and Latvia as well as Estonia and Slovakia.

Now let's look at the unemployment rates for the countries with the highest corporate taxes.  Malta (corporate tax rate 35 percent) has unemployment of 6.5 percent, France (corporate tax rate 34.4 percent) has unemployment of 9.7 percent and Belgium (corporate tax rate of 34 percent) has unemployment of 8.4 percent.  All three of these "corporate tax nightmares" have unemployment that is far lower than Ireland's rate of 13.9 percent and in the case of Malta, less than half.

To summarize this data; Ireland has the third lowest corporate tax rate, well below the EU average, but has the sixth highest unemployment rate, well above the EU average.  One cannot conclude that Ireland's low corporate tax rate has not particularly led to job creation since the joblessness is, at least in part, due to other factors in the economy.  As well, one cannot particularly conclude that the ultra-low corporate tax rate has bailed out Ireland's economy by creating untold thousands of jobs, particularly now when the country needs jobs the most.  Despite the very low tax rate in comparison to its neighbours, Ireland's corporate tax policy is not benefitting the 13.9 percent of unemployed Irish workers.  Yes, it is possible that Ireland's current unemployment situation could be far worse without low corporate taxes but we'll never know the veracity of that relationship just as we'll never really know how much the low tax rate was actually responsible for job creation now or in the past.  My suspicion is that the uncertainty of the relationship between corporate tax levels and job creation will apply to Canada and the United States as well.

Voters in Canada, the United States and other nations where governments are touting low corporate tax rates as the panacea for all the economic and unemployment woes facing their economies had better think twice when examining this issue.  As seen from the example of Ireland, jobless rates are affected by many factors, corporate tax rates being only one of them.  The best laid plans of government do not always come to fruition, and in this time of rapidly mounting deficits and debt, corporations should not be excused from paying their share of government revenues.  It should not be the responsibility of individual tax payers to cover a larger proportion of government revenues while corporations use their tax savings to pad their profits and ultimately their share prices.

Nothing in economics is certain and the relationship between corporate taxation and job creation is no exception.

Will Ireland's austerity plan become the template?

Today, the Government of Ireland announced its austerity budget for 2011 and a critical budget it is, considering that the country is standing on the precipice of fiscal insolvency.  These measures were necessitated by the promise of a European Union/International Monetary Fund bailout package, think of it as a sort of bribe to get things in fiscal order.  Without the €85 billion bailout, Ireland most likely would have been unable to both support its banking sector and provide services to its citizens.  Basically, now Ireland is owned by the EU/IMF until proven otherwise.

Here are some of the highlights of what is most likely the Cowen government's final budget in a last gasp effort to balance a €19 billion deficit:

1.) The government proposes a package of tax increases and spending cuts that will total €6 billion.

2.) Civil servants just starting out in the "business" will see their pay cut by 10 percent.  As an added measure, 6 percent of the entire public sector (or 18,500 workers) will be made redundant and the pensions of those still working will be reduced by up 8 percent.  Public service pensions will be reduced by an average of 4 percent if the pension is greater than €12,000 annually.

3.) On the upside, the Prime Minister's salary will be reduced by an additional €14,000 to €214,000 bringing the total cuts to the Prime Minister's salary over the past two years to €90,000 or 28 percent.  Government ministers will see their pay reduced by a total of €60,000 or 23 percent.  Nice of them to share in the misery they helped create, isn't it?

4.) Of the €6 billion changes to the county's bottom line for this year, €2.1 billion will come from a net reduction to recurrent current spending (€2.2 billion gross), €1.8 billion will come from cuts to capital spending and €1.4 billion will be raised through tax increases.  The largest savings will be made in Health and Children (€743 million) and Social Protection (€873 million).

5.) One-fifth of the government's contributions to the bailout package will be generously "donated" by a withdrawal from the National Pension Reserve Fund (NPRF) and other domestic cash that was just lying around collecting dust.  As the government says "...it is not credible to suggest we could have retained a sovereign wealth fund while expecting others to make resources available to us.".  I'm certain that the pensioners of the future would agree.  For your information, the NPRF was created in 2001 to meet the projected demands that would be placed on Ireland's social welfare and public pensions after the year 2025 (due to demographic changes).  The funds were not to be drawn down until at least 2025.  I guess someone forgot to tell the Cowen government that their withdrawal of €17.5 billion out of the €24.5 billion in the plan this year was 15 years ahead of schedule.

6.) A maximum pay level of €250,000 will be imposed on the public sector and will apply to the next President of Ireland.  I'm certain that those who saw their minimum hourly wage cut by €1 are breathing a sigh of relief.

7.) The top marginal income tax rate will be maintained at 52 percent.  The top corporate tax rate will also be maintained but at a much lower level; the rate of 12.5 percent is the second lowest amongst EU Member States.  I would imagine that the unemployed Irish are thrilled to hear that.

8.) The maximum payment for weekly schemes under the country's social welfare system will be reduced by €8 per week.  This will save €397 million in 2011.

9.) The Air Travel Tax is being reduced to €3 temporarily.

...and last but not least:

9.) All bookmakers taking bets from Ireland will pay 1% betting duty on those bets in the same way that betting shops currently do.

In addition, let's not forget that the National Recovery Program announced in late November already cut €1 per hour from the country's National Minimum Wage and increased the country's VAT to 22 percent in 2013 and 23 percent in 2014.

All of these measures combined will bring the country's budget deficit to 9.4 percent of GDP, down from the earlier estimate of 12.2 percent.  Had all of the austerity measures undertaken in the past two years not taken place, the deficit will be a rather unhealthy 20 percent of GDP at this point in time.  Just to show how accurate the Cowen government's economic projections have been, it was assumed one year ago that a budget "adjustment" of €7.5 billion would have led to a deficit to GDP ratio of 3 percent by 2014.  Not so.  Apparently, the government underestimated the cuts necessary to achieve that goal by half; a total of €15 billion in adjustments is now necessary because economic growth projections were overly optimistic.  Does this overly optimistic growth projection scenario sound familiar to anyone?

One thing that really hurt Ireland was a rather massive 7.6 percent drop in GDP in 2009.  That alone, would have caused the country's debt and deficit to GDP ratio to rise had all else remained constant.  Interestingly enough, today's budget projects real GDP growth of 2.75 percent annually to 2014 (just in time for the next recession if it doesn't happen sooner!).  Perhaps the fact that between the years 2000 and 2008, public spending rose by 140 percent compared to a CPI increase of just 35 percent may have had something to do with the problems faced by Ireland's government today.  As well, the proportion of income earners who paid no tax rose from 34 percent in 2004 to 45 percent this year.  Take note President Obama.

As an aside, the loan losses by Irish banks that were caught with their pants down when the real estate market collapsed totals between €70 billion and €80 billion, nearly one-half of Ireland's total GDP for this year.  That's enough to bring any nation to its fiscal knees, unless of course, they have Ben Bernanke on location with a pocketful of fiat currency.  Here's a quote from today's speech by Ireland's Finance Minister Mr. Brian Lenihan:

"Public debate of our current difficulties is focused, almost exclusively on our banks. Much of what is said is plain wrong. For example, it is regularly claimed that the taxpayer will end up bearing most or all of the cost of the banks’ bad loans. This is not the case. As the Governor of the Central Bank has previously indicated, over the period 2008 to 2012, the total loan losses of the domestically-owned banks are expected to reach €70-80 billion, equivalent to about half of this year’s GDP. Loan losses on this scale are unforgivable. They reflect the recklessness of lending decisions during the bubble years and the weakness of the previous regulatory framework. We must ensure they never happen again.

What is almost entirely overlooked, however, is the fact that tens of billions of these losses have been absorbed by the private shareholders in the banks. It is clear there has been no taxpayer bailout for bank shareholders....

It’s true the State has had to inject large amounts of capital into the banks. In return, the State will own the bulk of the banking system. The use of funds in the National Pensions Reserve Fund to recapitalise the viable banks is necessary to ensure that these institutions can serve the needs of the economy."

Oh the poor bank shareholders, most particularly, the executives at all of the banks who saw the value of their incentive plans plummet.

It would appear that the main difference between the banking systems of Ireland and the United States is that the United States has a Federal Reserve Chairman who is not afraid to dump trillions of dollars into a moribund banking system operated by his buddies on Wall Street and Ireland doesn't.

It is interesting to see what has happened to Ireland and its near fiscal collapse in comparison to the current situation in the United States where bipartisan wrangling over cuts to the country's $1.294 trillion deficit in fiscal 2010 and $13.8 trillion debt are taking place.  I look at the situation in Ireland as a template for economic recovery that will be used by other debtor nations.  There are so many similarities between the situation in Ireland and the situation in the United States; a booming economy that went bust, a high-flying real estate market that collapsed bringing the country's banking sector to its knees, stubbornly high unemployment and an economy that is lukewarm at best.  Seeing Ireland's government use tools like tax increases, cuts to social programs, cuts to the country's minimum wage and a raid on sovereign savings (pension plans) in an 11th hour attempt to bail themselves out of a hole should send a signal to the rest of us.  Governments, who are largely to blame for the fiscal mess that we are in because of their spend and tax philosophy, will think nothing of bailing out their economies on the backs of the "sweaty masses".  No matter who is to blame, you know who will pay.

As I've said before, politicians are not particularly well known for original thinking.  Ireland's government has now supplied the fiscal template necessary for governments requiring a bailout.

Ireland - Now owned by the IMF and the rest of the EU!

Today, Ireland's Prime Minister Brian Cowen, announced details of the IMF/EU bailout package that is going to save the country's economy from collapse.  Here are the highlights:

1.) The bailout will total €85 billion; of the €85 billion, €17.5 billion will come from Ireland's National Pension Reserve Fund and other cash that the Irish government has lying around collecting dust resulting in a net loan of €67.5 billion.  Each of the European Financial Stability Mechanism, the IMF and the European Financial Stability Fund will kick in €22.5 billion.   A total of €50 billion will be allocated to run the country's operations (i.e. pay civil service and the all important politicians who really didn't help create this mess) and funds will be drawn down as required by the state. A total of €35 billion will go to run the banks.  An immediate investment of €10 billion will go to the banks because, after all, that's what created the mess in the first place.  The remaining €20 billion will be doled out to the banks on an "as need" basis, in other words, sooner rather than later.  The United Kingdom is kicking in €3.44 billion which they can ill-afford because they have their own debt demons to deal with. 

2.) The combined average interest rate for the funds will be approximately 5.8 percent but, in fact, will vary according to when the funds are drawn and market conditions at that time. 

It is now being acknowledged that Ireland may not meet the deficit to GDP target of 3 percent by 2014 that last week's National Recovery Program had originally targeted and that an additional year may be required because growth estimates for 2011 and 2012 were over-stated (other governments beware of your own overly optimistic projections for return to fiscal balance based on projections of economic growth!).  It is now anticipated that Ireland could reach the 3 percent deficit target by 2015, just in time for the next recession!  In order to meet this target, the country is cutting expenditures by €10 billion and increasing taxes by €5 billion as noted in last week's National Recovery Plan.

Interestingly enough, Ireland now gets to bail out of its assistance to Greece, its fellow fiscal eunuch.  Ireland's commitment to the Loan Facility to Greece would have totalled €1 billion to mid-2013.

Another interesting fact is that, according to the National Pension Reserve Fund website, the NPRF was not to be drawn down before 2025 since it was formed to provide security for Ireland's pension scheme.  In February 2009, the Minister for Finance announced that the Fund would provide €7 billion to recapitalize Ireland's banks.  Once again, Ireland's banks have come to the NPRF trough for a bailout.  Interestingly enough, as of October 2010, the fund totals only €24.5 billion as shown here:

Fortunately, the Cowen government planned ahead and raised the state pension age to 66 years of age in 2014, 67 in 2021 and 68 in 2028.  Who knows what it will be by 2035?

I'd say that between increases in VAT, cuts to the National Minimum Wage and the pillaging of their Pension Reserve Fund, that the taxpayers of Ireland have done plenty to bail out their banks, wouldn't you.  Heaven help us if other nations around the world reach the position where they are backed into the same fiscal corner.

Coming soon to a country near you - tax increases and pay cuts!

In yesterday's National Recovery Plan 2011 - 2014 issued by the government of Ireland at the behest of the IMF as a condition of their bailout loan, a couple of key items caught my attention.

In the first, the government of Prime Minister Brian Cowen will reduce the Ireland's minimum wage by €1 per hour to €7.65.  The government claims that the current level of the National Minimum Wage (NMW) created "a barrier to employment".  Here is the direct quote from the Plan:

"Where a NMW is imposed at a level higher than the equilibrium wage rate, unemployment will result. Some workers will be willing to work for a wage lower than NMW but employers are restricted from providing these job opportunities. Other negative effects include:

␣ Acting as a barrier for younger9 and less skilled workers to enter the labour force and take up jobs;

␣ Preventing SME’s from adjusting wage costs downward in order to maintain viability and improve competitiveness; and

␣ Reducing the capacity of the services sector to generate additional activity and employment through lower prices for consumers.

The NMW was introduced during a period of sustained economic growth and rapid wage increases. Our circumstances have changed dramatically in the last three years. Price levels have reduced and earnings have adjusted downwards to help to preserve jobs. A reduction in the minimum wage level – as proposed by the OECD10 - can also be expected to remove a barrier to job creation. Therefore the Government have decided to introduce legislation to reduce the rate of the minimum wage by €1 per hour, or 12% to €7.65"

So, basically, the government is now stating that they erred by allowing the minimum wage (which was set in 2000 at €5.59 and has increased 55 percent over its original subsistence level to a new subsistence level) to rise out of sync with local price increases.  That would never do!  They state that the new NMW rate will still keep Ireland in the top tier of EU minimum wage rates.

What is particularly galling about this move is that the elite (and highly paid) leadership of the country is asking those at the bottom of the economic ladder to bear a rather large disproportionate share of the misery that they had no part in creating.  That is not fair!

As an aside, Prime Minister Cowen's salary for this year was €228,446, a cut of 11 percent from the previous year.

But, on the other hand, corporations still benefit from the largesse of government.  Here's a quote from the Plan:

"Finally, it is important that we look at revenue raising measures across all areas – income, capital, indirect, expenditures, reliefs and incentives. The Government remains steadfastly committed to the maintenance of our 121⁄2% corporate tax regime as the cornerstone of industrial policy. Research by the OECD34 points to the importance of low corporate tax rates to encourage growth. In ranking taxes by their impact on economic growth, corporate tax was found to be most harmful. In other words, governments seeking additional tax revenues would be advised to consider increasing all other types of tax (property, consumption and income) before increasing corporate taxes."

Here's a chart showing the corporate (and personal) tax rates for all EU Member States taken from the European Commission Taxation and Customs Union website:

Note that the corporate tax rate arithmetic average (on the top line) for all 27 member states in 2010 was 23.2 percent.  Ireland is third lowest after Bulgaria and Cyprus who are both tied at 10 percent.  I'd say that the Cowen government really likes big business far more than they like those who get paid the National Minimum Wage, wouldn't you?  As voters, we hear far too often that corporate taxes must remain low to create jobs.  Look how well the 12.5 percent corporate tax rate has worked out for the 13.6 percent of Irish workers who were out of work in October 2010.

Secondly, Ireland will raise its VAT rate from 21 percent to 22 percent in 2013 with a further increase to 23 percent in 2014.  As it stands now, 23 EU Member States have VAT rates in excess of 19 percent including the United Kingdom where the rate will rise to 20 percent on January 4th, 2011.  This additional tax burden is expected to yield an additional €620 million in a full fiscal year.

Now, back to where the rest of the world lives.  We see growing and alarming debts and deficits from many developed nations around the world; the United States, Japan, the United Kingdom, France, Belgium, Austria, Germany and Canada to name but a few nations with mounting debt levels and deficits that are becoming structural where, no matter how fast an economy grows, the government is simply unable to balance its budget.  As we all know, politicians are not particularly original thinkers; they look to other leaders around the world and mimic the solutions adopted elsewhere to suit their own local circumstances.  Now that Ireland has set a standard by lowering its minimum wage and raising its consumption tax to stratospheric and obscene levels, how far behind can the United States, Canada and the United Kingdom be?  To politicians, it looks like a very simple solution; cut the minimum wage and the jobs will magically appear.  Maintain low corporate taxes and even MORE jobs will appear!  Raise taxes and the debt and deficit will magically disappear.

Unfortunately, my suspicion is that wage cuts and tax increases (unless you happen to be a corporation) are going to happen sooner rather than later, particularly in the United States and Canada where corporate taxes are higher and consumption taxes are far lower than the EU.

'Til Government Debt do us part - Part 2 - The Irish Crisis

Update November 24th, 2010:

As part of the country's National Recovery Plan 2011 to 2014, the Government of Ireland today announced that it would further gouge taxpayers by increasing the standard rate of VAT from 21 to 22 percent in 2013 and to 23 percent in 2014.  This measure is expected to bring in an additional €620 million.  In other news, corporations will continue to benefit from a 12.5 percent corporate tax rate.  Oh yes, and a cut in minimum wage by €1 per hour to 7.65.  Nothing like hitting the helpless who had nothing to do with the mess Ireland is in, is there?

Original Posting:

Ireland has been all the talk in the mainstream media the past week or thereabouts.  While the information in this posting is not particularly new, I am providing readers with a summary of the entire Irish economic crisis in one place.  As well, I thought I'd compare their debt issues to that of the G8 nations from my previous posting found here.  As usual, I have gone to the original government sources for both fiscal and population data; if they are prevaricating, then I'm just passing it along so don't blame me!

From the Government of Ireland's Department of Finance, here's a look at their own national debt numbers, current to the end of fiscal 2009 from a report dated September 2010:

Here's a look at how much it is costing Ireland to service their national debt on an annual basis:

Now let's look at my favourite debt per capita number.  With a population of 4,470,700  and debt of $102 billion at the end of in April 2010, the per capita debt for the residents of the Republic of Ireland comes in at $22,815.  Note that this is well below that of the United States and Japan, somewhat lower than France and Italy and roughly on par with the United Kingdom.

From the Department's Monthly Economic Bulletin for November 2010, they announced the following:

1.) The revised estimate for the 2008 General Government Balance is a deficit of 7.3 percent of GDP.

2.) The revised estimate for the 2009 General Government Balance is a deficit of 14.4 percent of GDP.

3.) The forecast for the 2010 General Government Balance is a deficit of 32.0 percent of GDP.

Is it just me or is this ship heading in the wrong direction?

Here's more bad news:

1.) Ireland's ratio of General Government Debt to GDP at the end of 2008 is estimated to have been 44.3 percent.

2.) The revised estimate for General Government Debt to GDP ratio at the end of 2009 is estimated to have been 65.5 percent.

3.) The forecast for General Government Debt to GDP ratio at the end of 2010 is estimated to be 98.6 percent.

That puts Ireland in 12th place (in 2009) after such fiscally responsible nations as Portugal, Italy, France, Germany, the United Kingdom and Austria.  All hands abandon ship!

Here's an interesting chart from the Department's Monthly Economic Bulletin for November 2010 that pretty much summarizes the first part the entire problem:

 Notice how for at least the period of time from January 2004 to early 2008 that loans for house purchases grew by more than 20 percent year over year?  Notice how that slumped to near zero by the end of 2009?

...and here's the second part of the problem:

  

In Q1 of 2010, average new house prices fell by 11.3 percent and average second-hand house prices fell by 16.7 percent compared to Q1 2009.  In the capital city, Dublin, average new house prices fell by 14.8 percent and average second-hand house prices fell by 22.3 percent compared to Q1 2009.  All of this is on top of the fiscal 2009 drop in average new house prices of 20.7 percent and 21.1 percent in 2009.  From the peak in 2006, average national house prices have dropped by 36 percent as shown in this chart:

From a Central Bank of Ireland press release dated November 17th, 2010, it was announced that 5.1 percent of all mortgages in Ireland were in arrears by more than 90 days.  On the upside, the total value of the 789,000 outstanding residential mortgages dropped by €316 million to a total of €117.4 billion since Q2 2010.

The drop in real estate prices and rise in unemployment led to dramatically increased stress in Ireland's banking system.  The Irish government formed the National Asset Management Agency (NAMA) to acquire problem loans from banks in exchange for government bonds.  From a speech given on November 18th, 2010 by NAMA Chairman Frank Daly, to date, the original book value of the 11,000 loans acquired by NAMA is €73 billion and it has issued over €30 billion to the affected institutions.   It is estimated that at least €45 billion ($61.2 billion) (and possibly up to €60 billion ($81.6 billion - roughly 80 percent of Ireland's current debt) will be required to recapitalize Irish banks, roughly one-third of Ireland's GDP.  If the best case scenario bank bailout is put into a per capita perspective, the roughly 2 million taxpayers of Ireland will have to pony up $30,600 each (or $13,700 for each man, woman and child) to keep the banks afloat.  To put the $30,600 into perspective, the United States' Troubled Asset Relief Program (TARP), which allowed the U.S. government/taxpayers to purchase up to $700 billion in "troubled assets"  from financial institutions, had a maximum per capita cost of $2260.

Three letters: OMG!

Can the United Kingdom help Ireland?

Update December 22, 2010


The United Kingdom announced today that their monthly budget deficit reached a record £23.3 billion, up from a previous record of £21.1 billion in December 2009 and £17.4 billion a year earlier.  It now appears that it is increasingly unlikely that the U.K. will meet its target of a £149 billion deficit for this fiscal year.  The marked increase in the deficit was mainly due to increased government spending, up 10.8 percent year on year.


Update November 21, 2010

Ireland has been forced to take an economic bail-out from the European Union and IMF totalling £77 billion after an emergency telephone conference this weekend.  British taxpayers will now pony up £7 billion as their share of the EU - IMF bailout.  

Next on the bailout list - Portugal.  

All in the name of saving the euro.

Original Article

Coverage of the Irish debt situation has been extensive over the past few days.  Ireland's banks desperately need a bailout after the country's real estate market suffered a major "readjustment".

Here's a quote from George Osborne, the United Kingdom’s Chancellor of the Exchequer from the Guardian today:

"Ireland is our closest neighbour – the only country with which we share a land border – it is in our interest their banking system is stable. Britain stands ready to support Ireland to bring stability." 

A very nice bit of support from one government to another don’t you think, especially for two nations that share a common border?

Let’s take a quick look at the United Kingdom’s own fiscal situation before we get that warm and cozy feeling all over, shall we?

On June 22^nd, 2010, the coalition government of U.K. Prime Minister David Cameron released its emergency Budget.

The United Kingdom has reached the point of budgetary desperation. As it stands now, the United Kingdom is considered by many economists to be the most indebted nation in the world. Their national debt stands at nearly £924 billion. Their public sector net debt (as shown in the chart below) is projected to reach 74.4 percent of GDP by 2013 - 2014.  As it stood in 2009, according to the CIA World Factbook, the U.K.’s public debt as a percentage of GDP put them in 21st place in the world after such nations as Italy (115.8 percent – 6^th place), Iceland (113.9 percent – 7^th place), France (77.6 percent – 17^th place) and Germany (73.2 percent – 19^th place).

By comparison, the United States public debt to GDP ratio is 53.5 percent and Canada's is in the neighbourhood of 82.5 percent.  I realize that the debt to GDP numbers vary depending on the source used but I have consistently used numbers from the CIA World Factbook.

Here's a chart from the OECD showing just how bad their structural deficit as a percentage of potential GDP is compared to other nations:

It's a rather dire looking situation, isn't it?

One item that caught my eye in this time of HST implementation in Canada was the change to the UK's Value Added Tax (VAT). On January 4th, 2011, the tax will increase from its current level of 17.5% to 20%. What was particularly interesting was that this increase is expected to raise over £13.5 billion in a full year by 2014 - 2015. As well, the United Kingdom VAT rate still falls well short of the maximum of 25% allowed under European Union law.  Heaven help U.K. residents if it reaches that level as it has in Denmark and Norway.  Fortunately though, if you are a corporation, your tax rate will drop from 28 percent to 24 percent over the next 4 years.  Lucky you!

The United Kingdom's budget deficit is projected to be £148 billion for fiscal 2010 - 2011; it is hoped that the increased taxes (except corporate taxes) and reducing spending in the 2010 budget will help balance the budget by 2014 – 2015 (just in time for the next recession). In the budget of June 2010, the government anticipates expenditures of £44 billion on debt interest alone in 2010 - 2011; this is projected to rise to £67 billion by 2014 - 2015.  Should interest rates rise to historic norms, I suspect that this projection will also be tossed out the window.  The UK had been threatened with cuts to their credit rating by two rating agencies unless the new government made major changes to their tax and spend philosophy; the UK had not balanced their budget since 2002 - 2003 and their debt growth far exceeded their economic growth.  The Cameron government will also reduce spending by £32 billion per year by 2014 – 2015 in a further desperate attempt to balance its budget.  To put this into perspective, this small spending reduction compares to government spending of £697 billion in 2010 – 2011 and approximates what is currently budgeted for personal social services.

To keep track of public finances, the coalition government created the Office for Budget Responsibility (OBR) whose mission it is to independently assess the economy, control economic forecasts and make key judgments that drive official government economic projections most particularly for each Budget and Pre-Budget Report.  All this for only £1.75 million per annum!  Here's their fiscal forecast for the 2010 Budget showing that they expect the United Kingdom's finances to return to balance by 2014 - 2015 and surplus by 2015 - 2016 from a deficit of 5.3 percent of GDP in 2009 - 2010.  The OBR also assesses the probability of actually reaching the government's debt and deficit targets; their forecast shows that the government has a greater than 50 percent chance of actually meeting its targets for the period from 2014 to 2016 which, if you look at it realistically, means they have roughly a 50 - 50 chance of doing what they say they will do.  It may be just me, but that indicates to me that the forecast is relatively meaningless and that a coin toss would just as easily predict whether or not the government’s targets are met.  Here's the fan chart showing their borrowing as a percentage of GDP projections for the next few years.  Note how wide the fan becomes the further out in time they project data indicating growing uncertainty:

In conclusion, here is a direct quote from the 2010 Budget document showing U.K. residents just how serious the situation is:

“The fiscal challenge in the UK is, on some measures, larger than in any other advanced economy. In May, the International Monetary Fund (IMF) forecast that UK public borrowing would be the highest in the G20 in 2010; it is also estimated that the UK’s structural deficit will be the highest among all OECD countries and the 27 EU Member States. The rating agency Fitch has pointed out that “the rise in public debt ratios [in the UK] since 2008 is faster than for any other ‘AAA’-rated sovereign.”

And this is a government that has pledged to assist Ireland in its time of distress?  Nice sentiment but not entirely realistic.