Patrick Honohan: Echoes of crash present and we should heed them

Ten years after the high drama of the bank guarantee, it is instructive to reflect on some parallels with today in Ireland. To be sure, much has changed. The Irish banking system is smaller, less ready to make poorly judged and insufficiently secured loans, and subject to more onerous capital requirements and other regulations.

Having been obliged by the Central Bank to pay almost a billion euro in redress to customers whose interests they had not protected, it is to be hoped that a chastened bank management will act with less of a sense of corporate entitlement than was the case in past decades. Whatever one thinks about the banks’ role and standing in Irish society, comparable threats to the nation’s economic security are unlikely to come from that quarter in the foreseeable future.

So history is not repeating itself. But there are echoes. In particular, the two dominant features of the pre-crisis macroeconomy have re-emerged in new forms. Once again we see reliance of the public finances on precarious sources of revenue; and we have again a distorted and dysfunctional housing sector. Although the two are less obviously linked now than they were leading up to the crisis, there is a link to be made.

Both then and now, the volatility of Ireland’s tax revenue reflects the deep globalisation of our economy. Without financing from the global financial system, the pre-crisis property price and construction boom could never have scaled the precarious heights it reached. The tax revenue spilling out of this property boom lulled the government of the time into lowering income tax rates and relaxing budgetary controls.

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Forecasts that revenue growth would continue were used to justify what would prove to be an unaffordable easing of fiscal discipline. It was the need to row back on this mistaken extravagance – much more than the cost of the subsequent bailout of bank creditors – that resulted in so much painful fiscal austerity. Budgetary planning should have focussed much more on the danger that boom-time revenue sources might dry up.

Corporation tax

With the massive increases in corporation tax receipts from a small number of multinational firms, especially since 2014, a new source of revenue risk has emerged post-crisis.

The low rate of Irish corporation tax is a long-standing feature of Irish industrial development policy, but the last few years have pitched Irish tax policy into controversial territory. Government should never have allowed the loopholes that enabled some firms to pay almost no tax on large parts of their global profits. Even if defensible in strictly legalistic terms, it was inevitable that such tax avoidance would be seen as ethically questionable and reputationally damaging.

Although Ireland does not qualify as a tax haven under the definitions agreed by international organisations such as the OECD, the scale of profits booked to Irish subsidiaries of multinational firms means that Ireland is prominent in all international discussions of this phenomenon.

Paradoxically, the financial engineering being used by large firms to try to dodge the intergovernmental drive to reduce tax avoidance has shifted even more of their global profits to Ireland.

This is bloating Irish tax revenues just as the pre-crisis property bubble did; just as that proved unsustainable, so we should assume that the new revenue boom will be transitory.

While the Government is not unconscious of this and the other significant fiscal risks, it is not clear that budgetary planning is taking enough account of it, but is implicitly assuming that most of this flow of revenue will continue indefinitely.

So far Government measures to improve housing supply have produced more noise than results

Even if the Government does not take the super-conservative stance of applying all of the recent surge in corporation tax to debt reduction, it is clearly not a licence for tax-rate reductions. Nor should it be used to launch spending commitments that will recur year-in year-out. There would be less of an objection to applying it to one-time outlays needed to unblock specific challenges. And here is where the link with housing could re-enter.

Slow recovery

The slow recovery of private residential construction post-crisis – despite housing prices being back at or above 2003 levels in Dublin – has puzzled many. Several competing hypotheses are discussed.

One factor is the difficulty some smaller builders have had in rebuilding and maintaining a skilled workforce in the face of the Dublin office-construction boom. Another is the reluctance of those who purchased land during 2004-7 to dispose of it at a loss, especially considering the fact that land prices are still rising. Low interest rates make holding on an inexpensive option.

They may also be hoping for a relaxation of costly building regulations; planning approval delays are also cited as an obstacle.

So far Government measures to improve housing supply have produced more noise than results. Partly this reflects an implementation lag, but it also can be attributed to the Government’s reluctance until comparatively recently to go much beyond the use of subsidies to encourage residential construction (this year’s half-hearted site value tax being the exception that proves the rule).

But subsidies simply add to the effective demand, thereby increasing prices. Government has been unwilling or unable to get back at sufficient scale into the troublesome business of direct provision of housing for those who cannot afford market prices.

Policy aimed at ensuring an increased supply of housing at a more reasonable overall cost will not be effective until the owners of development property realize that Government policy is not aimed at advancing their sectional interests. (Indeed, the pre-crisis property price bubble was stoked-up by tax incentives for construction activities).

Rentals

Heavy reliance on developer-driven residential expansion has failed in the current environment, pushing rentals too high, and, in particular, leaving much of Dublin’s city centre underdeveloped and with insufficient physical infrastructure.

As many observers have argued, the development of Dublin’s residential and transport infrastructure urgently needs more decisive public action. Such action will have upfront budgetary costs, whether for compulsory purchase of needed development land for coherently-planned – and in part publicly financed – housing construction or for the provision of essential infrastructures.

The evident immediate need for a large-scale approach to the future development of Dublin – and especially for social housing – emphasises the importance of not diverting the windfall revenues from corporation tax into income tax reductions when they could be used to ease the housing crisis.

Patrick Honohan was governor of the Central Bank between 2009 and 2015