I'm afraid of sandcastles

I keep worrying about our fiscal sandcastles. Since the 1950s we have built these sandcastles, until something comes along, usually an external shock like the oil crisis of the 1970s or the global financial crisis of the 2000s, and kicks it over. Rather than asking ourselves why we spent so much time making sandcastles in the first place, we get stuck in immediately, clean up the mess, rapidly forget about the stupid thing falling over, and get right back to building our castles again, sometimes even using the same sand.

In Ireland, we have a curious tendency to treat short-term (and potentially transitory) increases in taxation revenue as if they will be there long-term, and usually at levels we can rely on to fund the expenditure of the social system. While we’re not alone in this behaviour, we certainly are an extreme, perhaps even cautionary, example.

There are so many stories. The most obvious sandcastle stories are the reduction in income tax rates during the last boom, which were compensated for by stamp duties and capital gains taxes. One whack and it collapsed. Or worse: South Dublin County Council voting this year to reduce the amount of income it would otherwise get from property taxes during a housing and homelessness crisis. At the national level: using the unexpected extra revenue coming from an economy recovering after a bout of austerity and combining it with lower than expected unemployment levels to finance new spending on nurses, gardai, childcare, and other longer-term commitments. It’s not wrong to do these things; in fact, with unemployment at over 9 per cent, it is probably a good thing to do some of these things – but each time our taxation income trends above its profile, we tend to trade off stability for giveaways or for current spending increases. Once the sandcastle goes for a wobble, it is costly to rebuild. In the 2002 to 2007 period, income tax revenues were supplanted by property-sale-related tax revenues; these taxes evaporated after 2008, and income taxes had to rise very quickly to meet the increased demands for social protection spending in particular, increasing from 31 per cent of all taxes in 2007 to 42 per cent in 2014.

It gets worse. Not only did these tax ‘types’ change in a way almost designed to make the system more fragile, but current spending also rose very rapidly. Correcting for the inflation that took place over the period, current spending rose by 77 per cent between 2000 and 2008 – around six times the eurozone average. The only thing that could have happened was that spending increases would reverse. And reverse they did, in a style reminiscent of the finest of Italian tanks. Now the state, which has historically under-invested in almost every kind of capital expenditure bar the odd road, has pledged only to keep the status quo; a large-scale revision to how we do things seems not to be possible, despite the fact that, under the troika, the government implemented something like 270 actions to cut spending and increase taxes to reduce the deficit. Where there is a will, there is a way. And so there is no will to understand where we really are in budgetary terms, and where we might be going. Policy-makers are sometimes content to sit on short-term forecasts of gross domestic product growth and call that success.

Why is this? One answer is political, and you can probably fill that answer in for yourselves, dear readers, but we’ll return to it presently. The other is technical. The way the state’s finances really work is pretty similar to a GAA club. It only looks at money coming in from taxes in a given year, and money going out in spending on things like social protection, education and justice.

Serious accrual accounts aren’t really built. Accrual accounting roughly means the timing of the claim on the asset is recorded. So when I hire a new nurse from the public purse, I know I may have to give him a salary and a pension for the next say 75 years, combined. His work represents an asset to the state and a liability that the state needs to recognise, but usually doesn’t. This is because some of the contingent liabilities out there are massive and would be very scary to account for in one year, or even in ten. The current attempt to account for public sector pensions, for example, is costed at more than €116 billion. In 2016 they will ‘only’ cost €2.913 billion. You can see the difference pretty clearly.

To produce a balance sheet is to draw up a statement of assets owned and liabilities owed at a given point in time, usually every year. The economy’s balance sheet at the national level is a way to measure our total wealth: the net worth of everything, produced, non-produced, and financial. For example, accounting for public sector pensions as well as a variety of off-balance-sheet objects such as Nama and our various PPP (mis)adventures, the state would almost surely have negative wealth.

In 2013, Sebastian Barnes and Diarmaid Smyth of the Irish Fiscal Advisory Council made a stab at understanding what a national balance might look like. Their work was very thorough, but still incomplete. Despite this, they found out that Ireland’s net worth, as a percentage of gross domestic product, in 2009 was around 12 per cent. The substantial deterioration in the finances of the state meant that, by 2012, the net worth figure was around – 47 per cent of gross domestic product. That’s quite the deterioration.

The standard of national income accounting across the world is broadly similar. Only Australia and a few other pioneers actually produce consolidated national accounts. When you add up the accounts of the many different units in the economy – households, firms, banks, the government – consolidating means you only see transactions between the sectors.

Now back to the political. The old management truism ‘what is measured is what matters’ applies here, too. If politicians and officials are not accountable (no pun intended) for the development of these accounts, then they simply won’t be produced. We know the state has a set of contingent assets on its hands now. The bits of the banks the taxpayer saved from immolation during the crisis now need to be sold off, along with other bonds. Valuing these assets will take time, and will form part of a market test of the state’s balance sheet. The state will exchange those shares for cold hard cash. And then we’ll get another chance to find out what our politicians really think the state’s finances should be used for – to build new capital infrastructure, or build new sandcastles.