Notes on the Front

High inflation. Sanguine Government. Desperate Trade Unions. Indifferent Employers. Oh, and let’s not forget the citizens – they have an interest in all this. Does anyone know what to do about inflation?

The CSO’s latest report for May shows inflation stubbornly high: 5% over the last six months. None of this was supposed to happen. When Towards 2016 was negotiated the Government insisted that inflation wouldn’t run above 3% – 3.5% in 2006. On that basis, the trade unions didn’t insist on a review that would allow them to return to the table in the event that inflation seriously eroded the annualised 4.8% pay rise. They probably regret that, especially in light of SIPTU’s Jack O’Connor’s call to have the negotiations for the next wage agreement brought forward.

In the short-term ICTU intends to table at least two proposals:

• Increasing Tax Relief on Mortgages to a higher threshold and to the higher marginal tax rate
• Reducing the Rate of Vat from its current level of 21 per cent.

In contrast to ICTU’s pro-active position, IBEC seems content to state that inflation will tail off later this year and that workers shouldn’t try to protect their living standards (i.e. seek higher wages). And the Government – or, rather Fianna Fail – have been the ones presiding over this debacle.

However, being fair to ICTU still requires a hard examination of its proposals. As regards mortgage interest relief (MIR), this would at best have only a standstill effect as the ECB has signalled two more interest rate increases before the end of the year. This might be fair enough except the MIR proposal may not have the effect ICTU seeks.

Raising MIR to a higher threshold will be largely regressive. The current operation is already regressive. The Revenue Commissioners’ 2005 Statistical Report shows that over half the cash-benefit of MIR goes to the top 20% of taxpayers (when one includes all households, the benefit becomes even more regressive). If one accepts the proposition that the amount one can borrow reflects one’s resources, higher interest thresholds will benefit those with more income – households which, in many if not most cases, are in a position to better absorb higher mortgage payments. The problem, however, is that there are people who are on or below the current thresholds that are being pinned to the collar. Increasing the threshold won’t be any of benefit to them.

Second, allowing MIR at the higher tax rate would be even more regressive, reversing a long-established and equitable policy of standard rating tax reliefs. Again, this would benefit no one under that threshold – a minimum of €68,000 for a couple (and probably higher when other reliefs are taken into account – especially pension relief which is taken off the top).

That is the problem with manipulating tax reliefs – it can be an extremely inefficient tool with dubious benefit for those in real need. For Governments, it is a lazy option – using a tax short-cut, rather than giving more imagination and work to programmes that would have better effect. The Programme for Government indicates the new Government will take the lazy option – increasing the MIR threshold from €8,000 to €10,000.

The proposal to reduce VAT would seem a better proposal. VAT is highly regressive, impacting more on those with low incomes, while keeping prices high. However, reducing VAT is no guarantee prices will decline. This was tried back in 2000 – when Minister McCreevey reduced the top VAT by 1%. The Tax Strategy Group suggested that no discernible downward movement in prices could be detected. In other words, business pocketed the reduction. This is not to suggest there should be no reduction in indirect taxes – just that it must be accompanied by monitoring and sanctions to ensure that equity is achieved.

So what can be done? First, there is no silver bullet. Inflation, at national and sectoral levels, has many causes and impacts different households in different way. Some problems are amenable to short-term action; others require more long-term thinking and strategies. Second, some proposals are defensive and short-term in nature, dealing with the effects of causes which we have little control over (e.g. interest rates). Other proposals attempt to tackle at least some causative aspects of inflation (e.g. VAT reduction). Let’s re-think the ICTU proposals from these perspectives.

Even if future policy resolved affordable housing and the development of a modern private rental sector to facilitate long-term, sustainable tenancy, we still will have to deal with the effect of rising interest rates in the short-term – especially on households who have over-reached themselves (one could say, well, its their responsibility and taxpayers shouldn’t be called on to bail them out – however, a stream of foreclosures and duress sales wouldn’t benefit the market and, besides, the long-term neglect of the private rented sector by successive governments has forced people into house-purchase).

Rather than inefficiently manipulating tax reliefs, a new means-tested programme could be introduced which would allow in-need households to have a portion of their mortgage payments subsidised by a special fund. This wouldn’t be a hand-out – the subsidy would be re-paid in the long-term but this could be linked to either income or lowered interest rates. In effect, this would act as a short-term fixed interest respite. The fund could be resourced by a temporary levy on mortgaging institutions (banks, etc.) in conjunction with National Pension Reserve Fund. Neither financial institutions nor the Reserve Fund would be out of pocket – the subsidies would be repaid, but on a much longer-term basis.

In regards to VAT, a more forensic approach – as part of a long-term strategy of redirecting Government revenue from indirect to direct taxation (a progressive tax reform approach) – could be utilised. For instance, VAT could be reduced on both electricity and gas to the EU minimum (12.5%) while telecommunications could be reduced to a similar level. For telephone bills, this would mean a reduction of 8.5% for every €100 of calls charged. The Government could further remove the Public Service Obligation Levy from ESB bills and provide subsidies through the Exchequer. The benefit of this approach would be that it would (a) benefit all households and businesses and, (b) would be verifiable and easily monitored.

These targeted approaches – protecting only those who are at immediate risk from rising inflation, while implementing proposals with widespread social and economic benefit – would be preferable to scatter-gun approaches.

At the end of the day, however, inflation results largely from an economy that is unbalanced. Static productivity, declining exports combined with cheap credit that allows more money to pursue goods and services is dry grass for inflationary fires. This calls for a more fundamental re-think.

In addition, our anorexic welfare state means that otherwise ‘free’ services are experiencing high inflation. For instance, primary and secondary education is running at nearly twice the national inflation rate, while the failure to provide a proper childcare service means that families are paying some of the highest fees in Europe.

In the meantime, however, there are some calming measures. But we had better be sure that the measures we pursue hit the mark. Otherwise, we may end up running and be lucky if we even standstill.