The Economic System Badly Needs A Rewrite

​​In 1974, US economist Arthur Laffer devised a novel policy that aimed to generate higher tax revenue for the government. The idea, although controversial, was simple. By cutting corporation taxes businesses would create more jobs and improve economic output. After almost a decade of high unemployment and inflation, economic policy thus shifted towards supply driven incentives. Lower taxes, Laffer believed, would kick start the economy and boost government revenue in the longer term. 

By the early 1980’s the US economy was in a deep recession. Interest rates had peaked at 19% and in 1982 unemployment rose to 10%. Ronald Reagan, who had just come into power, hired Laffer as one of his key economic advisors and promised to put an end to big government.
 
Large deficit spending programmes which had previously defined the past decade were blamed by the Republican party for the runaway inflation of the 1970’s. Under Reagan’s watch, the US economy would be a leaner more self-regulating one, guided by the ‘invisible hand’ and the doctrine of free-markets. Trade would be liberated from state bureaucracy and the government’s role in economic management would be considerably reduced. The Keynesian era thus came to an abrupt end, replaced by a new right-leaning economic system that would focus primarily on rewarding big business.
 
Along with corporation tax cuts, ‘Reaganomics’ oversaw widespread deregulation of the banking sector. Unfettered capital began flowing between banks and financial institutions domestically and across borders turbocharging globalisation. In the period between the mid 1980’s and shortly after China joining the World Trade Organisation in 2001, the money supply in the US grew by 400%. Global credit markets boomed, fuelled by lax lending rules and giddy consumer demand. Profits on Wall Street soared coinciding with the explosion of the derivatives market that quickly began to dominate the investment industry. Today options, forward contracts and futures are valued at over $500 trillion, approximately 7 times bigger than the world stock market.
 
Indeed, the growth in mortgage backed securities and collateralised debt obligations in the early 2000’s, arcane bond investments, were instrumental in bringing down the global financial sector in 2008. Giant bailout packages for banks and insurance companies soon followed curtesy of taxpayers and sovereign governments worldwide. When the dust settled austerity, high unemployment and rising inequality were all to show for an unprecedented period of financial engineering.
 
In the aftermath of the crisis, the economic system was in dire need of a rewrite. The financialization of the economy that enriched a few left large parts of society feeling disillusioned and cheated. The capitalist system had failed and played ordinary workers in a zero sum game designed by elites. The recovery period was slow and arduous. Where public investment was needed, politicians chose spending cuts. Tax increases replaced subsidies and policies turned yet again towards reflating asset prices. Zero percent interest rates and new unconventional monetary policies such as quantitative easing pulled capital out of domestic economies into stock markets and global property funds. In Ireland, house prices and rents have since surpassed their pre-crisis levels in 2007 outlining the calamitous nature of social planning and the failure to prevent yet another housing bubble in just over a decade.
 
While globalisation lifted billions of people out of poverty in China, millions of American’s lost their jobs or saw their wages badly affected by the outsourcing of labour to cheaper regions in Asia. By 2016 Donald Trump’s “America First” campaign was well on its way to securing him an unthinkable victory in the presidential election and a year later the UK chose to leave the European Union. Living standards in the UK are now lower than Slovenia and on a par with its poorer European neighbours Portugal and Greece, a far cry from the economic powerhouse it once was some 50 years ago. Brexit is thus a symptom of a deeper malaise that has been festering for many years in the UK, namely chronic underinvestment in public services and regional neglect.

The rise in populism worldwide is of no great surprise. Stagnant wages, rising rents and the disappearance of decent paying jobs are just a few of the common themes we associate with the ‘squeezed middle’. The wealth gap is ever widening and it is now estimated that the wealthiest 10% of households in developed economies hold 50% of the wealth while the least wealthiest 25% own almost no wealth at all. 

Research by the Economic and Social Research Institute shows that the share of 25 to 34-year-olds in Ireland who own their own home more than halved between 2004 and 2019, falling from 60 per cent to just 27 per cent. For the remaining 73%, many are forced into over-crowded rent-sharing arrangements in old shabby buildings badly maintained and poorly serviced by public transport. For the first time in human history adult children are worse off than their parents.
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Sinn Fein’s surge in popularity is a direct response to conditions young people face in Ireland today. Indeed, in an era of big government, the stage seems perfectly set for a left-leaning party like Sinn Fein to sweep into power and undertake radical reform. While tackling housing would be an obvious priority, the multifaceted issues surrounding the crisis could take years to resolve. Re-designing planning laws, stamping out nimbyism, reducing the availability of public land for foreign capital and so forth take time. Housing policy alone, therefore, is unlikely to form the basis of a winning mandate or re-election for a new government. A comprehensive overhaul of the tax system in the meantime, however, could serve as the blueprint for a new beginning of economic prosperity and fairness for all. Decades after the Laffer Curve helped benefit the rich, tax cuts for ordinary workers would ensure that a wider demographic get a more equal slice of the economic pie.
 
One idea would be to increase the threshold where a person starts to pay the higher rate of tax from €40,000 to €50,000. Any earnings up to €50,000 would thus be taxed at 20%. These adjustments would mostly benefit 60% of the salary distribution in Ireland. Approximately 6 out of every 10 workers would see their standards of living dramatically improve. There would also be positive knock-on effects to VAT receipts for the government since most of the spending in the economy takes place within this income range. Given that their needs have already been met, higher incomes have a much higher savings rate than lower incomes. The highest 10% of incomes, for instance, allocate a higher proportion of their earnings in non-productive areas of the economy such as stock markets.
 
For the purposes of the exchequer and to close the short fall in income tax revenues, the government could introduce wealth taxes. As attitudes towards wealth and inequality have soured, these policies would be widely welcomed. Wealth taxes would consist of both a higher band of income tax plus higher property taxes. In Ireland, approximately 12% of households are defined as millionaires where the value of their labour income plus returns on investment and property, less what they owe, is valued at over €1 million. In the past decade the number of Irish millionaires has doubled, largely due to rising property prices and booming stock markets. On average, owners of capital with assets valued above €1 million earn over €200,000 per annum from their labour income plus around 5% -7% on financial assets. It is now estimated that the top 1% of Irish society own 25% of Irish wealth, two-thirds of which is tied up in property.
 
In response, a new tax rate of 50% for labour incomes above €200,000 per annum would be applied plus a ‘millionaire’ tax of 55% on any individual with net worth exceeding €1 million. Property taxes would also increase for homes valued at over €1 million. Currently, local property taxes in Ireland for homes in that range are taxed at approximately 0.1% 0.15% per annum. Adjusting the rate to 0.5% would mean a household that paid €1,000 per annum on their €1 million home would now pay approximately €5,000 per annum. Spread out over 12 months and divided by 2 working adults per household a repayment of approximately €208 per month seems an affordable outlay.
 
Critics will no doubt argue that taxing high worth individuals discourages entrepreneurs or damages businesses. Entrepreneurship, however, is a natural instinct that can’t easily be switched on or off. The unrelenting drive to seek market opportunities is a distinctive characteristic of an entrepreneur which is written in their DNA. During the 1960’s, for instance, the golden age of economic expansion and invention in America, income taxes were as high as 77%. People adapted and businesses flourished. The introduction of relatively small wealth taxes in Ireland will do little to subdue animal spirits. The world will go on. 
 
The world will indeed go on and perhaps take a brave new direction. The enormous fiscal packages unleashed by governments during the pandemic may have been the inflexion point that inadvertently catapulted society forward towards a form of ‘social capitalism’. Responsive governments, workplace empowerment and a general shift in the axis of power from capital to labour forms the fabric of today’s post pandemic world. Politics will blow with the wind, as it always does, and choose the path of least resistance. Political incumbents and challengers alike will curry favour with popular opinion while desperately grappling for power. That power now lies firmly in the hands of the proletariats while the elite classes look on, forced to pay their fair share as a new economic order unfolds.