13/11/2014: There is a Household Income Crisis Out There

Irish League of Credit Unions have published their Q4 2014 survey yesterday. Some very interesting results overall (see full release here: http://www.creditunion.ie/communications/news/2014/title,8698,en.php)

• 1.76 million of adults (51% of total adult population in Ireland) have less than EUR100 left in disposable income each month after key bills and taxes are paid. This means that de facto, more than 1/2 of Irish adults have not enough money left every year to cover a mild dental emergency or child's braces.
• 730,000 of working adults in the country (41% of working adult population) have less than EUR100 left at the end of the month. This means that for an average household with 2 working adults, assuming no emergency demands on their funds, a saving of 10% downpayment on an average (nationwide) house will require 9.6 years worth of savings.
• A person aged around 35-40 should be saving around EUR350-400/month to cover pension top up, as well as to provide some cushion for emergencies. Only 632,000 people in the country currently can afford such a 'luxury' - only 21% of our adult population. Of working adults, only 427,000 (24%) can afford reasonable pensions and insurance savings cover.
• 37% of adults in this country cannot afford (regularly) to pay their bills in full every month. This is up on 32% a year ago and up on 31% in August 2014 survey.
• In Q4 2013, 90% of Irish adults said they either occasionally or regularly rinding themselves in a position of not being able to cover their monthly bills. In Q4 2014 survey, this number rose to 92%.
• The survey results largely confirm the trends in household deposits recorded by the Central Bank of Ireland.

26/12/2013: Strategy for Growth 2014-2020 - A Fruitcake of Policy?

This is an unedited version of my Sunday Times column from December 22, 2013.


It is a well-known fact that virtually all New Year’s resolutions are based on the commitments adopted and promptly abandoned in the years past. Our Government’s reforms wish lists are no exception. Like an out-of-shape beer guzzler struggling to get out of the pub, our State longs to get fit year after year. Most of the time, nothing comes of it: bombastic reforms announced or committed to quietly slip into oblivion. Smaller parts of resolutions take hold; bigger items get buried in working groups and advisory panels. Thus, over the last decade, we have seen promises of reforms across the domestic sectors, protected professions, pensions and health systems, quangos, social welfare, government funding, tax systems, and so on. Virtually none have been delivered so far.

This week’s Strategy for Growth: 2014-2020 is the latest in the series of Governments’ ‘New Year, New Me’ resolutions. It is a lengthy list of things that have already been promised before. With a sprinkling of fresh thinking added. All of it is based on a strange mixture of pragmatism in fiscal targets, resting on economic forecasts infused with an unfunded but modest optimism. Giddy exuberance in confidence concludes the arrangement: confidence that the reforms which proved un-surmountable under the Troika gaze will be feasible in over the next seven years. The entire exercise promises a lot of reforms, but delivers little when it comes to realistic costings and risk assessments of the promises made.

In brief, the new Strategy is a disappointingly old fruitcake: pretty on the outside, inedible on the inside and full of stale trimmings, held together by the boisterous dose of potent optimism.


On Monday, the National Competitiveness Council unveiled its own version of a roadmap to the proverbial growth curve. The 32-page document on the New Economy contained no less than 65 references to the building and construction sector and 39 instances of references to property sector. No other sector of the economy was accorded such attention.

In the footsteps of NCC, on Tuesday, the Government launched its own multi-annual post-Troika policies roadmap.

The core point of the glossy tome is that Ireland needs a combination of policies to get its economy moving again. No one could have suspected such a radical thought. Majority of the policies listed are of ‘do more of the same’ variety. Some are novel, and a handful would have been even daring, were it not for the nagging suspicion that they represent political non-starters.


The plan has three pillars. Pillar one: fiscal discipline to keep Government debt under control. Pillar two: repairing the credit supply system and the banks. Pillar three: create an economy based on innovation, productivity and exports, and… building and construction. If you find any of this new, you are probably a visitor from Mars.

The document fails to provide any risk analysis in relation to all three pillars. Instead, it fires off pretty specific and hard-set targets and forecasts. Normally, the forecasts reflect the impact of policies being produced. In the Strategy 2014-2020 normality is an inverted concept, so forecasts enable targets that justify proposals.

There are two scenarios considered: the baseline scenario (better described as boisterously optimistic) and the high growth scenario (best described as wildly optimistic). None are backed by an analysis of sources of growth projections. No adverse scenario mentioned.

For the purpose of comparison, based on IMF model, Irish GDP, adjusting for inflation is forecast to expand by less than 12.3 percent between the end of 2013 and the end of 2018. In contrast, Government latest plan projects GDP to grow by over 16.1 percent in the case of high growth scenario. Nominal GDP differences between the high-growth and baseline scenarios amount to just 0.1 percentage points on average per annum. In other words, the distance between boisterous and wild optimism in Government’s outlook for the next seven years of economic growth is negligible.

By 2020 we will regain jobs lost during the crisis. But unemployment will be 8.1 percent under the baseline scenario and 5.9 percent under high-growth projections. Both targets are above the pre-crisis levels of around 4.7 percent. Which means that the Grand Strategy envisions jobs creation to lag behind labour force growth. The only way this can be achieved is by lowering employment to labour force ratio. This, in turn, would require increasing labour force more than increasing employment. In other words, the numbers stack up only if we simultaneously reduce emigration and push people off welfare benefits and into the jobs markets, and do so at the rates in excess of the new jobs creation. How this can be delivered is a mystery, although the Strategy promises more reforms to address these.

We will also transition to a fully balanced budget by 2018, eliminating the need to borrow new funds. Of course, we will still be issuing new debt to roll over old debt that will be maturing. Government debt itself will decline to below 100 percent of GDP by 2019. Per IMF latest estimates released this week, our General Government deficit in 2017-2018 will average around 1.5 percent of GDP and Government debt will end 2018 at around 112.2 percent of GDP. By Governments baseline scenario, we will be running a deficit of 0.25 percent of GDP on average over 2017-2018 and our debt will fall to 104 percent of GDP by the end of 2018. Optimism abounds.

To make these achievements feasible, let alone sustainable, will require drastic reforms far beyond what is detailed in the strategy documents. Instead of detailing these, Strategy for Growth: 2014-2020 leaves the major reforms open to future policy designs by various working groups.

For example, the Government Strategy talks high about the need to ensure sustainability of pensions provision. In an Orwelian language of the Strategy, having expropriated private pension funds before, the Government is now congratulating itself on achieving positive enhancements of the pensions system.

Yet, we all know that the key problems with current pensions system in Ireland are two-fold. One: we have massive under-supply of defined contribution pensions plans in the private sector. Two: we have massive deficits in defined benefit schemes that are predominantly concentrated in the public sectors. The Strategy documents published this week simply ignore the former problem. With respect to the latter one, the Government plan amounts to hoping that the problem will go away over time. Overall, going forward, the magic bullets in the State dealing with the vast pensions crisis are exactly the same as before: higher retirement age, gradual closing of defined benefit schemes and more studies into “setting out … long-term plans in this area”.

Another complex of Augean Stables of economic policies left untouched, potentially due to the influence of Labour is the tax system. Current income and social security taxes de facto penalise anyone considering an entrepreneurial venture. The Strategy puts forward no income tax reforms proposals. The document brags about the ‘progressivity’ of our income tax system and promises to retain this feature of the tax codes. Unions will be happy. Entrepreneurs, self-employed, higher-skilled workers, innovators, professionals, younger and highly educated employees, and exporting sectors workers will remain unhappy.

The Strategy admits that “Traditionally in Ireland starting and growing a business is considered less attractive by many than working in larger employers.” It goes on to stake a bold policy claim “to find innovative ways to encourage an entrepreneurial spirit.”

Stripped of fancy verbiage, the ‘innovative ways’ amount to a call to educate us all, toddlers and pensioners alike, about the goodness of entrepreneurship, and develop unspecified policies to make business failure more acceptable. Given the shambolic nature of the personal insolvency regime reforms designed by the current Government, there is little hope the latter objective can be met.

For intellectual gravitas, key marketing and PR words were deployed in the Strategy, promising more assistance, subsidies and supports to entrepreneurs, and more “clusters”. The same Strategy also promised to cut the number of business innovation assistance schemes and streamline business development programmes.

Taken together, these changes suggest that the Irish entrepreneurship environment will remain firmly gripped by State bureaucracy and will continue churning out state-favoured enterprises with clientilist business models. The fact that the said platform of enterprise supports, having been in existence for some 12 years, has failed to deliver rapid growth of innovation-focused high value-added indigenous entrepreneurship to-date seems not to bother our policymakers.

Other elephants in the room – some spotted by the very same Government years ago, while in opposition – are mentioned and, predictably, left unchallenged. One example: the Strategy promises yet another Action Plan to “identify ways to use Government procurement in a strategic way to stimulate … innovative solutions.” Back in 2011, this Government has already promised to do the same.

Overall, the fruitcakes of economic policy planning by the Government and NCC both lack vision and details. The two documents do contain some good, realistic and tangible ideas, but, sadly, these are buried beneath an avalanche of unspecified promises and uncontested figures. Risks to implementation of these policies may outweigh incentives for reforms. Lack of realism in expectations may overshadow the potential impact of the proposals.

More fruitcake, anyone? There’s loads left…

Box-out: 

In the latest report published this week, the European Banking Authority (EBA) analysed data from 64 banks with respect to their capital positions and the underlying Risk-Weighted Assets (RWA) holdings. Overall, capital position of the EU banking sector “continued to show a positive trend,” according to EBA, with Core Tier 1 capital holdings rising by EUR 80 billion. This, “combined with a reduction of more the EUR 800 billion of RWAs” means that the EU banks are building up risk buffers at the same time as pursuing continued deleveraging. The latter is the price for the former: higher capital ratios are good for banks’ ability to withstand shocks, deleveraging of assets is bad for credit supply to the real economy. On the net, however, as capital ratios rise, the system is being repaired so the price is worth paying. The improvements, however, were absent in one economy. Per EBA, Irish banks (Bank of Ireland, AIB and Permanent TSB) are unique in the EU in so far as they are experiencing simultaneous reduction in capital ratios and a decrease in Risk-Weighted Assets, which only partially offset the drop in capital. Put simply, Irish banks deleveraging is not fast enough to sustain current capital ratios: we are paying the price, but are not getting the benefits.

EBA chart (click to enlarge):

20/11/2013: Irish pensions: a crisis of policy, institutions and savings - Sunday Times November 17

This is an unedited version of my Sunday Times article from November 17, 2013.


Back in the early 2011, with the new Government coming into the office, fresh ideas were filling the airy halls of the Department of Finance. Armed with the knowledge that Irish pensions industry was the last vault in the country that still had money in it, Minister Noonan focused his sights. Hitting private pensions was a preferred alternative to raiding banks deposits or imposing cuts to public sector pensions. It suited the pseudo-fairness agenda of the Labor. Better yet, setting a levy on private pensions funds would, in PR-speak, allowed Fine Gael to avoid 'increasing taxes'. The fat cats (private pensions investors) were to share the burden of the fiscal adjustment while the Government was riding a high horse of delivering a rhetorical victory for the little man. The real logic of the move was exactly in line with the reasoning used in continuously raiding health insurance policies: go after the money.

Economics of the measure swept aside, the Government got busy expropriating private property and weakening the system of future pensions provisions. A temporary pensions levy was born out of this. With it, the country was firmly put on the road to a comprehensive dismantling of the already dysfunctional system.

Set at 0.6 percent per annum for 2011-2014 the original levy was dressed up in 2011 as a measure to free unproductive savings to fund jobs creation in the economy. Budgets 2012 and 2013 followed up with a raft of other measures, all designed to take more cash out of savings. Budget 2014 not only failed to curtail this onslaught but created a new levy of 0.15 percent that will run over 2014-2015 period and, according to a large number of analysts, is expected to continue beyond the 2015.

Yet, as the documents recently released by the Department of Finance show, back in 2011, the Department briefed the Minister as to the fallacy of his thinking. At the time, the pensions deficits accumulated in the Irish system totaled EUR10-15 billion. These deficits, according to the briefing, were in excess of what the nation's employers and employees could shoulder even before the Government moved on the funds. Between 75 and 80 percent of all Defined Benefit funds in the country were technically insolvent, accounting for two thirds of all pensions.

The Minister also had to be aware that a tax on capitalised value of the funds amounted to expropriation of private property. And that it cuts across the serious warnings concerning our pensions sustainability coming from the Troika and the OECD.

The problems with this approach to pensions systems are manifold and are setting us up for a long-term crisis. They include: exacerbating catastrophic pensions shortfalls, reducing future credibility of the system and undermining public confidence in the security of our financial system. Increasing future pressures on the Exchequer finances stemming from demographic changes and the legacy of the current crisis is the direct corollary of the short-termist position adopted by the Government.


Irish pensions system is fundamentally insolvent today and this insolvency is only made worse by our policies.

Top figures speak for themselves: at the end of 2012, there were 232,939 Defined Contribution schemes members, 527,681 Defined Benefit schemes signees and 206,936 PRSAs. Inclusive of PRSAs, total capitalisation of the system was around EUR78-79 billion. Defined Benefit schemes made virtually no contributions to the capital pool backing pensions system in the country. Excluding PRSAs, almost 7 out of 10 Irish pensions were funded by the IOUs on future taxpayers and company employees. The cumulated potential obligations in the pensions provisions of the Defined Benefits schemes amounted to some EUR 165 billion or around 100 percent of Ireland's GDP. These are growing, fuelled by early retirement schemes in the public sector and exits of private sector Defined Contributions savers.

Private pensions in Ireland remain not only underfunded, but also insufficient in cover. Currently, Ireland ranks the lowest in the OECD in terms of net pensions wealth held for those earning at or above average wages. Things are somewhat better for those on lower incomes. Still, we rank below OECD mean in terms of pensions cover for workers earning less than the average wage. An Irish family with two earners and combined annual earnings of around EUR90,000 can expect a pension cover of 40% of the pre-retirement earnings for 10.5 years. Budget 2014 has reduced this number by at least 0.5 years. OECD average for such coverage is closer to 28 years. OECD estimates show that at the end of 2009 only 41.3 percent of our public and private sectors’ workers were enrolled in a funded pension plan.

Since the beginning of the century, the systematic policy approach adopted by the Irish Governments to dealing with the pensions crisis has been to rely on Defined Contribution schemes to plug the vast deficit in the Defined Benefit schemes. The former are dominant in the private sector, the latter are the cornerstone of the public sector. Since the onset of the crisis, Irish state has acted to level huge burden of fiscal adjustment on future retirees, with levies and tax adjustments reaching into billions of euros and rising rapidly. The measures hit hard not only the savers at the top of the income distribution, but ordinary middle class investors. For example, according to a recent report on Budget 2014 measures, a young worker setting aside annually some EUR2,500 as a starting pension in 2011 will see a life-time cost of the pensions levies reach EUR32,500. He or she will face a reduction of EUR1,625 per annum in annual retirement benefits thanks solely to levies alone.

All of this is gradually eroding the public credibility in the system and acts to lower future solvency of the private and public schemes. According to the Pensions Board and OECD data, Ireland pensions coverage is declining over time. The numbers of workers covered by both, Defined Benefit and Defined Contribution schemes have fallen steadily since 2006 for the former and 2008 for the latter.

This trend is compounded by the nature of the crisis that hit Ireland since the end of the Celtic Tiger era. Unprecedented collapse in property markets triggered massive destruction of household wealth and catastrophic inflation of the debt crisis for households that are nearing the age when they normally accelerate their pensions savings.

Despite this, the Government continues to reduce tax deferrals available for those retirement savings. Examples of such policies include changes to lump sum payments tax treatments, changes to the Standard Fund Threshold, elimination of the PRSI and health levy/USC relief and so on. In effect, pensions funds became a ground zero of the Irish Government-waged war of financial repression – a brutal and cynical policy aimed at protecting own interests at the expense of the future retirees.


The OECD report on Irish pensions system, presented to the Government earlier this year, before Budget 2014 contained the usual litany of complaints about the system.

These include the fact that Ireland does not have a mandatory earnings-related pensions system to complement the State pension at basic level. According to the OECD, as a result, Ireland "faces the challenge of filling the retirement savings gap to reach adequate levels of pension replacement rates to ward off pensioner poverty." Furthermore, private pension coverage, both in occupational and personal pensions, is uneven and needs to be increased urgently. The latest changes introduced in Budget 2014 clearly exacerbate this, and the Government cannot claim that it was not aware of this problem. The existing tax deferral structure in Ireland, based on marginal tax rates, provides higher incentives to invest in pensions for higher earners, resulting in severe pensions under provision for middle classes. The OECD identified "unequal treatment of public and private sector workers due to the prevalence of defined benefit plans in the public sector and defined contribution plans in the private sector."  The reforms aiming to address this gap by introducing new pensions scheme for public servants are "being phased in only very slowly and [are] unlikely to affect a majority of public sector workers for a long time".

The OECD produced a long list of recommendations for the Government aimed at improving the system design and addressing some of the above bottlenecks. Virtually none of these saw any significant action.

The two options for a structural reform of the State pension scheme recommended by the OECD: a universal basic pension or a means-tested basic pension remain off the drawing board. Explicitly, OECD stated that “to increase adequacy of pensions in Ireland, there is a need to increase coverage in funded pensions. Increasing coverage can be achieved through 1) compulsion, 2) soft-compulsion, automatic enrolment, and/or 3) improving the existing financial incentives.” Instead, the Government continues to treat private pensions savings as funds it can raid to raise quick revenues. This makes it impossible for broad and structural reforms to gain support of the public, undermining in advance any future effort to address the crisis we face.

Note: this information was just released today: http://www.independent.ie/business/personal-finance/pensions/thousands-of-oaps-facing-the-shock-of-cuts-in-their-pensions-29768766.html

Box-out:

In economics terms, it is often impossible to put a hard number on the value of less tangible institutional capital of the nation. Yet, systems and institutions of governance and democratic participation do matter in determining nation’s economic capacity and competitiveness. Sadly, it appears that the Irish Government is giving the idea that open and transparent state systems are a necessary condition for building a sustainable and prosperous economy and society little credit. Instead, the Irish authorities are about to significantly restrict effective access to state information. To do so, the Government is planning to introduce a new, more complex and expensive system of fees that apply to the requests filed under the Freedom of Information Act. Some observers have been arguing that the true objective is to reduce the public disclosure of information. Others have suggested more benign reasons for the proposals. Irrespective of the motives, over time, these changes are likely to lead to greater opacity and lower accountability across the State and private sectors. Such trends usually go hand-in-hand with increases in corruption, mismanagement, poor design of public policies, and increased political and civic apathy. In the long run, the proposed reforms can, among other things, spill over into generating greater economic inefficiencies, less meritocratic distribution of resources, and distort returns to investment. They can also reduce our attractiveness as a destination for domestic and foreign investors, entrepreneurs and workers. The victims of poor governance that can arise on foot of any effort to reduce effective access to information will be both the Irish society and our economy.

Ireland's Black Economy: Sunday Times, October 27, 2013

This is the unedited version of my Sunday Times column from October 27th.

In four and a half years through June 2013, Irish personal and public consumption of goods and services has declined on a cumulative basis by EUR 78.4 billion. Over the same period, Irish black economy has gained around EUR 1.2 billion worth of new business. Today, the unofficial shadow economy in Ireland runs at around EUR20 billion per annum.
Much of the recent activity in this economy is courtesy of our budgetary policies pursued since the onset of the crisis. And much of the growth is in the areas relating to the illegal supply of goods and services that are supplied also via the legitimate retail trade. In simple terms, virtually all of the growth in our shadow economy is down to high costs of State regulations, price controls and taxes. The balance of the demand increases in the grey and black markets is down to the households’ responses to changes in income taxation and the crisis impact on our earnings and employment.

The classic definition of the black markets covers a range of activities from trade in illegal drugs to money laundering, from untaxed cash transactions to underground employment, from intellectual property theft to contraband and/or illegal manufacturing of goods and services. One is tempted to depict the black market economy as being a part of urban markets, such as Dublin’s Moore Street or Meath Street, where shifty-looking characters offer illegal wares, ranging from controlled substances to contraband cigarettes. In reality, many more transactions in the black markets take place by private delivery and reach across all socio-economic demographics and into various urban and rural geographies.

In contrast, grey markets include goods legally purchased and imported by individuals, which do not register in the official accounts and as the result do not contribute to the Exchequer balance and the wholesale and retail trade revenues. The best examples of these are goods purchased for personal consumption outside Ireland. Some are imported legally, within the strict limits on values and quantities stipulated by the customs laws. Others are brought in excess of the personal allowances and can be resold or bartered to relatives and friends. Whilst illegal, such transactions are largely undetectable and these laws and regulations are not easily enforceable once the border is crossed. Grey market is the domain of the middle and upper-middle classes: from the South Dublin set’s stereotypical shopping trips to London or New York, to Middle-Ireland’s excursions into the Northern Ireland for a spot of bargains hunting.

The costs of illicit and unofficial trade also reach deeper than the headline numbers suggest. At the top of the pyramid sits the Exchequer with an estimated loss of some EUR 7 billion per annum in revenues – an amount equal to almost 3 years of austerity measures.

Beyond that, shadow economy imposes losses on consumers, legitimate producers and the society at large. The former arise from the poorer quality of counterfeit goods and services supplied and the risks inherent in illegal transactions. Included are the health and safety risks linked to consumption of counterfeit medicines and consumer goods. Losses to legitimate producers of goods and services come from the fact that black market economy takes custom from the legitimate domestic retailers and producers. In many cases, ordinary customers are reluctant to frequent areas where illegal trade takes place. Further losses arise from Intellectual Property theft, and loss of demand for officially-supplied goods and services to cheaper substitutes sold under the counter. Social losses - compounding those listed above - include increased organised crime, links between illegal financial flows and international terrorism, prostitution, and human trafficking, rise in crimes associated with drugs abuse and so on.


In Ireland's case, we are witnessing a rather unique dynamic in the growth of the black markets, courtesy of the current crisis. During the Celtic Tiger period, rising incomes and employment, and declines in personal taxes partially helped to offset the impact of higher consumer prices and hikes in excise taxes on alcohol and tobacco - the two staple goods traded in the grey and black markets. With the onset of the crisis, lost earnings and jobs were compounded by higher taxes, including VAT and excise rates. This resulted in an increased demand for illegally sold goods, but also for legal goods purchased in the Northern Ireland and the rest of Europe.

The composition of the shadow economy in Ireland also changed. Prior to the bust, majority of the losses in economic activity to grey and black markets related to cash-based construction and household maintenance activities. Since 2008, the focal point of growth in the shadow economy shifted to supplying substitutes to goods where Irish regulatory and tax-induced prices have by far exceeded European norms, such as pharmaceuticals, alcohol, tobacco and premium consumption goods.

Construction and property-related services still play significant role in driving black economy, but their overall importance in the illicit trade has declined mirroring the fortunes of the legitimate construction sector.


To see how tax-induced growth in the shadow economy has become a quintessential feature of our reality, consider Irish fiscal policies in relation to alcohol and tobacco taxation. Over the last seven budgets, increases in alcohol and tobacco taxes were supposed to raise additional EUR 494 million in revenues. Instead, the measures fuelled an already sizeable trade in illicit goods. Official consumption of these goods declined, and revenue collected fell short of targets.

Based on recently published research by Grant Thornton, losses to the Exchequer from illegal sales and personal importation of tobacco products for personal use in 2012 amounted to between EUR 240 million and EUR 569 million.
Over the last 11 years, all increases in the cost of tobacco products to consumers came from the hikes in taxes. Post-Budget 2014, Ireland will have the highest retail price of tobacco in the entire EU27, while some 80 percent of every pack of tobacco legally sold in the Republic will go to the Exchequer. Based on KPMG data, almost one in every five cigarettes consumed in Ireland in 2012 were counterfeit and contraband – second highest in the Euro area. In his three budgets, Minister Noonan ‘contributed’ some 40 cents or 9 percent profit premium to the bottom line of the criminals illegally importing goods into the country.

My estimates suggest that post-Budget 2014, total economy’s losses from illicit sales of tobacco products will rise to EUR760 million per annum. In addition, estimates based on the data from the Revenue Commissioners and the World Health Organisation suggest that illicit trade in alcohol will cost us close to EUR125-130 million in lost economic activity in 2013. Budget 2014 is expected to push this out toward EUR160 million.

Research shows that increased taxation of alcohol is driving more drinking into homes and out of public view. Much of this shift in drinking patterns falls outside the data we collect from the licensed sales. With both the state policies and the recession increasing the incentives to purchase cheaper and often illegal alcohol, actual consumption of alcohol per person in Ireland might be well above the currently reported levels. In January-July 2013, Irish Revenue seized some 3.5 times more illegal alcohol than in the full year 2012.

Overall, based on the study by Grant Thornton, my own estimates, and using data from various other sources referenced above, illicit trade in fuel, tobacco, pirated software and digital economy services, pharmaceuticals and alcohol in Ireland accounted for some EUR1.5-1.6 billion in 2013. Post-Budget 2014, this figure can rise to over EUR1.7 billion.

Last, but not least, the same forces that propel growth in the shadow markets for alcohol, tobacco, fuel, pharmaceuticals and healthcare, and digital economy services will also act to draw more purchases of other goods out of the Republic and into Northern Ireland and off-shored on-line trade.

Behavioural research shows that when people take targeted trips to purchase specific large-ticket items, they tend to ‘load up’ on other purchases along the way, especially if their trip takes them to diversified retail locations. Thus, a family travelling to Northern Ireland to shop for alcohol in bulk will also be likely to stock up on other goods, such as groceries, household equipment, car parts, fuel and so on, to ‘cover’ the cost of travel. Retail substitution in alcohol purchasing away from Irish stores will lead to compounded losses due to other purchases made abroad.


In his Budget speech, Minister for Finance Michael Noonan referenced the shadow economy on three occasions, including a direct reference to the VAT fraud, illegal tobacco selling, unlicensed trading in alcohol products, and fuel laundering. In line with these concerns, the Minister unveiled a host of policy measures aimed at targeting illegal tobacco and alcohol sales and fuel laundering. So optimistic was Minister Noonan that his measures will bear fruit that he penciled in EUR20 million in added Exchequer revenues from increased enforcement measures. Yet, both the Department of Finance and the Revenue are well aware of the fact that the current state policy on excise taxation of alcohol and tobacco contributes to the growth of the illicit trade. Both know that any measures to combat this trade are not cost-effective, requiring more spending on policing than the revenues such policing helps to generate. In other words, if we want to make a dent in shadow economy, we need to re-think our excise tax policies and markets regulations.

Box-out:

Media analysis of the Budget 2014 placed significant focus on the impact of the changes to the pensions levies. Overlooked by the majority of the analysts, however, was the issue of longer-term sustainability of our pensions system. Irish pensions remain grossly underfunded in the private sector. On the other side of the economy, State’s social insurance funds are projected to hit deficit of EUR9 billion in 5 years rising to EUR 20 billion within the decade, according to the OECD latest research. Taking into the account current deficits in private and semi-state sectors, we are facing an economy-wide pensions crisis. Unfunded pensions liabilities for those who do have some retirement savings or pensions contracts will rise from the total deficit in excess of 15 percent of our GDP today to over 75 percent in 20 years time. The impact will be equivalent to the banking sector crisis experienced in 2007-2011. Beyond this, hundreds of thousands of families will be left without any pensions provisions. The only ‘solution’ to the pensions crisis proposed by anyone to-date involves compulsory pensions enrolment whereby the state mandates required minimum levels of ‘savings’ for households. While good in theory, such a solution presents a number of problems in the case of Ireland. In today’s world, who can afford setting aside some EUR500-700 per month per person into a pensions pot to assure modest retirement 20 years after?  How will such a scheme help those who are currently in their 40s and older and have total assets with negative or near-zero net worth?

19/7/2012: Minister Noonan's 'valuations' & NTMA's latest scheme

An interesting - and potentially revealing - contribution from Minister Noonan on the prospective ESM involvement in purchasing Irish banks assets held by the Government - see full link here (H/T to Owen Callan of Danske Markets).

Here are some interesting bits (from my pov - note, emphasis in quotes is mine):

"...if Europe's new rescue fund takes over the government's stakes in its banks, it would need to do so at prices significantly above their current low valuations."

So what should be the prices benchmark to be paid by ESM for Irish banks?

We know what Minister Noonan thinks what they should not be:
"We wouldn't think we were being assisted or treated fairly if we were only offered the terms we could get from a willing hedge fund who wanted to purchase the stake the Irish government has in the banks," Noonan told a news conference"

Ok, a willing hedge fund is mentioned as a benchmark floor. What willing hedge fund? 1) Have there been approaches that set out some valuation? 2) Have these approaches involved sufficient depth of discussion to show the actual price the fund was willing to pay, other than the low-ball first bid? 3) Have these approaches been systematic or random?

Now, suppose there has been a series of approaches and the hedge funds' willing price is €X million. Suppose Minister Noonan insists on ESM paying a minimum price of €Y million that is above €X million, which means there is a positive premium to be paid by ESM.

What principle should guide this premium valuation? "The valuation will be an issue for negotiation but before we could agree, they would need to be significantly in advance of those figures," Noonan added, referring to figures showing that investments by the country's National Pension Reserve Fund (NPRF) in its top two banks were now worth 8.1 billion euros."

Is Minister Noonan seriously suggesting ESM should pay Irish Government more than €8.1 billion? Since NPRF valuations of the banks stakes are make-believe stuff with absolutely no proven testability in the actual markets, will ESM be buying into a loss then? Ex ante?!



Another interesting comment in the article cited above is the following one:

"The NTMA also confirmed plans to diversify its sources of funding later this year with its first sovereign issuance of annuity bonds to Irish-based pension funds and inflation-linked bonds also aimed at domestic investors.

Corrigan said it was not inconceivable that it could raise 3 to 5 billion euros over the next 18 months from the two new instruments.

"International investors don't owe us a living, they don't have to buy our paper, and if the local investors don't have the confidence to invest in the market and aren't seen to have that confidence, it's going to be very difficult to get international investors back," he said."

Which, of course is all reasonably fine but for two matters:

1. Domestic pension funds will be acting against normal practice and investing in low-rated (high risk) government securities within the very same economy in which they face future liabilities (reducing risk diversification). In other words, Irish insurance funds will have to be compelled to undertake such investment in violation of acceptable international standards. Have the Government now also taken over the pensions industry to add to their banking sector portfolio?
2. If foreign investors 'won't owe Irish Government a living' why should domestic investors owe Irish Government anything? By treating two investors differently rhetorically, does Mr Corrigan explicitly differentiate treatment of domestic investors from foreign investors? It appears to be exactly so because the products he references are not going to be offered to foreign investors. Which begs the third question:
3. Will NTMA create sub-category of seniority for Irish pension funds and 'domestic investors' to effectively load even more risk onto them compared to foreign investors? After all, he seems to suggest domestic investor owe him something that foreign investors don't?

Economics 06/03/2010: Pensions Plan that confirms my worst fears

Per comments to my blog posts on pensions:

Article 4.2.3. of the National Pensions Framework states (emphasis is mine):

"The individual will be provided with a range of investment choices reflecting different levels of risk, accompanied by suitable, easily understood information about the level of that risk and the benefits expected. The range of funds will include very low risk options to provide members with a high level of security on their savings. The Government will not, however, provide any guarantees on investment returns."

This resolves the issue of asymmetric nature of returns: we will be compelled to invest, but Government is not compelled to guarantee.

At the same time, provision of very low risk option plans – traditionally fixed income only funds – does not disqualify these funds from purchasing Irish Government bonds, implying that the funds are not shielded from the Government ‘borrowing’ against our pension savings. This, coupled with direct State oversight over the approved funds (see next quote) means that it will be difficult to create functional Chinese walls between the State and our cash.

“The limited number and types of funds (which will be required to have life-styling built in) available under the scheme will be provided by the private sector through a competitive process run by the State.”

So rationing is the State objective, making the funds subject to potential State interference and influence.

“Members will have the option of choosing between these approved funds or providers, or else they will be enrolled in one of the low risk default options. Charges will be kept to a minimum as marketing expenses and investment advice are minimised."

How is this automatic enrollment into ‘one of the low risk default options’ be determined – who will select a specific provider option? The State? Some proportional competitive formula? Either way, someone else will decide what to do with the money some of us will be compelled to part with. It is, therefore, a tax, especially absent guarantee of a return.

The last sentence above is beyond any belief. This the State pushing on a retail client a major financial undertaking, while promising to keep advice to a minimum?!


Per my concern with contractual aspects of the plan, the entire NPF makes no mention of any contractual arrangements under the proposed plans. This means that either the authors of the document did not understand the importance of securing pension holders’ rights, or they omitted this consideration to exempt the state from committing to any sort of a scheme-related obligations. My questions regarding the legal validity of this ‘pension’ arrangement in the future are, therefore, correct and justified.

There are no references to any value-for-money frameworks within the document, which puts it in direct contrast to the green paper on pensions (the latter being full of cheerful promises of delivering this golden fruit of all public sector schemes).

There is no economic impact assessment, and there is no actuarial evaluation of the new plan, which means that the Government has promised not to guarantee returns which may or may not resolve the problem of the pensions funds shortfall in 2030-onward. If this still qualifies as a well thought-through proposal, I am off fly-fishing for the rest of my life.


Page 19 of the NPF states: “…the Government will seek to sustain the value of the State Pension at 35 per cent of average weekly earnings and will support this through the PRSI contribution system.”

This clearly states that the Government does not contractually guarantee the benefit for which it imposes a tax. I would love to 'seek to sustain' my tax contributions to the State at the current rates, but hey, I am actually obliged to do so. The opposite is not true for the state's duties to me. Again, asymmetry inherent in the rights and obligations of taxpayers vis-à-vis the State are re-affirmed here.

Even more insulting is the NPF statement concerning the State employees Defined Benefit pensions which reads (page 46): “However, only these core benefits granted plus revaluations to date would be guaranteed, and this would be underpinned by regulation.” So while not guaranteeing ordinary taxpayers anything at all, the State guarantees a large proportion of the Defined Benefit Rolls-Royce pensions to its own employees.


With respect of tax relief ‘reform’ NPF states (page 30) that “Another reason is that people are often unsure about the value of the incentives provided by the State to encourage pension provision. By providing a matching contribution equivalent to 33 per cent tax relief, the Government will introduce more transparency to the system – allowing people to see the exact value of the Exchequer support.”

This is pure hogwash – if people are unsure about the speed limit on the road being in miles or kilometers per hour, does the state change the number on the speed signs? And why not provide relief at 41%, or better yet – at 50%, since the Government is now taking half of the paycheck for many employees in this country?

With respect to opt-outs:

Section 2.3.2 page 17 states: “If people decide that retirement saving is not feasible, they can opt-out but there will be a once-off bonus payment for people who contribute to the scheme for more than five years without a break in contributions.”

In other words, the State will restrict competition in pensions provision by subsidizing the ‘approved’ plans mentioned earlier. In effect, to discourage people from undertaking purely private pension provision.

Page 32 states: “Employees will be permitted to opt out of the auto-enrolment scheme after a period of three months. Employees can opt in again whenever they wish but, in any event, they will be automatically re-enrolled every two years... Once a person remains in the scheme for six months, their contributions will be held in a pension account and no withdrawals will be allowed.”

So I am right to state that there can be instances of double payment into pensions funds by individuals who opt-out for a private pension. And that there has not been any thought given to how this can be avoided and how duplication of pensions will be prevented.

Page 34: “To ease administration costs, contributions will be collected through the PRSI system. In addition, the opting in/opting out arrangements will be made as straightforward as possible. The Government recognises, however, that any additional labour and administration costs will have an impact on small firms, particularly in the current economic environment.”

So it is a tax that will impact more smaller firms. And it will be the State who will collect the funds and then, somehow (how – remains to be determined) disburse these funds to ‘approved’ providers and to the ‘low risk option’. The latter, of course, being some new state quango managing the new retirement tax windfall. How will our choice of provider be entered into? How can we switch from one provider to another? How can we carry our pensions out of the state if we move places of work, including with the EU? Which open up another question – is this proposal actually in compliance with EU directives on portability of benefits?


There is an amusing table 4.1 on page 32 that illustrates just how dire is both the analytical part of the NPF is and how dangerous the Government promise to provide minimal advice can be. The table calculates replacements and returns on pension savings under the new scheme using an assumption of, hold your breath, 7% investment returns per annum! This, in the view of the report authors represents a safer type of investment…

I really rest my case here. Good luck to anyone who still believes this proposal to be a well thought-through idea.

Economics 05/03/2010: More questions on pensions plan

In a recent post (here) I have asked 12 questions concerning the new Government plan for pensions.

Here are more questions to follow. But before we begin, let me state the following:

• Lack of clarity on any of the questions raised by myself and other observers,
• The fact that these questions can be raised in the first instance; and
• Two independent confirmations of my questions validity from the industry sources

show that I am right in suggesting that the entire plan is badly thought through and most likely represents a new tax with no contractually verifiable benefits.

Question 13: Given that the Government will be forcing people of all ages to save 8% of their income per annum for pensions provision, the plan is not even sufficient to provide reasonable pension protection for the 22-year olds who will be enrolled into it. How will it help to defuse the demographic (aging-induced) time bomb the Government is facing?

The Government is hoping to start enrollment in 2014. It is facing pensions system meltdown around 2030-2035, which will cover by then retired generations born between before 1965. These generations by 2014 will be of age 49 or more, with 18 years or more left to go before a pension. This, in turn means that their pension provisions should be in excess of 20% of their income, assuming they are starting anew at 2014. Massively more than 8% the Government has in mind.

At the same time, the younger generations pension savers will be facing a dependency ratio of less than 2 workers per retiree by 2050. This means their total provision for pensions as well should be around 18-20% of their income annually. With 1/4 of this delivered in a promissory Government offer of 35% AE state pension, even assuming the Government will keep its promise, the unfunded contribution required is around 13.50-15% of income annually. Not 8% set by the Government.

Then there is a third sub-component of those who are in the older (pre-1970) cohorts who are currently outside private pensions schemes. They will require savings of more than 25% of their income annually to underwrite reasonable pensions provision. Again, 8% state run pension is not going to cover their shortfalls.

Question 14: If the funds were to go into the NPRF, then the life-span of the cash in the fund is about 5-10 years before the money is spend on some new emergency, e.g. another banks bust or another fiscal crisis (potentially the one induced by the collapse of the public sector pensions scheme). How will the Government protect our money from itself? It was not able to do so with the current NPRF set up and the signs are not good for any future funds security.

Question 15: Given that public sector pensions insolvency is already a known, the best for the Government to do is to reform the Rolls-Royce pensions it provides to its own employees. Why is the Government not leading by example?

Question 16: Anyone who has been outside the state scheme for 2 years will be automatically re-enrolled into the system. In the period of time between the re-enrollment and a new opt-out (which can be months), a taxpayer will be liable to pay into two pensions simultaneously (her own private plan and her state plan). Is this the case? How will the Government compensate such families who will incur overdraft charges due to such double pension provisioning courtesy of the state? How will the state actually monitor the opt-outs and whether people in the opt-out are still in a pension plan?

Question 17: What is the feasibility of the entire proposal ever being implemented, given the logistical nightmares it would entail?

• The proposal would require massive bureaucracy (and invasion of privacy) to verify - e.g. Revenue data being used by another State agency to generate demand for enrollments, re-enrollments and clear opt-outs. Is this even legal?
  
• The proposal will require the state to engage in the areas in which it has no expertise, running an investment undertaking with retail clients. What are the implications of a massive state monopoly with statutory enrollment powers to the market for pensions and financial services in Ireland? How long and how expensive will be the state battle with the EU Competition authorities to clear this scheme?
  
• How big will the paper trail be if the state were to require continued monitoring of compliance with the opt-outs? What will be the cost of this to businesses and employees? How many paper pushers will the state need to hire to keep the track of these mountains of evidence?
  

From the point of conception, to the point of translating the new authority's documents into Irish, the undertaking cannot be envisioned as an efficient and cost-competitive operator.


So why is the Government engaging in the scheme at all?

Since 'resolving the pensions problem' is clearly not on the cards (see above), one possible explanation is to get its hands on more cash through 'borrowing' against the funds raised. Another possible explanation - to raise tax (unimaginable otherwise) on business.

Remember -

• corporate tax is a sacred cow of the State;
• personal income tax is already high and will rise again in the next Budget;
• indirect taxes are crippling and the local authorities will be coming for more of their cut in the next few years.
  

So the only means for raising new cash is to levy a new charge - on businesses and incomes - that can be called something else other than tax. A promise of a service (new pension) 20-plus years down the road is a fig leaf of decorum, especially since the Government has no contractual obligation to actually honor such a promise and has set no specific target for a return on this undertaking.

This pensions proposal is a tax on employers (+2%) and a tax on people (+4%). And this tax will have the greatest negative impact on smaller businesses and entrepreneurs, since MNCs and larger companies are already offering much better pensions.

The Government might have solved the conundrum it faced courtesy of the EU Competition rules. Unable, since 2003, to charge differential tax rates on domestic and multinational businesses, it now devised a 'pensions' scheme to charge smaller companies more through a new levy. And it didn't have to raise official corporate tax rate to do so...


Of course, there is always a better solution than what our folks in the Government Buildings can deliver. That solution would be -

1. set a flat income tax rate of 12% on all income and no exemptions except for a generous up front personal tax-free limit (to exclude the real working poor from taxation);
   
2. And then tell people - including public sector workers - that they must invest at least 10% of their income in pensions of their choice, provided privately with real international competition in place (my preference would be to avoid compulsion, though);
3. Make the entire pension contribution, up to 20% of gross income, tax deductible;
   
4. Set up self-funded insurance scheme to underwrite pensions providers;
5. Done. End of story and no need for white papers from over-paid and over-staffed task forces and for bureaucrats, lawyers, mountains of paper and pensions tzars.
   

Simple, folks. Really simple. Chile did so already.

Economics 04/03/2010: Another grab of taxpayers cash?

Update 1: 04/03/2010: 10:15pm


Yesterday, the Government announced a plan to reform pensions provision system in Ireland by creating a mandatory pension scheme with a limited opt-out clause. The announcement is covered here. While lacking specific details we can only ask questions and await for some answers, here are my top-level views.

Question 1: Will additional contributions required from the taxpayers yield additional cover over the already committed state scheme that supplies 35% of the average earnings in exchange for PRSI contributions?

Question 2: What will determine the return on top-up pension? While the state is quick at setting the cost to the taxpayer (4%) and employers (2%) there is absolutely no reference to the returns to be earned from the scheme. Is the rate of return fixed? Guaranteed? Market-related? Who will underwrite this return?

Question 3: Who will manage the assets? NPRF? NTMA? Private providers? Who will actually write the policy - if any policy will be written at all.

Question 4: The plan exempts those on defined benefit pensions - aka public sector workers. Thus, in effect, the plan opens up two massive problems:

• Defined benefit pensions are the ones that are facing the largest shortfall and they are also being managed by the agent (the State) who will control our top-up pensions. How is this conflict of interest going to be resolved? Will public sector pensions hole be plugged using top-up pension funds?
• Defined benefit pensions are contractually guaranteed, while top-up pensions are not (see below), so in effect the opt-out potentially directly exposes ordinary taxpayers to underwriting the public sector pensions through both their statutory pension (already the risk we are bearing) and through the top up. If so, the top-up element of the proposal is nothing more than a tax on ordinary income earners that can be used to cover public pensions shortfalls.

Question 5: A 4% top-up requirement for 'higher earners' (undefined level of earnings) will create a further erosion of the wage premium for higher educated and higher skilled workers in this country (on top of already punitive levels of personal income taxation). How does this square off with the Government intentions to build a Smart Economy, if Smart workers require higher wage premium?

Question 6: What are the contractual rights of the taxpayers paying top up rates with respect to the pension benefits?

A private sector pension is governed by a clear contract. This contract is fully enforceable in the court of law. State pensions (with exception of those provided to public workers) are not. If you doubt this statement - check numerous legal cases where this has been deemed to be the case.

And look no further than the change in the statutory retirement age that the Government is planning to enact. In effect, forcing retirement age 2-3 years forward means that all of us who have paid PAYE are now entitled to 2-3 years less of the benefits. If this was done by your private pension provider, you would have a legal case against a unilateral change in the terms of the contract. But because it is done by the Government and we have no written legally binding contract with the Government relating to pensions provision, the State simply can cut our benefits, while still requiring us to keep our end of the deal - continuing to pay into the PAYE pot.

So the biggest issue of all is - will the new top-up requirement be legally binding for both sides of the deal or will it remain asymmetric (and therefore subject to the risk of arbitrary changes in the terms and conditions by the Government)?

Question 7: The new pension system would re-enroll people who quit every two years. This begs a question - will this 're-enrollment' be performed with crediting for years lapsed or not. If yes, then the risk of underpayment due to interruptions will be borne by the collective pool of funding. Which means that everyone paying into the system will be at a risk of bearing the cost of higher jobs exits and unemployment. If no, how will the recovery of underpayment take place? Simply requiring people who dropped out to repay the shortfall accumulated over two years of absence will not work, as it will impose huge burden on those with uncertain employment prospects.

Question 8: How will the system manage those in part-time employment, self-employment and those with hybrid income sources (multiple jobs, etc)?

Question 9: Since top-up clause requires private pension plan with employer contribution in excess of 4%, can the new plan be deemed anti-competitive? For example, if a self-employed person obtains no contribution from the employer, does the new pension mandate commit a person to a minimum contribution of 6%, thereby forcing them out of other private pension arrangements they might have, which may include single payment/lump sum contributions?

Question 10: If a person is forced to switch away from a smaller pension plan into the 'top up' Government plan, given that Government plan is not comparable in terms of risk of payout to a private plan, will this not in effect reduce the quality of pension that the employee will obtain? In other words, the Government scheme might result in a reduced quality of pensions for some savers.

Question 11: Will the new top-up arrangement cancel out PRSI contributions, or will it be on-top of the PRSI levies? If the former, who will fund the 35% promisory note of statutory state pensions? If the latter, this constitutes a massive increase in taxation burden in this economy.

Question 12: How will the Government reimburse those of us who might have higher pensions contributions by employers, but whose employers will now opt for a default position and drop their contribution to the effective minimum of 2%?

So far, the proposal is yielding more questions than answers. Which, of course, simply indicates that there is a good chance that the Government has not thought through the whole scheme and might be risking entering into another 'Policy-based evidence' scenario for which we, as a country, are so well known around the world.

On the net, however, given the nature of the top-up arrangement, unsecured contractual status of the proposal and the fact that the State decided to exempt its own employees from the obligation, the whole proposal looks like another tax by the Exchequer.