Celtic Tiger Lessons

Commentary, Taxation, Peter Holle

Irish unions, politicians and business leaders, it might fairly be said, stumbled onto this formula in 1987 when they agreed to a package of policy changes that produced one of the fastest growing economies on earth. They lowered the corporate tax rate to 10% and, in just two years, 1987 to 1989, they reduced government spending from more than 50% of GDP to less than 40%.

The results speak for themselves. Just 15 years ago, Irish per capita income averaged only 40% of Canadian; today, thanks to supercharged growth, theirs now surpasses ours by almost 20%.

Today the Irish are reaping the benefits of the knowledge-based, high-tech economy that emerged from the changes, the hottest in Europe. Despite the rate cut, corporate tax revenues have more than doubled since 1990. Since 1993 growth has averaged 8% a year, exceeding 9% in 1998 before “cooling off” to 6.8% in 1999. Unemployment, at 18% in 1988, will drop to 5% in 2000, among the lowest in Europe.

The story of Ireland’s escape from its legendary poverty is documented in Road to Growth — How Lagging Economies Become Prosperous, a recent book from the Atlantic Institute for Market Studies. The author, Fred McMahon, describes how low-growth economies in Europe and parts of the United States transformed themselves.

The 1980s were one of the worst decades in Irish economic history. Government was bloated. Militant unions gave neither government nor employers much peace.

“We had declining economic growth and declining employment,” Manus O’Riordan, head of research for Ireland’s largest union group, told McMahon when the latter visited to investigate the turnaround. “Wages were up, but inflation and taxes were up more. Living standards were declining. We knew we had to do something.”

That something was quite remarkable. “People won’t invest if they can’t make money,” O’Riordan explained. So the unions sat down with business and government to work out a new deal. They pledged labour peace and wage moderation in return for tax cuts.

Critics originally called the new strategy a race to the bottom. They were wrong. The government created what economists call an “expansionary fiscal contraction”, an awkward clump of words that describes what happens when a reduction in government activity stimulates, rather than retards, growth. Entrepreneurs and consumers suddenly had money to invest and spend. Workers are earning what once would have been unimaginable wages. Pay, in real terms, has risen faster than it did during the period of labour militancy when inflation and higher taxes ate up gains obtained by belligerent behaviour. Tax revenues have soared.

Critics also claim the boom is a result of regional development subsidies received when Ireland joined the European Union. Not wishing to acknowledge the benefits of tax-rate and spending cuts — which would be ideologically painful — these detractors have exaggerated the magnitude of the subsidies. Total transfers rose from just over 5 percent of GDP in 1986 to a peak of 7% in 1991. They have now fallen to about 4 percent, or roughly the level of the equalization payments Manitoba received last year. The subsidies are ending, and Ireland will soon become a net contributor to EU coffers. In bright contrast to Canada’s politicized regional subsidy imbroglio, Ireland’s outside money was carefully deployed to maximize growth.

Ireland’s high-quality education system has proven another source of strength. Many corporations have moved in to tap the island’s skilled workforce, which came into being as a result of the free tuition that had lured young people to universities during the period of chronically high unemployment. Notably, 60% of them had specialized in “hard” fields like business, engineering and science.

The policy implications for Canada and Manitoba seem obvious: eliminate low-quality public spending and cut corporate taxes to boost profits, create jobs and raise incomes. Such a strategy, of course, runs counter to many of our own policies of the last three decades. But many of our leaders remain wedded to an increasingly irrelevant 1970s philosophy of governance that looks to state spending as the mainspring of economic growth. That’s why we’re growing far below potential with our hodgepodge of high taxes, equalization transfers and infrastructure programs.

In the foreword to Fred McMahon’s highly readable book, Ireland’s former prime minister (and finance minister) John Bruton has written: “Achieving economic success is not simply a question of cutting taxes. It is a question of cutting the right taxes. The lesson of Irish economic history is that one should have a low and predictable rate of tax on the factors that generate growth. Companies and people at work generate growth. If government working with opposition can guarantee predictable economic conditions, it will be doing the best it possibly can to help create economic success.”

Understanding Ireland’s success story is one important key to consigning our slow-growth mode of economic management to the public policy museum.