Why the “working poor” makes for an inappropriate policy target

The publication by the CSO of the results from the Survey on Income and Living Conditions (SILC) always generates plenty of reaction.  One focus following the release of the 2017 results has been the “working poor” such as the headline of this piece.

The CSO provide income and poverty rates by principle economic status and the 2017 outcomes are summarised here:

As can be seen for the “at work” category the at-risk-of-poverty rate (equivalised disposable income below 60 per cent of the national median) is given as 5.4 per cent.  When we add in measures of deprivation, we find that 1.4 per cent of those with a principle economic status of “at work” live in households deemed to be in consistent poverty.  Given how low these levels are relative to other categories, the “at work” group seem a peculiar group to focus on.

Here we provide five reasons why targeting the at-work at-risk-of-poverty rate may be inappropriate.

1. Ireland already has the second-lowest AROP rate for employees in the EU15.
2. The measure is as much a function of household type, especially the presence of children, as it is labour market outcomes.
3. When it comes to labour market outcomes the most important factor is the amount of work with low AROP rates for households with high or very-high levels of work intensity.
4. The link between low pay at the level of the individual and low income at the level of the household is weak.
5. One-third of the “working poor” are self-employed who are excluded from most policy proposals.

1 Comparison across the EU15

Eurostat provide figures that allow us to compare the at-risk-of-poverty rates across the EU for people who are employed and one feature of this is how well Ireland does.  Here are the AROP rate for employees since 2009:

The 2017 figure for Ireland has not been provided to Eurostat yet but it seems likely that Ireland will have close to the second-lowest in-work at-risk-of-poverty rate for employees in the EU15.

2 The role of household type

The determination of whether of being at-risk-of-poverty is based on equivalised household income rather than than earnings of the employee on their own.  For example, you could have two employees both earning €30,000 – one could be deemed to be at-risk-of-poverty and one may not. How can that be if there are both earning the same amount? Type of households or, more particularly, children. 

If there are more people in the household then the available income has to be spread over more people thus reducing the equivalised, or per (weighted) person, income of the household. 

Here are the figures from Eurostat for the at-risk-of-poverty rates for people at work but living in two different types of households in Ireland:

• Household with two or more adults with dependent children
• Households with two or more adults without dependent children

It can be seen that, bar the peak crisis years of 2009 to 2011, the at-risk-of-poverty rates of workers in the households with children is about twice that of households without children.  It is not the labour market that drives in-work at-risk-of-poverty rates; it is household type.

3 The amount of work

This amount of work can be measured by household work-intensity: the amount of available time that someone is working.  If the working-age adults in a household have a high or very-high work intensity there is close to no chance of that household being at-risk-of poverty.

In-work, at-risk-of poverty rates are highest for those households with low work intensity.  These are households where members of working age worked between 20 per cent and 45 per cent of their total potential during the previous 12 months.  Households composed only of children, of students aged less then 25 and/or people aged 60 or more are completely excluded from the work-intensity indicator calculation.

Again, relative to the rest of the EU15, Irish households with low work intensity have at-risk-of-poverty rates well below those of other countries.

Over 60 per cent of Irish households who are classed as in-work and at-risk-of-poverty have either low or medium levels of work intensity.  It is not earnings that drives the in-work, at-risk-of-poverty rates; it is the amount of work.

Something, such as a refundable tax credit may have very little impact on at-risk-of-poverty households with children.  The at-risk-of-poverty threshold for a 2 adult plus 2 children household in 2017 was €29,000.  Even allowing for Child Benefit such a household close to that threshold which gets its income from work will have used almost all the available tax credits.  Making them refundable will make little difference to them.

The majority of households who are deemed be in-work and at-risk-of-poverty have low or medium work intensity.  Refundable tax credits in this instance would be a reflection of a low amount of work rather than low earnings.

4 Low pay and household income

The link between low pay and at-risk-of-poverty rates is weak.  Ireland has workers who are low paid but they are not in low-income households.

The chart would suggest that something around six per cent of low-pay employees (below a threshold of €12.20 a hour in the analysis shown) are in households who are at-risk-of-poverty. Or, in other words, 94 per cent of low-pay employees are in households who are not at-risk-of-poverty.  Indeed, over half of low-pay employees are in households in the top half of the income distribution.  There are almost as many low-pay employees in households in the top decile as there are in the bottom decile.

Policies, such as refundable tax credits, that target the low paid seem likely to make overall inequality and at-risk-of-poverty rates worse as very little of the benefit would accrue to those at the bottom of the income distribution.  It is likely that part-time second earners would appreciate it but in most cases these already come from middle- to high-income households.

It is also not clear how a refundable tax credit would work in the case of the self-employed. It was noted at the press briefing for the SILC publication that around one-third of those deemed to be in-work and at-risk-of-poverty are self-employed. Refundable personal and PAYE tax credits would mean that one-third of the target group is excluded. And a large share of the resources used would go to people outside the target group – the low-paid in high-income households.

Saying that the “working poor” should not be a policy target doesn’t mean we shouldn’t have policies that try to increase incomes. We should. But using the in-work at-risk-of-poverty rate as a benchmark for either the justification of certain policies or in judging the success of polices may not be appropriate.

We conclude with a comparison we have made before:

For all levels of household work intensity Ireland has at-risk-of-poverty rates that are lower than Sweden’s, and significantly so in some cases, e.g. medium and low. Yet, the overall at-risk-of-poverty rates of the countries are very similar.

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Corporation Tax and the Balance of Payments

A previous post looked at how the current account of the balance of payments can be an early-warning indicator of an economy “living beyond its means”.  This is particularly so if the unsustainable income arises via credit expansion.  The post concluded, though, by saying that a red flag might not always go up for the balance of payments if the unsustainable income flows through it.

Getting a handle on Ireland’s underlying balance of payments position isn’t straightforward.  The CSO have published a modified current account that attempts to strip out many of the distortions, mainly from MNCs, that pollute the headline position. 

For our purposes here we are interested in the end result rather than the modifications made.  The most recent version of the modified current account is available for the period 2007 to 2017 and here it is as a proportion of GNI*.

As we now now know there was a significant deterioration in the current account up to 2008.  Since then, like many economic indicators for Ireland, there has been a significant turnaround.

In the early years of the crisis one factor that contributed to the improvement in the current account was the reduction in imports.  We were spending a large amount of the unsustainable, credit-fueled income on imported goods.  There was a reason champagne was removed from the Consumer Price Index in 2011 (see Table 1.1).

In recent years, food exports have boosted the underlying position, most notably dairy products for the past two years or so.  On the income side, the amount of outbound interest on the government’s debt has been declining.

There is some level of uncertainty about all of these but concerns over volatility do not necessarily translate into concerns of sustainability.  One item affecting the current account that generate such concerns are Ireland’s surging Corporation Tax revenues.

And this is what we see if we put Ireland’s revenues in the context of the EU15.

It wouldn’t be usual to link tax revenues to the current account.  In general, tax revenues are raised from activities and entities in the domestic economy while the current account reflects the cross-border flow of trade, income and transfers.  But Ireland is unusual for the amount of Corporation Tax that comes from foreign-owned companies and unique for the amount that comes from foreign companies which are US-owned companies.

The following table gives the domestic company/foreign company split for the gross operating surplus generated in the business economies of the EU15.  Gross operating surplus (GOS) is a relatively useful proxy of the corporate income tax base but some caution is warranted because it is before the deduction of depreciation.  For this, and a few other reasons, we will use data from 2014 rather than a more recent year.

The foreign share in GOS is highest in Ireland (69.4 per cent).  Luxembourg is the only other country to have more than half of GOS generated by foreign-controlled companies.  The median for the EU15 is 24 per cent.

And it is for US companies that Ireland really stands out.  After Ireland’s highest share at 56.8 per cent, next is again Luxembourg but this time the gap is all the way to 14.7 per cent.  The median for the share of GOS generated by US-owned companies in the EU15 is 3.6 per cent.  It was only in the sentence before last but Ireland is 56.8 per cent (or at least was in 2014; it is likely higher now).

The issue is that the surge in Corporation Tax is coming through the current account. The current account looks fine.  The deficits built up in the previous boom have been eliminated and there have been underlying surpluses for the past few years.  This suggests we could increase our consumption and investment spending from within our existing resources.

However, we need to be mindful of the impact Corporation Tax from US MNCs has on how we measure those existing resources using the current account.  These receipts are somewhat of a transfer to Ireland that are boosting the current account – could we compare them to the EU receipts of the late 1980s and early 1990s?

Of course, we don’t know what will happen Corporation Tax revenues over the coming years and it is much better to be receiving €10 billion of Corporation Tax than not receiving it. Our point here is that looking for the current account to provide a red flag for “living beyond our means” - as the previous post did – may not be wholly appropriate.  The current account will only reflect any unsustainability in these Corporation Tax receipts when it is too late, i.e. when they are gone.  

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Does one-third of Income Tax and PRSI come from IDA client firms?

The IDA summary of their 2018 results includes the following:

IDA Ireland’s clients are also significant employers; with average salaries at €66,000 in 2017 they are consistently above national averages (€46,402). As a result foreign MNCs account for one third of total Income tax, USC and Employers PRSI paid in the state.

Does one-third of Income Tax, USC and PRSI come from IDA client firms? No.  Ireland’s national income is heavily influence by the contribution of foreign-owned MNCs but that does not extend to them being the source of one-third of income tax revenues.

According to the Revenue Commissioners net receipts in 2017 from Income Tax/USC and PRSI came to €28.7 billion in 2016 and €30.2 billion in 2017.  It is easy to see that the IDA claim is incorrect from this summary table.

The numbers are impressive but unless almost all the €11.7 billion of payroll from these companies in 2017 went to tax and PRSI there is no way they can contribute one-third from a total of €30.2 billion.

The footnotes to the table state that the IDA’s claim is “based on Revenue analysis of foreign owned multinational employer returns for 2016 of income tax, USC and employer PRSI excluding wholesale and retail trade.”  They are referring to this paper by McCarthy and McGuinness which includes the following figures:

We can see that payroll Income Tax, USC and Employer’s PRSI from foreign-owned MNCs came to €6.7 billion in 2016.  This is for all foreign-owned MNCs not just those who are IDA clients.  The IDA note that they exclude firms in the wholesale and retail trades (who won’t be their clients) but are probably still left with a figure that is around €5 billion (which is 45% of the payroll total for 2016 from the first table).

Now, this may be nearly one-third of the €16.7 billion shown for Income Tax, USC and PRSI shown in the table but this is only the amount that arises from companies.  It excludes the self-employed, the public sector and non-labour related sources of income taxes. 

IDA-client firms may be the source of one-third of a particular sub-set of income taxes but that is not what they have claimed. It looks like the answer may be around one-sixth (c.€5 billion out of €30 billion) which is, of itself, pretty significant and substantial.  But with 80 per cent of Corporation Tax coming from foreign-owned MNCs we have enough evidence of concentration risks without the need to be exaggerating their contribution to other tax headings.

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“Living away beyond our means”

The concept of an economy living beyond its means does not have a uniform definition.  However, there are outturns in the national accounts that can reflect it.  Once such event is when Net National Saving turns negative.

Net National Saving is a measure which shows the difference between national income and the amount necessary to fund current expenditure on consumption and the investment needed just to maintain the capital stock. This is spending that does not bring long-term living standard benefits and is primarily to maintain living standards as they are now.

[There are a number of things that could be considered exceptions to this, one of which is current expenditure on education.  Although counted as consumption of goods and services it could be argued that this current expenditure leads to long-term benefits but for our purposes here we will treat it as current spending as we are looking to see whether we can afford it – the main cost being included being teacher salaries which is government consumption.] 

If national income is not sufficient to fund consumption of goods and services and cover depreciation of the capital stock an economy could be said to be living beyond its means.  There have been two instances in the past 50 years when this has happened in Ireland: 1980-81 and 2009-2012 (n.b. the series break in 1995).

In both instances significant adjustment was required.  The differing pace of that adjustment can be seen through the improvement in the net national saving ratio after coming out of negative territory; gradual and prolonged in the 1980s; steep and rapid in the recent instance.  Net National Savings was the starting point for a recent presentation I gave on Ireland’s national income (slides, text).

Should we be looking at Net National Saving as a sign of macroeconomic imbalances? No. By the time this particular canary has fallen off its perch the damage has been done.  Ireland’s problems were in train well before Net National Saving turned negative in both 1980 and 2009.  Net National Saving might be useful if you want to go on television to talk about “living away beyond our means” but a red flag is needed to try and help prevent things getting as far as that in the first place.

That red flag might be the current account of the balance of payments.

It can be seen that the two instances of Net National Saving turning negative (the shaded regions) were preceded by significant deteriorations of the current account of the balance of payments.  Prior to the 1980 the current account deteriorated from a relatively small deficit of 1.6 per cent of Gross National Income in 1975 to a deficit of 6.4 per cent of GNI in 1978 and to one of 12.2 per cent in 1979. 

Before 2009, the modified current account deteriorated from a surplus of around 1 per cent of modified gross national income in 2003 to a deficit of 5.0 per cent of GNI* in 2006 and further again to a deficit of 7.5 per cent of GNI* in 2008.

Net National Saving doesn’t signal the problem as imbalances are building up because the unsustainable income isn’t picked up by it until the tide goes out.  As long as some sector can inject the money into the circular flow it will appear as income in the national accounts.  Credit can be the source of this injection.  The government did the borrowing in the late 1970s with the private sector doing so in the run-up to 2008.  And the spending driven by this increase in debt showed up in the deterioration of the current account – or at least it does now.

One major issue with the current account in the run up to 2008 was that the scale of the deterioration was not fully identified at the time.  Here are the first estimates of the changes in the current account from the publication archive and the latest estimates for 2000 to 2008:

There are likely a range of measurement and methodological reasons for the differences but it can be clearly seen that from 2004 to 2007 the latest estimate shows significantly larger deteriorations than the real time data.  And if we look back at the first full-year estimates for 2006 published in March 2007, which did show a current account deficit, but the first sentence of the release points to the “continuing the trend of reducing deficits during 2006.”

When it comes to assessing imbalances both measurement and interpretation matter.  There are plenty of reasons why the CSO’s modified current account balance is important.  It looks fine at the moment with a surplus of just over 1 per cent of GNI* showing for 2017.

But it is not the be all and end all.  For example, there would be no red flag from the current account if the unsustainable income that makes net national saving appear comfortably positive also shows up current account of the balance of payments.  Corporation Tax receipts from US MNCs could fit that bill. The link between CT receipts and the current account is something we may come back to but, for the moment at least, the scale of the potential imbalances seem much smaller than those of the late 1970s and mid-2000s.

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