- International Monetary Fund
- Published Date:
- March 1986
Ireland recorded positive growth rates in every year from 1972 to 1982. The growth path was irregular, however, ranging between 2 percent and 8 percent a year, reflecting the vulnerability of the highly open economy to external influences. Foreign trade is equivalent to approximately one half of GDP. Although economic development was assigned the highest priority and fiscal policy was instrumental in stimulating economic activity, unemployment remained very high by international standards throughout the period. Registered unemployment rose from 6½ percent of the estimated total labor force at the beginning of the period to 8 percent in 1980, and even more steeply to over 12 percent in 1982, partly as a result of a switch toward restrictive economic policies to counteract growing imbalances in the economy. Over the period, the task of containing unemployment was rendered more difficult by a rapidly growing labor force.
Inflation has remained high, and the impact of the first oil price explosion was especially marked. Consumer prices rose from 8½ percent in 1972 to 21 percent in 1975. The inflation rate abated to 7½ percent in 1978, but in subsequent years, consumer prices surged upward, increasing by over 20 percent in 1981 and 17 percent in 1982. Factors contributing to the persistent price rises include the second oil price shock in 1978, depreciation of the currency against the pound sterling, increase in indirect taxation, and large increases in wage rates, especially in 1980. The external current account was in deficit throughout the period, ranging between 1½ percent and 15 percent of GDP; the largest deficits were registered during the three-year period to 1981. The policy response to adverse external influences on the economy and intensive fiscal measures to foster economic development resulted in large and continuous fiscal deficits over the period covered.
Ireland’s central government sector expanded more sharply over the period than in any of the smaller industrial countries. As a ratio of GDP, total expenditure rose from 36½ percent to almost 58 percent between 1972 and 1982. This rise accelerated in the 1972–75 period but stabilized during the following two years when the policy stance shifted in a less expansionary direction to phase out the current deficit. From 1977, when a new government resumed an expansionary policy to improve the employment situation, the expenditure/GDP ratio was on the rise, especially in 1980 when it grew by 5 percentage points. All expenditure categories, as classified by economic type, rose at a faster pace than GDP, but the relative significance of each category in total expenditure changed somewhat. Expenditure on goods and services declined from 20 percent to 16½ percent of the total, and wages and salaries, which account for more than two thirds of expenditure in this category, underwent a similar decline. However, growing public employment, stemming in part from the unemployment relief policy, led to an appreciable rise in the share of wages and salaries in GDP over the period. Interest payments on government debt rose as a share of total expenditure from 9½ percent to 15½ percent between 1972 and 1982. However, inflation had reduced the budgetary burden by eroding the stock of outstanding government debt in real terms.
Over one half of total expenditure is in the form of subsidies and other current transfers; their share in the total rose from 51 percent to 53 percent over the period, after having exceeded 54 percent in 1975. Although this increase is less dramatic than in many other countries, it nonetheless represents a substantial rise in relation to GDP. Demographic factors, including a reversal of a traditional net emigration pattern, unemployment and other social security benefits, as well as industrial support, contributed to the increase. Capital expenditure averaged almost 9 percent of total expenditure over the period, with small deviations in individual years. Net lending rose from 9 percent to 16 percent of the total between 1972 and 1974 and has since ranged between 7 percent and 9½ percent. The last two categories reflect in large measure the development effort, and, taken together, their share in GDP rose over the period.
Between 1972 and 1982, total revenue rose as a proportion of GDP from 31 percent to 42½ percent, which is substantially less than expenditure growth. The share of income taxes in total revenue increased steadily from 28 percent to 31 percent. Despite partial adjustments for inflation and successive tax relief measures to stimulate private investment, the impact of the progressive rate structure of the personal income tax more than outweighed the revenue loss, A special feature of the income tax system is the heavy concentration of the tax burden on wage and salary earners and the much lighter burden on farmers. The share of social security contributions rose from 9 percent to 13½ percent, which broadly matches the financing needs of the relevant social insurance schemes that are intended to be self-financing.
|Real GDP, percentage changes||6.4||4.7||4.3||3.7||1.4||8.2||7.2||2.8||3.3||2.9||1.9|
|Rate of unemployment||6.4||5.9||5.9||7.8||9.3||9.1||8.3||7.4||8.2||10.1||12.2|
|Consumer prices, percentage changes||8.7||11.4||17.0||20.9||18.0||13.6||7.6||13.3||18.2||20.4||17.1|
|External current account balance as percentage of GDP||–2.2||–3.5||–9.9||–1.5||–5.3||–5.5||–6.9||–13.6||–12.0||–15.1||–10.9|
|(as a percentage of GDP)||31.1||31.1||32.0||31.9||35.3||34.3||33.8||35.0||38.6||40.0||42.6|
|Percentages of total revenue||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0|
|Social security contributions||8.9||9.6||11.5||13.6||13.2||13.2||12.9||12.9||12.8||12.7||13.3|
|Payroll (manpower) taxes-||—||—||—||—||—||—||—||—||0.2||0.1||0.7|
|Taxes on goods and services||32.5||33.0||31.1||29.9||30.1||30.0||29.8||26.6||24.8||23.9||25.6|
|Taxes on international trade||16.5||15.9||15.3||13.8||14.2||12.0||11.4||11.4||12.8||14.9||13.2|
|Nontax revenue and grants||10.8||9.4||10.3||10.5||10.4||11.6||12.2||15.0||15.0||13.9||14.6|
|(as a percentage of GDP)||36.7||37.9||43.9||44.3||45.4||43.7||45.2||47.1||52.0||55.0||57.8|
|Percentages of total expenditure||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0||100.0|
|Expenditure on goods and services||20.1||19.5||18.2||19.6||18.7||18.2||17.5||17.8||17.3||17.5||16.6|
|Wages and salaries||14.0||13.6||12.4||13.9||13.2||12.6||12.1||12.4||12.0||12.4||11.4|
|Subsidies and other current transfers||51.2||50.1||48.4||54.3||53.7||53.5||53.6||53.2||52.8||51.8||52.9|
|Social security funds||10.1||9.9||9.7||11.6||11.7||11.3||10.6||9.9||10.5||11.1||12.0|
|Lending minus repayments||8.8||11.5||15.9||8.4||9.5||8.6||7.8||7.1||7.8||8.5||6.8|
|(as a percentage of GDP)||–5.6||–6.8||–11.9||–12.4||–10.2||–9.5||–11.5||–12.1||–13.3||–15.0||–15.2|
|General government expenditure and net lending/GDP||39.8||41.9||49.7||50.5||51.2||49.3||49.5||50.8||56.2||59.2||61.7|
|Central government debt outstanding/GDP||52.3||59.7||65.0||73.4||79.2||77.9||82.1||89.5||91.4||99.3||108.7|
Domestic taxes on goods and services declined as a proportion of total revenue from 32½ percent in 1972 to 25½ percent in 1982 and did not keep pace with nominal GDP growth. Over half the revenue in this category is derived from a value-added tax (VAT) that was introduced in 1973 with Ireland’s membership in the EC. Excise taxes, which account for most of the other revenue in this category, explain the slow overall growth and reflect the authorities’ reluctance to raise the mostly specific rates in view of the resulting inflationary impact. Substantial increases in excises were implemented, however, toward the end of the period and in the VAT in 1982. Taxes on international trade declined from 16½ percent to 13 percent of total revenue over the period as customs duties were lowered in accordance with EC membership. Other tax revenue, mainly property taxes, accounted for 2 percent to 3 percent of total revenue. Nontax revenue, on the other hand, rose from just under 11 percent of total revenue and grants in 1972 to 14½ percent in 1982, reflecting mainly increased property income.
The Fiscal Balance and ITS Financing
As noted earlier, the central government finances were in deficit throughout the period. The deficit widened rapidly from 5½ percent to 12½ percent of GDP in the 1972–75 period when a strongly expansionary fiscal policy attempted to moderate the effects of the international recession on the economy. In response to mounting concern over rapidly growing expenditure and the monetary implications of the large deficits, the policy stance was shifted in 1976 to a less expansionary direction and the deficit was reduced to about 10 percent of GDP in that and the following year. A new government that took office in 1977 resumed an expansionary stance, however, in view of the deteriorating employment situation, and the deficit widened to 11½ percent in 1978. It continued to rise for the rest of the period and reached over 15 percent of GDP in 1982. Information on deficit financing is not available from the basic statistical source (GFS), but there is evidence that in the early years of the period, domestic financing—the banking system and the nonbank private sector—covered four fifths of the borrowing requirement; the rest was financed abroad. The domestic capital market is small in relation to the size of the deficit, however, and in subsequent years over half the financing requirement was met by external borrowing. In 1981 and 1982, for example, three fourths and three fifths, respectively, of the exchequer borrowing requirement was met by external financing. The large and persistent fiscal deficits have implied mounting government debt. Expressed as a percentage of GDP, this debt expanded from 52½ percent to 108½ percent between 1972 and 1982, and a sharp expansion is foreseen in the near future as well as in the servicing of the debt. In 1982 the foreign component was 42 percent of total debt, having risen from 9 percent in 1972.
The framework. The central government budget is the dominant instrument of fiscal policy in Ireland. In 1982 the ratio of public expenditure to GDP was almost 62 percent, of which the Central Government accounted for over nine tenths, if transfers to other levels of government are included. Such transfers in turn amounted to almost three fourths of total local government revenue and grants in that year. This ratio has since risen, making local governments increasingly dependent on the Central Government for their revenue.
In the central government budget a clear distinction is made between current and capital expenditure and revenue; traditionally, the basic operational rule of fiscal policy was to balance current revenue and expenditure in each fiscal year. When deficits on current account threatened to emerge, the authorities took swift corrective action—often by introducing supplementary budgets. This approach was motivated by the need to avoid pre-empting resources to finance public investment as well as to contain inflation and limit the external current account deficit. Later events of both domestic and external origin caused the authorities to depart from the principle of balancing the current budget, and since 1972, substantial current budget deficits have emerged.
In 1969, in an effort to better control the growth of public expenditure and improve resource allocation, a system of program budgeting was introduced. The system was to be gradually extended to all government departments by fiscal year 1975/76. However, by that time, experience with this innovation, including difficulties with conceptual aspects, systematic ranking of priorities, and the size of the administrative machinery required,1 had led the authorities to abandon the idea, and no budget documents in this form were published. A new approach to budgeting was introduced in 1978. This involved an annual planning process by which expenditure priorities and policy options were set out in the context of medium-term growth potential and economic and social policy issues. This form of national economic planning was to provide a comprehensive framework for the allocation of funds in the annual budget. The underlying idea was to achieve a sustained reduction in unemployment, and for that purpose an ambitious 7 percent annual GNP growth target was set. In the event, the second oil crisis grossly upset basic assumptions of the plan, and it has not been worked out in this particular form since 1979.
Aims and measures. Promotion of economic growth through industrial development and reduction of unemployment has been the overriding goal of fiscal policy throughout the period. Another policy objective was to preserve living standards and redistribute income in favor of lower income groups by tax reductions and ambitious social welfare programs. Toward the end of the period, faced with growing internal and external imbalances, the Government, in an attempt to contain domestic cost increases, adopted an incomes policy approach to prevent excessive wage settlements; however, this approach met with little success and was subsequently abandoned.
Other prominent measures aimed at promoting industrial development and sustaining employment included direct capital outlays and investment loans. In the early 1970s, the public capital program accounted for approximately one half of gross domestic fixed capital formation, and by 1982 this ratio had risen to 60 percent. Among other measures introduced for this purpose were various tax allowances to stimulate private investment. In particular, as part of the authorities’ industrial policy, liberal tax advantages were offered for export-oriented investments in the manufacturing sector. Thus, in 1981 the standard rate of corporate tax for manufacturing firms was fixed at 10 percent for the period to 2000. Also, the Central Government has provided funds for employment-creation schemes and encouraged capital expenditure by semipublic bodies to sustain employment. In addition, temporary employment premiums were offered to employers recruiting from the unemployed. Capital expenditure has at times been used as a countercyclical instrument; however, its effectiveness has been limited by the employment situation and the emphasis on economic development, and expenditure control has taken the form of changes in the rate of growth of capital outlays in accordance with cyclical conditions, rather than of direct reductions.
The policy reaction to the first oil price crisis and the ensuing world recession was to preserve living standards and maintain employment. The public capital program continued to operate at a high level, and various social benefits were increased in real terms and extended, including reductions in the qualifying age for pensions and extensions of pay-related unemployment and sickness benefits. Personal income and company tax concessions were also granted and items were exempted from the value-added tax. The expansionary fiscal policy continued as the recession deepened. However, by 1976 concern was growing over the rapid expansion of government expenditure and the monetary impact of the widening fiscal deficit. The Government announced in that year that it intended to phase out the current budget deficit over a three-year period; to that end, it introduced several measures, including a sharp increase in indirect taxation. Similar announcements were repeated in subsequent years, but without material success, especially after 1977 when the new government that came into office in that year adopted a highly expansionary fiscal policy stance within the framework of the national economic plan referred to above. The fiscal stimulus generated by this plan was intended to be temporary, on the assumption that the private sector would react to achieve self-sustaining growth. The Government stated that containment of domestic cost increases in the context of national pay agreements was preferable to deflationary fiscal and monetary policies. This approach found expression in an agreement reached with the social partners in 1979 of a “national understanding for economic and social development.” The agreement marked a departure from the traditional wage bargaining process in Ireland, in that it involved the social partners in the formulation of economic and social policy. The agreement included new tax concessions, increased social welfare payments, and higher wage increases for public employees. Not only did this approach further weaken the fiscal position, but it did not achieve its main objective of containing domestic wage costs. It was abandoned in 1981.
Since mid-1981, the stance of fiscal policy has tightened, as a widening fiscal deficit, associated with a sharp increase in the current external deficit, won growing public and political acceptance of the need to reduce public borrowing. The brunt of the fiscal adjustment effort has so far fallen on taxation rather than expenditure. The authorities have reiterated their intention of continuing their efforts on the fiscal front, with a view to eliminating the current budget deficit over a five-year period.
Overview and implications for future policy. During the 1972–80 period, expansionary fiscal policies characterized financial developments in Ireland. The justification for these policies is, in part, the perceived need for public sector initiative to stimulate overall economic growth and employment. Economic progress and the working of an international demonstration effect have at the same time generated increased demands for improved social security. In the wake of the first oil crisis, the official policy was to stimulate consumption; by that time the principle of current budget balancing had been dropped. Both policy decisions tended to weaken effective financial constraint on the growth of social expenditure, and entitlement programs were initiated that added to the inflexibility in public expenditure and constituted a severe drain on the budget. Unstable external influences have undermined attempts to set growth targets that, inter alia, would serve as a framework within which demands for public services could be met. Similarly, the setting of consistent policy objectives has been complicated by the different political priorities of governments. These factors exerted strong upward pressure on government expenditure, while revenue growth was hampered by a narrow income tax base, specific rather than ad valorem excise duties, and a depressed economy. On the whole, while fiscal policy has been countercyclical in recessions, it has tended to be procyclical during periods of expansion.2 As a result, fiscal deficits have been experienced on a rising scale, with wide economic implications, not least for the external position and monetary policy whose stance was for the major part of the period largely determined by fiscal developments. Debt accumulation proceeded at a fast pace, and the size of government debt in relation to GDP is the largest among industrial countries.
While the medium-term objective of eliminating the current budget deficit poses a dilemma for fiscal policy because of the unemployment problem, the growing structural element in the fiscal deficit and the long-run implications for the development of the economy make this medium-term action highly desirable. In particular, debt servicing will constitute an increasing claim on budgetary resources in coming years and threatens to make the deficit and further debt accumulation self-perpetuating. Recent tax increases have narrowed the scope for further action on that front, so that the announced fiscal adjustment will have to concentrate on the expenditure side. The past record strongly suggests, however, that a satisfactory result would have to be associated with a major change in policy priorities and political attitudes to public spending.3
Maurice F. Doyle, “Management of the Public Finances in Ireland Since 1961,” Public Budgeting and Finance, Vol. 3 (Summer 1983), p. 75.
Peter Bacon, et.al., The Irish Economy: Policy and Performance, 1972–1981 (Dublin: Economic and Social Research Institute, 1982), p. 58.
Since mid-1981, fiscal policy has remained less expansionary and the exchequer borrowing requirement has been reduced. This restrictive posture was maintained despite three changes of government over a period of 18 months. The announced government objective of eliminating the current budget deficit by 1987 has been superseded by events. In early 1984, the authorities indicated their intention to reduce the current budget deficit and the exchequer borrowing requirement over the next three years in order to slow down the growth of public debt with a view to stabilizing the ratio of interest payments to both GNP and tax revenue.