Ireland—Selected Issues

This Selected Issues paper analyzes budgetary developments in Ireland during the 1990s. The paper highlights that Irish fiscal policy has been central to the social consensus on macroeconomic policies. The economic buoyancy has reinforced this cycle by facilitating the tax cuts and increases in social spending that have been instrumental to the social consensus on policies, while also helping to keep deficits low. The paper also discusses the participation of Ireland in the European Monetary Union.

Abstract

This Selected Issues paper analyzes budgetary developments in Ireland during the 1990s. The paper highlights that Irish fiscal policy has been central to the social consensus on macroeconomic policies. The economic buoyancy has reinforced this cycle by facilitating the tax cuts and increases in social spending that have been instrumental to the social consensus on policies, while also helping to keep deficits low. The paper also discusses the participation of Ireland in the European Monetary Union.

Ireland: Basic Data

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Sources: Central Statistical Office, Statistical Bulletin; and data provided by Irish authorities.

Preliminary.

I. Recent Budgetary Developments and Prospects1

A. Introduction

1. Irish fiscal policy is often cited with justification as an example of how—through confidence effects and virtuous debt dynamics—fiscal contraction can boost output. The tight public spending controls introduced in 1987 to bring the Irish economy back from the brink of a ruinous debt spiral engendered declining interest rates and set the stage for rapid economic growth. At the same time, a social consensus was forged on an economic strategy whose main elements include, in addition to fiscal restraint, a monetary policy aimed at preserving price stability, outward looking economic policies oriented toward benefiting from forces of globalization and technological change, and deeper integration into the European Union (EU). Once a favorable macroeconomic environment was established, the other sources of Irish economic strength—a rapidly growing and increasingly skilled workforce, and the attraction of foreign direct investment in dynamic, export-oriented sectors—flourished, contributing to average output growth of 5 percent annually since 1987. This strategy has borne fruit in the form of rapid employment creation, rising real disposable incomes, convergence of Irish living standards toward those of the EU, and the growing prominence of a highly productive and dynamic modern sector in Irish output.

2. Irish fiscal policy has been central to the social consensus on macroeconomic policies. Budgetary restraint, rapid economic growth, and favorable debt dynamics have generated a virtuous cycle that has facilitated a rapid decline in the debt ratio. Economic buoyancy has reinforced this cycle by facilitating the tax cuts and increases in social spending that have been instrumental to the social consensus on policies, while also helping to keep deficits low. As a result, the Exchequer borrowing requirement (EBR) has averaged about 2 percent of GNP during 1988-96, and the Exchequer debt ratio has Men from 125 percent of GNP at end-1987 to less than 81 percent in 1996 (Chart 1 and Table 1).

CHART 1.
CHART 1.

IRELAND GOVERNMENT FINANCE

Citation: IMF Staff Country Reports 1997, 077; 10.5089/9781451818697.002.A001

Sources: Department of Finance, Economic Statistics.1/ Budgeted.2/ Maastricht basis.
Table 1.

Ireland: Fiscal Indicators

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Sources: Budgets; Quarterly Bulletin; information provided by the Irish authorities; and staff estimates.

In percent of potential GDP or GNP.

Maastricht bases, based on debt and GDP calculated using 1979 ESA convention, (based on 1993 SNA) will become effective for EU reporting purpose in 1999. Technical changes to debt and GDP calculation will add approximately 7 percent to the debt ratio bringing its 1999 levels to 70 percent. However the downward trend will be unaffected.

See footnote 2/.

3. This performance has supported the goal of being among the first to enter into EMU. Ireland appears set to observe the Maastricht fiscal convergence criteria. The 1996 fiscal outturn (a general government deficit of 0.9 percent of GDP) was the eighth in succession to fall comfortably within the Maastricht 3 percent reference value. During 1994-96, the general government deficit averaged 1½ percent of GDP, a performance bettered by only one other EU member. At the same time, the general government debt ratio has plunged by over 20 percentage points (from 95 percent of GDP at end-1993 to 72 percent at end-1996). The medium-term fiscal targets adopted for 1997-99 aim at limiting the general government deficit to 1½ percent of GDP and further reducing the debt burden. On current policies, the debt ratio appears set to fall below the Maastricht reference value of 60 percent of GDP early in the next century. The new government which was elected in June has indicated that if current conditions continue, it aims to eliminate Exchequer borrowing over the next two to three years.

4. Despite this impressive track record, fiscal challenges remain. First, the growth of current spending remains an issue. Expenditure ceilings announced in the past have not been observed, although they have succeeded in slowing the pace of spending growth. Tighter controls on the costs of social services and the public sector wage bill would support current spending restraint, together with ongoing efforts to improve expenditure management. Second, the procyclical cast of fiscal policy in recent years has left the budget somewhat exposed to any substantial reduction in the pace of economic growth. Particularly noteworthy in this regard are the terms of the EU Growth and Stability Pact, which envisage that fiscal deficits will be kept below 3 percent of GDP in all but exceptional circumstances.2 Such exceptional circumstances are defined as a decline in output rather than a reduction in the pace of growth. The terms of the Pact thus impose tighter discipline on fast-growing countries such as Ireland which can experience a significant fall in the pace of growth without suffering a decline in the level of output.3 Finally, the rapid convergence of Irish living standards toward those of the EU raises the possibility that EU structural and cohesion fund transfers might diminish after the current program expires in 1999.

1996 fiscal outturn

5. A surge in revenues generated by strong economic growth in output and employment helped hold the EBR to 1.2 percent of GNP in 1996, compared with a budget target of 2 percent and the 1995 outturn of 1.9 percent, notwithstanding some slippage on current spending growth (Table 2). The current budget balance recorded a surplus of 0.8 percent of GNP, and the primary surplus was 4.6 percent. Reflecting these developments and the strength of the Irish pound, Exchequer debt fell in absolute terms for the first time in almost 40 years; as a share of GNP, it declined from 89.2 percent in 1995 to 81.8 percent in 1996.

Table 2.

The 1996 Budget

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Source: Data provided by the Irish authorities.

6. Fiscal performance measured using Maastricht conventions was equally impressive: the 1996 deficit was the eighth in succession to fall well within the 3 percent Maastricht reference value. The general government deficit was limited to 0.9 percent of GDP in 1996, compared with a budget target of 2.6 percent of GDP and the 1995 deficit of 1.9 percent of GDP. The general government debt ratio fell by 9 percentage points of GDP to 72.4 percent.

7. Revenue performance surpassed budget targets by a wide margin, with virtually all tax heads buoyed in the wake of rapid output growth. Current revenue rose by 11 percent in 1996, compared with a budgeted increase of 6.6 percent. Tax revenue (up 10½ percent compared with a budget target of 6½ percent) was boosted well above budget targets by a surge in corporation tax revenue (which exceeded the budget target by 10½ percent), reflecting a rebound in profitability. Where shortfalls in the 1996 tax take occurred, they reflected technical rather than economic factors: customs duties fell below target due to tariff reductions, and VAT receipts lagged owing to the elimination of the advance payment system. Which effectively resulted in only 11 months of VAT payments in 1996 (but will add an additional month of cash receipts in 1997).

8. Current expenditure has exceeded announced ceilings in recent years, while continuing to decline as a share of output.4 In 1996, current expenditure growth exceeded budget targets (increasing by 5.3 percent compared with a budgeted increase of 4 percent), despite lower-than-anticipated debt service costs, while falling by almost a full percentage point of GNP to 34.6 percent of GNP in 1996. The increase in gross real non-interest current expenditure was almost double the authorities’ announced 2 percent ceiling: health expenditure exceeded its budgetary allocation (by IR£37 million) due to pressure on demand-driven schemes, and an overrun on agricultural spending arose from EU beef tribunal fines (IR£70 million) and the costs of policing the border and other measures (IR£10 million) to combat “mad cow” disease.

9. Exchequer borrowing for capital purposes (2 percent of GNP) exceeded the budget allocation (1.8 percent of GNP), with a shortfall in capital resources and higher-than-budgeted capital each contributing about equally to the excess.

1997 budget

The 1997 budget envisages a widening deficit, despite continued strong growth, as a result of substantial tax concessions and additional outlays for social services associated with the new three-year centralized wage agreement—Partnership 2000 for Inclusion, Employment and Competitiveness (P2000). The EBR is budgeted to increase to 1.6 percent of GNP (from 1.2 percent in 1996) and the current budget surplus is slated to fall from 0.8 percent in 1996 to ½ percent (Table 3). The 1997 budget is the first ever to target a current surplus, although such surpluses have been achieved in the past, notably in 1994 and 1996.

Table 3.

The 1997 Budget

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Source: Data provided by the Irish authorities.

10. On Maastricht conventions, the general government deficit is budgeted to increase to 1.5 percent of GDP in 1997, from 0.9 percent of GDP in 1996. The primary balance is set to decline from 3.8 percent of GDP in 1996 to 3.3 percent in 1997, and the general government debt ratio to fall to 69 percent.

11. Total current spending is budgeted to increase by about 5 percent in 1997, with 40 percent of the increase accounted for by a wage bill (budgeted to grow by 7.6 percent) swelled by the backloading of increases under the previous centralized wage agreement, the increases envisaged under P2000, and additional public employment to improve public health services and strengthen crime prevention. Non-pay increases in current public spending are dominated by additional social welfare expenditure, including the carryover costs of policies introduced in the 1996 budget and those newly introduced in 1997—including a general increase in the rates of social welfare payments of 4-5 percent—under the P2000 centralized wage agreement (discussed further below).

12. Total current revenue is slated to increase by almost 5 percent, notwithstanding a sharp fall in non-tax revenue reflecting a return to a less exceptional central bank surplus and the one-off nature of the EU budget refund received in 1996. Tax revenue is budgeted to increase by almost 6 percent, reflecting a sharp increase in VAT collections (attributable to continued strong growth and the recovery of the cash flow lost in 1996 with the change in the timing of VAT payments) and a moderation in the growth of the corporation tax take following the surge in 1996. In addition, the 1997 budget included a number of measures aimed at increasing disposable incomes and business incentives in line with the P2000 agreement (see below). These measures included increased personal allowances, exemption limits and income thresholds, widening the standard tax band, reducing the employee social insurance contribution rate (by 1 percent), and cutting the standard tax rate by 1 percent (to 26 percent). The standard corporation tax rate was decreased by 2 percent (to 36 percent), and the reduced rate applying to the first IR£50,000 was lowered by a similar amount (to 28 percent).

13. Exchequer borrowing for capital purposes is budgeted to remain at about 2 percent of GNP, with capital spending and resources slated to remain at about 4 percent of GNP and 2 percent of GNP, respectively.

14. On both the Exchequer and general government measures, the 1997 budget results in an increase in the structural deficit (by ½ percentage point of potential GDP in the case of the general government deficit). A procyclical budget stance has been a recurrent feature of Irish fiscal policy in the 1990s. In the early 1990s, when the Irish pace of growth slowed with the international recession, fiscal policy was relatively restrictive, and the structural deficit declined (by almost 2 percentage points of potential output during 1991-93). The sharp upswing experienced after 1993 was accompanied by relative fiscal laxity through 199S (during which time the earlier fall in the structural fiscal deficit was reversed). In 1996, the surge in tax revenue that contributed to a much better-than-budgeted fiscal outturn also resulted in a decline in the structural deficit (by almost a full percentage point of potential output).

15. Actual budget performance through May surpassed expectations, as continued strong growth in output and employment propelled revenues higher at about twice the pace anticipated in the budget. As in past years, extremely strong revenue growth looks set to more than offset slippages on the current expenditure front to result in deficits well below budget. In light of the performance through May, the Minister for Finance announced in June that the general government deficit for 1997 could be as low as 0.8 percent of GDP, about half the budget forecast. The 1997 fiscal outturn is thus likely to be the fifth in succession to surpass budgetary expectations.

Fiscal impact of Partnership 2000

16. A main factor underlying the Irish budget in recent years is the centralized wage bargaining system which seeks to promote competitiveness, sustainable employment growth, and steady improvements in living standards. The multi-year wage agreements concluded among employers, unions and the government that underpin this system set forth a quid pro quo of wage moderation in return for tax reform—aimed at increasing disposable incomes and improving employment incentives—and increased spending on social welfare benefits. Under these agreements, the proceeds of strong output growth are used to reduce the tax burden on workers and improve social services, contributing to an expansionary fiscal stance in an upturn. In times of sluggish growth, however, such as in the early 1990s, the objective of maintaining low deficits becomes paramount, with the result that the fiscal stance has been tightened even as output growth lags.

17. P2000, the centralized wage pact covering 1997-99, is the first to quantify the (substantial) tax and spending concessions offered in return for wage moderation. These budgetary measures are contingent on the fulfillment of expectations for continued strong output growth and on maintaining low budget deficits over the medium term, like its predecessors, the terms of P2000 are thus likely to give Irish fiscal policy a procyclical cast, as buoyant growth and revenues are likely to be seen as a facilitator of further tax reform and improved social services, while a downturn is still likely to bring the goal of maintaining low budget deficits to the fore.

18. P2000 envisages income tax cuts of IR£1 billion on a full-year cost basis over 1997-99 (just under 2 percent of 1999 QDP), including IR£900 million in personal income tax cuts and IR£100 million in reduced corporation tax rates. The tax cuts introduced in the 1997 budget—whose full-year costs represented about 1 percent of 1997 GDP—went a long way to meet this medium-term objective: 44 percent of the personal income tax cuts and all of the corporation tax cuts envisaged under P2000 were awarded in the 1997 budget.

19. P2000 also envisages increases in social spending of IR£525 million on a full-year cost basis over 1997-99, with the objective of protecting the real value of social welfare payments and counteracting the marginalization of certain social groups. This latter emphasis on “social inclusion” represents a change in focus for the system of centralized wage agreements, reflecting the participation, for the first time, of representatives of the unemployed in the negotiation of P2000.

Medium-term outlook

20. The 1997 budget was the first to be cast in an explicit medium-term framework, a framework both consistent with and supported by the terms of P2000. The main assumptions underlying the multi-annual budgetary projections for 1998-99 include: a moderation in the growth of output (to 4½ percent annually in 1998-99) and employment (2½ percent annually during 1998-99); pay increases in the private sector in line with the provisions of P2000;5 public sector pay increases of 3.7 percent in 1998 and 4.2 percent in 1999 (following a budgeted 7.6 percent increase in 1997);6 and the tax and spending concessions envisaged in P2000.

21. The 1997 budget also ushered in initiatives to restrain spending growth over the medium term by improving administrative expenditure controls and planning. Increased responsibility for spending decisions is to be devolved to departments within established budgetary allocations, and a rolling program of expenditure reviews will be initiated in 1997.

22. On these assumptions, the medium-term budgetary projections through 1999 (Table 4 and Chart 2) envisage a general government deficit of 1½ percent of GDP in each year and a decline in the debt ratio to 63 percent of GDP, on a comparable basis.7

Table 4.

Medium-Term Budgetary Outlook, 1996-99

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Sources: Data provided by the Irish authorities; and staff projections.

Includes contingencies of 0.4 percent of GNP and 0.7 percent of GNP, respectively, in 1998 and 1999.

Includes contingencies of 0.3 percent of GDP and 0.6 percent of GDP, respectively, in 1998 and 1999.

Changes to the Maastricht conventions for the measurement of debt service payments, debt and GDP are expected to add 0.4 percentage point to the general government deficit and 7 percentage points to the general government debt ratio in 1999.

CHART 2.
CHART 2.

IRELAND MEDIUM-TERM FISCAL OUTLOOK

Citation: IMF Staff Country Reports 1997, 077; 10.5089/9781451818697.002.A001

Sources: Department of Finance; and staff calculations.1/ In percent of potential GNP.2/ In percent of potential GDP.

23. Beyond 1999, there is uncertainty surrounding the prospects for continued inflows of EU structural funds. In the 1990s, net EU transfers (including CAP payments) have declined from a peak of 6.6 percent of GDP in 1991 to about 4 percent in 1996 and are projected to decline further to 3 percent of GDP by 1999. About half of these net flows represent a program of structural funds set forth in the Community Support Framework for 1994-99 that are aimed primarily at raising Irish living standards toward the EU average, an objective toward which substantial progress has been made. The level of flows under a new program of structural funds after 1999 is a matter of negotiation. While the level of flows after 1999 is uncertain, any change is expected to be gradual. Moreover, because of lags between project implementation and disbursement, flows under the 1994-99 program will continue for at least one year beyond the end of the program.

1

Prepared by David J. Ordoobadi.

2

Under the Pact, a deficit ratio in excess of 3 percent of GDP is only automatically justifiable when output Ms by 2 percent in one year. A case can also be made if output declines by at least 0.75 percent.

3

If, for example, real output growth were to decline by 2 percentage points from trend in 1998-99 (bringing Irish growth in those years to European wide trend growth of 2½ percent), the 1999 general government deficit ratio—notwithstanding the 0.6 percent of GDP contingency amount incorporated in the baseline outlook—would threaten to exceed the Maastricht reference value of 3 percent of GDP. However, the decline in the rate of growth that precipitated this deficit would not be considered as exceptional under the EU Growth and Stability Pact.

4

Real current expenditure growth during 1990-94 of 5½ percent annually prompted the adoption by the government of ceilings on the growth of current non-interest spending (6 percent in nominal terms in 1995 and 2 percent on average in real terms during 1996-97). Despite some slippage, these ceilings dampened the pace of expenditure growth in 1995 and 1996 and in the 1997 budget.

5

Private sector earnings are expected to increase by about 4 percent during 1998-99, taking into account the provisions of P2000, productivity improvements, and drift.

6

Taking into account increments, the carryover effects and outstanding claims of the previous centralized wage pact on the 1997 budget, and the terms of P2000 in 1998-99.

7

The introduction of the new 1995 ESA accounting conventions in 1999 will add approximately 7 percentage points to the debt ratio. This is a technical change and will not affect the downward trend in the ratio.

Ireland: Selected Issues
Author: International Monetary Fund