This Selected Issues paper examines the competitiveness of the Irish manufacturing sector. The paper highlights that in 2001, production cuts and accelerating wage growth arrested the trend improvement in external competitiveness, but the level remains high. The paper presents some medium-term fiscal scenarios. It discusses indicators of financial system soundness based on official data and publications, as well as discussions with the authorities. The paper also examines indicators on the vulnerability and solvency of the financial system and presents a brief description of supervision arrangements.


This Selected Issues paper examines the competitiveness of the Irish manufacturing sector. The paper highlights that in 2001, production cuts and accelerating wage growth arrested the trend improvement in external competitiveness, but the level remains high. The paper presents some medium-term fiscal scenarios. It discusses indicators of financial system soundness based on official data and publications, as well as discussions with the authorities. The paper also examines indicators on the vulnerability and solvency of the financial system and presents a brief description of supervision arrangements.

II. Ireland: Medium-Term Fiscal Scenarios1

A. Introduction

1. Ireland’s fiscal position strengthened substantially during the recent decade. Stellar economic growth in the latter half of 1990s was accompanied by a gentle decline in the share of revenues to GDP reflecting cuts in income and standard corporate tax rates. At the same time, total expenditure increased at a steady pace, but the total expenditure-to-GDP ratio declined sharply reflecting the strong growth in GDP (Figure 2.1). As a consequence, general government finances turned from a deficit into a surplus—peaking at 4.5 percent of GDP in 2000—and the gross debt-to-GDP ratio was more than halved to the second lowest in the EU.

Figure 2.1.
Figure 2.1.

Ireland: General Government Finances

Citation: IMF Staff Country Reports 2002, 171; 10.5089/9781451818796.002.A002

Sources: Department of Finance; and staff estimates.1/ Excludes allocations made for public pension prefunding in 1999.2/ Depreciation, investment and capital transfers. Excludes allocations made for public pension prefunding in 1999.

2. The year 2001, however, marked a substantial turnaround for public finances. Fiscal revenues were influenced by substantial tax cuts, slowing economic activity and various temporary factors, and fell considerably below budgeted levels. Concurrently, the expenditure-to-GDP ratio leapt up due to a 20 percent increase in primary expenditure and slower GDP growth. This led to a marked fall in the general government balance both in nominal and cyclically-adjusted terms. In spite of some temporary revenue-increasing measures, the fiscal balance is projected to deteriorate further in 2002 to a deficit of 1 percent of potential GDP in cyclically-adjusted terms.2 Simultaneously, the outlook for Ireland’s medium-term fiscal path has become much less benign. Against this backdrop, this note discusses the main factors likely to influence the Irish public finances in the medium-term and analyzes the sensitivity of Ireland’s fiscal position to three alternative sets of assumptions.

B. Explaining the Recent Weakness in General Government Finances

3. The sudden deterioration of the general government fiscal position reflects mainly the following factors:

  • There has been a surge in total expenditures in 2001–02. While the government’s investment on infrastructure has increased rapidly since the mid-1990s, the main contribution to the recent jump in overall spending has come from a surge in current spending (Figure 2.1), which has risen by an estimated rate of 15½ percent in 2001–02 despite falling interest payment burden and cyclically low level of transfers to the unemployed. In particular, the rate of growth in general government consumption—i.e., compensation of employees, purchases of goods and services and depreciation—as well as transfers have accelerated briskly. Consumption has almost doubled and transfers have increased by some 64 percent between 1997 and 2002. The main factors behind the rapid rise in current spending have been increases in health, education and social welfare spending.

  • Various tax and spending measures introduced during fiscal year 2001 may have had a larger impact on both tax revenues and current expenditures than had been previously expected.3

  • In 2001, a rapid deceleration of economic growth worsened the outlook for profits and increased uncertainty over a potential increase in unemployment. As firms canceled or postponed investment plans and household spending slowed, tax buoyancy was smaller than budgeted.

  • Several temporary factors that occurred in 2001 had an impact both on revenue and expenditure. These include travel restrictions and compensation related to animal diseases that had negative implications for both indirect taxes and current expenditure. Moreover, September 11 influenced both tax revenue and incurred costs via increased support for the national airline and tourism industry. At the same time, unwinding of a partly millennium-related boom in auto sales had a strong negative effect on indirect taxes in 2001.

C. Outlook for the Medium-Term Fiscal Position

4. In the medium term, revenue growth is expected recuperate somewhat for the following reasons:

  • The underlying revenue performance should recover somewhat as the economy’s growth rate is likely to bounce back towards its potential. Moreover, the negative revenue impact arising from the temporary factors mentioned above should disappear relatively quickly.

  • Further tax cuts are likely to be limited in the coming years. First, the harmonization of the corporate tax rates in 2003 would put an end to a series of cuts in the standard corporate tax rate.4 Second, the current government has signaled that it will take a more cautious approach to further income tax cuts.

  • The phasing in of an earlier payment date for corporate taxes will yield a temporary but prolonged upward level shift for tax revenues from 2002 to 2006.5

Nevertheless, growth in tax revenue is not likely to return to the double-digit levels that prevailed during the latter half of 1990s, given more limited growth potential for both the economy and the tax base.

5. Persistent spending and wage pressures are likely to underpin robust growth in public spending. The recent economic success and the subsequent increases in expenditure to improve the quality of public services and infrastructure have created expectations amongst the general public that substantial resources will continue to be allocated to finance new spending initiatives. At the same time, the recent fiscal developments have raised concerns that the overall spending growth is becoming difficult to control and that actual expenditures is overshooting budgeted levels. Moreover, the recent surge in expenditure has increased the risk that its overall quality is deteriorating. Spending pressures are most intense in the areas of public sector pay, health, and infrastructure mainly pertaining to, among other things, the benchmarking exercise for public sector employees, the implementation of the Health Strategy, as well as the completion of the National Development Plan.

Baseline scenario

6. Revenue projections are subject to considerable uncertainty.6 The revenue forecast for the current year is based on estimates presented in budget 2002, but updated to reflect recent developments.7 Revenue projections for 2003–04 reflect the authorities’ estimates for growth in income, corporate and indirect taxes, but are adjusted for differences between the official and staff estimates of nominal GDP growth (Table 2.1). Therefore, staff’s estimates implicitly include any tax measures planned by the authorities at the time of presentation of budget 2002. Revenues for 2005–07 are projected by using staff’s estimates of economic growth and the authorities’ estimates for tax elasticities.8

Table 2.1.

Ireland: Medium-Term Outlook for General Government Finances 1/

article image
Source: Staff estimates

Figures may not add up due to rounding.

The baseline assumes that tax revenues will perform according to the latest Stability Programme projections in 2003–04, but are adjusted for the difference between the government’s and staff’s growth assumptions. Expenditure estimates for 2002 are based on the latest available official information, whereas projections for 2003–04 assume expenditure to increase at the pace envisaged in the Stability Programme (except for interest rate expenditure). From 2005 onwards, tax revenues are projected using the authorities’ estimates of tax elasticities, while primary expenditure-to-GDP ratio is expected to remain constant.

This scenario assumes similar revenues as the baseline, but larger spending pressures in various areas resulting in the full use of the contingencies amounting to approximately 1 percent of GDP in 2003–04. Furthermore, this scenario presumes that the cost of implementing of the national Health Strategy (at an estimated cost of EUR 12.7 billion in 2001 prices) would be spread evenly over the period 2003–11 and would not be included in the projected contingencies.

This scenario is identical to the baseline, except that it adjusts revenue growth for 2003–04 to differences between tax elasticities as reported by the OECD and the authorities, uses the former elasticities for projecting revenues for 2005–07, and applies interest payments projections that are adjusted for the changed fiscal position.

7. Expenditures are estimated based on the latest update of the Stability Programme (SP 2002–04). In 2002, total expenditure is expected to turn out as projected in the latest official spending estimates from March 2002. Since the revised expenditure-to-GDP ratio for 2002 is considerably higher than estimated in the budget for 2002, the total expenditure projections for 2003–04 are based on the estimated nominal spending increases presented in the latest update of the Stability Programme rather than their envisaged levels. Contingency provisions of 0.8 and 1.1 percent in 2003 and 2004 are treated as expenditure. From 2004 onwards, primary expenditure is expected to grow in line with nominal GDP.

8. According to the baseline scenario, the medium-term fiscal deficit is expected to stabilize around one percent of GDP after an initial deterioration in 2002–04. General government finances are expected worsen fairly rapidly in 2002–04 owing mainly to subdued growth in tax revenues and large spending increases. The improving economy, an expected end to generous tax cuts, and deceleration in the rate of spending increases would, however, stabilize the fiscal position around one percent of GDP in 2004. In the following years, general government balance is projected to improve gradually until 2007,9 when the phasing-in of the new corporate tax date ends.

9. Although the path for fiscal balances has shifted down considerably, Ireland’s medium-term fiscal position would still remain sound. The debt level is currently low and—under this scenario—the gross debt ratio is expected to fall gradually to around 32½ percent of GDP by end-2007. In addition, the fiscal implications from population aging are expected to be fairly limited during this period due to favorable demographics.10 Moreover, in order to partially fund the government’s long-term pension liabilities, the authorities have established a National Pension Reserve Fund to which they are committed to contribute 1 percent of GNP annually. By end-2001, the Fund had accumulated 6.7 percent of GDP in assets.11

Spending pressures scenario

10. The government has launched several spending plans in response to the mounting pressure to improve the quality of public services and public infrastructure. Although these plans are likely to have significant fiscal implications, many of them were not explicitly budgeted for in the SP 2002–04. Instead, sizeable contingency provisions were used to at least partly cover for the estimated expenses of executing these plans. Perhaps, the largest budgetary impact will arise from the implementation of the National Health Strategy—whose total cost is estimated at €12.7 billion over 2002–11 measured in 2001 prices. Since the 2002 budget made only marginal allocations for the Health Strategy, this scenario assumes that the costs of the plan will start to be incurred only in 2003 (being evenly spread over years 2003–11 at an annual cost of around 1 percent of GDP) and would be fully additional to the contingency provisions already included in the spending estimates. It is assumed that pressures in other spending areas—particularly additional compensation of employees arising from the implementation of the benchmarking exercise,12 potential cost overruns related to the completion of the National Development Plan, as well as the provision of additional resources for education and security—would fully deplete the scope for additional spending provided by the contingencies.

11. Implementing these plans would result in a rapidly deteriorating fiscal position, in the absence of revenue-enhancing measures or offsetting expenditure cuts. The projected path for general government balances suggests that under this scenario the overall fiscal balance would worsen by almost 4 percentage points of GDP between 2001 and 2004 (Table 2.1). The government finances would be expected to strengthen marginally in 2005–06, although this improvement would be more than offset by the fall in corporate tax revenues due to the completion of the phased-in change in corporate tax payment dates. The bulk of the deterioration in the overall balance would result from the additional spending due to the implementation of the Health Strategy,13 while higher interest costs induced by increased borrowing would result in a further annual weakening of some ¼ percentage points of GDP in 2005–07. Projections based on this scenario indicate that fiscal measures of about 2½ percent of GDP will be needed over the medium term to keep the SGP requirement of zero balance and to halt the rise in the public debt to GDP ratio.14

Alternative revenue scenario

12. More cautious assumptions concerning the revenue elasticities would result in continuous worsening of the budget position. A third scenario—which is similar to the baseline for 2002–04, except that it assumes lower sensitivity of revenues to economic growth15—suggests that unless additional fiscal measures are taken, Ireland’s fiscal position would deteriorate considerably in 2005–07 (Table 2.1). This would imply that even if the authorities would make additional room for increased health expenditure by offsetting discretionary cuts in other areas of spending, it would face increasing need for either revenue-enhancing measures and/or further expenditure cuts that would exceed the cost of the currently planned spending initiatives. Moreover, simulations based on slower growth projections using both the authorities’ and the OECD’s tax elasticities (not reported here) show considerably deeper deficits in 2006–07.

D. Conclusions

13. This note has analyzed the recent developments in and outlook for the Irish government finances. The scenarios presented suggest that without further actions Ireland’s fiscal position could move from an era of substantial fiscal surpluses to a one of deficits. While the baseline scenario indicates that the fiscal position would stabilize given the assumed economic recovery, the alternative scenarios suggest that lower revenue elasticity and/or undertaking additional health or other expenditure would—in the absence of offsetting measures—pose a significant risk of a worsening fiscal position. Furthermore, a prolonged period of sluggish growth would put a considerable, additional strain on government finances. By the same token, rapid growth would alleviate budget pressures, although most likely not sufficiently to maintain fiscal balance in the face of significantly higher growth than envisaged in the baseline scenario. Given that the margins under the SGP are all used up under the baseline scenario, any additional spending commitments or adverse fiscal shocks (e.g., from lower revenue elasticity or lower potential growth) will need to be met with offsetting fiscal measures to meet Ireland’s commitments under the SGP.


  • Commission of the European Communities, 2002, “Commission Recommendation for the 2002 Broad Guidelines of the Economic Policies of the Member States and the Community”, ECFIN/210/02-EN, European Commission web-site.

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  • Department of Finance, 1999, “Report of the Tax Forecasting Methodology Group”, Department of Finance web-site.

  • Department of Finance, 2000, “National Development Plan”, Department of Finance web-site.

  • Department of Finance, 2001, Budget 2002, Department of Finance web-site.

  • Department of Finance, 2002, Revised Estimates for Public Services, Department of Finance web-site.

  • Department of Health and Children, 2001, “Quality and Fairness: A Health System for You”, Department of Health and Children web-site.

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  • The Economic Policy Committee of the European Union, “Budgetary Challenges Posed by Ageing Populations”, EPC/ECFIN/655, the Economic Policy Committee web-site.

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  • The Economic and Social Research Institute, 2001, “Medium-Term Review 2001-2007”.

  • International Monetary Fund, 1999, “General Government Fiscal Position and Future Pension Liabilities”, Chapter III, Selected Issues and Statistical Appendix, IMF Staff Country Report No. 99/108, the IMF web-site.

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  • van den Noord, P., 2000, “The Size and Role of Automatic Fiscal Stabilizers in the 1990s and Beyond”, OECD Economics Department Working Papers No. 230 (Paris, France: OECD.

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Prepared by Jarkko Soikkeli.


Excluding a 0.5 percent of GDP windfall arising from the euro changeover. The windfall is, however, included in the nominal overall balance in Table 2.1.


These include further cuts in income tax rates, individualization of tax bands, the extension of the medical card to those aged over 70 years, and introduction of the Special Savings Investment Account scheme (SSIA).


Despite a uniform 12½ percent corporate tax rate from the beginning of 2003, several IFSC and manufacturing companies will continue to enjoy the preferable rates of 10 percent until 2005 and 2010, respectively.


Under the new system, at least 90 percent of estimated corporate taxes will be paid one month before the end of the accounting period. Phasing in the earlier payment date will yield, on average, an additional 0.6 percent of GDP in 2002–06 (see the 2002 budget for details).


Forecasting revenues is difficult, not only because of uncertainties related to the performance of the global economy and Ireland’s growth potential, but also due to major structural shifts in the economy—including the recent changes in the tax system—that complicate the estimation of tax elasticities.


Additional income tax revenue losses (relative to budget) arising from the SSIA is included in the projections. Under the rules of scheme, the Exchequer will contribute to the individual saver’s account an additional 25 percent of the amount saved by way of an income tax credit. The Department of Finance acknowledged in July 2002 that tax revenues were expected to fall short of budget by some 0.4 percent of GDP, partly due to the higher-than-expected take up of the SSIA.


Report of the Tax Forecasting Methodology Review Group, 1999.


In its assessment of the Irish budgetary policy, the European Commission concluded that Ireland’s latest Stability Programme—targeting small deficits for 2003–04—would broadly respect the commitments under the Stability and Growth Pact (SGP) provided that the contingency provisions will not be used. See Commission of the European Communities (2002).


According to the Economic Policy Committee (2001), Irish public old-age pension expenditure as a share of GNP is projected to increase to 5 percent by 2010, an increase of 0.4 percentage points from 2000. The corresponding figure for the EU average, expressed as a share of GDP, is projected to remain steady at 10.4 percent.


Earlier staff work has suggested that an annual set aside of 2½–3½ percent of GDP would be adequate to cover the government’s long-term pension liabilities. The estimate is, however, highly sensitive to assumptions about future GDP growth and real interest rates. See “General Government Fiscal Position and Future Pension Liabilities” in IMF (1999).


According to an initial assessment of the Department of Finance, full implementation of the recommendations in the Report of the Public Service Benchmarking Body would give rise to a full year cost of over €1 billion measured in current prices (around ¾ percent of 2002 GDP). However, the implementation of the Benchmarking Body’s recommendations has still to be discussed between public service employers and unions.


More than 60 percent of the total €12.7 billion cost of the plan is expected to be allocated to capital expenditure.


Alternatively, higher-than-projected GDP growth would also strengthen the fiscal position. Staff’s simulations suggest that—given unchanged primary spending—an average annual nominal GDP growth rate of 8½ percent in 2003–07 would be needed to achieve a zero balance by the end of the period.


As estimated by the OECD (see van den Noord, 2000). The OECD elasticities suggest that a 1 percent change in the Irish GDP results in a change of 1.2 percent in corporate taxes; 1 percent in personal income taxes; 0.5 percent in indirect taxes; and 0.8 percent in social security contributions. This compares with the corresponding estimates of the authorities of 1.5 percent, 1.3 percent, 1.3 percent, and 0.6 percent, respectively.