What will Ireland’s government finances be like in 2015? A five-year view on the Budget

Earlier this month, Minister Lenihan announced Budget 2010. This Budget was generally received very well both nationally and internationally. In last week’s post, I gave it a 7/10, although there was a one big caveat: while this may indeed turn out to be the toughest Budget in our economic recovery (which is technically what the Minister said), it certainly won’t be the last tough Budget (which seems to be the impression taken away from what he said).

What will Ireland’s government finances look like in 2015, though? Will we be back in Maastricht territory, with a Budget deficit of less than 3%? What about our national debt? And how tough will the next five Budgets be? To understand that, it’s necessary to go right back to basics with Ireland’s finances. For example, we all know that the Government will take in just €34bn this year while spending over €60bn, right? Wrong! Those figures are net figures, it turns out. To go back to basics, we need to look at the gross figures, i.e. count receipts such as PRSI and health levies as part of income, as opposed to netting them off against government expenditure. Doing that, total receipts for 2009 come to just over €50bn, while total expenditure will top €76bn.

By coincidence, total receipts for 2005 were also just over €50bn, giving us an appropriate year to compare ourselves to. The distinction between gross and net turns out to be an important one, because it reveals how the Government’s funding sources have changed. Whereas PRSI, other levies (such as the health levy) and what is classed as “non-tax revenue” brought in about €10bn in 2005, Budget 2010 estimates that these sources will bring in over €17bn – a staggering 70% increase. (The government’s income going up? Now, there’s a headline you won’t read in the papers!) Meanwhile, indirect, direct and other taxes (“other” includes stamp duties and capital taxes) have fallen during the same period from just under €40bn in 2005 (they actually peaked in 2007 at €47bn) to about €32bn in 2009 and 2010.

It is in expenditure, however, where the real changes have occurred. In 2005, instead of €69bn, total expenditure by the Government was €51bn. To repeat, whereas the Government’s total income next year will be the same as in 2005, expenditure will be more than one third higher. Of the €18bn increase in spending, half has come from gross spending on social welfare. Most of the remaning increase (a further €7bn) has come from other current expenditure areas, most notably health and education. It’s worth pointing out that all the money spent on social welfare and the vast majority of the money spent on health and education goes in the form of someone else’s income.

There can be no clearer illustration of the need for massive reductions in the total public pay bill of the kind introduced by the Minister for Finance earlier this month.

So far, so good. But where will we be in five years time? To shed some light on where we might be then, I’ve crunched some numbers. Here are the assumption underpinning my (somewhat benign) baseline scenario:

Government Revenues in 2015

• Indirect taxes are left largely as they are, and a modest economic recovery pushes up receipts by 2% a year on average. The picture is largely the same for direct taxes, with one exception. As I mentioned last week, income taxes are going to have to go up for everyone so income tax receipts will increase 5% in 2011. Apart from that, direct tax receipts increase 2% a year until 2015, with reductions in the tax credits bringing in higher income but that effect is partly offset by an ongoing fall in the number employed.
• Other taxes – including property and capital taxes – have been a huge part of the problem, with receipts in this area falling from €7bn in 2006 to €1.5bn next year. The nettle of a property tax will have to be grasped over coming years and a phased-in land value tax (which replaces stamp duty) is estimated to boost income in this area by 10% in 2011 and 25% in 2012, its year of real impact, before 5% increases in subsequent years. The total tax take from this category would be €2.5bn in 2015, compared to €1.5bn in 2010 and almost €5bn in 2005.
• Average economic growth of 2% between 2011 and 2015 translates into similar increases in income from PRSI and other levies, with a further €1.5bn in capital receipts each year. The only other revenue to estimate is “non-tax revenue” which will include NAMA levies. These are estimated to be almost €2.5bn next year. I think €1.5bn is more realistic.

Government Expenditure in 2015

• Gross spending on social welfare is estimated to go down 2% a year – in line with economic growth – from 2011 on. (Post-bust, Ireland’s “natural” unemployment rate is going to be much higher than what we’ve got used to, so it’s unlikely there’ll be a quick recovery here.)
• I’ve assumed tough action will actually be taken in current expenditure areas, especially health and education. I’m not asumming further pay-cuts; instead, I’m angling for those transformational reforms that were discussed (without success) before the last Budget. Like any private sector company in such a situation, the Government should be looking at getting the same amount of output for 5% less a year, through better productivity.
• I’ve assumed that almost all other expenditure – in particular capital expenditure (transport and environment) – stays constant over coming years at €10bn (i.e. similar to 2010 levels).
• The only remaining item is the one we’ve all been dreading – servicing our national debt. Based on all the other estimates, it’s possible to work out an estimate of the deficit and (assuming of course we stay in the eurozone) to put some numbers on how much we’ll be spending per annum on our national debt. In 2008, we spent €2.6bn servicing our national debt. By 2015, it’s likely that figure will have reached almost €8bn.

Borrowing and Debt in 2015

What might Ireland’s public finances look like in such a scenario? The graph below shows the totals for receipts and expenditure, based on the scenario above. It would take until 2015 for the deficit-GDP ratio to get back down to 4%, i.e. anywhere close to the Maastricht criteria for membership of the eurozone, which is 3%. Meanwhile, by that stage, our debt-GDP ratio would in all likelihood be about 100%, depending on how the recent shenanigans with the banks are counted.

Every bit as important is an understanding of the changed composition of the government in this scenario. The graph below shows how the main categories of income and expenditure would evolve from 2005 through 2010 to 2015, in the scenario outlined above. Tax revenues would fall as a contributor of total revenues from 78% to 65%, while PRSI and other levies – the new social contribution mentioned in the Minister’s Budget speech – would rise from 19% to 29%. And that’s allowing for a property tax that boosts revenues that area by 60% over the coming five years.

On the expenditure side, the big change is servicing our national debt, which will rise from 3% of total expenditure in 2005 to 12% by 2015, by my calculations. Gross current voted expenditure – mostly social welfare, health and education – would as a result of the productivity improvements assumed above (and gently falling unemployment) fall from €55bn to €45bn.

Alternative scenarios for 2015

So, what is the picture like for 2015? This is an Ireland where the government drives 5% annual productivity improvements in its day-to-day operations, introduces a land-value tax to replace stamp duty, gets €1.5bn in NAMA-levies from the banks and where the economy grows by about 2% a year on average. In that Ireland, servicing a national debt of €150bn – up from €35bn in 2006 – will be costing us €8bn a year, meaning one in every five euro raise in taxes will be going to pay off our debt. This will be the primary reason why there will still be a 4% government deficit in 2015 – a year beyond the extra grace already given to us by the EU.

Grounds for pessimism? A new paradigm for national development and solidarity would have to be developed, to replace social partnership, as the union leaders do not seem to recognise the precarious position of the Government finances and in particular the sums spent on public sector pay. Sustained growth of 2% may not come. The drip-drip of redundancies and receiverships might continue past early 2011, gnawing away at all forms of revenue…

Grounds for optimism? Serious reform of social welfare, making sure the most vulnerable are best served by the system and eliminating fraud, might deliver annual savings of 10% in that area, i.e. a couple of billion euro. The economy could rebound more rapidly or at the very least, Ireland’s corporate tax revenues could increase rapidly if the world economy grew rapidly.

OK, that’s enough crystal-ball gazing for one day, I think, I’ll leave it at that and open things up for discussion and comments.