Chapter 2  -  The Budgetary Policy Framework

Summary

The primary macroeconomic objective of Budget 2001 and the updated Stability Programme is the continuation of sustainable economic growth, supported by moderate inflation and wage developments reflecting the latest national agreement with the social partners, the Programme for Prosperity and Fairness (PPF).

 To this end, the aim of Budget 2001 has been to strike a sensible balance between the implications for inflation and growth on the one hand of failing to underpin adherence to the terms of the PPF or to respond adequately to emerging infrastructural bottlenecks and, on the other, of adding unduly to demand pressures in the economy.

 An average General Government surplus of 4.2% of GDP is forecast for the three years 2001-2003, (compared to an anticipated outturn of 4.7% this year) comfortably complying with Stability and Growth Pact obligations.  

The debt/GDP ratio is expected to fall to 24% by 2003 from an expected 39% at end-2000.  Further substantial sums of not less than 1% of GNP annually will continue to be set aside for the pre-funding of pension liabilities.

 In response to the urgent infrastructural needs of the economy, capital expenditure will average 5.3% of GDP over the Programme period in line with the National Development Plan 2000-2006.

 The Budget 2001 tax reductions will increase the reward from work of all taxpayers, remove 107,000 taxpayers from the top rate of tax and remove 133,000 taxpayers on low income from the tax net altogether.  These measures will also help to increase participation in the labour market.

 The provisions for day-to-day spending will, at the same time, underpin substantial progress across the broad range of social and other objectives.

2.1 Budgetary Review 2000

 The December 1999 Stability Programme Update forecast a General Government Surplus for 1999 of 3.2% and for 2000 of 3.3%.  The outturn for 1999 has since been revised upwards to 3.9%[2] of GDP.  The General Government Surplus estimate for 2000 has also been revised upwards to 4.7% of GDP, which represents a tightened fiscal stance compared with Budget.

Table 7 sets out the comparison between the General Government position for 1999 and 2000, as set out in the December 1999 Stability Programme Update, and as now estimated.

This improved budgetary position can largely be explained by higher tax receipts resulting from stronger than expected economic growth.

The General Government Debt/GDP outturn at end-2000 will also be significantly below the target set in last year's Stability Programme Update.

The 2000 Broad Economic Policy Guidelines recommended that the Government should “be ready already in 2000 to use budgetary policy to ensure economic stability”. The better than projected outturn for 2000 is in line with this recommendation.

  Table 7 - General Government Position for 1999 and 2000

 

Stability Prog Dec’99 forecast

Outturn

Stability Prog Dec’99 forecast

Outturn

 

1999

1999

2000

2000

 As a % of GDP

Current Account Surplus

Capital Account Deficit[3]

5.2

2.0

6.1

2.2

5.8

2.5

7.4

2.7

General Government Surplus

- of which Primary Surplus

3.2

6.0

3.9[4]

6.4

3.3

5.8

4.7

6.7

General Government Debt 

52

50.1

46

39

GDP IR£ M

66,850

69,052

74,025

80,625

GDP € M

84,881

87,677

93,992

102,372

ESA95 Basis [Preliminary National Accounts Assessment]

2.2 Economic and Budgetary Policy Context

The primary macroeconomic objective of Budget 2001 and the updated Stability Programme is the continuation of sustainable economic growth, supported by moderate inflation and competitive wage developments reflecting the latest national agreement with the social partners, the Programme for Prosperity and Fairness (PPF).

Chapter 1 set out the economic background to Budget 2001.  The Irish economy is growing strongly reflecting both cyclical and structural factors.  It is undergoing a period of rapid change as living standards converge on those of more prosperous EU Member States.  Ireland’s GNP per capita is currently estimated to be about 100% of the EU average.  In this context policy must address supply side issues, especially in the labour market and infrastructure areas, to facilitate further ‘catching-up’ by the Irish economy without giving rise to unsustainable price pressures.  

Managing the transition of the Irish economy to a more sustainable growth path while maintaining economic stability is a challenge for policy.  In meeting that challenge, Ireland’s participation in EMU means that the available tools are limited to incomes and budgetary policy.

Due to its direct impact on competitiveness, incomes policy is particularly important and that is why the continuation of a successful social partnership process is regarded by the Government as crucial.  In recognition of this and of the less direct impact of budgetary policy in a small open economy, budgetary policy plays a key, if supporting, role.  

Budgetary policy must therefore strike a balance between running a large budgetary surplus and not adding unduly to demand pressures on the one hand, or on the other hand, of failing to adequately address infrastructural, labour supply and other supply-side needs or to adequately underpin adherence to the terms of the social partnership agreement. 

  Box 2.1 Social Partnership

The Partnership approach has underpinned the success of the Irish economy since 1987.  Through a consensus-based approach to wage determination, covering both the public and private sectors, successive multi-annual agreements have sought to improve the competitiveness of the economy through moderation in pay increases in a framework in which fiscal and monetary policy are geared towards price stability.  The agreements also cover areas of policy such as taxation reform and public services provision.  In this integrated approach, actual pay increases are underpinned by government commitments regarding taxation reform, public services and social expenditure.

The Partnership approach has been remarkably successful in delivering relative industrial relations peace, strong economic growth, low inflation and reduced unemployment.  For example, between 1994 and 1999 GDP growth averaged 9.3%, GDP per capita grew by 50% and inflation averaged 2%.

The latest agreement, called the Programme for Prosperity and Fairness (PPF), began in March 2000 and will last for 33 months.  The Programme aims to further enhance living standards and reduce social exclusion on a basis that will prove sustainable over the longer term. The Programme focuses on the continued competitiveness of Ireland in a global economy and the need for a flexible, dynamic and well educated workforce.  

The 2000 Broad Economic Policy Guidelines implicitly acknowledge that the wage increases in the Programme for Prosperity and Fairness were consistent with the maintenance of  employment growth.  

The PPF was underpinned by a commitment that there would be increases in net take home pay, from pay increases and tax reductions combined, of up to 25% or more.  The Programme also included Government commitments in relation to public service provision and social inclusion.

The dynamic and flexible nature of the new Programme has already been tested by the recent increase in inflation.  The Government and the other social partners moved quickly to deal with this issue within the framework of the new agreement.

2.3 Taxation Policy

In Budget 2001 the Government has continued its wide-ranging reform of the income tax system - designed to improve equity, to better reward work and to encourage greater participation in the labour market.  (The Government’s tax reform strategy is outlined in more detail in Box 2.2).  The Budget's significant tax changes are also designed to address unemployment and poverty traps and to improve the interaction of the tax and social security systems.

The tax reductions in the Budget deliver on the commitment of the Government under the PPF to reduce personal taxation in order to support a competitive pay evolution and, thereby, economic and social progress.

In this regard, it should be noted that the IMF Executive Board in its recent Article IV Examination of the Irish Economy stressed that ” the commitment to further moderate tax cuts under the national wage agreement should be respected.”[5]

In 2001 a reduction in the numbers in the various tax brackets, as shown in Table 8, will increase the reward from work to all taxpayers. The changes will remove 107,000 taxpayers from the top rate of tax and will completely remove 133,000 taxpayers on low income from the tax net.  These tax changes will complement the Government’s structural reform agenda, as set out in Chapter 3.  

Table 8 - Distribution of Income Tax Payers by Tax Band  

Tax Year

Exempt Cases

Marginal Band

Standard Band

Higher Band

 

No.

%

No.

%

No.

%

No.

%

1997/1998

380,000

25.5

108,000

7.25

580,000

38.75

424,000

28.5

1998/1999

394,000

25

82,000

5.25

643,000

40.5

463,000

29.25

1999/2000

474,000

28.5

25,000

1.5

655,000

39.25

510,000

30.75

2000/2001

535,000

29.5

7,000

0.5

718,000

41

509,000

29

2001/2002

668,000

37.75

4,500

0.25

695,000

39

402,000

23

Source : Revenue Commissioners, (No.s rounded to the nearest '000)

Box 2.2 – Reforming the Irish Tax System  

The Government is implementing a wide-ranging reform of the income tax system designed to improve equity, while at the same time incentivising greater participation in the labour market.  The three main elements involved are:

 - reducing tax rates

- replacing tax allowances with tax credits

- widening the standard rate tax band

As regards tax rates, both the standard rate and the top rate have been reduced by a total of 8 percentage points over the past three years and will now be at 20% and 42% respectively in 2001/02.  These changes are designed to reduce marginal tax rates and improve the incentive to work.

Tax credits are of equal value to all taxpayers regardless of income whereas the previous system of tax allowances gave greater benefits to those paying tax at the higher rate.  Nearly all personal tax allowances have been converted to tax credits, with the initial tax credits being set at a level which leaves the position of higher-rate taxpayers generally unchanged and improves the position of those at the standard rate.  This has resulted in a significant increase in the income level at which people enter the tax net, which is £144 (€183) in 2001/02, compared with £71 (€90) in 1997/98.  In the PPF the social partners and the Government have agreed that, over time, all those earning the minimum wage will be removed from the tax net (currently £172 (€218) per week).

As regards the widening of the standard rate band, since 1980 married couples had double the personal allowance and rate bands of single people, with full transferability between spouses.  This frequently resulted in the second spouse facing high marginal tax rates on all income when taking up employment.  It also resulted in the width of the tax bands being held down for cost reasons, bringing progressively more single people earning less than the average industrial wage into the top tax rateIn this context it was decided to widen the standard rate tax band over a period with the objective that each person should have his or her own non-transferable standard rate band.  In Budget 2001 the standard band is being increased to £20,000 (€25,395) for single people and £40,000 (€50,790) for two-earner married couples (with a maximum transferable band of £29,000 between spouses), and £29,000 (€36,822) for one-earner married couples. The policy of widening of the standard rate band in this way was supported by the social partners in the PPF.

2.4 Expenditure Projections 2001 – 2003

Public expenditure policy must strike a balance between the requirement not to add excessively to domestic inflationary pressures on the one hand, and on the other, to meet the public service and social inclusion commitments in the key Programme for Prosperity and Fairness as well as to maintain our cost competitiveness through necessary investment in public infrastructure.

 Public expenditure policy priorities are also in line with the areas identified for Government action at the Lisbon European Council in March namely: employment, innovation and research, economic reform and social cohesion.  Public expenditure policy for the period of this Programme is being formulated in the context of significant budgetary surpluses and a falling debt/GDP ratio.

The Government recognises the need not to threaten inflation by adding excessively to demand and agrees with the recommendation in the 2000 Broad Economic Policy Guidelines that public expenditure growth be restrained.  The Government also recognises that public expenditure policy has a key contribution to make in containing inflation by underpinning the recent agreement with the Social Partners in relation to public service provision and social inclusion.

The expected trend in general government current expenditure as a percentage of GDP is given in Table 9.  In terms of GNP, which is a far more satisfactory measure of Irish taxpayers' ability to support public spending, General Government Current Expenditure is estimated/projected at 30.8% in 2000, 30.5% in 2001, 29.5% in 2002 and 28.4% in 2003. 

 Table 9 - Total Government Current Expenditure [6]

 

2000

2001

2002

2003

as a percentage of GDP

General Government Current Expenditure

of which:

- Interest payments

- Goods and Services

- Other Transfers

25.9

2.0

12.3

11.5

25.4

1.8

12.1

11.5

24.5

1.4

12.2

10.9

23.5

1.2

12.0

10.4

[Preliminary National Accounts Assessment]

Infrastructural Investment

The 2000 Broad Economic Policy Guidelines acknowledged that despite substantial investment in recent years, Ireland still has a significant infrastructural deficit. They therefore recommended that budgetary policy should aim to ensure that the objectives of the National Development Plan are accorded high priority, given the infrastructural needs of a strongly growing economy.

In response to the urgent need to remedy infrastructural deficits, thereby easing cost competitiveness pressures, capital expenditure will average 5.3% of GDP over the Programme period in line with the National Development Plan 2000-2006[7].  The bulk of this planned investment in roads, public sector transport and water and sewerage services is aimed at addressing existing bottlenecks and allowing for further economic growth in the years ahead.

 Table 10: Capital Account

 

2000

2001

2002

2003

as a percentage of GDP

Total Government Investment

Capital Resources

5.1

2.4

5.4

2.6

5.5

1.7

4.9

1.1

Capital Deficit

2.7

2.8

3.8

3.7

 [Preliminary National Accounts Assessment]  

The investment measures contained in Budget 2001 and in the National Development Plan represent a prudent use of available resources to support sustained economic progress into the future.  Their financing, despite an expected continuing reduction in EU funding, will respect the Stability and Growth Pact.  With a view to maintaining investment efficiency, new approaches to public investment are underway including a series of Public Private Partnerships.  

 Table 11: Total Government Current Resources

 

2000

2001

2002

2003

as a percentage of GDP

General Government Current Resources

of which:

-Central Government Taxes

-Social Security Receipts

- Miscellaneous Current Receipts

33.3

27.2

4.2

1.8

32.5

26.6

4.1

1.8

32.5

26.6

4.3

1.7

32.7

26.8

4.3

1.6

[Preliminary National Accounts Assessment]

2.5 Budgetary Projections 2000-2003

The projected General Government balance for the period to 2003 is shown in Table 12.  An average annual surplus of 4.2% of GDP is forecast for the three years 2001-2003.

The budgetary stance represents a responsible and realistic approach in the context of Ireland's strong fiscal position and is in comfortable compliance with Ireland’s obligations under the Stability and Growth Pact.

It represents a considered balance between the need to avoid adding to domestic inflation, while underpinning the Programme for Prosperity and Fairness - the cornerstone of economic policy - and adequately addressing infrastructural constraints as envisaged in the National Development Plan.

It should be noted that:

·         the Government plans to run significant General Government surpluses each year of the up-dated Stability Programme despite a decline in net EU receipts by the Irish Exchequer from 0.6% of GDP in 1999 to an estimated -0.3% of GDP in 2003;

·         there will be a further substantial reduction in the debt to GDP ratio, to 24% by 2003; and

·         Ireland will continue to set aside further substantial sums of not less than 1% of GNP annually, to pre-fund pensions liabilities (the National Pensions Reserve Fund already has assets of almost £5.05 billion (€6.4 billion) or 7.4% of GNP).

Table 12 - Budgetary Projections: 2001- 2003

 

2000

2001

2002

2003

as a percentage of GDP

Current Account Surplus

Capital Account Deficit [8]

Contingency [9]

7.4

2.7

0.0

7.0

2.8

0.0

8.0

3.8

-0.4

9.2

3.7

-0.8

General Government Surplus

- of which Primary Surplus

4.7

6.7

4.3

6.1

3.8

5.4

4.6

6.0

General Government Debt

39

33

28

24

ESA95 Basis [Preliminary National Accounts Assessment]

The 2000 Broad Economic Policy Guidelines recommended that “given the extent of overheating in the economy” the Government should “gear the Budget for 2001” to ensuring economic stability.  The Government’s budgetary policy framework for 2001-2003 is in line with this recommendation.

These budgetary projections take account of an increase in the deficit on the capital account from 2.7% of GDP in 2000 to 3.7% in 2003 reflecting increased public sector investment as a result of the roll out of the National Development Plan

They also incorporate a contingency provision against possible future developments which could adversely affect the budgetary position amounting to 0.4% of GDP in 2002 and 0.8% in 2003.

Box 2.3 Public Finance Impact of Third Generation Mobile Phone Licences

The impact on the public finances of the sale of third generation mobile phone licences is not yet clear; it will depend on the level of fees set for them in 2001.  The budgetary arithmetic included in this Update does not incorporate possible 3G-related revenue.

In July, the Director of Telecoms Regulation launched a consultation process which proposed that the competition for the award of licences for third generation (3G) mobile telephony services will be by way of a comparative selection process. The Director also proposed the award of four licences including one reserved for a new entrant to the market.

The level of fees for 3G licences will be established later taking account of developments in 3G competitions elsewhere in Europe.  The consent of the Minister for Finance is required in relation to the proposed fees, and this will be sought at the appropriate time.

It is anticipated that the licensing process should be completed by around May 2001.

 

2.6 Disposal of State Assets

A number of State asset disposals are expected next year.  If the proceeds of these disposals are used for pensions prefunding they will have no impact on the budgetary outturn.

2.7 Effect on General Government Balance of Pensions Prefunding

Payments to pensions pre-funding do not have an impact on the General Government Balance.  It had been anticipated, when last year’s Stability Programme December 1999 Update was being prepared, that two funds would be established one of which would be outside the Government sector.  Accordingly, it was then anticipated that prefunding payments would reduce the General Government Balance by 2.2% of GDP in 2000 and by 0.3% of GDP thereafter.  It is now the case that only one fund, the National Pensions Reserve Fund, is being established.  Payments to this Reserve Fund do not have an impact on the General Government Balance, as it is treated as part of the General Government sector.

 An amount of £3.015 billion was set aside for pensions prefunding in 1999. This together with a further £1.85 billion set aside this year gives a total projected value for the Fund, including interest, at end-2000 of £5.05 billion (€ 6.4 billion) or 7.4% of GNP.

The bulk of this funding (about £3.6 billion) was financed from the proceeds of the sale of shares in Eircom (formerly Telecom Eireann) in 1999 and 2000 and the balance is financed from a minimum annual contribution of 1% of GNP. (The public finance implications of population ageing are discussed in more detail in Chapter 3).

 2.8 Sensitivity to Lower Growth

The economic and budgetary projections contained in this updated Stability Programme are based on a prudent assessment of Ireland’s growth prospects for the next three years.  The impact on the budget position of different economic scenarios is considered in the sensitivity analysis contained in Appendix I.  In the event of slower than expected growth, the Government is committed to ensuring that the budgetary position continues to respect the terms of the Stability and Growth Pact.

 

[1]This is the net amount of investment that must be financed by Government after internal capital resources and EU capital transfer payments are taken into account

[2] To maintain comparability, the above 1999 General Government Surplus of 3.9% does not take account of discharging future pensions liabilities associated with some of the employees and former employees of An Post and Eircom (formerly the state owned telecoms company) at a cost of 1.8% of GDP.

[3] Source : Public Information Notice  for the 2000 Article IV Consultation

[4]These apportionments for general government current expenditure by category are provisional.

[5] The National Development Plan was discussed in detail in last year’s Stability Programme, section 3.14.

[6]This is the net amount of investment that must be financed by Government after internal capital resources and EU capital transfer payments are taken into account.

[7]This is a provision made against factors that may impact on the Budget but cannot be quantified at this stage.

[8]This is the net amount of investment that must be financed by Government after internal capital resources and EU capital transfer payments are taken into account.

[9]This is a provision made against factors that may impact on the Budget but cannot be quantified at this stage.