Wednesday, October 6, 2010

Closing the Gap

In 2009, using eurostat figures Irish government expenditure was €77.3 billion.  The compares to tax revenue of €54.4 billion.  This represents a fiscal deficit of €22.8 billion.

Annual Tax and Spend euros

We have undertaken a quick analysis of Irish tax revenues and government expenditures relative to the EU averages.  Using figures relative to Gross National Income this analysis suggested that Irish tax revenue is below the EU average (4th lowest) and that Irish government expenditure is above the EU average (the highest!).  This situation is unsustainable and resulted in a general government deficit to GDP ratio (GGD/GDP) of 14.3%.

It is suggested that relative to 2009 levels the fiscal deficit should be closed by a combination of a €6.6 billion increase in tax revenue and an €11.0 billion reduction in government expenditure.  This roughly suggests that the necessary fiscal adjustment should be one-third tax increases, two-thirds expenditure cuts, but it should be noted that the 2009 expenditure total excludes money used for the bailout of our ailing banks.  These payments will not be recurring (hopefully!) and will provide a large chunk of the necessary expenditure cuts.

If tax and expenditure had been at these proposed levels in 2009, the fiscal deficit would have been €5.3 billion (€66.3 billion expenditure versus €61.0 billion tax revenue).  This gives an implied GGD-to-GDP ratio of 3.3% – just above the Stability and Growth Pact limit of 3%.

Our immediate targets should be a tax-to-GNI ratio of 46% and spend-to-GNI ratio of 50%. At the current GDP/GNI ratio these equate to a tax/GDP ratio of 38.2% and a spend/GDP ratio of 41.5%.  There still would be a fiscal deficit but one that would manageable compared to the current crisis and once this passes there would be ample time to restore long-run equilibrium to the public finances.  Now if only we could find a map!

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