Thursday, December 29, 2011

Mortgages in Irish Banks (and their interest rates)

A previous post looked at loans in Irish banks.  Here will we confine ourselves to mortgages and will start from this graph in the earlier post.

Household Loans for House Purchase

The Central Bank report Private Household Credit and Deposits Statistics which allow us to look at this in a little more detail.  Here is the same graph (going back to 2003) from the Household Credit series.  The data is quarterly and runs to Q3 2011 so does not include the shifts that occurred in October 2011 that guided the previous post.

Total Loans for House Purchase

In general, the series from the two graphs are similar though the securitised series in the latter graph shows a ‘jump’ in the second quarter of 2009 that is not evident in the first graph.  As there is no corresponding decrease in “on balance sheet” loans it is not clear what was securitised (if anything).

It can be seen that banks in Ireland began securitising mortgages in the middle of 2006 and stopped by the end of 2009 (apart from €17 billion that was “derecognised” in October 2011 of course!)

The benefit of the household statistics is that we can look a little deeper into this although most of the data series only start from the fourth quarter of 2010.  We can, however, get the breakdown of the “on balance sheet” loans for house purchase back to 2003.

On Balance Sheet Loans for House Purchase

Most of the significant step decreases can be explained by increases in securitised loans although the drop that can be seen at the end of 2010 is as a result of Bank of Scotland (Ireland) leaving the Irish market.

The more detailed series are only available for four quarters.  There has been little movement in the series over this period so there is little value in graphing the series.  Here is the most recent data for September 2011 in tabular form. 

First, the total amount of loans for house purchases.

Loans for House Purchase

The €102 billion total of residential mortgages in September 2011 is significantly lower than the €114 billion reported in the Financial Regulator’s Residential Mortgage Arrears Statistics for the same time.  The primary reason for the difference is the absence of Bank Scotland (Ireland)’s mortgage loan book from the above figures.  

We are also provided with a breakdown of the €132 billion of mortgages by interest rate type: standard variable, tracker and fixed for different periods.

Mortgages by Interest Rate

More than half of mortgages in Ireland are tracker-rate loans linked directly to the ECB base rate.  With the ECB rate now back to 1% the repayments on these loans are now much lower than when these loans were taken out in the 2006 to 2008 period.  Finally, we can get a breakdown by interest type for residential, buy-to-let and holiday home mortgages.

Here is a breakdown of the €102 billion of residential mortgages by interest rate type.

Principal Dwelling Loans by Interest Rate

Just over half of residential mortgages on are on tracker rates.  If the €10 billion or so of mortgages in the former Bank of Scotland (Ireland) were included this proportion would be even higher as most of its mortgage book comprised tracker-rate loans. 

The proportion of buy-to-let mortgages that are on tracker rates is even higher.

Buy to Lets by Interest RateAlthough they make up a very minor part of the overall market here is the same data for holiday home and second home mortgages.

Holiday and Second Homes by Interest Rate

Loans in Irish Banks

Here we will give a look at the asset side of the balance sheets of Irish banks, looking specifically at loans and in particular at some large changes that seemed to have occurred in October based on the most recent release of the Central Bank’s Money, Credit and Banking Statistics.

First up, is the total amount of loans on the balance sheets of the domestic banks, broken into the covered group (AIB, BOI, IBRC and PTSB) and the non-covered group (Ulster Bank, National Irish Bank, etc. and also credit unions).

Total Loans in Domestic Banks

There has been a fall in the amount of loans on the balance sheets of the covered banks.  Some of this is due to repayments on existing loans exceeding the amount of new loans issued but most of the drop from a peak of €513 billion in July 2009 can be explained by the transfer of over €70 billion of developer loans to the National Asset Management Agency (NAMA) and the sale of loans to other banks.

The total amount of loans the covered banks had was steady at around €400 billion from May of this year but there was another sharp drop to €377 billion in October.  It would be possible to explain this drop in a chart or two but we will use the drop as a reason to have a fuller look at the loans on the balance sheets of the banks.

Loans in the non-covered domestic group peaked at €165 billion in October 2008 and have fallen by more than half since then, although for 2011 loans in the non-covered domestic group have been relatively steady.  In January they were €79 billion and by October they were also €79 billion.  From January to November 2010 these loans fell steadily from €113 billion to €99 billion.

The large drop in December 2010 (from €99 billion to €79 billion) can be explained by departure of Bank of Scotland (Ireland) from the Irish market.  The loans still exist but they were transferred to Bank of Scotland’s parent group in the UK and no longer appear on the Central Bank of Ireland’s aggregate banking balance sheet statistics. 

From here on we will focus on the €377 billion of loans on the balance sheet of the covered banks.   It is important to note that these are non-consolidated figures, that is they just cover the Irish operations of the banks.  Here is the Irish/non-Irish resident split of the loans.

Loans by Origin in Covered Banks

Loans to Irish residents peaked at €364 billion in June 2009.  Repayments but mainly transfers to NAMA saw this fall under €300 billion May of this year.  Loans to non-Irish residents from the covered banks have fallen from €156 billion in June 2010 to €102 billion now. 

The large drop in October from the first graph can be mainly attributed to the drop from €294 billion to €275 billion in loans to Irish residents, though loans to non-Irish residents also fell (from €108 billion to €102 billion).

Looking at loans to Irish residents (because it is the largest drop but also because we don’t have this breakdown for loans to non-Irish residents) gives a further insight into this drop.

Irish Resident Loans in Covered Banks

Loans on the balance sheets of the covered banks to the private sector (households and businesses) peaked at €256 billion in October 2008.  They then showed a consistent fall over the next three years at stood at €178 billion in September 2011.  From here the big fall in October 2011 can be seen with a drop to €157 billion. 

The exposure of balance sheets of the covered banks to Irish private sector loans has fallen by nearly 40% in the past three years.  The increase in loans to general government are the €30 billion of Promissory Notes given to the IBRC during 2010.

To get a further insight into the changes to private sector loans we have to move away from the balance sheet data and move to the data presented on overall credit in Ireland.  This is credit forwarded by all credit institutions and not just the covered banks but the covered banks make up about two-thirds of the total.  Here are the private sector loans to the household, non-financial corporation, financial intermediary and insurance on the balance sheets of all banks operating in Ireland going back to the start of 2005.

Loans to Private Sector by Sector

It is clear that that the reason for October drop is to be found in the household sector.  The drop in business loans from a peak of €170 billion in August 2008 to €87 billion now is almost fully explained by the transfer of developer loans to NAMA. 

The next step is loans by purpose for the household sector.

Household Loans by Purpose

There seems to have been a huge drop in loans for house purchase (residential and investment) to the household sector over the past few years from a peak of €128 billion in May 2008 to €81 billion in October 2011, with a €17 billion drop in that month alone. 

Of course, Irish households are not repaying debt at that rate and a drop of €17 billion in one month is absurd.  The transaction data provided by the Central Bank show that loans for house purchase to the household sector declined by €319 million in October.  The €17 billion drop is on the balance sheets of the banks not the households (and is down to one of the covered banks as we have seen above). 

So what gives?  The next table from the Central Bank gives outstanding amounts (including securitised loans).  Here are loans for house purchase to the household sector.

Household Loans for House Purchase

This explains what has happened in October.  Loans for house purchase on the balance sheet of the covered banks fell but only because securitised loans increased by the same amount. 

We can see that the total amount of loans to the household sector from bank operating in Ireland stopped rising in 2008 and has been falling gradually since then.  The stepped drop at the end of 2010 is again explained by the departure of Bank of Scotland (Ireland) from the Irish market.

The Information Note from the Central Bank to the October Money, Credit and Banking Statistics gives mention of this securitisation in a footnote of page 2:

This is due to a credit institution derecognising loans from the statistical balance sheet that had been securitised, in line with the methodology applied by the reporting population in general.

Hmmm.  One the covered banks didn’t realise that it had been reporting €18 billion of securitised loans on its balance sheet that shouldn’t have been there at all.  How very reassuring.  So what did it replace the €18 billion of mortgages on its balance sheet with?  If we go back to the aggregate balance sheet data of the covered banks we can probably infer the answer.

Irish Securities held by Covered Banks

There was an €19 billion rise in the holding of securities issued by the Irish private sector.  This has risen quite significantly recently with most of the rise occurring when the banks received NAMA bonds for their developer loans in 2010.  It was largely steady for the past year until the almost vertiginous rise in October which as we have seen is as a result of “a credit institution derecognising loans from the statistical balance sheet that had been securitised”.  It now seems they had €18 billion of bonds they didn’t know about as well!

The above graph also shows that the banks hold about €16 billion of bonds in Irish banks.  It is not clear how many of these are from the covered banks or in fact if much of it is the banks’ holding of their own bonds.  The rise in the banks’ holding of Irish government bonds can also be seen and stood at €12 billion in October.  This is about 14% of the total stock of Irish government bonds.

I can’t say that there is much to be learned from digging into this non-securitised / securitised shift in October.  It is hard to say who is now carrying the risk of these loans.  It is probably a company linked to the bank as it is unlikely they would have overlooked a transaction with an external third party.

Tuesday, December 20, 2011

Investment, Depreciation and the Capital Stock

Last Friday’s release of the Q3 Quarterly National Accounts contained some interesting figures but the standout one was the 20% drop in Investment that occurred in the quarter.  Investment is now down more than two thirds on its peak and is the main reason for the fall in the Irish economy over the past four years.

In fact, if we do an unusual dichotomy for the national accounts and break it into expenditure on “Goods and Services” and expenditure on “Capital Formation” we see that the former has held up while the latter is down nearly 70%.

Current and Capital GDP Expenditure

The distinction is a little crude but “Goods and Services” is made up of C + G + NX:

  • C – Personal Consumption of Goods and Services
  • G – Net Expenditure by Central and Local Government on Current Goods and Services
  • NX – Net Exports of Goods and Service (Exports minus Imports)

In the third quarter of 2007 these summed to:

€22.8 billion + €7.5 billion + (€37.9 billion – €33.4 billion) = €34.7 billion

The most recent figures for the third quarter of 2011 the figures were:

€20.0 billion + €6.4 billion + (€40.5 billion - €29.7 billion) = €37.3 billion

There have been reductions in expenditure by households (-12%) and government (-15%) but these have been offset by an increase in net exports (+70%).  For the period 2007 to 2009 this was as a result of falling imports rather than rising exports but for the past 18 months or so the improvement in net exports has been as a result of increased demand abroad for goods and services produced in Ireland.  Overall demand for goods and services is up €2.6 billion over the four years.

“Capital Formation” is just I from the National Accounts: Gross Domestic Fixed Capital Formation.  Over the period used above quarterly investment fell €5.6 billion from €9.1 billion to €3.5 billion. 

Quarterly GDP fell 7.6% from €43.5 billion in the third quarter of 2007 to €40.2 billion in the third quarter of 2011.  Using the dichotomy we have applied here this is largely explained by the collapse in capital expenditure.  To explore further the nature of the fall in investment see this post on patterns of investment over on  The general idea is fairly clear  - it is mainly a story of households and housing.

Two weeks ago the CSO released the 2010 update of the Estimates of the Capital Stock of Fixed Assets.  Here is a graph of the value of the stock of fixed capital (excluding land) in 2009 prices.

Net Capital Stock

The capital stock increased consistently from 1995 to 2008 and this is true for the overall capital stock and the capital stock excluding dwellings (other buildings, roads, transport equipment, other machinery and equipment, cultivated assets, computer software).

Of course, it is not that there was no investment in 2009 and 2010.  There was €25.3 billion of gross capital formation in 2009 and €19.0 billion in 2010, but this was just enough to cover the amount the consumption of the existing stock of fixed capital (depreciation) so the increase in the net capital stock was much less.

[The investment figure here is form the National Income and Expenditure Accounts and the depreciation figure is from the Estimates of the Capital Stock of Fixed Assets.  There may be some non-overlapping between the definition of fixed capital/assets used in each but it is unlikely to change the overall conclusion.]

Investment and Depreciation

The fall in investment has continued and in real terms 2011 is 15% behind 2010 so it is clear that investment this year will not be sufficient to cover depreciation.  For the first time since the series began the real value of the capital stock in Ireland will fall.  The picture is equally bleak if we exclude dwellings (with land excluded in all of the analysis here).

Investment and Depreciation excluding Dwellings

For most categories investment in 2010 exceeded the level of depreciation estimated by the CSO, but the gap has gotten substantially narrower and for 2011 will be negative in many cases.

Investment by Use

The depreciation for Dwellings and Other buildings includes the costs associated with the transfer of land and buildings but a breakdown under gross investment or depreciation is not included.  The Net Investment under Dwellings and Other Buildings could be larger if conveyancing costs were included in the gross investment figure (as they are in the depreciation figure).  It should also be noted that the gross investment figure for Other Buildings and Construction includes land rehabilitation but land is not included in the depreciation figure.

The negative net investment figure for other machinery and equipment is large but a lot of this could be explained by the almost stalling of activity in the construction sector.  It be argued that a lot of the machinery and equipment here is out of use rather than depreciating and will never be replaced.

For 2011, it is likely that gross fixed capital investment will struggle to get much over €16 billion (in 2009 prices).  It is €12.6 billion for the first three quarter of the year.  The 2010 depreciation figure of €16.2 billion is unlikely to the much changed for 2011.   An increase in the capital stock for 2011 is unlikely and the prospects are that a similar outcome will occur in 2012.

Finally here’s net investment as a percent of GDP.

Net Investment

Thursday, December 15, 2011

Wealth (and Taxing Wealth) in Ireland

Wealth has been getting a lot of attention in Ireland recently particularly in relation to the claim that it would be possible to raise €10 billion per annum from a 5% wealth tax on the wealthiest 5% of the population as detailed in the Budget Submission of the United Left Alliance and repeated on an almost nightly basis on television and radio.

The adult population of Ireland is around 3,400,000 so the 5% that are liable for this tax would be 170,000 people.  In order for the €10 billion total to be achieved these people would have to be pay an average of an additional €60,000 in tax every year.

The ULA’s budget submission also envisages an additional €5 billion of income tax to be raised from those earning in excess of €100,000.  According to data from the Revenue Commissioners in 2009 there were 110,000 tax cases reporting an income in excess of €100,000.  The average income in this category is €180,000, but two-thirds of those who earned more than €100,000 earned less than €150,000.  In order for the €5 billion target to be achieved those earning more than €100,000 will be required to pay an average of an additional €45,000 of income tax. 

This is an addition to the €60,000 average income tax that this group paid.  In 2009, this excludes payments made because of the Health Levy and also PRSI contributions.  Anyway, the focus here is on the potential to raise €10 billion from a wealth tax.

Back in February the United Left Alliance were proposing that €6 billion a year could be raised from a wealth tax.  Just ten months later they have increased this to €10 billion. 

The original claims were based on a 2006 report by Bank of Ireland Asset Management on The Wealth of The Nation.  The current claims are based on the Global Wealth Report (and accompanying Databook which has the details on Ireland) from Credit Suisse.  For 2011, the report estimates that the average net wealth per adult in Ireland is $181,434 (median equals $100,351).  With an adult population figure in the report of 3,403,000 that puts total net wealth in Ireland at $617 billion. 

The Credit Suisse report estimates that there are around 70,000 millionaires in Ireland (and four billionaires).  This means that around 100,000 of those in the top 5% have a net wealth of less than €1 million.  Net wealth is

Financial wealth + Non-financial wealth  - Debts = Net wealth

This figures under each heading are:

  • Financial wealth $435 billion
  • Non-financial wealth $484 billion
  • Debt $302 billion

We are not given an exchange rate to convert this into € but the euro has recently been around 1.30 to the dollar but was probably trading higher when this report was written.  If we use an exchange rate of €1 = $1.40 that would give:

€310 billion + €345 billion - €215 billion = €440 billion

The estimate is that there is €655 billion of gross assets in Ireland and €440 billion of net wealth.   The 2006 figures from the earlier Bank of Ireland report are:

€270 billion + €695 billion - €161 billion = €804 billion

The figures provided by Credit Suisse for financial wealth and debt are not that distant from the official figures given in the CSO’s Institutional Sector Accounts.  This puts financial assets of the household sector in Ireland for 2010 at €311 billion and household financial liabilities at €194 billion.  The asset figure is almost identical to the Credit Suisse figure but the liability figure is a little higher than the CSO’s.

The CSO put total financial wealth in the household sector at €117 billion.   The following gives the breakdown of the assets and liabilities that gives rise to this figure.

Household Sector Balance Sheet

The Bank of Ireland report puts the 2006 total of financial assets at €270 billion and exclude life assurance reserves from their total.  Credit Suisse have a figure of €310 billion but the composition of this is not given.

To get a measure of overall wealth we need to add non-financial assets to those listed above.  The Bank of Ireland report includes residential (€671 billion) and commercial (€24 billion) real estate in the €695 billion total for 2006 in that report, but seem to exclude land and other assets.  Even putting an approximate value on all of these assets is extremely difficult. 

It is not clear what Credit Suisse include as non-financial wealth but is it “principally housing and land” and they provide a figure of €345 billion but there is no way of knowing how this is derived.

The CSO do not provide an estimate of non-financial wealth in Ireland but the organisation’s Action Plan under the Croke Park Agreement states that “there is demand for a … survey
of household Income, Wealth and Assets.”  It is not clear when this will be delivered.

And finally onto the distribution. Credit Suisse estimate that 5% of adults (175,000) have 46.8% of the €440 billion of the net wealth they estimate that is in the country.  This is equal to €206 billion and would be an average of around €1.17 million per person.

A division of this by financial and non-financial assets is not provided and it is unclear what the asset allocation across this €206 billion is.  Apart from the nebulous concept of “wealth” in the ULA document it is not clear what should be taxed.  It will take a little more than an amendment to the Finance Act proposing that “a 5% tax be imposed on the wealth of the wealthiest 5% of the population”.

It is also not clear how sound this wealth distribution is.  The Credit Suisse report says that it has wealth distribution data for 22 countries and uses this data to infer distributions for the other 140 countries in the report.  Ireland is one of the countries that they claim to have wealth distribution data for and this is from 2001.  The 2001 data and the 2011 estimates are summarised in the following table.

Wealth Distribution

The series are reasonably consistent.  The 2001 figure is that the bottom 50% have 5.0% of the wealth.  For 2011 the reported figure is 4.8%.  In 2001 it is indicated that the top 10% has 56% of the wealth, in 2011 it is 58.9%.  For the top 1% the figures are 23.0% and 28.1%.

But where did the 2001 data come from?  The report says the data is from Inland Revenue Statistics and to go see Ireland (2005).  I doubt the UK’s Inland Revenue have data on the distribution of wealth in Ireland and we know that the Revenue Commissioners do not.  The Inland Revenue may have data on Northern Ireland and they have lots of neat stuff here.

So what is this reference to Ireland (2005).  From the bibliography this is:

Ireland, P. (2005): “Shareholder Primacy and the Distribution of Wealth”, Modern Law Review, 68: 49-81.

You can read this article here but the only mention of Ireland is because of the name of the author – Paddy Ireland.  There are no wealth distribution statistics for Ireland in the article. None, but the reference has the words “Ireland”, “wealth” and “distribution” in it!

This report by the some of the same authors has almost the same wealth distribution as those shown in the top of the above table.  The only issue is that there are for the UK in the year 2000.  See table 7 on page 37.

There is another wealth distribution provided for Ireland in this report but this is claimed to be from 1987 and cites a 1991 publication by Brian Nolan, The Survey of Income Distribution, Poverty and Usage of State Services.  However I think they actually a 1991 publication for the Combat Poverty Agency, The Wealth of Irish Households: What Can We Learn from Survey Data? (32mb!). Anyway here is the 1987 data which is confirmed on page 69 of the Combat Poverty Agency report.

Wealth Distribution (2)

When using the 1987 data this earlier report says “it is hoped that the shape of wealth distribution in these countries was reasonably stable from the late 1980s to the year 2000”.  By 2001, in the Credit Swisse report they are saying that the wealth share of the top 1% was 23.0% up from 10.4% in the 1987 data.  Not very stable.  Of course, this 23.0% is a UK figure so we cannot put much weight on it.

In fact, without any evidence to support the claims in the report we cannot put any weight on it at all.  Hopefully in time the CSO will address this data deficiency.  The Nolan (1991) data is from a survey which will tend to underestimate the wealth of high and very high net worth individuals as they will be under-represented in the sample.  Any information on the 2011 distribution of wealth in Ireland is little more than a guess.

A 5% tax on €206 billion would yield an impressive €10.3 billion but the proposal must specify what is to be taxed.  The possibilities are:

  • Cash
  • Current Accounts and Deposits
  • Life Assurance Reserves
  • Direct Equity Investment
  • Business Equity
  • Pension Fund Equity
  • Land
  • Commercial Property
  • Residential Property
  • Other Assets

Putting a 5% tax on cash, current accounts, bank deposits and life assurance reserves seems practically impossible.   The value of equities or private business comes from the dividends or incomes that these assets can generate and this are taxed under the income tax code.  We have introduced a 0.6% annual pension levy for private pensions.  A land tax is possible but unlikely and a residential property tax (or more particularly a site value tax) is due to be introduced by 2014.  Determining what other assets should even be included makes taxing them difficult (yachts, racehorses, art, antiques, cars, jewellery, …)

All this is not to say that a wealth tax does not have merits.  There have been moves away from wealth taxes in the past 15 years with many European countries abandoning them but France maintains the ‘Solidarity Tax on Wealth’.  This is liable on net assets above €800,000 and was paid by 1% of taxpayers in 2007.  See here and here for details (thanks to the Wikipedia entry) with more here and here.

The tax raises about 1.5% of general government revenue in France and is at a rate of around 0.5% of taxable net assets for the majority of those who pay.  The ULA proposal seems to be to set these at a level ten times larger in Ireland – t0 raise 15% of revenue at a rate of 5% of net assets – and to levy it on five times as many people. 

There is no way that this can be realistically achieved.  The numbers on which the claim is based are questionable but to push the proposal to such drastic lengths is absurd.  If we got €1 billion from a wealth tax it would be a start.

Tuesday, December 13, 2011

Do we want miss the budgetary targets?

The measures put together for last week’s budget(s) has the stated aim of getting the General Government Deficit down to 8.6% of GDP.  Although we know neither the final deficit nor the nominal GDP figure it is currently forecast that the deficit will be around 10.1% of GDP this year. 

The original Four-Year Plan published last November targeted a 2012 deficit of 7.0% of GDP but this was based on very optimistic assumptions which had the deficit falling to below 3% of GDP by 2014.  When the EU/IMF deal was brokered a few weeks later the timeframe for getting the deficit under 3% was pushed out to 2015 and at the ECOFIN meeting of 7 December 2010 a deficit limit of 8.6% of GDP for 2012 was set.

The 2011 Budget was announced the same day and still forecast a deficit for 2012 of 7.3% of GDP.  It wasn’t until the Stability Programme Update in April of this year that the 8.6% deficit figure for 2012 made an appearance in Irish documents.

Much has been made of the fact that at 10.1% of GDP the deficit for this year has come in “below target”.  This was not so much below target as below the 10.6% limit set by the ECOFIN meeting last December.  The target from last year’s budget was that this year’s deficit would be 9.4% of GDP.  The deficit is very much larger than the target.

This year the deficit limit was 10.6% of GDP, the target was 9.4% of GDP and the outcome will likely be somewhere in the middle.  Next year the limit is 8.6% of GDP and the target is also 8.6% of GDP.  While there was room for significant slippage this year (and the GGD is almost €800 million larger than forecast in last year’s Budget) there is absolutely no room for slippage next year.

If growth is slightly lower than expected or the measures introduced don’t have the anticipated impact than it is very likely that the deficit will come in above 8.6% of GDP.  This year we had the capacity to absorb such downward developments; next year we have none.

The reduction in the EU interest rates agreed last July will make reaching the 8.6% target a little easier.  These are estimated to save around €900 million in 2012.  If these were applied statically to the projections from the April SPU then the deficit target for 2012 would be around 8.0% of GDP.  This would have been a better target for 2012 but slippages elsewhere have fully absorbed the interest rate gains. Even with €900 million of savings announced in July the deficit target for 2012 is still at the 8.6% of GDP it was last April.

As a result of the interest rate savings we might be able to get fairly close to the 8.6% of GDP limit set by the EC.  How we will fare on the IMF targets are less clear.  The IMF does not make targets based on the overall general government balance and does not make them very far in advance.

The IMF budgetary targets are in terms of the primary exchequer deficit.  This is the deficit on the Exchequer Account excluding interest payments.  The IMF’s Third Quarterly Review (table 2, page 54) sets an indicative target for the end-June 2012 primary exchequer balance of €7.4 billion.  Up the the end of June 2011 the primary exchequer balance was €8.4 billion (exchequer deficit of €10.8 billion less €2.4 billion of exchequer interest payments).

The IMF targets are not affected by the interest rate reductions announced last July.  The primary exchequer deficit has to improve by €1 billion in June 2012 relative to its performance 12 months previously.

In last December’s budget tax revenue was forecast to be €34.9 billion for 2011.  It is now clear that tax revenue of around €34.2 billion will be achieved. And this was only possible with the addition of €0.5 billion from the private sector pension levy announced in the May Jobs Initiative.  On a ‘like-for-like’ basis, tax revenue for 2011 is around €1.2 billion behind last December’s target.

Just like the EC limit there was significant room for slippage when it came to the IMF target.  Last June when the primary exchequer balance was €8.4 billion, the limit set by the IMF was €10.1 billion.  We were well within the limit and had enough room to absorb the deterioration seen in tax revenues in the final quarter.  Once again we have decided to eliminate this capacity and made the limit our target.  The margin for error on the downside is zero.

Some of the numbers in last week’s budget do not stack up.  The Minister for Finance admitted that the 2% VAT increase would not bring in €670 million over a full year because the estimate did not account for a fall in demand.  The is an extra €160 million forecast to be brought in as a result of changes to CGT and CAT.  This is equally unlikely.  The €200 million gain from increases in Excise Duty also seems optimistic.  These make up the bulk of the €1,000 million of new tax measures announced last week.  

Many of the expenditure measures are equally woolly.  Here is a list of “savings” included in the €1,400 million of current expenditure cuts from the Summary of Budget Measures.

  • Enhance fraud and control activity.
  • Continued focus on delivering reductions in the price and volume of goods and services procured by the health services.
  • Savings from anticipated lower disease incidence and operational changes.
  • Miscellaneous Savings on the Vote
  • Achieve a reduction in non-pay administration costs through increased efficiencies.
  • Reduce costs associated with operation of the Mahon Tribunal.
  • Efficiencies and changes to business processes.
  • Streamlining the State’s employment rights bodies.
  • Rigorously review of every area of expenditure.
  • Introduce new efficiencies mainly through the use of IT.
  • Programme savings through efficiencies.
  • A range of measures to improve programme efficiency are being considered.
  • Introduction of efficiencies.
  • Efficiency measures in Revenue, Office of Public Works and savings in legal fees in Law Offices.
  • General savings in Departments of Arts, Heritage & the Gaeltacht and Communications, Energy & Natural Resources.

The arithmetic might add up to a budget with €3.8 billion of “adjustments” but the reality is likely to be somewhat different.

After a year of being “the best in the bailout class” are we actually looking to exceed the deficit limits set down by our external funding partners?  Is there political capital to be gained from missing these targets?

Thursday, December 8, 2011

Inflation edges higher

Today’s CPI release from the CSO reports that the headline rate of annual inflation rose from 2.8% in October to 2.9% in November.  As has been the case since inflation returned to positive territory in the middle of 2010 this continues to be mainly driven by just two categories; energy products and mortgage interest. 

The price of energy products are up 13.7% in the year, while the price of mortgage interest is up 17.8% in the year.  These make up 15% of the index and removing them gives a measure of ‘core’ inflation.  Core annual inflation in November was 0.66%, up from 0.55% in October.

Core Inflation November 2011

On mortgage interest, it is important to realise that the CPI measures the price of mortgage interest and not necessarily the cost.  The price of mortgage interest change but the cost to most households may not change if this change is not also applied to existing mortgages.  This has happened in Ireland for the past 18 months or so.  Mortgage variable rates have been increasing far more than tracker rates and these form most of the mortgage interest price in the CPI. 

The mortgage inflation rate in the CPI overstates the average increase in mortgage rates as it reflects mainly the rates that have been rising by more(standard variable rates) and largely omits the rates which rose only slightly (tracker rates).  Almost half of all mortgages are on tracker rates.  This is explained in a Information Note to the CPI release.

In line with normal practice for a fixed base price index, the current approach to measuring mortgage interest in the CPI reflects the situation in the base reference period December 2006 when the standard variable rate was dominant. Subsequently, tracker mortgages have become more popular. This did not give rise to any difficulties while the standard variable and tracker mortgage interest rates moved broadly in line with one another, which would be the normal expectation. However, the decoupling that has taken place since August 2009 has resulted in dramatically different trends emerging. For example, between September 2009 and September 2010 the standard variable rate increased from 2.93% to 3.66% whereas the tracker rate did not change. The Mortgage Interest component of the CPI, which is largely determined by the trend in the standard variable rate, increased by 25.1% as a result and contributed +1.25% to the overall change in the All Items index. It is crudely estimated that the latter impact would have been reduced by between 0.2% and 0.5% had the Mortgage Interest component been calculated on a current weighting basis. Users should take this “weighting effect” into account in interpreting the mortgage interest related movements in the index.

Monday, December 5, 2011

Social welfare expenditure to fall by €88 million

Today seems like an appropriate time to update this.  The 2012 expenditure of the Department of Social Protection was subjected to €475 million of “savings measures” today.  It is projected that the full effect of the measures announced today but which will come into effect over the next three years will be €811 million.

In 2011 it is estimated that expenditure on social welfare payments from either the Department of Social Protection or the Social Insurance Fund will be €20,030 million.  With the measures announced today the forecast for 2012 is €19,942 million – a fall of €88 million. 

Here are the expenditures by six main headings for 2011 and 2012.

Social Welfare Expenditure

The actual payments under each heading were detailed in the previous post on this issue.  It can be seen that most of the expenditure increases are for pensions and in particular the contributory pensions paid from the Social Insurance Fund.

Around €45 million of the 2012 savings announced today are as a result of reduction in Child Benefit for third and subsequent children.  Even with this the aggregate amount of Child Benefit is forecast to increase (albeit by just €8 million) from €2,067 million to €2,075 million.

The large drop is income support payments from the Social Insurance Fund is evenly split between a fall in Jobseeker’s Benefit and Redundancy and Insolvency Payments.  The fall in Jobseeker’s Benefit is because entitlements expire after 12 months. Recipients can switch to the means tested Jobseeker’s Allowance paid by the Department of Social Protection where expenditure is forecast to increase by more than €150 million.

In 2009, the outturn for social welfare payments was €19,959 million.  As shown above it is forecast to be €19,942 million in 2012.  This is a drop of 0.08%.  Next year, social welfare payments will be 99.92% of what they were in 2009. 

It is clear there have been significant adjustments to social welfare expenditure and these cuts continued today.  However, there has been no reduction in overall expenditure.  Rather, the same amount of money is being spent but it is going to more people (more children, more pensioners, more unemployed) so, on average, people are getting less.

Thursday, November 24, 2011

Back to ten percent?

Here is the one-day performance of the Irish government bond nine-year yield as calculated by Bloomberg.

Bond Yields 1D 24-11-11

So much for bond yield tranquillity!  And this is not too different to what was happening on November 24th 2010 only this time we’re going one percentage point higher.

How much austerity have we had?

Here is an exchange from last week’s meeting of the Joint Committee on Finance, Public Expenditure and Reform Debate which was attended by members of the Independent Fiscal Advisory Council.

Deputy Mary Lou McDonald: Far from viewing Professor McHale as cautious or conservative, my reaction to his contention that the austerity should be greater and quicker is that it is reckless. I would like him to give us the rationale for his commitment to austerity. Where is the evidence it is working? We have not seen a dramatic reduction in the underlying deficit despite €20 billion having been sucked out of the economy.

Professor John McHale: Deputy McDonald asked if the austerity is working. By that I understand her to mean if it is succeeding in bringing down the deficit. The question is sometimes asked whether attempts at deficit reduction is self-defeating in that the deficit does not come down. In my view it is working. Our assessment of the numbers is that it is working. The overall general government deficit fell from 11.7% of GDP in 2009, and the most recent projection is that it will be 10.3% of GDP for this year, so that is a reduction. The Exchequer deficit for the first ten months-----

Deputy Mary Lou McDonald: Is that a satisfactory rate of decrease?

Professor John McHale: That is a good question. It looks like the Exchequer deficit for the first ten months of this year will be €1.8 billion lower than it was for the first ten months of last year.

In making an assessment, we have to recognise that austerity is not the only factor slowing down the economy. There are significant forces pushing the Irish economy down and this refers to the earlier discussion of the balance sheet recession. There are significant issues of confidence and issues of credit access. This economy has been hit with a number of very severe shocks that have been slowing growth and particularly slowing the growth of domestic demand, which is critical to the fiscal position.

The Deputy is correct that these numbers as regards improvement in the deficit are not startling in the sense that the deficit is on this incredibly slow downward path but the fact that this has been achieved in the face of such headwinds shows that it is actually working. It is hopefully a question of when we get back to growth and the measures taken, such as the new tax and expenditure structures, will yield much more. When we get back to growth and, particularly and crucially, growth in domestic demand which is affected by much more than just the austerity measures themselves, the expectation and the hope is that the deficit will improve more rapidly.

Using our fiscal feedback model, we have also conducted simulations of what would have happened if there had been no adjustment at all. The Deputy referred to the €21 billion adjustment which has taken place so far. On conservative assumptions, the deficit in 2011 would have been 20% of GDP instead of the projected 10.3% if there had been no measures taken. We would be heading for a debt to GDP ratio in 2014 to 2015 of approximately 180% of GDP. We would be fast becoming like Greece. We would probably never get there because we would probably have ended up in default before then.

The question here is not so much on whether austerity is working but on what exactly entails the “€21 billion adjustment” which is referred to in the exchange. The McCarthy Report on State Assets provides a useful summary of the measures that have been introduced up to this year.

Budgetary Adjustments

The sum of measure introduced is indeed €21 billion, but has €21 billion been “sucked out of the economy” over the last three years?  The €21 billion was the projected full-year impact of the measures introduced.  Maybe we should look at what actually happened to see how close reality is to this €21 billion.  I think the answer is closer to €10 billion than it is to €20 billion.

To start we will look at what was introduced each time.  First up is the €1 billion of measures introduced in July 2008.  Here is the list from the Minister’s statement.

  • All Departments, State Agencies and Local Authorities – other than Health and Education - will be required to reduce their payroll bill by 3% by the end of 2009 through all appropriate measures identified by local management in the light of local circumstances. The parameters of this exception for the health and education sector are to be agreed by the Departments concerned with the Department of Finance.
  • All expenditure by Departments and Agencies on Consultancies, Advertising and Public Relations will be significantly reduced for the remainder of this year and by at least 50% in 2009.
  • Further savings in 2008 and in 2009 are to be secured by a range of measures including those identified as a result of the Budget day efficiency review initiated by my predecessor.
  • All of the above efficiencies will apply equally to State Agencies. In addition, I have asked that these agencies be reviewed to examine whether they can share services, whether it would be appropriate to absorb some of their functions back into their parent Departments or whether some agencies should be amalgamated or abolished. The outcome of this will be considered by the Government in the Autumn.
  • The Government has also decided, in the light of the current Exchequer position, that further expenditure for the acquisition of accommodation for decentralisation will await detailed consideration of reports from the Decentralisation Implementation Group.
  • Minister of State Martin Mansergh will head up a joint public procurement operation between OPW and the Department of Finance to drive a programme of reform and to produce a business plan for purchasing savings to be achieved by Departments and other public bodies in 2009. Minister Mansergh will report to me in the Autumn with specific proposals to target at least €50m savings in 2009 on this front.
  • Given the projected revision to GNP and other factors, there will be savings in Overseas Development Assistance of some €45 million this year. The revised total contribution in 2008 will be over €200 per citizen, totalling around €900 million. Ireland will still be far ahead of almost all other developed nations in our rate of ODA.

It is hard to class much of these as anything at all.  There are no tax increases and the expenditure measures are aspiration rather than actual.

The only actual cut was €45 million off the ODA budget.  Outside of Health and Education the pay bill increased from €4.1 billion to €4.3 billion between 2007 and 2008.  I don’t know what effect the announced cut in “Consultancies, Advertising and Public Relations” or “the Budget day efficiency review” had.  Very little I would guess.  This is €1 billion of the €21 billion but I don’t think it resulted in much austerity. 

Lets move to October 2008 and the early introduction of Budget 2009.  This was supposed to have revenue raising measures that brought in an extra €2 billion.  What also seems to be missed is that this budget also had adjustments that INCREASED expenditure.  The announced changes to social welfare in Budget 2009 had a full year cost of over €0.5 billion. 

Fully a quarter of the money that was planned to be raised from extra taxation was spent before the Minister sat down.  This isn’t “sucking money out of the economy”.

In the Budget speech the Minister also told us what happened to the savings made from the measures introduce the previous July:

The savings achieved have already been used to relieve pressures in areas such as:

  • health, where additional provision had to be set aside to meet the costs of a new consultants’ contract and

  • education, where the full year salary costs of about two thousand extra teachers and Special Needs Assistants taken on this year had to be provided.

The “savings” weren’t taken out of the economy; they were spent in the economy.  And what about the €2 billion of revenue measures introduced?  This table provides the full-year revenue effects from the Summary of Budget Measures document.

Summary of Tax Measures

These do indeed total €2 billion.  Of course the VAT increase to 21.5% was reversed in the following year’s budget so that €227 million was only temporary.

Although details of DIRT are not provided I would be pretty sure that the increase from 25% to 27% didn’t bring in an extra €85 million.  When the Budget was announced on the 14th of October 2008 the ECB base rate was 4.25%, just six months later it was 1.25%.

The Budget estimate was that Capital Gains Tax in 2009 would bring in €1,700 million.  What was the actual outturn for 2009? €542 million.  It should be fairly evident that increasing CGT from 20% to 22% did not bring in an extra €160 million. Increasing the rate to 25% in the middle of the year was also ineffectual.

We can do the same for Excise Duty.  Here is how the €491 million extra was supposed to be raised.Excise Changes

In 2008, Excise Duty brought in €5.60 billion.  The Budget forecast for 2009 was €5.74 billion.  Instead of rising by €150 million in 2009, excise duty revenue fell €700 million.  Consumption of petrol fell 8.4%, consumption of cigarettes fell 6.7%, consumption of wine fell 6.9%, the betting levy wasn’t increased to 2% and the Air Travel Tax brought in €105 million in its first full year in 2010 and was never applied to “small peripheral airports”.

We’ll come back to the Income Levy but it is clear that the taxation measures introduced did not raise the planned extra €2 billion.  Social welfare measures with extra expenditure of €0.5 billion were introduced.  In the Budget net current expenditure for 2009 was forecast to be €48 billion.  Net current expenditure in 2008 was €45 billion.  And this is a budget that “sucked money out of the economy”? 

Next up is the €2.1 billion of expenditure measures announced just four months later in February 2009.  These measures are summarised in this table.  Of the €1.4 billion to be cut from Public Sector Pay, €1 billion was to be raised by the Pension Levy.  In its first full year in 2010 this returned €916 million, about 9% below the projection. (Can anybody guess why?). 

It is not exactly clear where the other €0.4 billion of savings from Public Sector Pay were supposed to come from or whether they were achieved.  There was also supposed to €140 million of “general administrative reductions”.

We just have to move forward just two months to the April 2009 Supplemental Budget which has €5.4 billion of revenue and expenditure measures.  There was €3.6 billion of tax measures, with €2.8 billion to come from Income Tax changes.  Unfortunately at the time we did not get an individual breakdown of what impact the doubling of the Income Levy, the Health Levy and the increase in the PRSI ceiling would have.  We can use some other forecasts though.

In December it was revealed that when the rates were increased it was believed that the Income Levy would yield “approximately €2 billion in a full year”. In 2010, the first full year of the new rates the Income Levy raised €1,446 million – over half a billion lower than forecast.

In September it was revealed that the 2010 estimate for the Health Levy was €2,489 million which we can assume was close to the forecast used in April.  The actual outturn for 2010 was €2,018 million – nearly half a billion lower than forecast.

I think we can take it that the change in the PRSI ceiling did not bring in as much as was forecast.  It was announced that €2.8 billion of Income Tax measures were being introduced.  The actual impact of them was much lower.  The was nearly €160 million of capital tax measures announced and another €150 million excise duty measures which likely suffered a similar fate.

At the time of the 2009 Budget the previous October the estimate was that gross current expenditure would be €61,782 million in 2009.  The actual outturn of gross current expenditure for 2009 was €60,711 million – a reduction of €1,071 million.

The February package included €790 million of full-year cuts in gross current expenditure.  The 2009 savings would be slightly lower, lets say €600 million.   The Supplemental Budget in April also included €886 million of cuts to gross current expenditure for 2009 (€1,215 over a full year).  Combined these €1,486 million of cuts saw expenditure come in €1,071 lower.

Again it is hard to pin down where the failure arose.  The expenditure measures were not very specific apart from axing the Christmas bonus payment for social welfare recipients (€171 million), yet another reduction in the overseas development aid budget (€100 million) and the abolition of the Early Childcare Supplement (€105 million) .  There was €82 million to be saved in Social Welfare from “general control measures” and €150 million of payroll savings from a “range of initiatives”.

The Supplemental Budget announced that the 2009 capital programme would be reduced by €576 million on top of the €300 million announced in February.  This was delivered on.  The Budget estimate was that gross capital expenditure would be €8,231 million.  The outturn was €7,329 million -  a reduction of €902 billion.  There seems to have been an abject failure to reach the levels announced for the measured announced in the current budget, but this appears to have been different in the capital budget.

Next up was the €4.3 billion of expenditure cuts and tax increases announced in Budget 2010.  There was €0.1 billion of tax measures and, €3.1 billion of current expenditure measures and €1.0 billion of capital expenditure measures.

The biggest current expenditure measure was the graduated 5% to 10% reduction in public sector salaries which was estimated to “lead to savings of over €1 billion in 2010 and in a full year”.  These savings are of course in gross pay.  Public sector workers were not €1 billion worse off because of the pay cut so the government could not be €1 billion better off because of the pay cut.

The government lost out on the income tax, income levy, health levy and PRSI it would have collected on the pay.  The pay of a public sector worker earning €50,000 was reduced to €47,000 as a result of the pay cut (Annex D).  The net pay of this worker would have fallen from €33,181 to €31,963.  The government might have made a gross pay saving of €3,000 but the employee’s net pay fell by €1,218. 

The pay cut might have knocked €1 billion off the gross pay bill but it could not have sucked €1 billion out of the economy.  There was also €800 million of cuts announced in the social welfare budget and these are actual cuts to recipients as there is no tax involved.  Even with these the level of social welfare transfer payments increased from €20.9 billion in 2009 to €21.0 billion in 2010.

There was about €1 billion of expenditure cuts outside of social welfare but most are small and difficult to evaluate.  Yet again, the Capital Budget took a relatively large share of the burden.  In 2009 gross voted capital expenditure was €7,329 million; in 2010 it was down to €6,256 million.

And finally we have the €6 billion from Budget 2011.  Obviously it will be much harder to see if the targets set for these measures are being delivered upon as it will be another few months before we can know the final year outturns for 2011.  The full-year impact of the measures introduced was:

Six Billion Budget

These do indeed sum to €6 billion.  However in this instance the “full-year impact” are actually the 2014 impacts rather than the impact that the measure will have in its first full year.

The revenue forecasts for 2011 are going a lot better than in previous years, but by September was still about €400 million below expectations.  It is likely that the revenue measures are achieving most of their targets.

On the current expenditure a lot of the cuts were real and reduced the incomes of many.  Several others were not quite so ground.

  • Social Welfare: A reduced live register from a more intensive labour activation strategy: €100 m
  • Health: Demand Led Schemes savings (drug costs and professional fee payments): €390 million
  • Health: Other procurement and non-core pay cost savings: €200 million
  • Health: Estimated payroll saving from voluntary exit package in HSE: €123 million
  • All Departments: Miscellaneous “Administrative efficiencies”: €513 million

These €1,326 million of “measures” account for 60% of the current expenditure measures announced last December.  There was €546 million of measures introduced based on the reduction of social welfare payments.  At the end of October net current expenditure was €571 million “below profile” it was stated that this was “mainly as a result of the timing of certain payments”. 

It will be the year end before we can judge if the expenditure targets were met.  In 2010 gross current voted expenditure was €54,265 million.  In the Medium Term Fiscal Statement it is forecast to be €53,240 million in 2011 – a reduction of €1 billion.

Once again, the savings on the capital budget are fairly decisive.  Gross voted capital expenditure in 2010 was €6,256 million.  This year it is estimated to be €4,640 million – a reduction of €1.6 billion.

There are some changes left out of the €21 billion starting total.  The February 2009 announcement also included the following:

In addition, the increases provided for under the Review and Transitional Agreement with effect from 1 September 2009 and 1 June 2010 will not now be paid on those dates. Further discussions in relation to these increases will be held in 2011, without prior commitment. This will save a total of €1 billion 2010.

Of course this is just deciding not to spend money that wasn’t been spent in the first place.  The Pre-Budget Outlook published prior a month before Budget 2010 included €750 million of cuts to the capital budget.  The €961 million of capital cuts announced in the Budget were on top of that.

So how much money has actually been sucked out of the economy?  The €21 billion figure is based on an estimate of full-year effects of the measures made at the time the measures were introduced.  The Department of Finance forecasts did not perform well, particularly early in the crisis and especially on the taxation side.

For example, the figures from Budget 2009 led to a forecast total tax revenue of €42,780 billion.  Tax revenue in 2009 was €33,043 million.  The forecast error is almost 25%.  It is wrong that we should be sticking to the €21 billion “austerity” total cost when it is clear that this is not what has actually happened. 

Looking back over the six packages of cuts and tax increases introduced up to now we can summarise them as follows:

Total Budget Measures

As a result of the half a billion of social welfare measures introduced in October 2008 the total is actually closer to €20 billion rather than the €21 billion figure commonly used.  Of course it would be better if the actual impact of these measures than the incorrect projected impact was used.

Let’s look at what has happened to the three areas:

Budget Outcomes

Compared to 2008 voted expenditure is down €4.8 billion (although nearly 90% of this relates to capital expenditure).  Over the same period current revenue is down almost €7.4 billion.  Although there are other elements to the budget not included here (non-tax revenue, non-voted expenditure) it is hardly surprising the deficit is higher now than it was in 2008, though it has been falling since 2009 (excluding the bank payments).

Capital expenditure has fallen €4.3 billion over the period even though €3.5 billion of cuts are in the austerity total.  The gap is explained by the November 2009 €0.8 billion of capital cuts that is not included.  Capital expenditure is bearing the brunt of the cuts so far.  As this is mainly the cancellation of projects that hadn’t even begun the victims of capital cuts are unknown even to themselves.

Almost €9 billion of current expenditure cuts have been announced but gross voted current expenditure is only €0.5 billion lower than it was four years.  There has been substantial shifts within that total.  At an individual level public sector pay has been cut and many social welfare payments have been reduced.  These are real cuts to the individuals and households.  However, at the aggregate level current expenditure is largely where it was four years ago.

Almost €8 billion of revenue raising measures have been introduced over the period, but revenue is actually €7.4 billion less than it was four years ago.  Once reason for this are the large over-estimates of the impact of the measures by as much as 25% in some cases.

How much austerity have we actually endured?  That is not a question that can be answered in a simple analysis such as this.  If it was €20.8 billion then that would be a average of €4,500 for every man, woman and child in the country or an average of €18,000 per family of four.  There have been tax increases and expenditure cuts but nothing on a scale like that.

I would guess that given the woolly nature of some of the current expenditure measures, the huge overestimates of the impact of the revenue measures, and the actual cuts in the capital budget the last three years has been around €12 billion “sucked out of the economy” with nearly 40% of that as a result of capital expenditure cuts.  This is only a guess. It would be useful if the actual figure was produced.

Monday, November 21, 2011

Public Sector Pay Once Again

This is old ground but somehow we keep having to go over it.  Yesterday’s Sunday Independent features an incredible article from James Fitzsimons, who “is an independent financial adviser specialising in tax and financial planning”.  It is incredible because it contains so many errors.  It is nearly difficult to know where to begin.

THE Government that lives in La-La Land has just created Disneyland for 300,000 public servants.

There are around 350,000 public servants in Ireland.  The breakdown of these is provided in Table A2 of the Earnings and Labour Costs Survey from the CSO (see page 15).

The 300,000 number that is commonly used is the number of full-time equivalent public servants.  Staff employed on a part-time basis and those engaged in job-sharing are only included on a pro-rata basis to get to the 300,000 figure.  The latest figure from the Department of Public Expenditure and Reform is that there were 302,769.7 full-time equivalents in the public sector in Q2 2011.

It is proposed to cut 37,500 jobs by 2015. This is 11.72 per cent of the 2008 figures when they were at their peak. Mr Howlin claims the gross public sector pay bill will fall by €2.5bn.

Based on CSO figures, the average earnings are €901.07 per week in the public sector. The savings for a cut of 37,500 jobs would be about €1.76bn a year. If 10 per cent of earnings constituted tax, the real saving would be less than €1.6bn.

When working out the reduction in the gross public sector pay bill compared to 2008, Fitzsimons focuses solely on the 37,500 reduction in headcount and completely overlooks  the average 7% pay cut for all public servants that was announced in the December 2009 Budget.  The reduction in the gross pay bill from this measure was almost €750 million.  Once this is included it is clear the the €2.5 billion claim from Brendan Howlin is not that wide of the mark.

Fitzsimons then goes on to calculate some measure of “net savings”.  This time he seems to omit the impact of the Public Sector Pension Levy introduced in April 2009.  This levy had no impact on gross pay but did reduce net pay (by around €1 billion).

It is incredible that someone “specialising in tax” would suggest that 10% of earnings constitute tax.  The average earnings figure he uses (which we will return to) is equivalent to an annual income of just under €47,000.  Using a fairly simple tax calculator it can be seen that the net pay for a public sector worker is €30,600.  Of the €16,400 of deductions €2,200 is a pension contribution so the tax on this average worker is €14,200.  That is 30% of gross pay.  Why is a figure of 10% used in the article?

According to the CSO average pay in the public sector is €901.07 compared to €611.88 in the private sector.  We have previously considered the impact our progressive tax system has on the 47% differential.

It is also important to note that the average of €901.07 provided by the CSO is based on around 400,000 public sector workers.  This is because it includes just over 50,000 employees in semi-state companies.  These are not paid from government resources and have not been subject to the pay cuts, levies and other changes introduced in the public sector.

I have asked the CSO to provide a breakdown of average wages in the public sector under the same headings used in Table A2 in the Earnings and Labour Costs release.  I have been told that this figure is not available.  The €901.07 average is likely higher because of pay in the semi-states.

The McCarthy Report on state assets reports (Table 4.4, page 23) that average pay in December 2009 for the 40,000 employees in the semi-states considered under the terms of reference of the report was €54,600 or €1,050 per week.  If we apply this to the CSO data it means that average weekly pay for the public servants in the total is around €880.

A 2% difference may not seem that significant it would be useful if the correct figure was available.  I have made further requests to the CSO but nothing has been forthcoming.

If the average pay in the public service were brought in line with the private sector, it would be cut by 30 per cent. This is without taking account of the cost of public sector pensions. It would achieve annual savings of €5bn to €6bn. We need this now, not in 2015 or 2020.

We can get some crude measures using The Analysis of Exchequer Pay and Pensions 2006-2011 which gives total pay and employment numbers across a number of categories.  The measure of gross pay given here includes salaries, employers’ PRSI and employers’ pension contributions.  The figures given here are for 270,000 public servants paid from the Exchequer.  The table excludes about 30,000 local authority employees.  The total public sector pay bill will be around 10% higher than the figures given here.

Exchequer Pay

In 2008 the gross Exchequer pay bill was €17.7 billion.  In 2011 it will be €16.2 billion.  There has been a drop of €1.5 billion or 8%.  Brendan Howlin is projecting a  further fall of €1 billion and a total drop of 14% on the 2008 level.

Exchequer net pay is calculated by subtracting employee pension contributions (€534 million in 2010), the public sector pension levy (€916 million) and some other minor appropriations-in-aid (€59 million).  Exchequer net pay has fallen from €17.1 billion in 2008 to €14.8 billion in 2011, a drop of 14%.  The projected fall to 2015 will be around 20%.

If a measure of net pay was provided to account for Income Tax, the changes to income tax would mean that the fall in net pay from the employees’ perspective would be greater than the 14% shown above.  We previously estimated this to be 17% for a public sector worker earning the average wage published by the CSO.

Fitzsimons argues that public sector pay should be cut by 30% now.  There is no evidence to support the claim that this will bring it “in line with the private sector”.  A 30% reduction in the 2011 gross pay bill would be €4.9 billion (or around €5.5 billion if local authorities are included).  It is claimed that this would “achieve annual savings of €5bn to €6bn”.

The actual saving would be much lower.  When questioning Howlin’s €2.5 billion figure at the start of the article Fitzsimons argues that the actual saving  would be lower because of lower tax revenue.  However when it comes to his own figure of €5-€6 billion he makes no such adjustments.

The cut in gross pay would reduce employee pension contributions (estimated c. €0.3 billion) , pension levy receipts (c. €0.3 billion) and income tax receipts (c. €1.25 billion).  Of course, there would also be loss of VAT and Excise Duty receipts as the pay reduction reduces consumption expenditure. 

The actual saving from a 30% cut in average pay in the public sector would actually be closer to €3 billion and not the €5-€6 billion claimed in the article.  If we went the whole hog and cut public sector pay by 100% the actual saving would be around €10 billion.  The deficit in 2011 will be €16 billion.  Public sector pay is not the only reason for the deficit so cannot be expected to be the only solution.

Public servants might have to suffer the same increases in VAT as the rest of us, but they have 50 per cent more income to cover the cost.

People pay VAT from net pay not gross pay.  Public servants have a higher gross pay than private sector workers but the effect of a progressive tax system and the Public Sector Pension Levy substantially narrow the gap.  The Pension Levy is not a pension contribution but is just a pay deduction.  This was made clear by Brendan Howlin in the Dail a few weeks ago.

The Trident report assumes that the pension related deduction, commonly called the public service pension levy, is a pension contribution. This is mistaken and the law could not be clearer. Section 7(2) of the Financial Emergency Measures in the Public Interest Act 2009 states: “(2) A deduction under section 2 is not a pension contribution for the purposes of the Pensions Act 1990”. The pension levy contribution is a misnomer. It was called that by the previous Government, but it is a levy on pay.

I hope it will not be a permanent feature, as I said to the unions when I met them. In my judgment, it is mistake for unions to characterise it as a pension contribution because the fear will be at a future date that it will be subsumed into the calculation of pension contributions. Under the auspices of the Financial Measures in the Public Interest Act 2009, it is not, by definition, a permanent measure. I hope it will not be a permanent measure, but, obviously for the foreseeable future, it is required.

Maybe it is too much to expect a tax specialist to know the difference between gross pay and net pay.  To finish here is the conclusion to my previous post on public sector pay.

This doesn’t mean that public sector pay should not continue to fall by more than private sector pay. A staggered wage cut from 0% for those at the bottom (with possibly even some increases) rising to maybe a cut of 12.5% through to the top of payscale (and maybe even more targeted than that), along with forthcoming general changes in income tax could bring the average fall in net pay in the public sector to 25% (with most of the latter burden shared by those above the average wage). 

A 25% cut in net pay would be a huge contribution from the public sector but what needs to be remembered is that with a 17% cut in net pay we are already two-thirds of the way there.  At times this seems to get forgotten in the ongoing pay debate.

And that is a 25% reduction in average net pay for those who are in the public sector.  By 2015 there will also have been a 10% reduction in the number of full-time equivalent employees in the public sector.

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