“Legacy of Debt”

Lots of talk about a “legacy of debt” in response to yesterday’s re-arranging of the Promissory Notes/ELA framework.  First up, governments don’t repay debt, they roll it over.  And, as well as the size of the debt, there are two things that matter for debt rollovers:

• average maturity
• average rate of interest

Today’s announcement does not change the size of the debt but the maturity and interest rate changes are very significant (and beneficial in case there is any confusion).

Yesterday, Ireland was faced with the prospect of carrying a debt of €25 billion on the Promissory Notes and needed to roll that over with payments of €3 billion every year at whatever the best available rate at the time was.

At the end of the Promissory Notes (which would probably have been around 2022) the debt would still exist and what would need to be rolled over would have been the borrowings undertaken in the interim to meet the €3 billion annual repayments.  This legacy of debt was always going to exist and would have needed to rolled over in 2025, 2035, 2045 or whenever.  Government debt is not extinguished, the burden of carrying it (the interest) is eroded through growth and inflation.

Yesterday’s announcement offers some significant benefits for Ireland on both fronts.  Firstly, the average maturity has been extended to an average of 34 years.  This means the debt has to be rolled over far less frequently and through that reduces risk.  Under the current arrangement there would be €25 billion of debt being paid off in chunks of €3 billion and these would quickly accumulate into a total of tens of billions that would need to be frequently rolled over depending on the nature of the borrowings used to fund the annual payments.

The new arrangement postpones this roll over to an average duration of 34 years.  Rolling over €25 billion of debt in 2020 could present significant difficulties.  Rolling over €25 billion of debt on a staggered basis between 2038 and 2053 will be far less onerous.

The new arrangement also offers the significant interest rate benefits.  Under the Promissory Note arrangement debt with a very low net external cost of 0.75% (the ECB MRO rate) was transformed into much more expensive debt (EU/IMF loans at 3.3%) at a rate of €3 billion per annum. 

The net external cost remains at 0.75% but the rate at which the debt is transformed into more expensive debt has been significantly reduced.  As a result of the Central Bank of Ireland selling the bonds it receives as part of the swap this will happen at a rate of €0.5 billion per year up to 2018, €1 billion a year from then until 2023 and €2 billion a year thereafter.

The €25 billion of Promissory Notes would have been turned into full interest-costing sovereign debt by around 2022.  Today’s announcement means that the full €25 billion will not become fully interest-costing until around 2032.  We have gained because the debt with a net external cost of the ECB MRO rate is now available for longer.

Future generations were always going to have a “legacy of debt” of €25 billion.  What yesterday’s announcements have ensured is that they will have access to lower interest rates for longer and will be faced with rolling over the debt less often.  In the arena of public debt both of these are a win.

Here are some figures since 2008:

• 2008: €10.9 billion
• 2009: €15.4 billion
• 2010: €11.8 billion
• 2011: €10.2 billion
• 2012*: €7.0 billion
• 2013*: €3.4 billion

This figures will give a “legacy of debt” of €58.7 billion.  This is more than €30 billion greater than the total in question in yesterday’s restructuring.  What are these figures?  They are the underlying primary deficits (the deficit net of interest costs and banking measures) that the state ran from 2008 to 2011 and the projections of what the primary deficit will be for 2012 and 2013.

This is the excess of government expenditure on public sector pay, intermediate consumption, social transfers, capital formation and subsidies for the current generation over the tax revenue the government is raising from the current generation.  Over a six- year period the government is spending nearly €60 billion more on us in services and transfers than it is collecting from us in taxes and charges.  Why is no one concerned about this “legacy of debt” for future generations?

If we could borrow this money with a zero-interest perpetual bond there would be no need to worry about future generations.  They would have to pay nothing for our borrowings.  This highlights that for governments it is not the amount of debt that matters.  With governments debt doesn’t matter, deficit spending does.

The debt only matters insofar as it generates an interest cost.  If this money has to be borrowed at 4% it will cost future generations over €2 billion a year in interest for the privilege of us spending more on ourselves than we are willing to pay in taxes.  Is this a legacy we are willing to impose on future generations?

Deficit-, debt- and expenditure-impacting banking measures

A recent post over on Notesonthefront has attracted a lot of attention on “the cost of the banking crisis”.  The figures from Eurostat show that Ireland contributed 42% of the EU total and have been widely quoted including this prominent piece in The Irish Examiner

42% of Europe’s banking crisis paid by Ireland

Ireland has paid 42% of the total cost of the European banking crisis, at a cost of close to €9,000 per person, according to Eurostat.

This is not the correct interpretation of the Eurostat figures.  The Eurostat figures used to support the claim give one impact of the banking crisis on public finances, that is:

1. The impact on the flow of annual government deficits

It is not the case that this reflects the full cost of the banking crisis.  As will be discussed below not all of the measures introduced in response to the banking crisis are deficit impacting.  An additional impact that could be considered is:

2. The impact on the stock of the gross government debt

There is no reason to expect #1 to be the same as #2.  There may be transactions with the banking sector that are counted as deficit increasing but if they are funded from existing resources they will not add to the stock of debt. 

It will also be the case that there may be transactions which are not counted as deficit increasing but if funded with borrowed money they will add to the stock of debt.

Eurostat have produced figures on #1 as they can measure the revenue and expenditure flows on an annual basis.  However, they will not produce statistics on #2 for the simple reason that money is fungible.  Governments borrow money because their overall expenditure exceeds their revenue.  It is difficult to attribute changes in debt to a single expenditure item because reductions in any expenditure would reduce the need to borrow.  That doesn’t mean it isn’t attempted though!

The Eurostat figures show that between 2008 and 2011, measures related to the banking crisis contributed €41 billion to Ireland’s general government deficits.  By the end of 2011, the government had contributed around €63 billion to the banking sector and, of this we can guess that around €47 billion was with “borrowed” money (essentially it is non-NPRF money, but the assumption is that this expenditure increased borrowings).

The above paragraph shows a third, a more complete, measure of the impact of the banking crisis on the public finances:

3. Total expenditure incurred by general government as a result of the banking crisis.

Again Eurostat are not going to produce statistics on this as much of the expenditure will be by public investment funds (such as the NPRF) or by special purpose vehicles (such as NAMA).  A lot of these are “off-balance sheet” transactions.

So for Ireland, at the end of 2011, the figures were:

1. €41 billion
2. c. €47 billion
3. €63 billion

The first figure has received lots of attention but it is actually the smallest.  The second figure is a bit of a guess and although the largest the final figure could yet be under-stated. 

Number 3 will be clouded by the use of special purpose vehicles which initially keep the expenditure outside the government sector.  NAMA has spent €32 billion acquiring loans with a nominal value of €74 billion from our delinquent banks.  NAMA is not going to lose €32 billion but a shortfall of, say, €5 billion is possible on its operations which will have to be made good with expenditure by the government.

In Ireland in 2011 #1 makes up about two-thirds of #3.  In other countries the gap between #1 and #3 is likely to be even greater.  In part, this is down to the type of bailout adopted in Ireland, rather than the total cost.

For example, we know that the UK has contributed £66 billion to just two banks: Lloyds and RBS.  That is around €80 billion which would count in #3 (full expenditure) but the figure for the UK in the Eurostat deficit data is just €11 billion.  Where did the other €69 billion go?

To answer this question we must explore what Eurostat measured when they provided figures for the deficit-impacting measures introduced in response to the banking crisis.  This all comes back to a Eurostat decision published in July 2009.

The key is whether a measures is considered as a “financial transaction” or a “capital transfer”.  Financial transactions are not deficit impacting; capital transfers are deficit impacting.  The impact of both in the debt is not objective, while their impact on expenditure is unambiguous.  So what is a “financial transaction”?  Per the Eurostat decision:

The valuation of financial transactions: In principle the ESA 95 provides for financial transactions (which do not impact on the government deficit) to be recorded "at the transaction values, that is, the values in national currency at which the financial assets and/or liabilities involved are created, liquidated, exchanged or assumed between institutional units, or between them and the rest of the world, on the basis of commercial considerations only" (paragraph 5.134).

However it is acknowledged in paragraph 5.136 that "in cases where the counterpart transaction of a financial transaction is, for example, a transfer and therefore the financial transaction is undertaken other than for purely commercial considerations, the transaction value is identified with the current market value of the financial assets and/or liabilities involved".

It does, of course, leave something of a grey area but we can see that if a financial transaction is done at the “current market value” it does not impact on the government deficit, whereas if it happens above the “current market value” the transaction value is identified and the amount above that is considered a capital “transfer”. 

The Eurostat decision goes through different forms of banking support and shows whether they impact on the deficit or not.

1. Recapitalisation operations
2. Lending
3. Guarantees
4. Purchase of assets and defeasance
5. Exchange of assets
6. Classification of certain new bodies
7. Recording of certain transactions carried out by public corporations

Eurostat did not need to provide a separate decision for the general government gross debt measure it produces.  The debt is just the sum of all of the liabilities of the general government sector.  It does not matter what the money is used for.  All that matters is whether a liability exists or not.

For example, when the Promissory Notes were created in 2010 they were classed as a “loan to government” from Anglo/INBS and would immediately be added to the general government gross debt.  There was some issue of whether they would count in the 2010 deficit but the counter transaction to the loan was recorded as a “notional capital transfer” as the government promised to repay a €31 billion loan without first receiving the money from the bank as is the case with a typical loan.

Here is the full set of recapitalisation payments made to the banks since 2009, classified as “financial transactions” or “capital transfers”.

The payments under financial transactions were not deficit-increasing, whereas those recorded as capital transfers were deficit increasing.  It remains to be seen what value can be realised through the sale of the assets acquired through the financial transactions. 

There have been some sales already.  In 2011, €1.1 billion was realised from the sale of a 35% ordinary shareholding in BOI, while in January 2012 the €1 billion contingent capital note in BOI was sold at close to par.  There was also a transaction in 2010 that saw €1.7 billion of the preference shares in BOI converted into ordinary shares.

It can be seen that 75% of the capital transfers total arises from the Promissory Notes issued in 2010.  No other country has used such a scheme to prop up a bust bank and the loan loss figures mean that any mechanism devised would have been recorded as a capital transfer.

The transactions are split between those undertaken by the NPRF (directed by the Minister for Finance) and those undertaken by the Exchequer (directly by the Minister for Finance).

All of the financial transactions involving preference and ordinary shares in AIB and BOI were done through the NPRF.  It should be noted that the €3.5 billion of preference shares in both AIB and BOI bought in 2009 by NPRF was funded with €4 billion from the NPRF and a “front-contribution” of €3 billion from the Exchequer to the NPRF.  All the contingent capital notes transactions as well as the ordinary shares in PTSB and Irish Life were funded, and now held, by the Exchequer.

Most of the capital transfers were provided by the Exchequer but the €6 billion capital transfer provided to AIB in July 2011 was split with €2.3 billion coming from the Exchequer and €3.7 billion coming from the NPRF.  This €3.7 billion from the NPRF was a deficit-increasing expenditure (though didn’t impact on the debt as it came from pre-existing funds).

So has Ireland carried 42% of the total EU cost of the banking crisis?  Impossible to say.  We do know that Ireland has incurred 42% of the deficit-impacting measures introduced in response to the crisis.  But that is not the same thing as the total cost. 

In Ireland’s case, the Promissory Notes have pushed up the capital transfers to an extraordinarily high figure relative to other EU countries.  In fact the explanatory notes to the data say (on page 12) that:

The only case where government liabilities increased much more than government assets is Ireland. This can be explained by the fact that most interventions have been immediately recorded as deficit-increasing government expenditure and not as financial transactions.

Most EU countries have generally recapitalised their banks using financial transactions (purchase of shares and other instruments).   Ireland didn’t have any money to buy anything in Anglo and, as stated above, Anglo was nursing such loan losses that all efforts to keep it solvent were going to be recorded as capital transfers anyway.

Throughout the EU it remains to be seen what the assets acquired through these the financial transaction approach to recapitalising their banks will actually be worth.  If losses relative to the purchase price are crystallised on the sale of these assets then the difference will be recorded as a capital transfer and Ireland may not be such an outlier.

How much of the £66 billion pounds provided to Lloyds and RBS will be returned to the UK Exchequer? Will they get back much of the £14 billion (€17 billion) capital contributions that Lloyds through Bank of Scotland(Ireland) and RBS through Ulster Bank have made to their loss-making Irish subsidiaries?  In total, the UK has made a cash outlay of around €145 billion to rescue its banks.  See question on “current level of support” in this set of FAQs.

For the moment though, Ireland is extreme when it comes to the deficit-increasing impact of the banking crisis.  It makes a good headline and the extent and cost of the disaster in Ireland will always be high relative to other EU countries.  But it should not be thought that other countries have escaped lightly from the banking crisis.  They have simply gone about it in a different manner and haven’t used Promissory Notes.  The true cost of this period will only emerge over the next decade or longer when their investments and special purpose vehicles are unwound.

Debt and Deficits Decomposed

A new dataset from Eurostat has received a lot of attention recently as it highlights the deficit costs of the bailout of our banking system that began with the blanket guarantee of September 2008.  On the other side of the same coin the data allows us to determine the non-banking crisis element of our recent deficits.

The following table shows the €105 billion of general government deficits that were accumulated between 2008 and 2011.  According to the Eurostat data €41 billion of these was due to measures introduced to deal with the banking collapse.  The final section of the table gives the ‘underlying’ deficit which is simply calculated as the difference between the total and banking-related figures in the sections above it.

Between 2008 and 2011 the ‘underlying’ deficits totalled €64 billion and this is a running total as the deficits continue to accumulate. 

At the end of 2007, the gross general government debt was just over €47 billion.  2007 was the last year when the general government accounts were close to balance and a small surplus of €143 million was recorded.

Since the end of 2007, the debt has ballooned and by the end of 2012 it is estimated to be around €190 billion.  The increase can be broken down as follows:

The figure for the 2012 general government deficit will be finalised later in the year and is likely to come around €13 billion.  With guarantee fees, interest on contingent capital notes, dividends on preference shares it is also likely that the revenues from the banking measures will exceed the expenditures. 

The surplus income paid to the Exchequer from the Central Bank has increased significantly in recent years (2008: €290 million; 2012: €958 million).  The increase is mainly as a result of profits made by the Central Bank on the Exceptional Liquidity Assistance it is provided to Anglo/INBS.  This is not included in the ‘banking’ revenues measured by Eurostat.

The stock/flow adjustment is mainly the increase in cash balances held by the NTMA from €4.4 billion at the end of 2007 to €24.0 billion at the end of 2012.

Just over one-fifth of the 2012 debt is due to the banks though the full cost of the bank bailout is larger when non-deficit increasing expenditures are included.  This includes the value of the some of the funds depleted from the National Pension Reserve Fund to buy ordinary and preference shares in AIB and BOI. It also includes the expenditure by the Exchequer on shares in PTSB and Irish Life and the contingent capital notes remaining in AIB and PTSB.  

Nearly two-thirds of the debt has been accumulated because of deficit spending by the government sector.

The 2007 debt accounts for 25% of the current total and that was the legacy of the last incident of national insolvency in the 1980s. The debt that resulted from the accumulated deficits of the time were simply rolled over and never repaid.  Growth and inflation meant the debt burden fell from 120% of GDP in the late 80s to 25% of GDP by 2007. 

The ongoing deficits since 2008 have contributed around 40% of the current debt mountain but the nature of them is changing as we move closer to a primary budget balance.

Some Trends in Expenditure

Chapter 21 of the 2011 Comptroller and Auditor General’s Account of Public Services includes the following chart on trends in welfare expenditure.

The figures since 2008 used in the above table are in the first section of this table.

The 2012 figure is an estimated based on voted allocations at the time of the report (Sep 2012).  Since then there has been a supplementary estimate for the Department of Social Protection of €685 million, of which €264 million was due to more than anticipated expenditure on Jobseeker’s Allowance.  Thus the 2012 total for support for ‘people in the labour market’ will be around €5,200 million and the overall total for the table close to €21,000 million, with little overall change from 2011.

The trends in the chart are easily identifiable.  There have been falls in the aggregate financial support provided to ‘families and children’ and to ‘people in the labour market’.  Support for ‘people with disabilities’ fell in 2010 and 2011 but is due to rise very slightly in 2012.  Support for ‘older people’ continues to rise year-on-year with a rise of around €1 billion since 2007.  A more detailed breakdown of the expenditure under each category is in tables below the fold at the end of the post.

Here is a table taken from the Analysis of the Exchequer Pay and Pensions Bill published by the Department of Public Expenditure and Reform.

It can be seen that the gross Exchequer pay and pensions bill is forecast to rise in 2012, though only by €16 million or 0.09%.  The subsequent column show the breakdown of this.  The Exchequer pensions bill will rise by €285 million, while the gross pay bill will fall by €269 million.

The Exchequer net pay bill is the gross bill less employee pension contributions in the civil service, health, education, guards and army of €536 million which are used to fund other expenditure and the employee deductions for the public sector pension levy of €930 million across all departments which are also used to fund other expenditure.  Some other minor employee contributions bring the total to €1,509 million.  In essence, this is money that forms part of the gross pay bill but is deducted. 

The Exchequer net pay bill is expected to fall by €266 million this year to €14,402 million.  PRSI, Income Tax and the USC will be further collected on this to reflect the net pay measure from the employee’s perspective.

The fall in the pay bill in 2012 (both gross and net) was more than offset by the rise in the pensions bill which has risen €1 billion since 2007.

Since 2007, the social welfare bill for state pensions and the exchequer pensions bill has risen by around €2 billion.  Many of the reductions in current expenditure elsewhere are being consumed by increases here. 

Of course, this is mainly because of demographic factors rather than policy changes.  The number of people aged 65 and over increases by around 20,000 per annum as entrants to this category is greater than the death rate, while the number of public sector pensioners is rising by around 8,000 per annum.

Carryover Effects

Here is an extract from Table 2.1 from the Medium Term Fiscal Statement published before Budget 2012 last year.

The 2012 Budget a few weeks later outlined the €1.45 billion of current expenditure cuts and the €1 billion of taxation increases.  With pre-announced cuts in capital expenditure and the taxation carryover effects from 2011 the total added to €3.8 billion.  There also was €0.4 billion of revenue carryover effects for 2012 from the introduction of the USC in 2011 but these were excluded in the table.  The total could then be put at €4.2 billion as was done by both the EU and IMF.

The €1.45 billion of new current expenditure measures is confirmed in table 5 on page 13 of the Economic and Fiscal Outlook released with the Budget.

Here is the equivalent, though slightly modified, table for Budget 2013.

The total sums to €3.5 billion but the “Tax” heading is replaced by “Revenue”.  This is because PRSI was moved from Expenditure to Revenue in the 2013 table. (PRSI is a departmental receipt (appropriation-in-aid) which reduces net expenditure).  Other revenue raising measures such as the third-level registration fee and charges for private patients in public hospitals remain under the “Expenditure” heading.

While in Budget 2012, €1.45 billion of current expenditure cuts were included in the table and subsequently introduced (though not necessarily implemented), for Budget 2013, €1.44 billion of current expenditure cuts were included in the table but €1.02 billion of current expenditure cuts were included in the budget.  This can be seen from Table 7  on page 14 of the Economic and Fiscal Outlook released with the budget. 

The €1.44 billion figure in the table for current expenditure cuts is reached with the inclusion of €0.42 billion of “carryover” effects from measures announced in previous budgets.  That is, the full-year effect of earlier measures won’t be felt until 2013 and these will serve to reduce expenditure in 2013.

However, for 2012 no expenditure carryover effects from the impact of measures announced in previous budgets were included.  The expenditure carryover effect was left out of the calculation of the total consolidation effort for Budget 2012, but included in the calculation of the total consolidation effort for Budget 2013.  Were there no expenditure carryovers coming into 2012 while there was €0.4 billion of them for 2013?

The inclusion of “Increased Dividends” as a consolidation measure also seems unusual and wasn’t included in this graph of Fiscal Consolidation 2012-2015 included as part of the IMF’s Fourth Review (page 13):

There is no distinction made between the current spending measures for 2012 and 2013, and as seen the €3.5 billion total for 2013 includes €0.4 billion of expenditure carryovers rather than being entirely new measures.  This was what was included in relation to Budget 2013 in the IMF’s Seventh Review released in September:

On the basis of the aggregate budgetary projections set out in the Medium Term Fiscal Statement (MTFS) of November 2011, consolidation measures for 2013 will amount to at least €3.5 billion. The following measures are proposed for 2013 on the basis of the MTFS:

• Revenue measures to raise at least €1.25 billion[2], including:
• A broadening of personal income tax base.
• A value-based property tax.
• A restructuring of motor taxation.
• A reduction in general tax expenditures.
• An increase in excise duty and other indirect taxes.
• Expenditure reductions necessary to achieve an upper limit on voted expenditure of €54 billion, which will involve consolidation measures of €2.25 billion on the basis of the MTFS, including:
• Social expenditure reductions.
• Reduction in the total pay and pensions bill.
• Other programme expenditure, and reductions in capital expenditure.

[2] Inclusive of carryover from 2012.

Carryover effects are included for revenue but not expenditure.  It can also be seen than a €54 billion limit for voted expenditure in indicated.  This was not adhered to in the budget:

• Gross voted current expenditure: €51,070 million
• Gross voted capital expenditure: €3,435 million
• Gross voted expenditure: €54,505 million

The excess over the limit is not very different from the level of carryover effects in the current expenditure consolidation effort included in the budget, but is more than likely because the current expenditure ceilings for 2013 laid out last year were increased.

One final point on carryovers relates to the tax carryovers in 2014.  Last week’s budget contained a lot of tax measures which will not come into full effect until 2014. Some of the main measures are:

• Full introduction of Property Tax less NPPR: €180 million
• Taxation of maternity benefit: €25 million
• Removal of PRSI allowance: €26 million
• Removal of PRSI block exemption: €24 million
• Changes to maximum allowable pension fund: €250 million

These sum for more than €0.5 billion, though some reduced taxation measures will reduce the full carryover effect to close to €0.45 billion.  If €1.1 billion of tax consolidation is required in Budget 2014, then €0.65 billion of new measures will be required.

New Budgetary Measures

The following table summarises the new measures included in Budget 2012 and Budget 2013 that impact on the White Paper ‘no policy change’ figures released the Friday before each budget. 

Most of the figures come from the Economic and Fiscal Outlook released with each budget (Table 5 for 2012 and Table 7 for 2013).  The current expenditure figures for each Vote are taken from the Expenditure Allocations (2012 and 2013).

The new Property Tax is expected to raise €250 million but as it replaces the Household Charge a figure of €90 million is included here.  

The total for 2013 is more €726 million than the total for 2012.  This is because of a lower capital reduction in 2013 and also because the White Paper for 2013 was done on the basis of expenditure ceilings which were issued with last year’s budget as part of the Comprehensive Expenditure Review.

The level of current expenditure savings  included in Budget 2013 is comparable to those in Budget 2012, but increases in the current expenditure ceilings for most votes partially offsets the impact of the savings.  A table that compares the expenditure ceilings for each vote as announced last year and adjusted this year is below the fold.

The General Government Accounts

The Economic and Fiscal Outlook released with yesterday’s budget presents a useful table of the general government accounts.  This is the accruals-based set of accounts by which the Excessive Deficit Procedure limits under the Maastricht Treaty are set.  It is the deficit on these accounts that must be reduced to below the 3% of GDP limit by 2015. Click to enlarge.

The €13.4 billion deficit for 2012 is the result of expenditure at €69.1 billion and income at €55.6 billion.  When the projected deficit gets below the 3% of GDP limit in 2015 it will still be €5.3 billion and this will be the result of expenditure at €68.4 billion and income at €63.1 billion.

In nominal terms over the next three years general government expenditure is projected to fall by 0.9% with nominal general government revenue due to rise by 13.3%. 

With inflation and rising GDP, real expenditure will fall while there will be a slight rise in real income.  As a percentage of GDP, expenditure will fall from 42.3% in 2012 to 37.7% 2015.  On the revenue side, the change will be from 34.1% of GDP in 2012 to 34.8% of GDP in 2015.  As shown below this is projected to bring the deficit to 2.9% of GDP by 2015.

Excluding interest payments, it can be seen that the projected improvement in the primary balance is even greater.  This means that although overall nominal expenditure might remain largely unchanged there will be changes in the composition of expenditure with interest consuming a greater amount and standard government expenditure a lower amount.

Evening Echo 28/11/12

The text of a recent article for The Evening Echo is below the fold.

The last year in which the government’s accounts were in balance was 2007.  In that year, both government revenue and government expenditure were around €68 billion, but as we know with hindsight this position was very fragile.

This year is the first year since 2010 that direct payments to the banks will not form part of the deficit.  The deficit this year will be almost €14 billion, the gap between government revenue of €56 billion and government expenditure of €70 billion.

Compared to 2007, it is evident that the deficit was caused by a collapse in tax revenue.  The level of government expenditure is slightly up on 2007 but government revenue is down significantly.  This is the hole created by the stamp duty, capital taxes, VAT, and income tax which was pouring into the government’s coffers from the construction and property sectors.

Most of this money was borrowed money.  From 2004 to 2007, the impact of bank lending was to pump an average of €3.5 billion a month into the economy and about a third of this found its way to the government.

The only way to close the deficit is for expenditure to fall and/or taxation to rise.  In good times, a country could watch as economic growth would do a lot of the work.  Early plans to close the Irish deficit were predicated on a strong return to growth within two years.  However, as 2009 became 2010 and 2010 became 2011 the return to strong growth was, and still remains, two years away.

With the precarious state of the public finances the only way to close the deficit is through explicit expenditure cuts and tax increases.  Next week, ministers Michael Noonan and Brendan Howlin will present a budget which will include €3.5 billion of budgetary adjustments.

It should be noted that this adjustment to take money out of the economy over a year is equivalent in size to what the banks were previously pumping into the economy in a month.  The Irish economy is not in the ruined state it is in because of austerity.  The Irish economy has gone cold turkey because it has lost the monthly adrenaline shot of a €3.5 billion monthly injection of bank lending.

Ireland’s budget deficit opened in 2008 and by 2015 it is envisaged that it will still be around €5 billion.  Over this period, the excess of normal government expenditure over government revenue will add around €100 billion to the national debt.  We have poured €64 billion into the banks, but face the prospect of getting at least some of that back. 

The borrowed money that has been spent on funding public sector pay, social welfare, government services as well as the interest on money borrowed for previous deficits is gone forever.  Since 2007 we have built up a huge national debt.  Most of this has been because the deficit.  The deficit must be closed.

Next week’s budget will be another step in that direction.  People will argue about the measures being introduced but there is no argument over the need to close the deficit. 

One approach to take would be to try to do so through taxation.  The problem is that there is no pot of money out there just waiting to be taxed.  We have a €14 billion deficit.  In the run up to the budget there have been proposals from elements of the opposition that suggest that taxation along can bridge the gap.  It can’t.

There is an uncosted Sinn Fein proposals for a wealth tax which uses very unsteady assumptions to argue that €800 million a year could be raised.  The Socialist Party have examined the benefits of increased income taxation.  One of their costed proposals is for incremental increases in the rate of income tax on very high earners up to 78%.  Analysis  presented by the Minister for Finance shows that this would only raise €850 million.

There is the potential to raise additional tax revenue from the wealthy and the high earners but they can only every go a small way towards addressing the huge deficit we face.  The Sinn Fein wealth tax would be applicable to fewer than 15,000 people while the Socialist Party tax increases would be applied to just over 5% of earners.  After these taxes have been introduced the bulk of the deficit will remain.

We can try to raise a lot of money through large tax increases on a very small number of people but the reality is that more revenue will be raised with small tax increases on a very large group of people.  Next week we are likely to see lots of small increases in tax rather than one big taxation measure.

The biggest will likely be the property tax which will aim to raise an extra €300 million on top of the money collected by this year’s temporary household charge.  This will be around €200 per household.  There will be some changes to excise duties such as cigarettes and motor tax.

Although changes to income tax have been ruled out, there may be some changes to the Universal Social Charge which is an income tax in all but name.  Other changes will include reductions in pensions reliefs and increases in capital taxes but the gains from these will be relatively minor. 

All told, around €1 billion of new taxation measures will be announced.  On the expenditure side there will be more than €2 billion of cuts and this is where most of the interest will lie.

There will be debate and arguments and the reason for this is that we still have autonomy over the particular measures that are used to reduce the deficit.  The EU/IMF have set deficit targets but they don’t dictate how those are achieved.  They simply want to see Ireland get back on a sound macroeconomic footing. 

Ireland is making steady, but slow, progress in emerging from the carnage left behind by mismanagement of the economy culminating in bursting of the property bubble.  Next week’s budget can be another step in this direction. 

There will be difficult, and unpopular, choices.  Few politicians want to be increase taxation and reduce expenditure.  The current government knew what they were getting into when they joined forced in early 2011. 

We cannot avoid the pain of closing the deficit and the best we can hope is that they try to choose the right balance between workers, retirees, students, employers, the unemployed and the infirm.   It’s not easy but we’re getting there.

Government Sector Non-Financial Accounts

The non-financial general government accounts in the Institutional Sector Accounts give a cash-based view of the general government sector which is more complete in scope than the Exchequer Accounts.  The general government accounts used for the Excessive Deficit Procedure are accruals-based.

Below the fold are the current accounts of the general government sector since 2007 (noting that the figure for ‘Value of Output’ is the sum of subsequent items in the accounts rather than a starting input, as most government output is non-market).

The current cash deficit of the general government sector has declined in each of the past two years (albeit slowly).   Here are the capital accounts for the same period.

The largest item in the capital account in recent years has been “other capital transfers” which reflects the direct capital injections into the banks (excluding those made via share acquisition).  These transfers were €4 billion to Anglo in 2009, the €31 billion of Promissory Notes to Anglo/INBS in 2010 and around €5 billion of the AIB/EBS recapitalisation in 2011.

Investment expenditure by the government sector has declined markedly since 2008, and once depreciation of existing capital is accounted for, the net capital formation of the government sector in 2011 was just €1.8 billion.

Meeting the fiscal targets

The eighth quarterly review of the EU/IMF programme for Ireland was concluded last week and once again Ireland was praised for steadfast policy implementation and the expectation that fiscal targets will be met once again.  Statement here.  The general government deficit targets for 2011 to 2013 are

• 2011: 10.6% of GDP
• 2012: 8.6% of GDP
• 2013: 7.5% of GDP

At the conclusion of the sixth review back in April a statement released by the Department of Finance said that:

“We are pleased that we have met our targets, all measures have been implemented and the programme is on track. This successful outcome illustrates, once more, the ability and the commitment of the Irish State to implement a challenging programme effectively.

Economic data released since the last Troika review in January has shown that the Irish Economy has returned to growth in 2011, the first time since 2007, our underlying deficit for 2011 is 9.4% - significantly ahead of the target of 10.6%, our tax take is growing and we are on track to meet our 8.6% deficit target in 2012.”

Last week the Department’s statement was equally ebullient:

“The programme remains on track and we continue to meet all of our targets. We are confident that the headline deficit targets of 8.6% of GDP will be achieved in 2012 and we remain fully committed to reducing our deficit to below 3% of GDP by 2015.

Back in April there was delight that the “underlying” deficit was below the 2011 limit.  By September that delight was that the “headline” deficit would be below the 2012 limit.  The deficit is falling (albeit slowly) but I wonder what deficit measure will be used to ensure we are below the 2013 limit?

It should also be noted that the March statement said “our underlying deficit for 2011 is 9.4% - significantly ahead of the target of 10.6%”.  What was the deficit target set at the time Budget 2011? Among other places, the answer can be found in the third paragraph of page 12 in The Economic and Fiscal Outlook released with the Decemeber 2010 budget:

“The measures being introduced in Budget 2011…will reduce the General Government Deficit to 9.4% of GDP.”

The 10.6% limit comes from the December 5th 2010 Council Recommendation to Ireland under the Excessive Deficit Procedure which set out the deficit limits for each year out to 2015 by which time Ireland has to bring the general government deficit under the Maastricht limit of 3% of GDP.  Budget 2011 was a couple of days later but as the late Brian Lenihan said in his budget speech:

In the National Recovery Plan, we have set out the timetable for achieving this adjustment over the next four years. These targets are reflected in the Joint Programme of Assistance. Because the European Commission has more conservative forecasts for the medium-term, we have been given an extra year to reach the 3% deficit target required under the Stability and Growth Pact. But this changes neither our targets nor our timetable for reaching them.

The Department of Finance deficit target for 2011 was 9.4%.  As the recent Maastricht Returns Information Note has shown the actual 2011 deficit was 13.4% of GDP, but excluding direct payments to the banks the deficit was 9.1% of GDP.  As pointed out previously this does not exclude direct receipts from the banks.  This 9.1% of GDP deficit is below the 9.4% of GDP budget day target. 

There was never a deficit target of 10.6% of GDP that we could be “significantly ahead of”.

The ‘Underlying Deficit’ and the banks

This week the Department of Finance have released the Autumn Maastricht Return and a useful information note which includes this table.

Ireland entered the Excessive Deficit Procedure (EDP) in April 2009 and the deadline for restoring the deficit to below the 3% of GDP Maastricht Limit was subsequently extended twice.  The current deficit limits come from a December 2010 Council Recommendation and were set at

• 2011: 10.6% of GDP
• 2012: 8.6% of GDP
• 2013: 7.5% of GDP
• 2014: 5.1% of GDP
• 2015: 2.9% of GDP

It seems that the actual deficit for 2011 of 13.4% of GDP was hugely in excess of the 10.6% of GDP limit set under the EDP.  However, the information note highlights that part of the reason for the 2011 deficit was because “[a] significant amount of this deficit arises from capital injections into financial institutions that took place in July”.

The information note then presents the underlying deficit which “excludes the effect of capital injections into financial institutions in 2009, 2010 and 2011 and gives a better picture of the balance of receipts and expenditures of general government.”  This was presented in next table.

Ireland’s underlying deficit for 2011 was estimated to be 9.1% of GDP well below the 10.6% limit set under the EDP.  So using the underlying deficit Ireland “met the deficit target”.

For 2012, it can be seen that General Government Balance and the underlying deficit are the same (8.4% of GDP) as there are no planned deficit increasing capital injections for the banks this year.  With the EDP deficit limit of 8.6% it can be seen that for 2012 Ireland is in line to “meet the deficit target”.

However, direct capital injections are not the only impact the banking-related measures that have been introduced over the past few years have on the general government balance.  If one is trying to get “a better picture of the balance of receipts and expenditures of general government” then it would be prudent to remove all the temporary effects on the bank bailout on the general government balance.

We can get the impact of the banks on the 2012 General Government Deficit from two sources:

1. From the September Exchequer Statement we must include the following receipts and expenditures:

Non-Tax Revenues:

• Central Bank Surplus: €958 million (usually around €200 million)
• Guarantee Fees: €799 million
• Contingent Capital Interest: €300 million

Non-Voted Expenditure*

• Interest: some portion of national debt interest (€4,065 million to date)
• EBS Promissory Note: €25 million (no general government balance impact)

(*There is also €1,300 million for the purchase of Irish Life but that is classed as a financial transaction rather than expenditure as the Exchequer added an asset worth an equivalent amount (apparently)).

Determining how much of the debt interest that will be paid this year is due to bank bailout is difficult as borrowing is not made for specific or earmarked purposes.  We could as easily say that the bank bailout money came from Income Tax while social welfare payments came from borrowing as say the bank payments came from borrowed money. 

However, it is pretty clear that the bank payments have increased the Exchequer Borrowing Requirement over the past few years.  Here are the payments that have been for the banks from the Exchequer Account since 2009.

• 2009 – Anglo Irish Bank: €4,000 million
• 2009 – National Pension Reserve Fund: €3,000 million
• 2010 – Irish Nationwide: €100 million
• 2010 – Educational Building Society: €625 million
• 2011 – Irish Life and Permanent: €2,300 million
• 2011 – Promissory Notes: €3,085 million
• 2011 – Bank Recapitalisation Payments: €5,268 million
• 2012 – Irish Life Limited: €1,300 million
• 2012 – Promissory Notes: €25 million

The total amount of these payments comes to €19.7 billion.  Using an assumed interest rate of 4.5% this would imply an annual interest bill of just under €900 million.  There is also interest on the €3.4 billion bond that was issued in March to make this year’s €3.06 billion Promissory Note payment to the IBRC.  This will contribute €140 million to the 2012 interest bill.

It is clear that the Exchequer interest bill from the bank bailout will be around €1,000 in 2012.

Using all of the above figures it can be seen that with additional revenues of around €1,850 and additional expenditures of €1,050 million the Exchequer Balance is probably around €800 million lower than would be the case if the full impact of the banking measures was removed.

2. The NPRF performance update for the six months of the year says:

On 20 February 2012 Bank of Ireland paid a preference share dividend of €188.3m in cash.

On 14 May 2012 Allied Irish Banks paid the preference share dividend of €280m

The NPRF has received €468 million so far this year from the banks (though the AIB dividend was paid in the form of 3,623,969,972 ordinary shares.)  

All told, the effect of the banks is to reduce the 2012 General Government Deficit by around €1.3 billion.    As shown above Ireland run a 2012 general government deficit of €13.6 billion which will be around 8.4% of GDP and below the Excessive Deficit Procedure limit of 8.6% of GDP.

However, if the full impact of the banking-related measures was omitted to calculate an alternative underlying deficit for 2012 the deficit would be €14.9 billion (actual deficit of €13.6 billion less than €1.3 billion gain from the banking-related measures).  This would be  an estimated 9.2% of GDP.

This underlying deficit excluding the impact of the banks means Ireland would be in breach of the 8.6% limit set out under the Excessive Deficit Procedure.  The Council Recommendation says that:

the projected annual deficit path does not incorporate the possible direct effect of potential bank support measures.

It is not specified what this means.  It could be argued that increases in national debt interest and central bank surplus income are indirect effects of the bank support measures (but it is also the case that these roughly offset each other). However, receipts of nearly €800 million of bank guarantee fees and €300 million contingent capital (subordinated bond) interest are surely direct effects of the bank support measures and should be excluded from the EDP calculation.

If that was the case Ireland would not be below the 8.6% of GDP limit set for 2012.

IMF Fiscal Multipliers and Ireland

The release of the October 2012 World Economic Outlook by the IMF has attracted some attention.  In particular is a three-page box-out by Blanchard and Leigh on pages 41-43.  A report on this featured on the front-page of today’s Irish Examiner.

IMF: We got effect of austerity wrong

The IMF has admitted it completely underestimated the effects of austerity on the Irish economy and believed the tax increases and spending cuts would not have cost so many jobs.

I had read box-out and glanced through the WEO before I saw today’s papers and I was surprised to see the above reporting of it.  Yes, the findings suggest that the IMF had been applying fiscal multipliers that were too small but this was based on an analysis of 28 countries rather than just Ireland.

From what I can tell the report makes no specific references to any IMF estimates of the “effects of austerity on the Irish economy”.  The finding that the IMF’s fiscal multipliers were too small was based on this graph.

The horizontal axis is the IMF forecast of the change in the primary structural balance as a percent of GDP for 2010-11. The vertical axis is the error in the IMF’s growth forecast for 2010-11 compared to the actual 2010-11 growth outcomes.  Both forecasts are from April 2010.

It can be seen that Ireland was second only to Greece in being expected to introduce budgetary measures leading to an improvement in the structural balance. 

The trend line shows that when the structural balance was forecast to deteriorate, on average, the IMF tended to underestimate the growth outcome, and that when the structural balance was forecast to improve, on average, the IMF tended to overestimate growth performance.  The implication being that the IMF were understating the effect of fiscal loosening/tightening on economic performance in 2011.  This conclusion is based on the linear regression line shown in the graph.

The box-out reports the IMF forecasters were using fiscal multipliers of 0.5 when multipliers of around 1.0 may have been more appropriate.

And what about Ireland?  The actual data used to generate the graph is here.  For Ireland, the IMF expected fiscal consolidation of 3.2% of GDP and when their 2011 growth forecast was examined they made a growth forecast error of –0.1%, which to all intents and purposes is zero.

Across the 28 countries in the sample, the analysis indicates that the IMF was underestimating the impact of fiscal adjustment.  The sample includes eight countries where there was expected to be fiscal loosening and 20 countries where there was expected to be fiscal tightening.

Of the eight countries with fiscal loosening, seven of them recorded growth surprises above the IMF forecast (only Denmark fell short of its growth forecast) and the growth outcome for five of the countries places them above the trend-line.

Of the 20 countries with fiscal tightening, 16 of them under-performed relative to the IMF’s growth forecasts, though for many of these either or both of the expected fiscal consolidation and growth forecast errors were small as represented by the large grouping in the middle.

The box-out is interesting but it says nothing specific about the IMF’s estimates of “the effects of austerity on the Irish economy”. 

In fact if the IMF had used larger fiscal multipliers for their 2010-11 growth forecast for Ireland the forecast should have been lower.  The IMF forecast in April 2010 was that real growth in Ireland would average 0.2% in 2010-11.  If this was based on the assumed fiscal multiplier of 0.5 then using a multiplier of 1.0 as inferred from the analysis of Blanchard and Leigh the IMF should have made an average growth forecast of around –1.5% for the two years, given the scale of the fiscal adjustment that was anticipated to be introduced in Ireland.  

If this higher fiscal multiplier had been used it would have been the case that Ireland would have significantly over-performed its IMF growth forecast as according to the CSO real growth in 2010 was –0.8% and in 2011 it was +1.4%, for an average of +0.3%. 

The analysis doesn’t tell us anything about the appropriate fiscal multipliers for Ireland now but using the numbers inferred above a re-write of the first paragraph of the Irish Examiner piece might be:

The IMF completely underestimated the effects of austerity on global economies and based on that made growth forecasts for Ireland that were far too high.  The IMF’s growth forecasts for Ireland should have been much lower as it underestimated the cost of tax increases and spending cuts on jobs. However, when the actual economic performance is analysed the impact of austerity in Ireland was not in line with the new IMF forecasts and growth turned out to be significantly higher than revised fiscal multipliers and growth models predicted.

I doubt that verbiage would get on the front page though.

Income (and taxing income) in Ireland

The forthcoming budget will contain a €3.5 billion set of expenditure cuts and tax increases with a rough breakdown of 2:1.  The objective is ensure the general government deficit is below the limit set out under the Excessive Deficit Procedure.  The table below refers to these are targets but the ECOFIN decision clearly states that they are limits which the deficit “does not exceed”.

There has been much debate about the composition of the expenditure cuts and tax increases to be introduced.  Much has focussed on whether the balance is too heavily weighted in favour of expenditure cuts and that more of the necessary burden of closing the deficit be carried by taxation, particularly tax increases on the “rich”.

Let’s assume that the pre-announced reductions to capital expenditure for 2013 of €0.5 billion are persisted with but we look to income tax to achieve the €3.5 billion total required for the budget.  This is unrealistic but as an exercise it should give an insight into what can be achieved.

Back in October 2010, John O’Donoghue set the following PQ for then Minister for Finance, Brian Lenihan:

To ask the Minister for Finance the amount the tax rate for those earning over €100,000 would have to be increased by for the Exchequer to save at least €3 billion.

The answer provided at the time was that the top rate of income tax for those earning over €100,000 would have to be 84%.  Once Universal Social Charge (7%) and PRSI (4%) are included the marginal rate of tax on incomes over €100,000 would have to be 95%. 

For the self-employed it would be 98% because of the 3% USC surcharge on self-employed earnings over €100,000 and for any public sector workers earning over €100,000 the marginal rate would have to be 105% once the 10% public sector pension levy is factored in.

It should be pretty clear that any suggestions that the budget deficit can be closed simply by “taxing the rich” are not realistic.   For reasons unknown it is generally taken that the “rich” are those earning more than €100,000.   However, there are just not enough of these people and they do not earn enough to raise the tax revenue necessary to meet the deficit targets.

Another PQ shows that the Revenue Commissioners estimates there was around 110,000 tax cases with an income over €100,000 in 2011, with 90,000 earning less than €200,000.  Tax cases with incomes over €100,000 had a combined income of €20.2 billion and paid €5.2 billion of Income Tax (PRSI, USC, PS Pension Levy are not included).

The excess over €100,000 earned by these 110,000 tax cases is €9.1 billion.  To raise an extra €3 billion would require a minimum extra 33% tax to be applied.  In reality it would be higher because 65,000 of these cases are married couples with both earning.  It is not clear how many individual incomes over €100,000 there are.  Revenue reports show that 75% of the couples over the €100,000 threshold earn less then €150,000 so it seems likely that many have these will have combined incomes over €100,000 without necessarily having one income over €100,00.

This is dealt with in this PQ in July 2011 when is was asked:

To ask the Minister for Finance the extra tax that would be raised by increasing the income tax on all taxable income over €100,000 for an individual and €200,000 for a couple by 1%. 

The answer was that it would raise €59 million in a full year.  To raise €3 billion as outlined above would require 51 such raises.  Thus we can update the answer provided by Brian Lenihan from October 2010.  To raise €3 billion from individuals with incomes over €100,000 would require a marginal income tax rate of 92%.  With USC and PRSI all marginal tax rates would be above 100%! 

Anyone with an income over €100,000 would face an increase in their tax bill of an amount greater than the increase in their earnings.  This is not to say that Income Tax should not be increases (it probably should) but there is no money tree out there that we can shake to eliminate the deficit.  Here are some other PQ answers.

• A 50% income tax on all incomes over €100,000: €490 million
• Increase the top rate of income tax from 41% to 42%: €205 million
• A 1% levy on all income over €50,000: €440 million
• A 60% income tax on all incomes over €100,000: €1,110 million

There is scope to raise income tax but raising income tax on high earners alone is not enough. Although the figures are slightly dates here is look at who earns more than €100,000

• PAYE Employees: 31,516 out of 1,515,648 (2.1%)
• Public Sector Employees: 15,278 out of 414,623 (3.7%)
• Non-PAYE/Self-Employed: 70,800 out of 437,585 (16.2%)

Almost two-thirds of the high-earners are in the Non-PAYE category so include the self-employed, company directors and the like.  This is also likely to be the group that shows the greatest fluidity.  That is, a person in this category could have a successful year one year and rise in the €100,000+ income category but fall below it the next year.  The make-up of the PAYE and Public Sector Employees in this group is likely to be relatively static but the largest group would be much more fluid.

Finally, it is often stated that those earning more than €100,000 are “rich”.  Income is a flow so technically they are “high-earners”.  Knowing someone’s income does not tell you if they are rich but it can be a good proxy.  Rich is a stock measure of the difference between a person’s assets and liabilities.  Some previous thoughts on wealth (and taxing wealth) in Ireland are here.

Funding the Exchequer Balance

Yesterday, the NTMA published its Q3 report on the Funding of the Exchequer Balance.  It includes the following table.

At the end of September there was €23.7 billion in the Exchequer Account.   The Exchequer has run a deficit of more than €11 billion in the first nine months of the year but, as can be seen above, has received surplus funding of around €10 billion over and above that required to finance the €11 billion cash deficit.

The source of the €21 billion of funding received by the Exchequer this year has been:

• EU/IMF Loans: €18.7 billion
• Long term government bonds: –€0.5 billion
• Commerical Paper: €2.3 billion
• National Savings Schemes: €1.3 billion
• Other Funds: –€0.6 billion

The funding from long-term government bonds is negative because there was a €5.5 billion bond that matured in March of this year and this offsets the €5.0 billion of new funding that was received from the NTMA’s ventures back into the long-term bond markets in July and August. [There was also €3.4 billion bond issued in April to meet this year’s Promissory Note payment but as that negated a cash payment it did not increase funding.]

At €23.7 billion (15% of GDP) it is clear that the Exchequer is sitting on a massive cash buffer.  There are reasons why such a buffer has emerged and is required.  The NTMA made the strategic decision to re-engage with bond markets at a time when bond yields allowed.  We didn’t need the money at the time but the signal of the moves was important. 

There are bond redemptions of €5.6 billion (April 2013) and €7.6 billion (January 2014) and a 2014 Exchequer Deficit to be funded.  Still, one would wonder whether we need a cash pile of €23.7 billion now and it should also be remembered that this offsetting asset exists when gross general government debt figures are quoted.

NERI Income Tax Proposal

The third Quarterly Economic Observer of the Nevin Economic Research Institute contains a specific income tax proposal for the upcoming budget.  The proposal is to raise the effective income tax rate of the top 20% of income tax cases by 1.5 percentage points.

We propose a modest increase in the effective income taxation rate faced by the top 20% of tax cases. Overall we suggest that the effective income tax paid by this group rises by 1.5% in 2013; meaning that on average the top 20% of tax cases would pay almost 23% of their income in income taxation in 2011.

The data used is from this Parliamentary Question tabled to the Minister for Finance in July.  Here I propose to use the data from another Parliamentary Question to assess the impact of this proposal on different income levels.  This provides us with the following table for 2011 incomes.

The table does not allow us to work out exactly the top quintile of tax cases (to which the NERI proposal would apply) but a quick calculation shows that the number of tax cases in excess of €50,000 is equal to 22.8% of the total.  It is likely that any change to the tax system would apply to a certain income threshold rather to a certain proportion of tax changes.  We will proceed by applying the proposal to this group.

Here are the average incomes, average amount of tax paid and the effective tax rates for the income brackets given in the PQ.

The table shows the progressive nature of the Irish tax system with the effective Income Tax rate rising from 4% for those earning between €20,000 and €30,000, to 14.5% for those earning between €50,000 and €60,000, to 25% for those between €150,000 and €175,000, up to a high of 34% for the ultra-high earners over €2,000,000.  These effective tax rates and the progressiveness of them would be even greater if PRSI and USC were included.

The final column gives the new effective Income Tax rates under the NERI proposal.  These are unchanged for all incomes up to €50,000 and thereafter are increased by 1.5 percentage points.  The report is silent on how this would be achieved but makes some suggestions that could be considered such as tax credits and the USC.  The report does rule out increases in the marginal tax rate (page 26)

Further changes in the marginal rate of tax (which currently is at 52% when maximum USC and PRSI rates are included) are not proposed.

The final table looks at the impact of the proposed increase in the effective tax rate by 1.5 percentage points for all tax cases above €50,000.  All incomes up to €50,000 are omitted are there are no changes proposed here.

The impact is an extra €690 million of tax revenue.  This compares to €650 million estimated for the NERI proposal.  As that only included 20% of tax cases and the above table is applied to the top 22.8% of tax cases it is clear that they are similar.

Of the extra €690 million that would be collected €388 million (56%) comes from tax cases with incomes of less than €100,000.  Those in the €50,000 to €60,000 income bracket would see their income tax bill rise from €7,911 to €8,731 (a rise of 10.4%).  Those in the €500,000 to €750,000 income bracket would see their income tax bill rise from €167,145 to €176,138 (a rise of 5.4%).

Is the current budget deficit improving?

At first glance the answer to this question is no as the year-to-August figures for current budget deficit in the Exchequer Account are:

• 2011: -€8,824 million
• 2012: -€9,458 million

The Exchequer Account current budget deficit is an important measure of the health of the government finances and the headline figure is a year-on-year deterioration of around €600 million.  However, there has been a number of changes and complications that need to be considered before a useful comparison between the two years can be made.  We have addressed some of these before.

1. The Sinking Fund Contribution of €646 million has already been made for 2012.  In 2011, this transfer of €683 million from the Current to Capital Account did not take place until November.  A year-on-year comparison is unfair on 2012 because it includes a payment from the current to the capital side of the Exchequer Account that was not made by August of last year.
2. Last year the debt interest cost for the eight months of the year was €3,031 million, but €577 million of that was paid from the Capital Services Redemption Account with the remaining €2,454 million coming from the Exchequer Account.  In 2012, all the debt interest bill of €4,021 million was paid from the Exchequer Account.
3. This year’s receipts include €231 million of Corporation Tax which should have been collected in December 2011 but a delay meant it was instead included in the January 2012 receipts.

To account for these we will remove the effect of the Sinking Fund contribution and the delayed Corporation Tax receipts from the 2012 deficit, and add the interest paid from the CSRA to the 2011 deficit.  So we have:

• 2011: -€8,824 million - €577 million = –€9,401 million
• 2012: -€9,458 million + €646 million - €231 million = -€9,043 million

On a like-for-like basis the Exchequer current budget deficit is €358 million improved this year.  On a primary basis (excluding debt interest) the improvement is an impressive-sounding €1,348 million.  However, the source of this improvement will not be permanent.

After a number of years of decimating the public finances, the banking measures introduced to rescue the covered banks are now skewing the current budget deficit to make it look temporarily good.  Here are the 2011 and 2012 banking-related revenues in the current account.

• Central Bank Surplus: €671 million versus €958 million
• Bank Guarantee Fees: €599 million versus €799 million
• Contingent Notes Interest: zero versus €300 million

The 2011 banking related revenues contributed €1,270 million to the Exchequer current account; for 2012 the receipts have been €2,057 million.  Receiving more than €3 billion from the banks should not be downplayed but these receipts are not permanent.

The primary current budget deficit is €1,348 million better when compared to 2011, but this is in large part because of a €787 million increase in temporary banking-related revenues meaning the actual improvement is around €561 million .  The primary current deficit is declining (slowly) but this is more than offset by the €990 million increase in debt interest costs.

All told, in the first eight months of 2012 the overall current budget deficit is €429 million bigger than it was last year.