Are we over-spending?

Posted on November 25, 2013 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

The Organisation for Economic Cooperation and Development (OECD) periodically publishes comparative data on a wide range of economic and social areas from education to pensions to overseas aid. In its latest Government at a Glance there is a wealth of data on many aspects of public service and management of public finance together with measures of outcomes in health and education across all 34 OECD member countries including Ireland (Republic).

Writing in the Irish Independent in an article entitled ‘Level of public spending still too high despite cuts’  on Thursday 21st November Brendan Keenan highlighted a number of comparisons including:

  • the impact of taxes and social benefits on income
  • public spending per capita and as a % of total national income
  • the structure or make up of public spending in each country.

This blog focusses on just one aspect – namely comparisons of public spending level and per capita and the claim or implication that they are ‘still too high despite cuts’.

All international comparisons must be treated with caution. The particular year in which OECD reports is 2011 when Irish public spending was boosted by the amount of money injected into private banks. This came to €5.7 billion net of receipts from the banking levy and added 3.6% to public spending as a % of GDP in that year giving  a total of 47% of which 3.6% points was due to bank recapitalisation. The gross spend on banking was even higher (at 8.5 billion) and may have been included in the OECD figure of 48% for Ireland in 2011.

Another crucial consideration is the extent of unemployment in any given year. Because unemployment was much higher in Ireland than most other   comparator countries in 2011 we can expect some impact on public spending   either by way of additional direct social payments to the unemployed or other public spending triggered by rising income inequality and poverty (e.g. increased eligibility for free health services). At a conservative estimate, if one half of total on the Irish unemployed Live Register (200,000) were at work direct social transfers to the unemployed would be €2 billion less. Add  to this the indirect impact on other social transfers under the headings of education and health and it is likely that Irish public spending would be at least 2 percentage points lower than it actually was in 2011.

As an aside the matter of military spending is sometimes adduced as a factor which explains high public spending in many other EU states, thereby distorting Ireland-EU comparisons. This is largely a red herring – with the exception of the U.K. and Greece public spending -  across the EU public spending on defence clusters around 1.3% of GDP compared to 0.4% in Ireland.

OECD averages are impacted by a wide range of countries including Mexico, Turkey, South Korea and a number of new EU accession States which are at very different stages of economic development to that of Ireland. When comparing with other OECD countries Ireland was close to the OECD average or somewhat lower if the effect of bank recapitalisation is excluded. It should also be borne in mind that interest payments on government debt are included in total public spending and this was somewhat higher for Ireland in 2011 compared to other countries.

A different picture emerges when the comparison refers to the European Union, only. NERI Quarterly Economic Facts uses the latest Eurostat data to compare public spending as a % of GDP [Indicator 7.1]

This shows Ireland consistently below the EU average except for 2010 when a huge amount of money was injected as capital transfers into the banks.  In 2011 total public spending came to 47% of GDP compared to 49% on average across the EU (average of all 27 countries). But, spending in Ireland, dropped to 42% of GDP in 2012 while it increased marginally to just over 49% for the EU28.

Frequently commentators object to the use of GDP for the purposes of statistical comparison of public spending or revenue because, it is claimed that a portion of GDP is not really ‘ours’ due to the way some multinational firms repatriate (send back) a large amount of their profits in Ireland. In some cases companies ‘book’ their profits here to avoid paying taxes in other jurisdictions.  Gross National Product (GNP) is claimed to be a better measure of ‘true’ income in Ireland. I don’t agree for the following reasons:

  • All income counted as part of GDP including taxable profits earned by enterprises resident here are liable to tax in Ireland.
  • Gross Domestic Product is the main measure of national income or output used by Eurostat and the European Commission to measure Ireland’s income. For example, all targets for public deficit and debt are with reference to GDP and not GNP.

I accept that GDP may not necessarily be as high as it is if, hypothetically, corporate taxes were significantly higher than they are now. To the extent that this might be true it could be argued that the capacity of Ireland to tax certain enterprises as much as other enterprises is constrained and, therefore GDP exaggerates the extent to which the Irish government can extract revenue from footloose multinational corporations.  As a consequence, the Irish Fiscal Advisory Council in its Autumn 2012 report suggested a ‘hybrid measure’ combining GDP and GNP with a weighting towards the lower GNP number. If such a measure were to be used it would probably put Ireland above the EU27 average in 2011. However, I remain unconvinced that this provides a robust estimate of ‘true’ national income in Ireland. It should also be pointed out that GNP flatters national income to the extent that some of the increased earnings of new formerly UK-based companies in the Republic of Ireland is attributed to decisions by these companies to change their HQ to Ireland for tax avoidance purposes. This seems to have increased substantially in recent years since the onset of the 2008 crisis.

Finally, a comparison has been drawn by the OECD in terms of total public spending per capita (adjusted for price differences). In his article Brendan Keenan draws attention to the fact that, according to Table 3.23 on page 75 of Government at a Glance, total spending in 2011 was above the OECD average and even higher (but only a little bit) than France – the home of high taxes and high public spending by European norms. Who would have thought!

The surprise finding needs to be put in context. Guess who is just ahead of Ireland in table 3.23? The United States of America where Government spends more per capita in US dollars than Ireland does. There are a number of reasons for these results – GDP per capital when adjusted for price differences is significantly higher in the US than in Ireland and in the latter compared to France. This outweighs the impact of a much higher % of GDP spent by Government in France compared to Ireland or the USA. It should also be recalled, as stated above, that the 2011 figure for Ireland includes a sizeable bank recapitalisation figure  as well as payments of interest on public debt. If public spending per capita in Ireland is above the OECD average in 2011 government revenue per capita is below.

Ultimately the question of how high public spending ought to be comes down to the following three questions:

  1. What level of public service and public goods does a society wish to provide?
  2. How should scarce public resources be best employed to achieve a given level of outcome be it in the domain of income-protection, education, health or crime-prevention?
  3. How will society pay for this agreed level of service from various sources of government revenue?

The notion that a very wealthy country such as Ireland with an exceptionally high level of GDP per capita cannot afford a proper public mental health service (for example) for teenagers is a nonsense. It comes down to societal choices and values. When it comes to evaluating the amount of human and other resources devoted to the provision of public goods it is necessary to focus on what we call ‘primary public spending’, i.e. the amount spent by public authorities after paying interest on public debt loans. This amount, when expressed as a % of GDP, is low by international comparisons. In 2012 it is estimated to have been 38.5% in Ireland (42.2% less 3.7% in interest payments). According to the International Monetary Fund (IMF) this proportion is projected to decline 31% by 2018. This would mean that Ireland would move from being the 6th lowest spender on public services in 2012 to being the second lowest spender in 2018 only ahead of one other EU Member State -  brave little Latvia that is a model of fiscal shock therapy, declining population, rising poverty and ageing population.

So, is Ireland spending more than it should or can afford to on its public services?  Given the continuing squeeze on public spending we have reason to fear that fiscal consolidation has gone much too far. What is needed now is a reversal of some of the most damaging cuts and a diversion of public funds from reversals plus areas of waste or duplication into priority public spending needs including early childhood support, health services for those in acute need and investment in training for those at risk of under-employment.

Using Eurostat data on public finances (Ameco database) it is possible to estimate the total public spend less interest payments and less defence spending per capita in each country in 2014. This shows a projected figure of €12,700 in Ireland compared to  €15,300 on average across the core 15 EU Member States which share more in common with Ireland in terms of economic development. If price differences are adjusted for the gap is even larger - €11,600 in Ireland compared to €15,100 for EU15  in 2014.

The recession has triggered a rise in social spending related to a collapse in income for some and a growth in unemployment or under-employment. Add to this the impact of bailing out the banks and Ireland's public spend comes close to the EU average in 2011 and in 2012. However, government revenue remains stuck at 35% and is projected to remain there indicating that we will remain a low tax society by EU standards. Public spending per capita, here, is not above that of other countries of similar size and level of economic development.


Posted in: Government Spending

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