Download The Government Budget and The National Debt

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Introduc)on
Therolethatthegovernmentplaysinaneconomyshouldneverbe
underes<mated.Theeconomicpoliciesthatthegovernmentenactplaya
vitalpartinthedevelopmentandthegeneralworkingsofaneconomy.In
general,thegovernmenthastwomaintypesofpoliciesthatitcanuseto
controlaneconomy(reduceinfla<on)ors<mulateaneconomy(promote
economicgrowth).TheyareMonetaryPolicyandFiscalPolicy.
MonetaryPolicy:Thoseac<onsbytheECB,whichinfluencesthemoney
supply,interestratesandtheavailabilityofcredit.
Asissuggestedinthedefini<on,theIrishgovernmentdoesnotcontrol
theMonetaryPolicythatitissubjectedtobytheEuropeanCentralBank
(ECB),andassuchthisisnotaninstrumentofeconomicpolicyavailable
totheIrishgovernment.
FiscalPolicy:Anyac<ontakenbythegovernmentwhichinfluencesthe
<ming,magnitudeandstructureofcurrentrevenueandexpenditure.
TheIrishgovernments<llretainscontrolofitsFiscalPolicybutonlyupto
apoint.SinceIrelandhasra<fiedtheTreatyonStability,Coordina<onand
Governance,theIrishgovernmentisrequiredtowriteintolawthe
followingfourfiscalrules.
1) Debt-to-GDPra<oshouldbe60%orless;
2) Governmentdeficitsshouldbe3%orless;
3) Governmentstructuraldeficitsshouldbe0.5%orless
4) Ifthedebt-to-GDPis“significantlybelow60%andwhererisksinterms
oflong-termsustainabilityofpublicfinancesarelow”thestructural
deficitcanbeupto1.0%
StructuralDeficit:Abudgetdeficitthatresultsfromafundamental
imbalanceingovernmentreceiptsandexpenditures,asopposedtoone
basedonone-offorshort-termfactors.
Adeficitoccurswhenthegovernmentspendsmoremoneythanthey
receivedinagivenyear.
Eachoftheserules(whicharenowlaw)effectthegovernmentsabilityto
controltheeconomyandassuchtheyeffectyou.Theques<onhastobe
askedtherefore,whatdoesanyofthemmean?
Toexplaintheserules,thereasonsfortheserules,thegeneral
governmentbudget,howitiscomprisedandwhatitcontainsandthe
Na<onalDebt,itseffectsandconsequencesarethepurposeofthis
handout.
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LCEconomicswww.thebusinessguys.ie©
TheIrishGovernment
TheIrishgovernmentcanbesplitintotwobroadcategories.
1) TheCentralGovernment:iscomposedoftheDáil,theSeanadandthe
CivilService.
2) LocalGovernment:iscomposedofthevariousurbanandcounty
councilswhichprovidecertaingovernmentservicesintheirownlocal
area.
ThefinancesofeachplayahugeroleintheNa<onalBudget,butforthe
momentweewilltakeeachoftheminturn.
TheCentralGovernmentBudget
Thegovernmentbudgetisdividedintotwocategories.TheCurrent
BudgetandtheCapitalBudget.
GovernmentCurrentBudget:Outlinesthegovernment’splanned
revenuesandexpendituresfortheforthcomingyearfordaytoday
purposes
GovernmentCapitalBudget:Outlinesthegovernmentsplanned
expenditureonitemsnotusedupduringtheyearbutwhichincrease
theproduc<vecapacityofthecountry
Aswassaidpreviously,whenthegovernmentspendsmoreinayearthan
ittakesin,thisisknownasadeficit.
TheEconomicEffectsontheIrishEconomywhenthegovernment
ReducestheDeficit
1) ReducedStandardofLiving:Taxpayerswillhavelowerdisposable
incomesduetohighertaxesandtheirstandardoflivingwillfall.
2) LossofPublicServices:Somepublicservicesmaybediscon<nued
(bustransportroutes/lessSpecialNeedsAssistants);othersmayfall
instandard(healthservices)whilemoremayhavetopaidforexample
householdcharges.
3) ChangedOwnershipofStrategicStateAssets:Somestatebodiesmay
bepriva<sedaffec<ngconsumers(prices),employees(nonemployment)andthegovernment(revenue).
4) PublicSectorEffects:Thenumbersemployedinthepublicsectorwill
fall;wagesmaybereducedandthismayaddfurthertothenumbers
unemployed.
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5) LevelofEconomicAc)vity:Lowerdisposableincomeshasreduced
domes<cdemandandthismayresultinanincreaseinthenumbers
unemployed.
6) GrowthintheBlackEconomy:Morepeoplemaybewillingto
par<cipateintheblackeconomyduetoreducedincomesandthe
possibilityoflowerpricesbeingchargedintheblackmarket.
7) WideningGapbetweenRichandPoor:Cutbacksinrateofsocial
welfarepayments;coupledwithstrictereligibilityrequirementsmay
meanthatsocialwelfarerecipientssuffer.Changesintaxa<onand
expenditurecutsmayhaveagreatereffectonlowerincomegroups.
8) PublicUnrest:Peoplemaybecomeinvolvedinprotests/strikeswhich
maydisrupteconomicac<vity.Someci<zensmaydecidetoemigrate
seekingabeherfuture.
TheGovernmentCurrentBudget
Eachyear,theMinisterforFinancepresentsthecurrentbudgettothe
Dáilwhichoutlinesthegovernment’splannedrevenuesandexpenditures
fortheforthcomingyearfordaytodaypurposes.
CurrentRevenue:ismoneycollectedbythecentralgovernmentinthe
formoftaxes(direct/indirect)andotherincomeduringtheyear.
E.g.IncomeTaxes,Corpora<onTaxes,DIRT,VATandStampDuty.
CurrentExpenditure:ismoneyspentbythecentralgovernmentonday
todayitems.
E.g.WagesofPublicSectoremployeesliketeachers,Gardaí,nursesetc.
OverleafisamorecompletelistofCentralGovernmentCurrentRevenue
andCentralGovernmentCurrentExpenditure.
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Current Budget
Revenue
Expenditure
IncomeTax
SalariesofCivilService,Armyand
Gardaí
ValueAddedTax
RunningCostsofgovernment
departments(sta<onary,lightand
heatetc)
Corpora<onTax
SocialWelfarePayments
CapitalGainsTax
InterestontheNa<onalDebt
CapitalAcquisi<onsTax
GrantstoLocalAuthori<esfor
CurrentExpenditure
ExciseDu<es
CentralFundServices
StampDu<es
CustomsDuty
ProceedsoftheNa<onalLohery
InterestonLoansgiventosemistatebodiesandLocalAuthori<es
Note:CentralFundServicesrefertogovernmentexpenditurewhichis
outsidegovernmentcontrol.Thisincludesthingslikethesalaryofthe
President,salariesofjudgesandourcontribu<ontotheEU).
Thecentralgovernmentcurrentbudgetcanendinoneofthreeways.It
canbeeitherabudgetsurplus,abalancedbudgetorabudgetdeficit.
CurrentBudgetSurplus:isasitua<onwherecurrentgovernment
revenueexceedscurrentgovernmentexpenditure.
CurrentBudgetDeficit:isasitua<onwherecurrentgovernment
revenueislessthencurrentgovernmentexpenditure.
ABalancedBudget:isasitua<onwherecurrentgovernmentrevenueis
equaltocurrentgovernmentexpenditure
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ThePosi)veEconomicEffectsofaCurrentBudgetSurplus
1) ReducedInfla)onaryPressures:Thegovernmentiswithdrawingmore
moneyfromtheeconomythanitispunngin.Thistendstohavea
defla<onaryeffectintheeconomy.
2) ManagingourFinances:Theexistenceofabudgetsurplusmeansthat
governmentdoesnothavedifficultyincontrollingitsfinances.This
canleadtoconfidenceintheeconomyandahractinvestment.
3) AdheringtoEUTreaty:Thefactthatabudgetsurplusexistsindicates
thatthecountryismee<ngtheEUStability,Coordina<onand
GovernanceTreatywithoutanydifficulty.Thisalleviatestheneedfor
thegovernmenttotakeautoma<ccorrec<veac<on.
4) ScopeforTaxa)onReforms:Thefactthatasurplusexistsindicates
thatscopeexistsforreforminthetaxa<onsysteminthecountry.This
shouldallowforimprovementsinthetaxsystemallowingpeopleto
retainmoreoftheirincomee.g.widenedtaxbandsetc.
5) UsesofthisIncreasedGovernmentRevenue:Withincreasedrevenue
flowingintothegovernment,theynowhavetheabilitytomakeuseof
thisaddi<onalrevenue.Theymayuseforcurrentprojectse.g.
servicesoronlongtermprojectse.g.infrastructure.
TheNega)veEconomicEffectsofaCurrentBudgetSurplus
1) RiseinConflic)ngExpecta)ons:Whenci<zensobservethebudget
surplustheymaydemandimprovementsinstateservicese.g.health
services;educa<onprovisionetc.However,thedemands/expecta<ons
madeonthegovernmentmayconflict.
2) PublicSectorWorkers:Whenpublicsectorworkersseethisbudget
surplustheymayseeitasanopportunityforwagenego<a<ons.
Workersmaythusdemandpayincreasesand/oranincreaseinthe
leveloftheworkforce.
3) TaxReduc)ons:Taxpayerswhofeelthattheyarepayingtoomuchtax
mayfeelaggrieved.Theymaydemandreduc<onsintheirtax/
improvedequityinthetaxsystem.
4) Discon)nuityinSocialPartnership:Theexistenceofthebudget
surplusmaycausediscontentwithinsociety.Ci<zensmayfeelthat
certainsectorsarebenefi<ngmorefromgovernmentpolicies.May
provedifficultinapprovingna<onalagreements.
5) GovernmentFinancialPlanning:Thesurplusmayindicatethatthe
planningbythegovernmentwasnotsufficientlyaccurateatbudget
prepara<on<me.
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6) OpportunityCostsofaSurplus:Thebudgetsurplusmayhavebeen
achievedbythereduc<onofexpenditureonserviceswithinthe
country.Thusessen<alservicessuchashealth,educa<onetcmay
havedeteriorated.
RevenueBuoyancy:Theactualtaxa<onrevenuecollectedduringthe
yearisgreaterthanthatwhichhadbeenplannedfor.
Whenthegovernmentremovesmoremoneyfromtheeconomythanit
putsinthisreducestheCircularFlowofIncome.Thiscausesareduc<on
inAggregateDemandandassuchhasaDefla<onaryEffect.This
Defla<onaryEffectisknownasFiscalDrag.
FiscalDrag:Isthedefla<onaryeffectthatoccursifgovernmentrevenue
isgreaterthangovernmentexpenditure.
ThePosi)veEconomicEffectsofaCurrentBudgetDeficit
1) EconomicGrowth:Abudgetdeficitincreasesthecircularflowof
incomeandincreasesaggregatedemand.Thisincreaseinaggregate
demandmayincreasethena<onalincomeofthecountry.
2) Employment:Asaresultofthiseconomicgrowthfirmsmayemploy
morepeopleinordertomeettheincreaseddemand.Thiswould
resultinahigherstandardoflivingforthosewhomanagedtosecure
employment.
3) Taxes:WithanincreaseinAggregateDemand,thegovernmentwould
starttocollectmoremoneythroughindirecttaxes.Thismoneycould
beusedinothersectorsoftheeconomytofurthers<mulategrowth
orbekepttoensurethatacurrentdeficitdoesnotoccurnextyear.
4) ImprovementinServices:Theextramoneybeingspentbythe
governmentmayresultinimprovedpublicservices.E.g.Improved
servicesfromtheESBorBordGaís.
5) Redistribu)onofIncome:Thegovernmentcouldusetheextramoney
thatitisspendingtoalleviatetheeconomichardshipenduredbythe
poorestci<zensofthecountry.E.g.Increasewelfarepaymentsofthe
oldagepension.
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TheNega)veEconomicEffectsofaCurrentBudgetDeficit
1) Infla)on:Asthegovernmentispunngmoremoneyintotheeconomy
thanittakesout,thiscausesAggregateDemandtorise.Thisrisein
AggregateDemandmaycausedemandpullinfla<ontoincrease.
2) TheDeficitmustbemetbyBorrowing:Ireland’sna<onaldebtstands
at€123.5billion.IrelandmustkeepitsdebttoGDPra<oat60%or
less.Ireland’sdebttoGDPra<owas108.2%in2011.Sincethe
ra<fica<onoftheTreatyonStability,Coordina<onandGovernance,
thegovernmentcannotbeseentoallowcurrentdeficitstocon<nue
asitisillegal.
3) ReducedInvestmentFunds:Also,iftheIrishgovernmentwereto
borrowmoneyfromIrishbanksinordertofinanceadeficit,this
wouldmeanthattherewouldbelessfundsavailableforprivate
entrepreneurstouseforinvestment.Thisprocessofpublicborrowing
reducingfundsavailabletoprivateentrepreneursisknownas
crowdingout.
CrowdingOut:Aneconomictheoryexplaininganincreaseininterest
ratesduetorisinggovernmentborrowinginthemoneymarket.
4) IncreaseinImports:AsIrelandhasarela<velyhighMarginal
PropensitytoImport,thisinjec<onofmoneyintotheeconomymight
bespentlargelyonimports,notcausinggrowthwhilehavingnega<ve
consequencesontheBalanceofPayments.
5) NotSustainableGrowth:Anyincreaseineconomicgrowththatmight
occurmaydependonthecon<nuedinjec<onofgovernmentfunds.
Asthisisunsustainableinthelongrun,theneteffectmaybeareturn
toeconomicoutputthatexistedbeforethedeficitsandalarge
na<onaldebt.
Thefactthatrunningacurrentbudgetdeficitisnotsustainable,
combinedwiththena<onaldebtofsomemajorEUmemberstatesrising
toneverbeforeseenlevels(Ireland,Greece,Spain,Italyetc),TheTreaty
onStability,Coordina<onandGovernancebroughtintherulesstatedat
thebeginningofthehandoutinordertotrytopromotesustainable
growthinEUmemberstates.BelowisashortexcerptfromtheTreaty.
BEARING IN MIND that the need for governments to maintain sound
and sustainable public finances and to prevent a general government
deficit becoming excessive is of essential importance to safeguard the
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stability of the euro area as a whole, and accordingly, requires the
introduction of specific rules, including a "balanced budget rule" and an
automatic mechanism to take corrective action.
Withthegoalofsustainableeconomicgrowthinmindandthefactthat
manyEUmemberstatesareopera<ngwelloutsidethefiscallimitsset
outbythetreaty,(IrelandDebt/GDPRa<o108.2%,Italy’sDebt/GDPRa<o
120.1%,PortugalDebt/GDPRa<o107%,SpainDebt/GDPRa<o72.1%and
theEUaverageis88%),theMinistersforFinanceintheEUmember
stateshavetocontrolCurrentDeficits.Belowisalistofwaystheycould
dothisandtheeffectsofsodoing.
WaystheGovernmentcouldReduceCurrentBudgetDeficits
Revenue
1) IncreaseIndirectTaxes:ByincreasingtaxessuchasVATandexcise
du<esthegovernmentwouldaimtoincreasetaxrevenuefrom
consump<on.
Effect
• Increasedsmugglinginordertoevadetax.
• Increasedinfla<onastheincreaseisautoma<callybuiltintotheprice.
• Reduc<oninaggregatedemandaspriceshaveincreased.
2) IncreaseDirectTax/Pensionlevy:ByincreasingtaxessuchasPAYE,
CGTorthepensionlevythegovernmentwouldaimtoincreasetheir
taxrevenuefromwealthandincomes.
Effect
• Increasednumbersworkinginthe‘blackeconomy’inordertoevade
tax.
• Decreaseinemploymentasthecostofwageswillincrease/decreased
incen<vetowork.
• Increasewagedemandswhichmayleadtoindustrialdisputes.
• Decreaseinaggregatedemandasrealincomesandspendingpower
falls.
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Expenditure
1) DecreaseNumbersEmployedinthePublicSector:Offerredundancy
packagestothoseworkinginthepublicsector.
Effect
• Increaseinshort-termcostsinmee<ngredundancypayments.
• Mayleadtoincreaseinlongtermunemploymentifnoworkisavailable
intheprivatesector.
• Reduc<oninaggregatedemandasrealincomesandspendingpower
havedecreased.
• Deteriora<oninpublicservices.
2) DecreaseWagesinthePublicSector:Introduceapayfreezewhere
workerswageswillnotincreaseoveraperiodof<me.
Effect
• Mayleadtoindustrialdisputes.
• Skilledworkersmayleavefortheprivatesectororemigrate.
• Discourageeffortandmo<va<oninthesector,reducingefficiencyinthe
long-term.
3) ReduceStateServicesorIncreasetheirCharges:Cutservicessuchas
medicalcard,cervicalcancervaccine,bookgrantsetcineach
governmentdepartment.
Effect
• Thoseonlowerincomesmaysufferadrama<cfallinstandardofliving.
• Mayincreasecostsinthelongruninordertoreintroduceservices.
• Mayleadtoindustrialdisputesandpublicprotestsbyaffectedci<zens.
4) ReduceSocialWelfare:Thiswillreducecurrentexpenditureand
reducethebudgetdeficit.
Effect
• Thoseonlowerincomesmaysufferadrama<cfallintheirstandardof
living.
• Mayincreasetheincen<vetofindwork.
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TheGovernmentCapitalBudget
GovernmentCapitalBudget:Outlinesthegovernmentsplanned
expenditureonitemsnotusedupduringtheyearbutwhichincrease
theproduc<vecapacityofthecountry
TheNa)onalDebt
TheNa)onalDebt:Thisisthetotalamountofoutstandingborrowing
bythegovernment.
ProblemsAssociatedwiththeIrishNa)onalDebt
1) OpportunityCostsInvolved:Withmorefundsbeingusedtomeetour
annualinterestrepaymentsthegovernmenthaslessfundsavailable
forotherpurposes.
2) IncreasedBurdenonTaxpayers:Theincreasewillmeanthatthe
governmentwillhavetoconsiderincreasingfuturetaxesfor
taxpayers.
3) IncreasedAnnualInterestRepayments:Anincreasingna<onaldebt
meansthattheannualcostofrepayingourna<onaldebtisrising.
4) Diminishedinterna)onalCredit-Ra)ng:ThefactthatIrelandisseen
tohaveanincreasingna<onaldebtmeansthatourcredit-ra<ngis
deteriora<ng.
5) EuroStabilityPactRequirements:Irelandhasdifficultyinmee<ngthe
condi<onsofthestabilitypactandhencecorrec<veac<onmustbe
takenineconomicpolicymahersandagreedbytheEU.
6) PoorManagementofEconomy:Someci<zensmaybecomeawareof
thegovernment’spoormanagementoftheeconomyandthismay
diminishtheirconfidenceintheeconomy.
7) PressureonGovernmenttoCutSpending:Duetoanincreaseinthe
na<onaldebtthegovernmenthascutbackspendingoncertainpublic
services,therebyaffec<ngtheprovisionofsomeservicese.g.the
healthservice;educa<onservice.
8) ServicingtheExternalPor)onoftheNa)onalDebt:Theexternal
por<onofthena<onaldebtissubjecttoexchangeratemovements,if
borrowedfromoutsidetheeurozone.TheIrishGovernmentdoesn’t
earntaxrevenueontherepaymentofexternalsources,unlikeonthe
repaymentofinternalsources.
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ReasonsForStateBorrowing/ReasonsforIncreaseinNa)onalDebt
1) IncreasedCurrentBudgetDeficits:Thegovernmenthavedecidedto
operateadeficitbudgetinordertocon<nuewiththeprovisionof
publicservices/nottofurtherreduceaggregatedemand.Any
borrowingtofinancethiscurrentexpenditurewillincreasethesizeof
thedeficit.Thismoneymustbeborrowedtherebyincreasingthe
na<onaldebt.
2) BorrowingforCapitalPurposes:Thegovernmentcon<nuestoborrow
toinvestininfrastructureandothercapitalprojects,whichwill
eventuallygenerateincomeandyieldtaxrevenuestomeetcostsof
repayingthemoneyborrowed(Self-Liquida<ngDebt).Thisalso
increasesthena<onaldebt.
3) SocialInvestment:Thegovernmentborrowedtoinvestinsocially
desirableprojectswhichmaynotyieldanytaxrevenuesuchas
hospitals,schools,publicameni<es.
EconomicConsequencesofanIncreaseintheNa)onalDebt
Posi)ve
1) ImprovedPublicServices:Iftheincreaseddebtiscausedbyan
increaseincurrentborrowingthegovernmentmaycon<nuetospend
onpublicservicesresul<nginacon<nua<onoftheseservices.
2) IncreasedSpendingonInfrastructure:Iftheincreaseddebtiscaused
byanincreaseincapitalborrowingthentheremaybegreater
spendingonthestate’sinfrastructurewhichmayassistthefuture
growthoftheeconomy.
3) FutureEconomicGrowth:IncreasedNa<onalDebtmayboost
aggregatedemandandmayprovideopportuni<esforfurther
economicgrowth.
4) Employment:Risingaggregatedemandshouldleadtoincreased
demandforlabourresul<nginlowerunemployment.
5) Self-Liquida)ngDebt:Ifthereturnontheborrowingsisabletomeet
thecostofrepaymentsthentheborrowinghasbeenself-liquida<ng.
Nega)ve
1) OpportunityCostsInvolved:Withmorefundsbeingusedtomeetour
annualinterestrepaymentsthegovernmenthaslessfundsavailable
forotherpurposes.
2) IncreasedBurdenonTaxpayers:Theincreasewillmeanthatthe
governmentwillhavetoconsiderincreasingfuturetaxesonfuture
taxpayers.
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3) IncreasedAnnualInterestRepayments:Anincreasingna<onaldebt
meansthattheannualcostofrepayingourna<onaldebtisrising.
4) DiminishedInterna)onalCredit-Ra)ng:ThefactthatIrelandisseen
tohaveanincreasingna<onaldebtmaymeanthatourcredit-ra<ng
worsens.
5) OutsideEuroStabilityPactRequirements:Irelandhasdifficultyin
mee<ngthecondi<onsofthestabilitypactandhencecorrec<ve
ac<onwillneedtobetakenineconomicpolicymahers.
6) PoorGovernmentManagementofEconomy:Ci<zensmaybecome
awareofthegovernment’spoormanagementoftheeconomyand
thismaydiminishci<zen’sconfidenceinthegovernment.
7) RiskinProvisionofPublicServices:Duetoanincreaseinthena<onal
debtthegovernmentmaycutbackspendingonpublicservices,
resul<nginadeteriora<oninprovisionofservicese.g.thehealth
service
BenefitsofReducingtheNa)onalDebt
1) ReducedAnnualInterestRepayments:Adecliningna<onaldebtto
GDPmeansthattheannualcostofrepayingourna<onaldebtis
declining.
2) MoreFundsAvailabletotheGovernmentforCurrentUse:Withless
fundsbeingusedtomeetourannualinterestrepaymentsthe
governmenthasmorefundsavailableforuseforotherpurposes.
3) ReducedBurdenonFutureTaxpayers:Thedeclinewillmeanthatthe
governmentwillnothavetocontemplateincreasingfuturetaxeson
futuretaxpayers.
4) ImprovedInterna)onalCredit-Ra)ng:Unlikeothercountriesthefact
thatIrelandisseentohaveadecliningna<onaldebtasapercentage
ofGDPwillmeanthatourcredit-ra<ngimproves.
5) AdheringtoRequirementsoftheEurostabilitypact:Unlikeother
membersoftheEuroIrelanddoesnothaveadifficultyinmee<ngthe
condi<onsofthestabilitypactandhencenocorrec<veac<onneedto
betakenineconomicpolicymahers.
6) PrudentManagementofEconomybyGovernment:Ci<zensmaybe
madeawarethatthegovernment’smanagementoftheeconomyis
prudentandthismayboostmorale.
7) PossibleDeteriora)oninPublicServices:IfthereduceddebttoGDP
ra<oiscausedbyareduc<onincurrentborrowingthegovernment
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mayspendlessonpublicservicesresul<nginadeteriora<onofthese
servicesi.e.thehealthservice.
8) ReducedSpendingonInfrastructure:IfthereduceddebttoGDPra<o
iscausedbyareduc<onincapitalborrowingthentheremaybeless
spendingonthestate’sinfrastructurewhichmayinhibitthefuture
growthofthecountry.
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