Why public spending/GNP ratio is misleading

Economics: A couple of weeks ago, the ICTU published an interesting paper entitled Tax Cuts did not create the Celtic Tiger. It is a significant and provocative contribution to an important national debate.

The document reflects part of the thinking that lies behind the ICTU's decision to reposition itself in the social partnership arena and, in particular, to redefine its stance in relation to taxation and public spending.

The core message is something along the following lines. The situation regarding taxation in this country at the moment is seriously flawed in two respects. First, insufficient revenues are being raised to fund the required level of public services. Second, the revenues yielded by the current system are being raised in an inequitable way with too much being extracted from workers by way of income tax and taxes on expenditure, and too little coming from capital taxes and the corporate sector.

The policy prescriptions that flow from this analysis are clear. The overall tax burden needs to be increased substantially, and that increase needs to be effected on the basis of raising corporate taxes and taxes on capital and property.

Would not such policies result in serious damage to the economy? Not according to the ICTU. Since tax cuts did not create the Celtic Tiger, tax increases cannot reasonably be expected to do the post-Tiger Irish economy any great harm. Thus, from the point of view of society as a whole, we are presented with a seemingly pain-free way of delivering what most people would regard as a highly desirable outcome: better public services.

From the viewpoint of ICTU members, of course, the proposition is even more enticing: better public services without extra taxes and, for its public sector members, some combination of more colleagues and higher pay to boot.

Is the current level of taxation insufficient to fund the required level of public spending? What is the required level of public spending? Some people, including the ICTU, seem to base their answer to this question on how the ratio of such spending to GDP or GNP has behaved over the past decade or so - and/or on how the current ratio for Ireland compares with that for other EU member-states.

By either criterion, it seems that there is a big shortfall. The ratio of government current spending to GNP in Ireland is currently about 10 percentage points below the EU average and also about 10 percentage points below where it was a decade ago.

These raw comparisons ignore a great many relevant qualifications such as the fact that the EU average is boosted relative to the Irish ratio by higher unemployment, higher military spending and the like.

But they also ignore a more fundamental point - which is that despite the ICTU's claim that it has been cut, government spending in Ireland has been rising more rapidly than government spending across the EU over the past decade. If the ratio of spending to GNP has fallen, it's not because the numerator has not been rising rapidly (it has - by over 8 per cent per annum since 1993), it's because the denominator has been increasing even more rapidly (by almost 11 per cent per annum over the same period).

This raises the issue of the capacity of the public sector to absorb resources and deploy them efficiently and effectively. Whatever one's opinion about how this capacity compares with that of private sector firms, there can be little dispute with the propositions that there are limits to it, and that those limits are likely to be reached or stretched in circumstances of sustained rapid spending growth.

Exchequer capital spending has grown at an unprecedented annual average rate of about 15 per cent over the past decade, but much of the benefit that might otherwise have flowed from this has been dissipated in inflation or in system failures of one sort or another.

It is clear - much clearer now than it was five or 10 years ago - that increasing the stock of public infrastructure in an economy operating close to full capacity is an extremely difficult undertaking, and that reaching desirable standards of infrastructural service under such conditions in a short timeframe is impossible.

Those who decry the fall in government spending as a proportion of GNP over the past decade (or who regard the relatively low ratio here compared with the rest of Europe as a badge of shame), should consider the following.

If that decline had not taken place, current spending would have grown by a cumulative 210 per cent since 1993, instead of the cumulative 140 per cent that actually transpired. The level of current spending this year would be almost 30 per cent higher than it is likely to be. That converts into about €11 billion in absolute terms - and suggests, among other things, a level of public sector employment about 100,000 higher than it actually is.

Now for a couple of questions on this scenario. One, do you believe that the public sector as currently organised would have the capacity to absorb these additional resources and deploy them efficiently and effectively? And two, what do you think would be the consequences of an additional €11 billion in current government spending and an additional 100,000 public sector employees for an economy that is already operating close to full capacity and already losing cost-competitiveness to a worrying degree?

Hey, I've run out of space! I'll have to return to the ICTU's taxation views in a later column.

Jim O'Leary is currently lecturing in economics at NUI-Maynooth. He can be contacted at jim.oleary@may.ie