In comparing the tax burden and the level of public spending between countries, the OECD and others usually scale individual country data by the size of that country’s economy.

The size of the economy is normally measured using GDP-or the amount produced in the economy in a given year. For example, in 2009 Irish public health expenditure was 7.1% of GDP compared to a euro area average of 7.5%. An alternative measure of the size of the economy is GNP, which measures the income from production which accrues to residents of that country, For most countries, the use of GDP or GNP as a denominator makes little difference as the profits made by foreign multinationals within the country is balanced by overseas profits of indigenous companies.

For some countries including Ireland (and Luxembourg) there is a substantial difference between the two. For example, preliminary figures for 2011 show that Irish GNP was 79.2% of GDP. The main difference between the two aggregates in Ireland’s case is due to the unbalanced nature of our profit flows; repatriated profits by foreign multinationals based here outweighs overseas profits generated by Irish companies.

Some argue that to express tax and spending as a percentage of Irish GDP gives a false impression of the level of public expenditure here.

What is the correct position? This note attempts to answer that question.

Tax Burden

If we regard tax as a burden, the tax/ GDP percentage will understate the real burden of tax on the domestic economy. This is because of the relatively low rate of tax paid by foreign companies located here as a result of our low rate of corporation tax of 12.5%. A truer measure of the tax burden on the domestic economy is obtained if the amount of corporation tax paid by foreign companies located here is deducted from the tax aggregate and the resulting domestic tax aggregate expressed as a percentage of GNP.

Value of Public Expenditure

The costs of providing public services in Ireland are much more related to GNP rather than GDP since one of the main costs is pay. Therefore, we should be able to enjoy the same standard of public services as other counties if our expenditure as a percentage of GNP is the same as theirs of GDP/GNP. This assumes that the Irish public service is as efficient as public services in other countries.

In these circumstances, it seems appropriate to use GNP as the most relevant aggregate for Ireland in judging the level of resources to be applied to spending programs.

Returning to the previous example, public health expenditure in 2009 was 8.6% of GNP in Ireland, compared to 7.9% in the euro area.

On this basis, we use Irish GNP as the denominator in making international comparisons of public expenditure throughout this website.

Public Sector Reform: Need for a Modern System of Public Accounting

We have the most crude accounting tools. It’s tragic because our accounts and our national arithmetic doesn’t tell us the things that we need to know.

Susan George, American Activist.

The present system of Government accounting has long been seen as no longer fit for purpose.

This is recognised in the Comprehensive Expenditure Report 2012-2014 (December 2011) which introduces what it calls “incentives for responsible expenditure management”. It states (page 95)

Under the existing processes for current expenditure, managers have little or no incentive to be prudent and to make savings with their allocation in a given year. Indeed, if a saving appears to be in prospect at the end of a year, the incentive for a manager is to spend all of that money, rather than see it ‘lost.’

The failure to introduce a modern, accrual accounting based, system of financial management and controls in the public service has been serious failure in the management of the public service.

What’s Wrong with the Present System?

First, it is cash based and thus takes no account of liabilities. Secondly, it ignores depreciation or amortisation in on-going costs; once an office is built it’s free. Thirdly, we do not track assets. When there is no balance sheet, then efficient use of capital – including realisation of assets when appropriate – gets no management focus.

Accounting systems give managers signals in relation to the costs of the resources that they are using. The present cash based system, which largely ignores future liabilities, does not meet modern standards and give misleading signals in the following areas.

• Employment: the failure to account for pension costs means that the cost of employing additional people is understated

• Once capital has been allocated, the failure to account for its use effectively means that capital is treated as free and there is little or no incentive to use assets efficiently.

• The cash based (“use it or lose it” system) leads to a rush to spend money before the end of the year.

The Government Proposals

To address some of these issues, the Government has proposed a new range of measures to help managers make the right decisions in the public interest.

These are

• A Department may carry over 80% of its saving, with the balance of 20% going to the Exchequer.

• Carried over funds may be spent on once-off projects or structural measures, but may not be used to create an on-going liability for the Exchequer.

In addition, Departments may retain up to 50% of the proceeds of certain property sales for once-off projects.

As a quid pro quo for the carryover entitlements, Departments which fail to manage within their expenditure ceiling in any year will be subject to an offsetting adjustment in the envelope for the following year and will need to devise policy measures to live within the reduced allocation.

Accrual Accounting

Under accrual accounting, transactions are recognised as the underlying economic events occur. Revenue is recognised when income is earned and expenses are recognised when liabilities are incurred.

An accrual accounting system is essential to see the full cost of government’s activities and to assess the efficiency of public services. It is a key element of any effective public sector performance management framework.(See Transition to Accrual Accounting, Abdul Khan and Stephen Mayes, IMF Fiscal Affairs Department, Technical Notes and Manuals 09/02, September 2009. http://www.imf.org/external/pubs/ft/tnm/2009/tnm0902.pdf)
Comment

A modern system of public accounting is an essential part of the infrastructure to deliver efficient public sector management. It is no longer sufficient to rely on a system largely developed in the Gladstonian era.

The changes proposed in the Comprehensive Expenditure Report are an attempt to counteract the perverse incentives in the current system. It will be interesting to see their effect.

While the changes are broadly positive, care will need to be taken to avoid other perverse incentives. Being able to keep 80% of savings is a powerful incentive to budget costs too high and could potentially lead to inefficient allocation of the resources carried forward. Similarly retaining 50% of property sales could lead to inappropriate disposals of property and similar less than optimal expenditure of the proceeds.

Further change is necessary. A modern accruals based system of accounting should be adopted which would take account of the costs of accrued pension liabiities and depreciation of fixed assets.