In the past two years, this Government has had to deal with the consequences of the most severe economic downturn in the history of the State. The crisis has primarily related to the public finances and the banking system. In a consistent way, the Government has acted swiftly and with determination to deal with each episode of the crisis as it emerged.
As a result of these actions, stability is being restored to the banking system, economic growth has resumed, albeit on a limited basis, and the economy has regained a considerable amount of the competitiveness it had lost. Notwithstanding these favourable trends, the interest demanded on Irish debt has risen and is set to remain high unless further decisive and credible action is taken soon to stabilise the public finances and establish the basis for sound economic growth for the years ahead.
The impact of the economic downturn has been severe. In the past two years, 2008 and 2009, gross national product per head is estimated to have fallen by more than 16%. Despite the severity of the downturn, however, I do not want to be negative about the economy because although last month's quarterly national accounts data were somewhat disappointing, they were not so in a uniform manner. For example, the quarterly GDP decline of 1.2% comes on the back of a very strong increase of 2.2% in the first quarter of the year, which essentially indicates that the level of economic activity has stabilised in the first half of the year.
The quarterly figures also point towards a bottoming out of gross national product, which is the most appropriate measure of Irish living standards. Gross national product fell by just 0.3% in the second quarter, a considerable improvement on the fall of nearly 11% last year. In summary, the national accounts figures for the first half of this year point to stabilisation as a prelude to growth.
The latest information on labour market trends also provides evidence of stabilisation. The Quarterly National Household Survey for the second quarter of this year showed that the downward trend in employment is slowing rapidly and that in some sectors the underlying trend has become positive. Even in unemployment, the latest figures point to stabilisation; in September the unadjusted live register fell by a record figure, and there was also a substantial fall when account was taken of seasonal factors.
In addition, the data confirmed another strong export performance in the second quarter of this year following a good performance in the first three months. This is encouraging. It is clear evidence that the improvements in competitiveness in recent years are having the desired effect. An especially welcome feature of the export figures was that they showed a broadening of our export performance, with strong growth recorded across a number of sectors.
Although the latest economic indicators point to a resumption of economic growth, this growth will — initially at least — depend on exports and will be at a modest pace because investment and consumption will take some further time to recover. We cannot rely on economic growth alone to stabilise the public finances in the short to medium term. In fact, and this is the key point, there is a structural gap in our public finances and without concerted action we will not repair the deficit and that would mean a continued drain on economic growth.
The impact to date of the downturn in growth on the public finances has been drastic. Despite the considerable efforts of the Government in the course of the last two years to bring stability to the public finances, additional and even serious adjustment measures are still needed over the next four years. A few figures will help to explain why so much adjustment is needed. Total current public expenditure increased by almost 150% in the period 2000-2010, with a near tripling in expenditure in the social protection and health areas as well as major increases in the education area. Over the same period the economy only grew by 40%, while consumer prices increased by just under 28%. Having recognised at an early stage in the downturn that action was needed to deal with the public finances, the Government has been engaged in a process of significant re-prioritisation and consolidation of all areas of expenditure since 2008. The measures introduced have reduced all aspects of Government spending, including public service pay and operating costs across Departments and State bodies. As a result, annual growth in public expenditure has fallen from 12.1% in 2007 to an estimated contraction of 1.8% this year. This major consolidation has been achieved in the face of significant pressures associated with rising numbers on the live register, increasing debt interest payments and a downturn in the economic cycle. This process of expenditure realignment has not been painless and has required a wide range of sometimes unpopular, but necessary, actions by the Government.
Ireland is now into the third year of a multi-annual consolidation period, and the Government is busily making preparations for the four year plan. It may be useful to recap the main initiatives undertaken by the Government over the past few years.
Shortly after coming into office, I put a range of efficiency and savings measures into effect in July 2008, including those identified as a result of the efficiency review process initiated by my predecessor in budget 2008. These savings included a 3% reduction in payroll costs for all Departments, State agencies and local authorities other than front line health and education services and a 50% reduction in expenditure on consultancies, advertising and public relations by Departments and agencies.
Budget 2009, which was brought forward to October of 2008, continued the objective of continuing to restore the sustainability of the public finances. A significant tax package to raise almost €2 billion in 2009 was introduced. I also announced the setting up of the special group on public service numbers and expenditure programmes in November of 2008 with a remit to identify potential savings in all areas of Government expenditure, including a thorough reduction in the number of staff working in the public service.
By the start of 2009, international forecasts for the global economy had been revised sharply downwards, reflecting the effects of the worldwide upheavals in the financial markets. In this context, the Government set out a multi-annual fiscal plan in January 2009, with the objective of bringing the overall deficit back within the 3% ceiling in a credible manner. That plan remains in effect today, and our subsequent policy actions have been designed to implement and to underpin our consolidation drive.
Accordingly, further programme and payroll savings of the order of €3.5 billion were announced in the first half of 2009. The main element of the February package of measures was the introduction of public service pension-related pay deduction. Additional capital and efficiency measures were also announced, including a 25% reduction in the rates of the domestic travel and subsistence allowances, and an 8% reduction in fees paid for professional services. The supplementary budget in April 2009 continued the process begun by these earlier measures, consolidating the expenditure reductions through a range of programme savings.
Budget 2010 continued the process of implementing a multi-annual plan, with an expenditure reduction of €4 billion delivered. This was achieved through a combination of payroll, social welfare and other programme reductions, reflecting the sharp fall in the price levels across the economy over the course of the year. The special group report, published in July 2009, has been a central point of reference in the Government's consideration of overall expenditure strategy in budget 2010, with savings of some €2.1 billion in 2010 arising from the report to date.
No doubt the Government has had to take some difficult measures in order to stabilise our budgetary position. Nonetheless, we are still well aware that it is vital for us to continue to invest in key infrastructure so that we can best position ourselves to take full advantage of the economic recovery.
Despite our straitened budgetary circumstances, the capital allocation for 2010 amounts to almost €6.5 million or 5% of GNP, which is very high by international standards. While it is inevitable that further adjustments in the capital allocations are now required, I still expect Exchequer capital investment to remain at a significant level and be a key source of infrastructural investment in this economy. This Exchequer capital programme will be supplemented by projects part-funded by private investment in the PPP programme and by the investment programmes of the commercial State-sponsored bodies.
Notwithstanding a scaling back of the investment programme, which will build on the high level of public sector investment which has taken place over the past decade, it still represents a major ongoing stimulus to the economy. The Government is determined that, in addition to scaling back on expenditure as necessary for fiscal correction, we continue to build the economic capacity for strong growth, to take full advantage of the recovery as and when it gathers strength. Government capital investment will, therefore, support those projects which will help the development of a productive and internationally competitive economy; the development of the smart/green economy; support sustainable long-term employment; and provide a modern social infrastructure.
Evidence that the Government's efforts to stabilise the public finances are now having a positive impact was provided by the most recent Exchequer returns of revenue and expenditure, covering the period to the end of September. These figures show that the overall Exchequer position is in line with target. Encouragingly, total tax revenue is exactly in line with profile, expenditure is approximately €1.6 billion down year-on-year and the underlying general Government deficit this year is expected to be in line with the budget target; in other words, after experiencing an unprecedented shock to the economy we have stabilised the public finances. The second phase of our task is to build on the measures we have taken, narrow the gap between day to day spending and what we earn and therefore bring longer-term sustainability to the public finances over the next few years.
Notwithstanding these encouraging figures, the position remains serious and a few crucial details clearly demonstrate why we need to change the path of the public finances. At the end of 2007, total national debt was only 23% of GNP and the Exchequer deficit in that year was only 1% of GNP. By contrast, in 2010, we expect revenues will be €35 billion and net expenditure is likely to be €54 billion, leaving a gap to be filled by borrowing of €19 billion — an average of over €4,200 for every man, woman and child in the country. As a result an underlying general Government deficit of 11.9% of GDP is expected this year.
On a purely headline basis, the general Government deficit this year will be extremely high — currently estimated at 32% of GDP. This is due to the accounting treatment of capital support being provided to some of the financial institutions. However, it should be stressed that no additional borrowing is required this year as a result of this large headline deficit and the Exchequer is already fully funded through the first half of 2011. In addition, the funding costs of the capital support are being spread out over the next ten or so years, thereby lessening the impact on the Exchequer and they are manageable in that context.
While these costs are manageable, the overall position is that the debt to GNP ratio is estimated to be 75% at the end of this year. With high interest rates, the annual interest bill is big and is getting bigger. If we were to allow this trend to continue, it would not be long before we were at debt levels last seen in the 1980s which, as we all remember, well exceeded 100% of GDP. This time, unlike in the 1980s, while we benefit from being a member of a strong global currency, the euro, we cannot unilaterally devalue. Furthermore, the prospect for strong global growth is mixed, inflation is low and, above all, the indulgence of the markets to build our rapid build up of debt levels is not available.
While substantial progress has been made in tackling our public finance difficulties, the Government is fully aware that the scale and speed of the deterioration in the public finances mean we have to make considerable adjustments now in order that we will not have to make even bigger ones later. We remain fully committed to reducing the general Government deficit to below 3% of GDP by the end of 2014. This means we have to take many essential decisions. Despite the scale and urgency of the necessary adjustments that have to be made, however, Irish people will still hold on to most of the gains built up in the many years of strong growth we have enjoyed since the mid-1990s. Over that period, we took many steps forward; we are now taking only one step back. Also, and most important, despite the urgent need for large-scale adjustments to the public finances, the Government is going about making these decisions to ensure they will be fair and will enhance the economy's growth prospects.
I have made officials from my Department available to the finance spokespersons of all the parties across the floor to explain to them and some of their colleagues the current macroeconomic position and the prospects and scale of the adjustment that needs to be made to the public finances over the next four years. I am pleased with the response from the main Opposition parties to this series of meetings in that they share with the Government a recognition of the scale of the adjustment that needs to be made, even if we do not have a shared view of the specific actions needed to achieve this adjustment. The first series of meetings on 18 October was followed by another meeting yesterday and I expect my officials and I will be available to Opposition parties between now and budget 2011.
Deputy Gilmore made a number of points this morning to which I would like to reply. However, in the time available I can address only a few of them. The Deputy makes the general point that insufficient figures have been provided to him by my Department and that the Government's proposals lack credibility. At this point, I can only reply that he will be provided with all the figures he could reasonably want when these have been finalised. I can also guarantee one thing about the Government's four year plan; it will not lack credibility.
On a more specific point, Deputy Gilmore cites a recent report identifying a claimed €11 billion of tax expenditures. More than 90% of these tax expenditures are the tax allowances from which all taxpayers benefit, such as the PAYE credit and basic income tax credits. It does not serve public debate well to misrepresent the basic PAYE credit or credits available to income taxpayers as in some way a tax shelter enjoyed by the very rich when they are a basic entitlement of every taxpayer.
Deputy Gilmore proposes the introduction of a 48% income tax rate. It should be borne in mind that such an increase would raise only €410 million in the next year. One of the great advantages of the multi-annual, four year plan approach is that one projects tax revenues over a four year period. If one thing is abundantly clear, it is that a 48% tax rate, in addition to the current levy and PRSI systems, would effectively mean an effective marginal tax rate of 62%, which would lead to a reduction in tax receipts in the subsequent years of the plan. The initial figure of €410 million would decline over the four year period as higher income tax earners, faced with income tax and impositions of tax from the State in excess of 60%, flee the jurisdiction. Deputy Gilmore needs to face reality when he claims that the deficit target of 3% can be met without examining any tax increases on incomes under €100,000.
A proposal for a strategic investment bank was referred to again. It is unclear from where the funding for such a bank would come. While the capital is to come from the National Pensions Reserve Fund, it is unclear from where the funds would come. In essence, the bank would compete with our two established banks and the State for increasingly scarce funding. The cost of borrowing to the State, as a sovereign, is at a very high level, while the cost of borrowing for the banks is at a higher level. The strategic investment bank, once capitalised, would face the same difficulty the banks and State already face. Every euro the bank would attract would mean one less euro for existing banks and the State which must now borrow €2 in every €5 spent on providing our public services. It makes little sense for the State to set up a new bank to perform the functions we are now correctly demanding of Bank of Ireland and Allied Irish Banks in return for the support given to these institutions by the taxpayer.
I will now address the proposed four year plan. The urgency, scale and duration of the adjustments required to stabilise the public finances demand a response that matches this challenge. It is vital that this response shows we have a clear, credible path for doing so. This response will be presented in the Government's four year growth and budget plan, which will be published in the next few weeks and presented to Dáil Éireann.
Yesterday, I announced the Government's decision that to achieve the 3% of GDP deficit target by 2014, an overall adjustment of €15 billion is now warranted and this figure will underpin the four year plan. The focus of the Government at this stage is on finalising the size of the necessary adjustment for 2011. The Government is conscious of the need to strike an appropriate balance between continuing to bring order to the public finances while, at the same time, taking account of the economic impact of budgetary adjustment. However, as I stated, there needs to be a significant element of front-loading in the 2011 budget given the scale of the adjustments.
In broad terms the plan will set out clearly the revised annual headline targets and necessary adjustments to adhere to a credible deficit reduction plan in the medium term. It will take on board the most up-to-date economic and fiscal data and the implications for the fiscal process. It will also chart the path of the economy and public finances towards recovery over the years 2011 to 2014. To underline the strength of our resolve, budget 2011 will contain a significant consolidation effort and the size of this, as well as the distribution of the adjustments over the remaining three years, will be also presented in the plan.
The plan will show in a detailed and credible manner how we can correct the imbalances in the public finances, while showing a pathway to sustainable increases in living standards and demonstrating to the markets that we have the vision and capacity to address our public finances problems and resume economic growth. As part of the budgetary plan, we will set out a strategy for underpinning and encouraging sustainable economic and employment growth in the medium term.
It is only through adopting policies that enhance our economic growth and job creation prospects and improve our competitiveness that we will achieve the necessary targets. To ensure the fiscal targets we set are delivered the four year plan will also feature reforms to the budgetary framework. I thank the Opposition parties for their participation at the Joint Committee on Finance and the Public Service on the proposed budgetary framework. I understand the joint committee is finalising its deliberations on that subject and look forward to receiving its report in that regard.
While the details of the plan have not yet been finalised, I can at this stage outline what I envisage it will contain. To begin with, the plan will outline the current economic position and outlook and explain why the necessary budgetary adjustments have to be made. This will be followed by a statement of the economic growth strategy, fiscal targets, details of the expenditure and tax adjustments as well as a statement of the principles that will underpin these adjustments. It will also include a review mechanism which can make adjustments to the plan as circumstances change.
An important element of the plan will focus on structural reform. This is an issue that has not received the attention it merits in recent years because of the need to deal with more imperative matters. Structural reform is about making the economy — both the private and public sectors — work better. It is not only about dealing with macroeconomic imbalances. It is not enough to sort out the public finances and leave untouched the way the economy works, particularly, as is evident, when it is in need of change. We, therefore, have to take action to ensure our policies support the restructuring of the economy in the wake of the present crisis. We have to ensure no sector will be a drag on economic growth, competitiveness will be maximised and that which is under the direct control of the Government — our tax system, public expenditure programmes, budgetary procedures and public services generally — will be reconfigured to achieve optimal efficiency, economy and effectiveness.
Structural reform measures often take several years to have full effect but announcing a set of wide-ranging structural reforms in the four year plan will have the immediate effect of adding further credibility to the macroeconomic and budgetary framework it will contain.
In the context of structural reforms, it is also relevant to mention that on 12 November next Ireland will submit an initial draft of its national reform programme under the EU 2020 strategy to the European Commission. This draft, which will be considerably influenced by the four-year plan, will contain the set of key structural reforms which can be implemented most quickly and which will address the main obstacles to economic growth. The final and more detailed plan will be submitted to the Commission in the spring of next year.
Being a member of the European Union has benefits but also involves responsibilities. The Government takes these responsibilities seriously and, accordingly, I have made considerable efforts to brief my fellow EU Ministers, as well as the Commission and the European Central Bank, on significant developments regarding our budgetary plans. Last Monday I visited Brussels to update Commissioner Rehn on the current economic position and on the progress being made in the preparations for budget 2011. As a result of these contacts with my colleagues, I am confident that they all have a clear and detailed understanding of Ireland's position and what the Government intends to do about it. The endorsement of the European Union Ministers, the Commission and the European Central Bank will be of key importance in demonstrating to the markets the soundness and credibility of our plan.
The language used in debating issues related to economics and public finances is often perceived by the public as lacking clarity, directness and impact. I wish to state the Government's position on its budgetary plans simply and as follows. The cost of the public services that we have been using is far higher than our current tax revenues. Economic growth will not on its own deliver sufficient revenue to close the gap for some years to come. This means that the difference between what we are spending and what we collect in revenue must be borrowed. The cost of borrowing is high and rising and unless we act soon to live within our means, those from whom we borrow may stop lending to us. Were this to happen, the continued provision of an adequate range of public services and social supports would be impossible to guarantee. Therefore, we must accept cuts in public expenditure and higher taxes. Even though these measures will be painful, we will continue to enjoy most of the substantial increases in living standards that were gained and secured in the past decade and they will provide the basis for regaining what we have temporarily lost.
There are those who, although they accept that strong corrective action must be taken to deal with the public finances, have argued that such action does not have to be taken now. Instead, they argue that it would be easier to put off the hard decisions which this action involves until economic growth has become established. There is, however, no better time than now to act. If we delay action, the problems will not only remain but will worsen and the necessary decisions will become harder to make and will have a more painful impact. Moreover, we will not fool the markets for an instant if we seek to defer any longer what evidently needs to be done now. We cannot backtrack on the commitments we have made to the European Commission and to the other European Union member states. In summary, in the real world in which we live, it is neither a credible nor a viable choice to defer the action that we now must take.