I thank the committee for giving me this opportunity to make a statement at the outset. In regard to 2001, if I may, I will refer to the written comments I made last July to the Comptroller and Auditor General which are published in his 2001 annual report regarding the forecasting of tax receipts.
Tax forecasting is not an exact science. There are many factors which can affect the outcome. There is the effect of shifts in economic growth and its composition and the impact of once-off or extraneous factors from year to year. There is also the quality and timeliness of the data available and the actual outturn for current year taxes. This outturn is not known until after the budget forecast is made.
On economic forecasts, these are subject to revision, especially in a very open economy such as ours. For various reasons, the economic data published by the CSO and other statistical bodies throughout the world for previous periods is subject to regular revision. Thus, the current CSO estimate of growth in 2001 may be revised again. In that context and given the magnitude of the figures we are dealing with, forecasting tax revenue is subject to an appreciable degree of uncertainty. There are other factors which can impact on the accuracy of tax forecasts. An example of this is major changes to the tax system giving rise to behavioural changes on the part of taxpayers.
Economic and tax revenue forecasting is all the more difficult because it is effectively attempting to predict the behaviour of economic actors and their patterns of buying, spending and investment, without having direct control over many of the events which can influence these decisions. The Department of Finance forecasts tax revenue each year in collaboration with the Revenue Commissioners. In the period before the budget the Revenue Commissioners supply the Department with pre-budget estimates of the expected tax revenue in subsequent years. These estimates take into account macroeconomic projections, including those for earnings, employment and consumption growth, provided in the first place by the Department to Revenue. It is important to note that the base year which is used to make these macroeconomic projections is also estimated because the projections are made before the end of the base year. The tax receipts for the base year are also projected outturn figures for the same reason. The tax forecasts take into account specific one-off factors known by the Revenue Commissioners to affect particular tax heads, such as tax settlements or repayments in certain areas.
In the case of excise duties a "ground-up" forecast, which takes actual consumption trends into account, is also supplied by Revenue. This is because some excisable products are less responsive to economic changes than other taxes and excises can be affected by specific factors such as cross-Border trade diversion.
The Department takes the Revenue estimates on board in the run-up to budget day with adjustments to reflect budget measures and the latest available information and projections. It should be noted in this regard that the four main tax heads, excise, VAT, income tax and corporation tax, together account for over 90% of annual tax revenue. The Department also looks at the total tax receipts projected to see if they are broadly consistent with the projections for nominal GDP.
The tax forecasting methodology used is outlined in more detail in the Comptroller and Auditor General's annual report. It is also published by the Department and is available on our website. The key point is that the overall tax forecast for 2001 was broadly similar in terms of its relationship to projected GDP growth to the average outcome experienced over the previous five years. On average, this experience supported the working assumption that every 1% increase in the nominal value of economic growth would yield an increase of about 1% in tax revenue, depending on whether growth was mainly domestic or externally driven and whether budget tax measures were more or less generous.
Clearly, this one to one relationship has proved less reliable in the past two years. The two years in question have seen much lower rates of economic growth than in the previous five years. We are continuing to examine the experience of the past two years in some depth with the Revenue Commissioners and the Central Bank. As new data become available for assessment, our understanding of the outturn will improve further.
Turning to 2001, the first significant factor in the shortfall in tax receipts in that year was that overall economic growth was lower than had been expected on budget day. Budget 2001 was predicated on a forecast of 8.8% growth for real GDP for the year 2001. This estimate was broadly in line with what was widely believed at the time to be the likely growth scenario for this economy. However, the actual outturn for economic growth was more than three percentage points lower than anticipated, with real GDP growth for 2001 at 5.7%.
The rate at which growth slowed can be appreciated when we see that annual GDP growth in volume terms fell from 11% in the first quarter of 2001 to 7% in the second quarter, 4% in the third quarter and 1% by the end of the year. The estimated outturn for GNP in 2001 was 4.6%. This was 2.8% lower than the December 2000 budget day forecast of 7.4%. It should be noted that these 2001 outturn figures published by the CSO are still preliminary estimates. This lower growth reflected the effect of the slowdown in the United States economy, exacerbated by the events of 11 September. It also reflected the outbreak of foot and mouth disease and related restrictions, which affected cross-Border activity and domestic spending in particular.
In 2001 the extent to which the world economy turned down took most economic commentators by surprise. For example, the European Commission had expected the EU economy to grow by 3.1% in 2001, but the latest data suggest that it only grew by 1.5%.
A second very important factor in determining the level of actual tax receipts is the overall composition of economic growth. Obviously, because we can only tax domestic sources of income, the growth arising from exports will yield less tax revenue than growth arising from domestic consumption. Likewise, investment in imported capital assets will yield less tax receipts than investment in domestically produced capital assets, whether this increased activity is reflected in extra jobs or extra hours worked. However, the make-up of economic growth is even more difficult to forecast than the rate of growth itself. This is especially true when the economy is subject to major shocks such as the events of 11 September and the foot and mouth disease restrictions.
The nominal level of economic activity in 2001, which includes the price effects of inflation, was only about 0.5% lower than expected at budget time. However, this did not generate the expected proportion of tax receipts because of the change in the composition of economic activity. For example, personal consumption expenditure, which is a major driver of indirect tax revenue, was 3.8% lower in nominal terms compared with the budget 2001 forecast. One area of lower personal consumption was the tourism sector, which the committee will recall was particularly badly hit by the travel restrictions to combat foot and mouth disease. Transport companies, hotels, pubs, restaurants and other tourism related services were affected and this impacted especially on VAT and excise duty revenues during 2001.
Certain cross-Border trade was disrupted and evidence from the UK National Audit Office in a recent report suggests that the revenue loss to the UK authorities from cross-Border trade between Northern Ireland and the Republic of Ireland in road fuels alone is substantial - £380 million sterling or €600 million in 2000.
I will now deal with the tax outturn for 2001. As I outlined in my response to the Comptroller and Auditor General on 26 July last, budget 2001 tax receipts were estimated at £23,990 million and the outturn at end 2001 was £21,993 million. I will outline the main factors giving rise to the tax shortfall of almost £2,000 million or €2,536 million. For ease of reference I will use euro amounts from here on.
Looking at the total €2,536 million tax shortfall in 2001 in more detail, about two thirds of this, or €1,662 million, was in the area of indirect taxes. These taxes would be the hardest hit by the lower than projected increase in personal consumption, tourism and disruption to cross-Border trade. A further €532 million related to income tax and the remaining €342 million shortfall was spread over the other tax subheads. Therefore, €2,194 million of the 2001 tax shortfall is accounted for by lower than projected indirect taxes and income tax. The fall in income tax, taking PAYE and non-PAYE together, can be explained in broad terms by the higher than projected cost of the 2001 income tax package - €242 million; the outturn for income tax in 2000 being lower than projected - €148million; and the additional cost of the post-budget Finance Act adjustments - €135million.
The causes of the VAT and excise shortfalls are more difficult to quantify. The lower than projected level of consumer expenditure, lower than projected car sales, the non-inclusion in the estimate of €88 million arising from the deferment of excise payments from December 2001 to January 2002 and a lower than projected 2000 outturn, when all combined explain more than half of the shortfall, €935 million. Bearing in mind that tax forecasting is not an exact science, the balance of the shortfall is most likely due to the economic disruption caused to patterns of spending and cross-Border trade by a combination of the events of 11 September and the restrictions due to the outbreak of foot and mouth disease. The outturn figures produced by the CSO for 2001 economic growth are preliminary and the final figures might help shed further light on this issue.
Moving on from VAT, excise and income tax, the remaining €408 million tax shortfall arises under a combination of tax heads. The most significant of these are capital gains tax, €111 million; customs duties, €66 million; corporation tax, €146 million; and stamp duties, €49 million. Customs duties and stamp duties would have been adversely affected by the 2001 economic developments to which I have referred.
In the case of corporation tax and capital gains tax the projections for 2001 were largely based on activity during 2000. Receipts from corporation tax and capital gains tax are prone to individual and one-off variations. In 2001 the Revenue Commissioners made exceptional repayments of about €160 million in corporation tax arising from changes in the tax treatment of contingent liabilities. This repayment was partly offset by a better than expected outturn in 2000 - €90 million - the base year. Allowing for these developments, the eventual shortfall in corporation tax in 2001 was €146 million.
As regards the capital gains tax shortfall, as the Accounting Officer of the Revenue Commissioners said in his reply to the Comptroller and Auditor General, this may have been an indication that the release of pent-up investment funds, which generated the acquisition of further capital assets in the years following the 1998 budget reduction of the capital gains tax rate to 20%, had slowed down.
The Department published the end-2002 outturn budgetary figures earlier this month. They showed an Exchequer surplus of €95 million and a general Government deficit of about €160 million. Net voted current and capital expenditure in 2002 increased by 13.9% over 2001 compared to the target for the year of 14.4%. Tax revenue in 2002 increased by 4.9% to €29.294 million over 2001 compared to the target for the year of 8.6% or €30,328 million.
As in 2001, the tax revenue shortfalls in 2002 largely reflected changed economic conditions. At budget time in December 2001, the expectation was that the international economy would recover in the second half of 2002 giving the Irish economy a similar boost. However, that did not happen. As a result, GNP in 2002 is now estimated to have grown by only 1.8% compared to the 3.5% we had forecast.
Regarding the 2002 tax shortfall of €1,034 million, €578 million is due to lower than projected receipts from corporation tax. Some €190 million of the shortfall can be attributed to the lower than expected outturn for 2001 when budget 2002 was framed. Corporate profits are very difficult to project when there are significant economic changes in the relevant period. The base year for the bulk of 2002 corporation tax receipts was 2001 and therefore the profits for that year reflect the impact of a rapidly slowing economy, 11 September and the foot and mouth disease restrictions. Ireland is not unusual in experiencing a significant shortfall in corporation tax in 2002. Other examples include Germany and the UK.
The balance of the €1,034 million shortfall in 2002 tax revenue - €456 million - largely reflects the fact that the economy in 2002 was weaker than had been projected at budget time. In particular, the widely expected upturn in the second half of 2002 did not happen. This caused the Department of Finance to revise its forecast of volume GNP growth for 2002 down from 3.5% at budget time to the current estimate of 1.8%. The major impact was on income tax which came in at €383 million below budget. It will be some months yet before the CSO publishes its preliminary estimate of the 2002 outturn for GNP and GDP.
As regards 2003, the Department's most recent projections for the economic and budgetary outlook are those published with the budget documentation on 4 December last. These estimates include relatively modest GNP growth in 2003 of 2.2%, with unemployment rising to 5.3% and a general Government deficit of 0.7% of GDP. At budget time the downside risks in relation to the international situation were emphasised.
The most recent EU Commission economic assessment has again emphasised these risks. In particular, it notes that the increased uncertainty stemming from heightened geopolitical risks and continued volatility in global stock markets has dampened confidence and is encouraging households and firms to delay spending. Oil prices have become more volatile as geopolitical risks centred on Iraq have mounted.
The Commission confirmed that the main risks that were outlined in its autumn 2002 forecast - of a further rise in oil prices and an additional correction in global equity markets - are still very much present. It points out that there are also positive factors, such as the lack of major imbalances in the euro area and the good growth prospects in non-Japan Asia, Russia and central Europe. However, the Commission concludes that the uncertainty affecting the global economy makes it difficult to be more optimistic. I hope that you have found these comments helpful. We will be glad to answer your questions as best we can.
