Shares of Public Expenditure

The lead editorial in today’s Sunday Times (not on the web) states

Many in Fine Gael believe it is almost impossible to judiciously — and fairly — cut €2.2 billion from spending if 70% of the total, in the shape of public-sector pay, is protected from further reduction.

Now I know that the Irish government is pretty hopeless at presenting its fiscal accounts but it’s really not too hard to find out the true figures on the shares of expenditure taken up by pay and other elements.

Go to page 49 of this document which we have to send to Brussels on a regular basis and which uses the perfectly sensible approach of reporting all of the government’s spending and revenue, rather than specific sub-components picked out according to some unintelligible criteria. The shares of public expenditure for major categories this year are as follows:

Pay and pensions = 25.5%
Social payments = 37.8%
Intermediate consumption = 11.4%
Interest payments = 8.4%
Capital formation = 6.4%
Other (including subsidies) = 10.5%

So not 70%. Closer to one-third of that figure. And, as I’ve dicussed before, when income taxes paid by public sector workers are factored in, the net cost is significantly less.

I have stated repeatedly that I think further cuts in public sector pay rates are required. However, it is hard to see how any reasonable debate on this issue can be had when so many of our media outlets hopelessly misrepresent the basic facts at hand.

Public Pay and the Sindo

Former Bertie Ahern Seanad appointee, Eoghan Harris, writes in the Sunday Independent today that he is confused that I can believe public sector pay should be cut and yet also believe that his newspaper has demonised this issue. His silly comments about academics and the Irish Times aren’t worth responding to but I’m happy to clarify what my position is.

In relation to public sector pay, one can argue until the cows come home about whether public sector workers in Ireland are paid more than private sector comparators or comparable public sector workers in other countries, and about how these premia have been altered by the pay cuts of the past few years. However, that debate doesn’t change the fact that Ireland has a very large budget deficit and every major component of expenditure will need to be cut to put the public finances back on an even keel. And that must include public pay.

I’m sceptical about whether an approach that doesn’t see pay rates cut can deliver substantial savings and would also prefer pay cuts to reductions in numbers of front-line workers that will affect the delivery of key public services. So my position is that public sector pay rates need to be cut.

If that’s my position, then what’s my problem with the Sunday Independent? My problem is its focus on high rates of public sector pay as the single cause of the budget deficit. Its coverage repeatedly gives the impression that “we are borrowing to pay for the public sector”. Other areas of spending such as welfare rates receive comparatively little coverage and topics such as our narrow tax base and generous income tax exemptions receive no coverage at all.

An examination of the figures reveals that a focus on public sector pay as the source of the deficit is misplaced. This year, the government will spend €18.1 billion on pay and pensions for the public sector. The general government deficit is projected to be €15.6 billion.

You might think this means we can eliminate the deficit via an 86 percent cut (0.86=15.6/18.1) in public sector pay. But, even if you did manage to get anyone in the public sector to work for 14 percent of their current salary, this strategy still would not work because public servants pay PAYE, PRSI and a pension levy and most of these payments would have disappeared. (They also pay VAT when they spend their salaries.)

I don’t believe the government releases figures on the net cost of the public sector pay and pensions, subtracting taxes and levies, but I would be surprised if it was more than €11 billion. So you could fire every public servant in the country and still not close the deficit.

Back in the realms of reality, even substantial cuts in pay rates will still leave a yawning deficit. For example, consider a cut of 25 percent in pay rate, reducing gross pay by €4.5 billion. The marginal tax rate on public pay rates above €36,000 is 62 percent. (See tax calculator here) so the deficit would only be reduced about one-third of the amounts cut for people on salaries above this level. I suspect the net reduction in the deficit, before accounting for reduced VAT revenues, would be less than half of the gross amount, i.e. somewhere below €2.25 billion.

So, sadly, if the enormous deficit is to be closed, then other categories have to be looked at. These include spending on social payments (which will cost €26.8 billion this year and are largely exempt from income tax), on capital programmes (which will cost €6.1 billion this year) and on the narrowness of our tax base.

The idea that public sector pay is the source of the deficit has a satisfying ring for many. It means that an identifiable group of “other people” is responsible for all our problems. And it allows people to think that the pain of all the spending cuts and tax increases they are being hit with is unnecessary and is only occurring because public servants are being protected: Nothing sells newspapers quite as effectively as rage. I suspect the commenters on this blog have well above the average level of economic literacy and I can tell from repeated comments that many of them believe the deficit is solely due to high rates of public sector pay. Unfortunately, the arithmetic doesn’t support this position.

So that’s why I dislike the Sindo’s coverage of public sector pay. It leads its readers to believe that there is a simple single bullet solution to the deficit and, via that logic, to a demonisation of a particular group as the cause of our problems. Ultimately, this kind of coverage is unhelpful because it undermines public support for the additional measures that need to be taken, over and above public sector pay cuts, if the public finances are to be stabilised.

No doubt Eoghan would still diagnose my position as being down to status anxiety twitch or some other mysterious condition but I’m happy to take a few shots from the Sindo if the result is a more informed debate about the options for closing the deficit.

Tax Deductibility of the Pension Levy

Eilis Quinlan of ISME has been at it again. On the Last Word on Today FM this evening, she again said that it was a mistake to say the public sector pension levy was a pay cut. The key argument she produced as to why the reduction in net take home pay related to the levy was a pension contribution rather than a pay cut was that it was tax deductible, just like other pension contributions.

Let’s think about this for a second. Consider a worker on €50,000 facing a 20% marginal tax rate. Now the government introduces a pension levy that see her gross pay reduce by €3,000. The pension levy isn’t taxed, so the worker now has a taxable income of €47,000. Consider the alternative in which her pay is cut by €3,000. In this case, the worker also has taxable income of €47,000.

So, in either case, whether it’s a pay cut or a “tax deductible” pension contribution, the worker has the same level of taxable income—the pension levy may be tax deductible but the government also can’t tax salary that a worker hasn’t been paid.

In other words, from the point of view of the worker’s take-home pay, the pension levy is identical to a pay cut. Now, of course, there are reasons why various tax breaks exist to encourage people to make pension contributions: The government wants to encourage people to put additional money aside to build up their pension entitlements. But, of course, the payment of the “pension levy” doesn’t add a cent to public sector worker’s pension entitlements.

To recap, the fact that the pension levy was tax deductible doesn’t make it different from a pay cut. It makes it exactly like a pay cut. And the fact that it doesn’t add to pension entitlements means that it has all the features of a pay cut and none of the features of a pension contribution.

To be honest, I don’t see how it serves the interests of the hard-pressed small and medium-sized businesses of Ireland to have the Chairman of their representative organisation continually making provative and misleading statements that only serve to upset thousands of public sector workers that have experienced very significant losses in take-home pay.

Budget 2010: Public Sector Pay

The government has cut public sector pay in the budget. A description of these cuts is available on page 27 of this document.

Pay has been cut by 5 percent for low earners gradually rising up to 8 percent for those earning €125,000. The cuts stay at 8 percent between €125,000 and €165,000 and €175,000. Those earning between €175,000 and €200,000 have cuts of 12 percent and those earning over €200,000 have cuts of 15 percent. An Taoiseach Brian Cowen gets a special cut of 20 percent.

Annex A of the document linked to above also described the cumulative cuts for different classes of workers, including public sector workers. To give one example, a public sector worker earning €75,000 in a one-income household with two children over 6 years of age has had a total reduction in net pay since last year’s budget of 18.2%. The comparable figure for a similar couple in the private sector was 5.4%.

I know there are many who will feel that these cuts have been too extreme. More interesting, I guess, is whether those who favoured cuts in public sector pay now think that this is enough or think that the government should come back and cut public pay some more.

Pre-emptive Strikes and Public Sector Pay

I’m almost reluctant to write about this topic because of the level of hysteria that it provokes. Still, we cannot deny that a national public sector strike is an important topic worthy of debate on this blog.

My overall reaction is that the debate about public sector pay is descending, perhaps predictably, into a damaging battle between vested interests. There is much to dislike on both sides of the debate.

Continue reading “Pre-emptive Strikes and Public Sector Pay”

The Public-Private Sector Pay Gap in Ireland: What Lies Beneath?

This new paper responds to the recent CSO study and also tackles several new dimensions of this question.

Paper here.

Abstract:

This paper provides a sub-sectoral analysis of changes in the public-private sector pay gap in Ireland between 2003 and 2006. We find that between March 2003 and October 2006 the public sector pay premium increased from 14 to 26 per cent and that there was substantial variation between subsectors of the public service. Within the public service the premium in 2006 was highest in Education and Security Services and lowest in the Civil Service and Local Authorities. In the private sector the pay penalty in 2006, relative to the public sector, was most severe in Hotels & Restaurants and in Wholesale & Retail and least severe in Financial Intermediation and Construction. The paper tests for the sensitivity of the pay gap estimates using a matching framework, which provides a stronger emphasis on job content, and finds the results to be broadly comparable to OLS. Finally, the study highlights the problems associated with controlling for organisational size in any study of the public-private pay gap in Ireland.

ESR Paper on Public Sector Pay

The new edition of the Economic and Social Review is now available online. The edition contains two policy papers. One is this paper by Eilish Kelly, Seamus McGuinness and Philip O’Connell on public sector pay rates. I think Richard Tol is going to open a thread on the other paper which focuses on the carbon tax.

The three regular papers in the edition (David Audretsh on entrepreneurship, Ken Benoit and Michael Marsh on political science in Ireland, and Vahagn Galstyan and Philip Lane on fiscal policy and competitiveness) are also, in my opinion, very interesting contributions.

Public Sector Pay Differentials: Regressions Can Actually Be Useful

Last week, the CSO released the latest results from the National Employment Survey, which reports detailed information on earnings across all sectors of the economy.  The data from the survey relate to October 2007.

The first media treatment of the story that I saw was the Sunday Independent’s lead story saying the public sector is “now earning 50 per cent more the private sector.”  My reaction was that while the headline might be true, this wasn’t a very useful way to think about the issue of public sector pay. 

The report also details a host of other well-known patterns: Those with more education earn more, older workers earn more, those in professional occupations earn more.  With the possible exception of Vincent Browne, I’m not sure there is anyone out there who would draw the implication from these figures that the government should intervene to eliminate all these gaps.

Continue reading “Public Sector Pay Differentials: Regressions Can Actually Be Useful”