Government revenue, expenditure and the budget balance

Where the money comes from and where it goes

The Government is like a very large household: it has income (revenue) and spending (expenditure). Both are split into two types.

Think of a family: paying the electricity bill and buying groceries is current spending. Buying a house is capital spending. The family treats them differently, and so does the Exchequer.

The rule of thumb is simple: if the money buys something that will still be useful in 20 years' time, it is probably capital expenditure. If it is used up this year (a teacher's salary, a Jobseeker's payment), it is current.

The budget balance

Once revenue and expenditure are listed, we compare them. The result is the budget balance. There are three balances, and each is revenue minus expenditure:

The national debt and the debt-to-GDP ratio

A deficit is a flow: it happens over one year. The national debt is a stock: the total amount the State owes at one moment, built up from all past deficits (less any surpluses).

Think of a bath. The water level is the debt. The tap running is the deficit. Pulling the plug (a surplus used to repay debt) lowers the level.

A debt of €200 billion is very different for a tiny economy and for a huge one. Economists compare it with the size of the economy using the debt-to-GDP ratio:

Why does the ratio matter? Lenders look at it to judge whether the State can afford the interest on its debt. A high ratio means more of each tax euro goes on interest instead of hospitals and schools, and borrowing becomes more expensive if lenders lose confidence.

Automatic stabilisers: cyclical and structural deficits

The budget balance is not only decided by ministers. It also moves by itself with the business cycle.

• In a recession, incomes and profits fall, so the State collects less income tax, VAT and corporation tax. At the same time, more people are unemployed, so it pays more Jobseeker's Benefit and other social welfare.

• In a boom, the reverse happens: tax revenue rises and welfare spending falls.

(Figures in € billion.) The swing from +5 to −5 happened with no new law: the stabilisers did it.

This leads to an important distinction.

A cyclical deficit is not a sign of bad management; a structural one is. The difficulty is that economists cannot see exactly how much of a deficit is which.

Fiscal policy and the multiplier

Fiscal policy is the use of government spending and taxation to influence the economy. There are three stances:

Used against the business cycle, this is stabilising fiscal policy. Expansionary policy works through the multiplier: an initial injection becomes someone's income, part of which is spent, which becomes someone else's income, and so on.

In the circular flow of income, households and firms pass money back and forth. Injections (J) add money to the flow: government spending (G), investment (I) and exports (X). Leakages (W), also called withdrawals, take money out of it: savings (S), taxes (T) and imports (M). Income rises when J is greater than W and falls when W is greater than J. The multiplier measures how much income changes after an initial injection.

At each round, part of the money leaks out of the circular flow: it is saved (MPS), paid in tax (MPT) or spent on imports (MPM). So:

where MPC + MPS + MPT + MPM $= 1$ (with no taxes or imports, MPS $= 1 - \text{MPC}$), and MPW is the marginal propensity to withdraw. The total rise in national income is $\Delta Y = k \times \text{injection}$.

Ireland is a very open economy: a large share of what people earn is spent on imports. Its multiplier is therefore smaller, and a stimulus leaks abroad more than in a large, closed economy.

EU and Eurozone fiscal rules

As a member of the EU and the Eurozone, Ireland has given up its own currency and interest rate policy, so fiscal policy is the main national tool left for managing the business cycle. But it is not fully free. Under the EU's fiscal rules (the Stability and Growth Pact and the national rules that follow from it), member states are expected to keep the budget deficit below 3% of GDP and the national debt towards 60% of GDP, or to be reducing it steadily. Spending growth is also monitored by the European Commission, and the Irish Fiscal Advisory Council (IFAC) comments on whether the Government is keeping to the rules.

The effect is twofold. In a boom the rules push the Government to save rather than overheat the economy, which is useful. In a slump they can limit how much it may borrow to stimulate demand, especially if lenders are worried, as in 2010–2013. In an emergency such as the pandemic the EU temporarily suspended the rules, which allowed large deficits.

Evaluating fiscal policy

Stimulus is not free. Weigh both sides:

• For: supports demand, jobs and incomes in a slump; investment (housing, water, public transport) also raises long-term capacity; borrowing is cheaper when interest rates are low.

• Against: it adds to the national debt and future interest bills; may crowd out private investment by pushing up interest rates; is subject to time lags (spending decided late may arrive after the recovery has started); in a small open economy much of the stimulus leaks into imports; and Eurozone rules on deficits and debt limit what Ireland may do.

A windfall: spend it, cut taxes or save it?

Sometimes the Exchequer collects far more than expected, often because of corporation tax paid by a few large multinationals. This is a windfall. A surplus sounds like good news, but deciding what to do with it is a classic discuss question.

Key ideas to bring into your answer:

• Risk: revenue concentrated in a handful of companies can vanish if they relocate or tax rules change. Permanent commitments should not rest on it.

• Intergenerational fairness: spending everything today benefits current taxpayers; saving shares the gain with future generations.

• Inflation: adding demand to an economy already close to capacity (for example with a tight construction sector) mostly raises prices instead of output.

A balanced answer usually proposes a mix and gives reasons: for example, once-off investment and saving rather than permanent tax cuts.

Back to the start: the Minister's "deficit" announcement on Budget Day is simply a number: revenue minus expenditure, below zero. It adds to the national debt, may be partly cyclical, and can be a sensible choice in a recession but a risky one in a boom.

Summary

• The Government's revenue (taxes such as income tax, VAT and corporation tax) and expenditure (welfare, health, education, debt interest) are split into current and capital.

• Current balance + capital balance = overall budget balance. A negative balance is a deficit, a positive one a surplus, zero a balanced budget.

• The national debt is the stock of accumulated borrowing. Debt-to-GDP $= \dfrac{\text{debt}}{\text{GDP}} \times 100$ can fall even with a deficit if GDP grows faster than the debt.

• Automatic stabilisers move the balance with the cycle. A cyclical deficit disappears with recovery; a structural one does not.

• Fiscal policy can be expansionary, neutral or contractionary. The open-economy multiplier is $k = \dfrac{1}{\text{MPS} + \text{MPT} + \text{MPM}}$, and it is smaller in Ireland because of leakages.

• Evaluate policy using debt, interest rates, crowding out, time lags, EU rules, risk, fairness between generations and inflation.