Deconstructing public sector pay cuts

Michael Taft, An tSaoi05/10/2009

An Saoi and Michael Taft: There is a fundamental misconception about the fiscal impact of public expenditure cuts. It is assumed that a reduction in public expenditure of ‘x’ equals a reduction in the borrowing requirement / fiscal deficit of that same ‘x’ amount. For instance, Emmet Oliver writes in the Sunday Tribune:

‘A 5% across-the-board cut in public sector pay would yield savings of €1bn in a full year; a 10% cut would deliver €2bn.’

Our analysis tests this assumption using the example of public sector pay reduction. In doing so we have had to make some estimates (e.g. the proportion of top rate taxpayers, etc.). While these are approximations and, therefore, should be treated as ‘ballpark’ figures, variations will not result in substantially different results.

The net Public Sector wages and pensions bill for 2009 is estimated by the Department of Finance at €18.3 billion. We calculate the net savings of an across-the-board cut of 5 percent. We assume

• 60 percent of pay is taxed at the top rate
• 70 percent of employees are insurable
• 20 percent are in receipt of pensions
• No change in behaviour, (e.g. parents reducing their hours as the pay-off between additional work hours and childcare costs become less worthwhile).

5 percent of the gross Public Sector pay bill is €988 million.

Income Tax: Assuming €16 billion of the €19 billion is taxable (i.e. net of employer PRSI, pension contributions, pension levies, widow & orphans, etc), the reduction in taxable pay is €800 million. €480 million is taxable at 41% and €320 million at 20%, thus reducing the tax take by approximately €261 million.

Employer PRSI Based on the above assumption, 56% of the total payroll is insurable. Assuming that they receive pay cuts of €350 million, the Social Insurance Fund loses approximately €37 million. As the Fund is slipping into deficit, this must be made up by general taxation. There is no saving under this heading.

Employee PRSI and Health Levy: Again, making an assumption that 75 percent of the reduction in taxable pay is liable to PRSI, this would reduce the Fund by a further €24. For the Health and Income levies we assume a reduction of 4 percent – or €46 million.

Pension Contributions/Pension Levies/Widow and Orphans: Almost all Public Servants contribute to all three. The only exceptions are Civil Servants appointed before 6th April 1995, who pay the levy & W&O. Pension Levy/Pension Contributions are estimated by the Department to be €1.5 billion. A 5 percent reduction would amount to €75 million. As there is no separate pension scheme in place, Finance nets off current contributions against current pensions.

* * *

While a 5 percent reduction in the gross public sector pay/pension bill would reduce Government expenditure by €988 million, the after-tax savings would be €545 million, or 55 percent of the gross reduction.

It should be noted that the above includes a 5 percent cut in pensions. If these payments were excluded, both the gross and after-tax savings would be reduced further (pension payments make up 10.7 percent of the total pay/pension bill, or €2 billion).

However, the after-tax savings of €545 million does not represent the net savings to the Exchequer or the reduction in the borrowing requirement. For instance, with less money in the pocket there will be a reduction in VAT and Excise tax payments. This is not included in the above.

Further, it does not take into account any negative multiplier resulting in the reduction of net wages. For instance, the ESRI estimates that a reduction of €1 billion in public sector pay expenditure will result in the following:

• GNP to decline by €442 million in the first year, with a long-term effect (after six years) of a decline of €684 million

• Consumption to decline by 0.9 percent

The ESRI estimates that, on the basis of the impact to the economy, the borrowing requirement will be reduced by 0.3 percent. However, we don’t know to what extent they have factored in the above tax reductions.

Given all of the above, it is reasonable to assume that the net savings to the Exchequer / reduction in the borrowing requirement will be close to 50 percent of the gross reduction in expenditure. In other words, a 5 percent reduction in public sector pay/pensions – or approximately €1 billion – will not produce ‘savings’ of €1 billion. Rather they true savings will be close to €500 million.

If there is to be a fact-based debate over public sector pay, it is imperative that we get the numbers right.

Posted in: PoliticsLabour market

Tagged with: public sectorWages

Michael Taft     @notesonthefront


Michael Taft is an economic analyst and trade unionist. He is author of the Notes of the Front blog and a member of the TASC Economists’ Network.



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