Next year's budget should respond to the downturn on three fronts: borrowing, spending and taxation

AS THE recession bites hard, the exchequer is haemorrhaging revenue. In the first six months of the year tax receipts were 8 per cent lower than in the same period of last year. At Budget time it was projected that tax revenue for 2008 would be 3 per cent above the 2007 level. Now it is expected that there will be a shortfall of €3-€4 billion at the end of the year. It is also looking increasingly likely that this year's Budget deficit will breach the 3 per cent of GDP limit specified in the EU's Growth and Stability Pact.

Time passes, and we are now at that juncture where it is appropriate to consider what next year's budget should look like and how the Government should respond to recession in its management of the public finances. It is useful to address the issue under three broad headings: borrowing, spending, and taxation.

As far as borrowing is concerned there is a clear case for allowing the 2009 deficit to exceed the 3 per cent limit. First, to keep it within that limit would require the adoption of measures that would add unduly to the downward momentum of economic activity. Second, if the much-lauded 'fundamental' of an uncommonly low ratio of Government debt to GDP (Ireland's ratio is currently 27 per cent, the second-lowest in the EU) is to have any concrete meaning, it must be to enhance the Government's room for manoeuvre in current conditions. Third, the State has embarked on a major capital investment programme, vital to the economy's future competitiveness, which requires borrowing

capital purposes of about 5 per cent of GDP. Personally, I would not be concerned if the overall budget deficit in 2009 reached this figure, although if I were Minister for Finance I wouldn't be aiming for that. I would instead aim for a deficit in the range 4-4.5 per cent of GDP, to allow a reasonable margin for the recurrence of unpleasant surprises.

The emerging budgetary arithmetic for 2009 is such that even a relatively permissive deficit target along the lines suggested will require very tough decisions on the spending side. The good news here is that after years of double-digit expenditure increases there is plenty of waste whose elimination should leave the quantity and quality of public services unaffected. The problem is identifying the fat and coming up with ways of excising it and it alone. There are some areas where this might be done more easily than others: the amalgamation of State agencies that are operating in broadly similar fields, and reducing the huge administrative overhead in the HSE, to name a couple. In other areas the risk is that attempts to cut out fat will have the effect of cutting into muscle as well, a risk that should be avoided, especially where the standard of service is already deficient.

What needs to be considered in all of this is the important role that high-quality public services can play in maintaining and enhancing Ireland's attractiveness as a place in which to live, work and do business. As such, actions that undermine service standards in areas like education, health and policing would compromise the economy's competitiveness and would be as short-sighted as the capital spending cutbacks of the 1980s.

My assessment of the likely budgetary arithmetic for 2009 is that a target deficit of 4-4.5 per cent per cent of GDP cannot be met on the basis of eliminating wasteful expenditure alone. In other words, achieving such a target will require either cutbacks in the levels of public service and/or increases in tax rates. Much of what has passed for public debate around this choice has amounted to little more than the exercise of an ideological reflex, namely that raising taxes is anathema. But, it is not clear why budgetary policy should saddle itself with this constraint. For one thing, there will be an unintended fall in the ratio of tax revenue to GDP this year (from about 33 per cent to 32 per cent) and it is likely to fall further in 2009 if there are no policy changes. Moreover, Ireland is one of the most lightly taxed economies in the EU with an overall tax burden about 10 percentage points below the EU average and almost 10 percentage points lower than it was 20 years ago. The notion that, in such circumstances, a modest increase in tax rates would represent a certain step on the road to economic perdition or a return to the failed policies of the 1980s is a little far-fetched.

That said, raising taxes is not something to which to be lightly resorted. Taxpayers will rightly object to paying more if they believe their money will be wasted, especially given the other negative shocks they are feeling. So, I believe that raising taxes in current circumstances can only be justified if certain conditions are met. One is that there be a public sector pay freeze (why should private sector workers, many of whom will be forced to accept a pay pause or a pay cut, and most of whom face a heightened risk of redundancy, have to pay higher taxes to finance pay increases for public servants?). A second is that the expenditure side of the 2009 budget identify and incorporate substantial savings and the elimination of waste. Another is that the budget provides for the implementation of a credible and thoroughgoing reform of procedures for the allocation, monitoring and reporting of public expenditure with a view to securing substantial further savings in the years ahead.

Jim O'Leary is a Senior Fellow of the Department of Economics Finance and Accounting at NUI-Maynooth. He can be contacted at jim.oleary@nuim.ie