ECONOMICS: If activity in the property and construction sectors falls by 10 per cent each year and prices grow by only 5 per cent during the same period, annual tax revenues will be €1 billion less than expected and by 2012, there will be a €5 billion hole in the government's accounts.

In what has precipitated something close to a national laundry crisis, a programme on RTÉ last month asked whether the economy was facing a "future shock; property crash".

The programme provoked a lot of responses, the best of which, for my money, came from Economic and Social Research Institute (ESRI) economist David Duffy.

Independent of commercial interests and with no axe to grind politically, Duffy is as impartial a commentator as you can get.

"We are not on course for a property crash, unless we choose to manufacture one with irresponsible comment on the state of the market," he said.

This doesn't mean that we aren't in for a whole lot of fun and games from the property and construction sectors.

Broadly defined, these sectors account for almost one-quarter of the economy. As activity in those sectors returns to a more sustainable proportion, the exchequer looks set to get a bruising.

But falls in house prices are unlikely to be the reason. To see why, consider what an overvalued housing market is; the existence of a gap between actual and "fundamentally justified" house prices.

In my estimation, this gap is now around 20 per cent. If we assume this gap can only be closed by prices coming down, we have something to worry about.

To show why we don't, we just need to extend the concept of relativity to the property market: If two cars are at different points, but the car behind is travelling faster, they will at some point catch up.

By the same token, so long as nominal gross domestic product (GDP) - the value of incomes received in the economy each year and a key driver of fundamental prices - continues to grow at rates of 6 per cent or higher, then overvaluation can be cured by keeping house price growth in low single digits.

As this eradicates most of the gap in the coming three years, two other forces will step in to mop up any remaining overvaluation: the inevitable reduction in stamp duty will provide buyers with extra bidding power and, more importantly still, interest rates will start falling early next year.

Unfortunately, for that outcome to materialise, something else needs to happen: the rate of housebuilding needs to contract and this will not be painless.

Rossa White of Davy Stockbrokers has analysed the extent of that pain and the first thing that becomes clear from his analysis is that the significance of property for tax revenue goes far beyond stamp duty. VAT revenues accumulated on new housing sales is up eightfold since 1997 from less than €400 million to around €3.2 billion last year, while capital gains tax on property has grown to around €1.5 billion. And let's not forget our old friend - stamp duty - it has grown from just €323 million in 1997 to about €2.7 billion in 2006.

Compared with 5.5 per cent in 1998 and 8 per cent in 2002, White estimates that total tax revenues from the property market now account for some 17 per cent of total tax revenues.

When considering growth rates, as distinct from levels, even this figure understates the exchequer's junkie status: if White's figure are correct, of the €12 billion jump in total tax revenues that occurred between 2002 and 2006 about €6 billion - or one-half - came from a sector that in 2002 represented less than one-tenth of the economy.

What property market giveth, the property market can taketh away. There are two channels for this to happen; prices and activity. I have argued that prices won't fall, but I do believe they must grow by less than the rate of nominal GDP for the market to correct. Let's make the assumption that prices in the whole of the property sector grow by 5 per cent on average between 2008 and 2012.

On activity, the Central Bank has said that from its present height of about 90,000 per year, it must slow to a steady state of 50,000 houses per year "over the medium-term". Taking that phrase to mean five years, this implies an annual decline of 12 per cent in housing activity. Even if the National Development Plan compensates for this rate of decline, it will only do so in a far less tax-friendly way.

Of the construction sector and property market activity that funds rather than draws tax revenues, a fall of 10 per cent per annum seems like a modest assumption. According to a table provided in White's analysis, if activity falls by 10 per cent each year and prices grow by only 5 per cent, tax revenues will fall below expectations by €1 billion each year: By 2012, there will be a €5 billion hole in the government's accounts.

In recent weeks, I did a quick simulation to see what would happen to both Fianna Fáil and Fine Gael/Labour assumptions on the economy if nominal GDP growth was 6 per cent (rather than the 7 per cent assumed) and if the tax multiplier was 1.0 rather than 1.1. Funnily enough, I came up with the same answer: By the end of government, regardless of who is elected, government finances will be short by €5 billion.

With the tax cuts and spending promises costing €8 - €9 billion in 2012's money, some election promises will have to be broken.

Either that or a virtually unbroken decade of balanced or surplused budgets will have to come to an end. Ah well, nothing lasts forever.