It is now clear the Department of Finance did not anticipate the severity of the slowdown, writes Pat McArdle

The Department of Finance, cautious or prudent depending on your perspective, assumed in each recent budget that the property market would slow and was pilloried when this did not happen and revenues overshot massively. It is ironic that the department's estimates for 2007, though they again foresee a slowdown, are the most optimistic of any recent year and that they are now caught on the other side. The department - though beaten into submission to a degree - was eventually proved right but will again be criticised, this time for being too optimistic.

It is now clear that they did not fully anticipate the severity of the slowdown and have now accepted officially that the Budget deficit will be closer to €1 billion than the €546 million projected on Budget day last December. The shortfall reflects lower tax receipts offset by savings on debt interest and miscellaneous spending as core current and capital spending is still forecast to come in on target.

The department now accept that the tax undershoot will be up to a billion. With three-quarters of the year gone, the shortfall, as compared with the Budget forecast, is already €500 million.

It is, moreover, accelerating rapidly. As late as end-July, the cumulative shortfall was only €14 million. The slowdown in the housing market was not apparent in the first half of the year - tax receipts were on target and completions were running at 2006 levels. Only housing starts and the Purchasing Managers' Index were pointing to trouble on the horizon and some commentators were inclined to dismiss these indicators as unreliable. All this changed with a bang over the summer. It is now clear that the housing market has slowed dramatically as builders cut supply in the face of declining demand in preference to the alternative of lower prices.

Completions are falling off sharply and property-related tax revenues are running well below target.

Stamp duty receipts may now undershoot by up to a billion while Capital Gains Tax is also underperforming as is Value Added Tax and excises, though the latter has little to do with housing and excise duties have been weak since early in the year. Tobacco sales took a hit from the Budget hike in excises and, as we suspected, car sales have disappointed. Sales are up about 5 per cent, much the same as last year (ie there is little or no SSIA effect). We do not see this trend improving. The final tax to disappoint was VAT, down €130 million. This deterioration is recent and there may be more to come as there is a substantial link to property.

The big offset is on Corporation Tax which is €300 million over target and Income Tax which is also doing well - €56 million over in a year in which employment growth is now slowing appreciably even if this has yet to be confirmed by official data which is out of date. These trends are likely to continue.

Overall, we see tax receipts down about €1.5 billion, offset by savings on spending of €0.5 billion, to give a net deterioration of €1 billion and an exchequer deficit of €1.5 billion instead of the €0.5 billion forecast in the Budget. The General Government Surplus, a wider and more relevant concept that includes social insurance funds and local authorities, would still be a very acceptable 0.7 per cent of GDP, down only moderately from the Budget estimate of 1.2 per cent. The 2007 Budget is still in good shape.

However, today's news has major implications for the 2008 budget. It means that the opening tax take will be €1.5 billion below what might have been expected just a few months ago. The Minister was already talking about the need to halve the rate of increase of current spending, currently an unsustainable 16 per cent. Such action is now, more than ever, necessary. This also means that any tax relief will be modest at best. The real challenge of the 2008 budget is to maintain planned infrastructural spending.

Too often in the past we have gone for the easy option and cut capital instead of current spending. Hopefully, this time will be different.

Pat Mc Ardle is the chief economist of Ulster Bank