Bank warns benchmarking may lead to hike in taxes

The Government will have to increase taxes or borrowings or cut services to pay for the benchmarking review of public service pay, the Central Bank said yesterday.

Calling for wage moderation in an autumn bulletin that repeated its 3 per cent growth forecast, the bank's head of economic research, Mr Tom O'Connell, said the additional funds were needed to pay for the benchmarking review.

Noting what he described as a "small" Government deficit this year of €750 million, Mr O'Connell said the bank's primary concern was to contain excessive growth in public spending. The froth had come off Government revenues as economic growth fell to sustainable levels after double-digit growth in 2000.

The overall economic climate was uncertain and the domestic economy was stable. "We're not doing a lot more than just ticking over," Mr O'Connell said.

On benchmarking, which will increase public sector pay by an average of 8.9 per cent, he said: "If one type of spending has large increases, something has to give."

The money would have to be raised through taxation, borrowing or by cutting services, he said.

The general rise in spending should be cut to 8 per cent in 2003 from 23 per cent this year, he said, sounding a warning about the public finances a day after the Government admitted for the first time that it would not return a surplus this year. The surplus was likely despite expenditure cuts of €300 million.

"The maintenance of a broad balance in the public finances would require public spending increases to be limited to the likely trend increases in Government revenue," said the bank.

Mr O'Connell compared the domestic growth projection with forecasts that the US and EU economies would expand by 1 per cent this year. But while risks internationally were on the downside and domestic "warning lights" were flashing, the bank cautioned against talking the economy into a crisis.

It said individual items of economic data were sometimes overplayed in the media.

An international pick-up was likely it said, suggesting the Irish economy could expand by 4.75 per cent next year. Such an expansion would be regarded as very strong in the US or EU, the bank said.

Mr O'Connell offered no opinion when asked whether the special saving incentive account scheme should be withdrawn to ease pressure on the public finances, stating that the bank did not comment on individual policy matters.

The bank said wage increases generally should be eased to reduce inflationary pressure on the economy.

Stating that Irish wages had increased by more than three times the European average, it said that national wage negotiation should take lower economic growth into account. Failure to reach a new national agreement in talks that commence this autumn would not be a disaster, the bank said.

Domestic inflation was Europe's highest and it was constraining job creation and reducing competitiveness in most sectors of the economy. Its effect was that Irish prices were significantly higher than those in the euro zone.

"Higher inflation here relative to the euro area is no longer a sustainable phenomenon. The Irish economy has largely come through the process of structural change and modernisation. As a consequence, the argument rationalising higher inflation here, based on our transition to a more modern economy, is not tenable," it said.

The bank said there was little scope for a discretionary fiscal stimulus due to the erosion of the budget surplus and inflation. It said increased competition and the removal of restrictive practices and barriers to entry were crucial factors in reducing inflation.