McCreevy should cut taxes to the fullest extent

The ESRI created a small stir recently when it forecast an imminent move to an overall balance of payments deficit - after years of surplus - for the economy. This was accompanied by considerable hand-wringing by various commentators and much muttering about storm clouds gathering and sowing the seeds of the next crisis. Which is a bit odd really, since the balance of payments between the Republic and the rest of the world is, thanks to the advent of the euro, about as interesting and relevant as the balance of payments between Sligo and Wexford.

It goes to show that too few people have grasped the full implications of the euro's introduction. The rules of the economic game have changed completely: those who understand them can exploit them to massive advantage. And it is not just domestic analysts who have missed the point; the venerable IMF has admonished Ireland for planning further tax cuts and has warned of overheating and unsustainable asset bubbles.

Having very nearly wrecked Asian economies the IMF's standing, thank goodness, is now at a low ebb: few people should pay any attention to their strictures. Charlie McCreevy should go for it in his next budget and cut taxes to the fullest extent possible.

Institutions such as the ESRI and the IMF might be forgiven for worrying about things like the Irish balance of payments: it is what they are paid to do (which suggests that they might be better paid to do something else). Deteriorating external balances have sometimes in the past been a good lead indicator of a financial crisis, often culminating in a destabilising run on the currency.

Now, of course, we have no currency to have a run with; the Republic is merely an insignificant part of somebody else's problem. The Republic accounts for 1 per cent of euro zone GDP, so none of our economic statistics ever register on anybody's radar screen, least of all those at the European Central Bank. The Republic can never again experience a financial crisis of any kind because we have no currency to sell and we are too small to count when it comes to the value of the euro. The small-country point is critical of course.

If we were talking about Germany or France, say, we could not be so carefree: financial markets avidly monitor the economic statistics of the larger countries and move the euro (and euro zone interest rates) accordingly. Whatever we do we cannot affect the euro or anything else. Of course, domestic policies will have domestic economic consequences.

Consider the arguments over tax cuts. We have a golden opportunity to slash tax rates to levels far below those of our European competitors. But, say the old-world thinkers, this will lead to inflation, a consumption boom, higher imports, higher house prices, higher wages, lost jobs and greater social exclusion (because tax cuts only benefit the rich). We could take each argument in turn, but we don't need to because each is either completely wrong or not worth worrying about.

The easy ones to dismiss are, firstly, Irish inflation: this is determined entirely externally as a result of the euro and the proper functioning of the labour market. Hasn't anybody noticed the Republic's low inflation rate after nearly six years of a booming economy? Consumption and import booms are irrelevant: that euro again. Higher house prices? With the economic boom there has been a one-off structural adjustment in prices: demographics, bad planning and regulation and a refusal to live in apartments (unlike every other country in the world) will keep prices relatively high.

But the most important influence on house prices has been interest rates: that euro again. Tax rates come very low down the list of determinants of house values.

The labour market is a more subtle concern. Initially, tax cuts will stimulate growth and employment. But, say the dinosaurs, that is bad because we already have too much of each. More will lead to a wage-price spiral and, ultimately lower jobs. But this is old-world thinking at its laziest. True, there is one part of the labour market where we should worry and that is the public sector.

Much credit has been given to national wage agreements for keeping the Republic competitive and keeping wage costs down. But the reasons for the Republic's competitiveness have more to do with the quality of the workforce and the proper operation of market mechanisms. Agreements between government and unions have been more to do with providing a fig-leaf of cover to an exploding public sector wage bill. (The way to deal with striking DART drivers is to begin immediate privatisation).

The continuing operation of a proper labour market - in the private sector at least - will keep the lid on private wage costs whatever the national consensus is. And that labour market will continue to operate well in part because of the euro: inward migration is a big factor here.

The debate over inequality rages in all developed economies and is rarely acquainted with the facts of economic life. The single factor that leads to most social exclusion is lack of a job. The US, with all its supposed inequality has 4 per cent unemployment and has created 20 million net new jobs in the 1990s. The euro zone, without a labour market to speak of, still has double-digit unemployment and has created zero - yes, zero - jobs in the 1990s. Tax cuts lead to jobs which lead to social inclusion.

The creation of the euro has contributed to a remarkable opportunity to spend our money on ourselves without fear of a balance of payments crisis or runaway inflation. Having given up macroeconomic sovereignty we no longer have macroeconomic constraints. In other circumstances this could - and might yet - present problems. But the luck we have had over the past five or six years combined with the post-1993 devaluation-inspired economic boom means that we are now in a unique position.

We can still make bad - or irresponsible - decisions. Infrastructure, public transport and Dublin taxis are but three examples. But these are all at the micro level. In the US my favourite bumper sticker refers to the preferred role of government - defend our shores and deliver our post. In the Ireland of the Internet age I am not sure we need either.

Chris Johns works in the fund management industry.