Tax shortfall estimate appears to err on the side of optimism

Official projections do not follow the year's pattern of accelerating deterioration, writes Jim O'Leary

YESTERDAY'S EXCHEQUER statement for end-September confirms the trends that had already become entrenched in previous months.

There is a gaping and growing hole in the public finances, as Government spending grows ahead of budget, and revenue falls behind target by an ever-increasing margin.

For the first nine months of the year tax receipts were running almost 10 per cent below the corresponding period of last year and an estimated €3.6 billion below what the Department of Finance had expected to receive at this point.

The extraordinary weakness in receipts remains concentrated in those tax categories where the public coffers were previously bloated by the property and construction boom.

In the third quarter both capital gains tax and stamp duties generated less than half the revenue they delivered in the same period of 2007. But, in truth, the contraction of receipts is evident across all tax heads, albeit to a more modest degree, mirroring the spread of recessionary conditions across the economy.

The particular significance of yesterday's figures is that they are the last set that will be available in time for the budget of Tuesday week.

As such, they will help to define the base that the Minister for Finance will use to project his likely tax receipts for 2009, a projection that will in turn heavily influence the Government's decisions on spending and borrowing.

On the basis of the position at end-September, the Department of Finance is now projecting a tax shortfall of €6.5 billion for 2008, up from its €5 billion estimate of end-August and its €3 billion estimate of mid-year. As such, the picture is a good deal grimmer and the budgetary constraints a good deal tighter than they appeared to be a month ago.

But the true picture may be even worse because, if anything, the official estimate looks to err on the side of optimism.

The pattern since the start of the year has been for the pace of deterioration in revenue to accelerate, but the department's projection of a €6.5 billion shortfall essentially assumes that this trend will be arrested before year-end. It may be, but I doubt it. A deficit of €7-8 billion (or more) seems more likely.

November could be an especially treacherous month as it typically accounts for upwards of half the annual yield from capital and corporation taxes.

Last November saw €1.6 billion collected in capital gains tax alone. This year, the yield is certain to be a small fraction of that. Capital gains? What capital gains?

Whether the black hole on the tax side is €6.5 billion or €8 billion is of secondary importance (although an underestimate will compromise next year's budgetary arithmetic). One way or the other, it will be immense, and will result in a fall of at least 2.5 percentage points in the ratio of tax to GDP.

It is important to recognise that this will be an unplanned and unintended fall: this year's budget set out to leave the ratio broadly unchanged. Moreover, it is likely that the ratio would fall again next year if there are no changes in taxes in budget 2009, probably to a level that would put Ireland about 10 percentage points below the EU average and possibly to a level that would push the Irish ratio below Bulgaria, Latvia and Romania.

In these circumstances, it would seem blinkered in the extreme to insist that spending cuts bear the full burden of the big fiscal adjustment that is required. However unpalatable it may be, raising taxes has a part to play too.