Book of Estimates a target-rich environment

The Government must move on from tax hikes to pruning public expenditure, writes Colm McCarthy

THE FINANCE Bill provides the statutory basis for the various tax increases which constituted the core of Brian Lenihan's first Budget. These include a gross income levy, an increase in the top VAT rate, extra duties on cigarettes and petrol, increased retention tax on deposit interest and a hike in capital gains tax.

There were no cuts in the aggregate spending totals. Public spending is set to rise next year by more than the likely rate of inflation, that is to say, there will be a further increase in the real volume of public spending.

The media hysteria about "cuts" should be seen as a measure of the distance to be bridged in creating an accurate public understanding of the extent of the fiscal crisis, for crisis it most certainly is.

The Government expects the deficit to reach 6.5 per cent of GDP next year, based on fairly modest assumptions about Ireland's economic performance. Unfortunately these assumptions already look rather shaky.

Forecasters now expect the economy to contract sharply next year. Ibec's Danny McCoy, for example, expects an output contraction of 4 per cent, and this seems to be the emerging consensus figure.

However the inflation rate is shrinking rapidly. Davy's Rossa White believes that it could be about zero for 2009. Combine these two figures and the implication is that the tax base is falling in nominal terms.

Tax revenue next year could be well below the Budget projection and the deficit could easily hit 8 per cent of GDP. It is the Government's stated intention to get back below 3 per cent by 2011.

Unless the economy recovers really strongly from 2010, the gap will not be bridged through a painless recovery in tax revenue. The choice is between further tax-increasing budgets or a serious programme of expenditure reductions.

One of the lessons of the 1980s is that the best way to deal with an emerging fiscal crisis is strangulation at birth.

A few years of uncorrected deficits at 8 per cent, combined with substantial bank bailout costs and the debt-GDP ratio could begin to build up a real head of steam.

We have been here before. If this year's holding operation is to form the basis for a medium-term fiscal strategy, the Government must move on to a root-and- branch pruning of public expenditure both capital and current. The alternative is to leave spending untouched and make all of the required adjustment through further taxation measures.

After a decade of lavish growth in public spending across all departments and State agencies, the Book of Estimates is what the US military would describe as a target-rich environment and it ought to be possible to avoid heavy additional taxation.

There is one tax measure in the Finance Bill with the potential to absorb much of its revenue potential in collection and compliance costs. This is the proposed levy on employee parking spaces.

Free parking spaces for employees in central Dublin are worth as much, at market rates, as the benefit of a free car. The latter is liable to tax as a benefit-in-kind, and rightly so. Annual rental for city-centre spaces is currently running at up to €3,000 and benefit-in-kind tax would be €1,400 or so. The proposal is a tax of €200, which is far too little, and will be collected from employers at, I suspect, substantial administrative cost.

There will be endless whingeing and demands for exemption. The Finance Bill has tried to anticipate some of these, but the task is impossible. Maternity leave, for example, is listed as a ground for exemption, but not paternity leave, a feature of many jobs nowadays. Is the Department of Finance guilty of gender discrimination?

The correct way to deal with this issue, in our self-assessment income tax code, is to tax parking spaces as a benefit-in-kind. This option has not been chosen, I suspect, because public servants, including TDs and senators, would have to pay.

Any chance of a Fianna Fáil backbench rebellion on this one?

Colm McCarthy lectures in economics at UCD.