Bulging pockets make McCreevy's tightrope walk more difficult

More than any previous Minister for Finance, Mr McCreevy will have an embarrassment of riches when it comes to framing his 1999 Budget. While this would have been undisputed good news for any previous minister, Mr McCreevy has to perform a difficult balancing act.

The pressures are building up on all sides. A battle over public sector pay is heating up for the autumn, the unions are demanding further tax cuts and our EU partners are putting the pressure on to keep the lid tight so as not to add further to inflationary pressures.

Indeed, it may have been easier for ministers back in the 1980s if there was no money in the kitty, the Government could not be expected to spend it. This time around Mr McCreevy is likely to have about £1 billion at his disposal. But he cannot simply decide to spend it or give it away in tax breaks

the EU Commission, the OECD and the European Central Bank, among others, have already laid down strong markers that it is a time for restraint.

Our euro partners and the international economic institutions have argued that with inflation growing and no possibility of using interest rate or exchange rate policy to control it, the Government would have to forego tax cuts in the Budget, as well as cutting back on any spending increases.

Mr McCreevy did repeat this mantra for a while, continually pointing to his pledge at the time of the pound revaluation to use any excess Exchequer funds to boost the surplus and frame the next Budget with inflation targeting at its core.

His tack appeared to change recently when he insisted that the president of the European Central Bank had no authority to insist Ireland follow this route. The signal from Government is that official thinking has fallen into line with economists at the Economic and Social Research Institute. The ESRI had argued that the potential economic benefits from running a tight Budget policy were nowhere near as important as the continuation of Partnership 2000 for keeping inflation in check and maintaining good growth in the economy. And keeping Partnership 2000 on track will mean delivering tax reductions.

This line would allow Mr McCreevy to deliver a tax reduction package aimed particularly at the less well off while also benefiting middle and higher income earners without appearing to risk inflation.

Holding onto Partnership may prove more difficult. Having conceded the Garda pay offer of more than 9 per cent, the Minister now looks set to face severe pressure on public sector pay in general. The authorities argue that the Garda is a special case and the deal is not outside Partnership conditions. But this is seen in the same light by some unions, with the teachers the first to push their demands.

It seems the Government took a calculated risk in solving the Garda dispute. But added to the craftworkers' settlement both groups received around 80 per cent of what they demanded the Garda deal has encouraged other unions to jump aboard the pay train and try to grab their share of the budgetary surplus.

Even before this, the public sector pay bill was the biggest expenditure item for the Government and also the fastest growing. The challenge now will be to hold the line on Partnership. With pay demands likely from 20,000 teachers and up to 100,000 other public servants that could be very difficult.

There is a clear perception that the Garda pay award breached Partnership 2000 guidelines, despite protestations to the contrary from Mr McCreevy and Mr Ahern. They must be hoping that some form of industrial peace could be bought through tax breaks in the upcoming Budget.

The problem for many trade unionists is they believed the Government had committed to efforts to target lower and middle-income earners in the 1998 budget.

But the agreement had been negotiated with the previous Rainbow coalition and Mr McCreevy appeared to put more store by delivering on election pledges then keeping to the spirit of Partnership. Hence a Budget package firmly targeted at the better-off in society, centred on two point cuts in the two income tax rates and a halving of capital gains tax.

It would now appear that the Government is firmly committed to changing course for the 1999 Budget. Tax cuts to the lower paid, it is argued, are not as inflationary as cuts for the higher paid, who may be more likely to spend their extra cash on more expensive imported goods.

A key point of the Government's argument will be that tax reductions will make it more attractive for people to move from unemployment to work and thus actually help to control inflation by cooling the job market.

But what of the strategy of cutting income tax rates in the Programme for Government? In a bid to keep these promises, Mr McCreevy is likely to go for a combination of widening the standard income tax rate band and increasing personal allowances, as well as some further reduction of tax rates in the 1999 Budget. It remains to be seen whether this will genuinely meet the promise to target the low paid. And it may be that the more the line can be held on pay the more will be delivered at least in theory.

A tax package aimed at low- to middle-income earners would have the added bonus of spreading some of the benefits of the growing economy to both the unemployed (who would find it easier to enter the workforce) and to private sector employees, who have been responsible for most of the growing competitiveness in the economy. So far these workers have been left behind by areas of the public sector.

It is also possible that some benefit will be passed to higher earners. There are voices calling for further cuts in the top 46 per cent rate, which would give potential returning emigrants an added incentive to come home.

Of the £1 billion, Mr McCreevy is likely to leave at least half in the form of surplus, which will eventually be used to repay some of the national debt.

That is what our European partners would like. They believe all countries should run surpluses in the good times so as to have more room for manoeuvre in the hard times which will almost inevitably follow.

But Mr McCreevy is not even obliged to do this. The only real pact we have signed the Stability and Growth Pact

only regulates for excessive deficits. And we are still a long way from approaching that danger area.

On the spending side, particularly with the pressures on public sector pay, Mr McCreevy is likely to try and hold a tight line. Last year one of the big surprises in the Budget was the huge amount devoted to capital spending.

The Minister is known to want to be seen to do something for future generations and frequently points to the decisions made on education in the past, which have contributed to the current boom.

He could plan in the 1999 package to act in a concerted manner to build up our infrastructure, particularly in the context of the likely run-down in EU funds. Without serious investment, our roads, railways and telecommunications are likely to prove a serious hindrance to future growth.

But this year it will be even more difficult than last to earmark huge sums for capital spending. There are few who believe it would have serious inflationary consequences over the longer term.

In the short term, the construction industry is stretched to capacity. Workers have already seen pay rises in the order of 17 per cent and a huge Government spending programme could stretch the sector to its limits.

Overall, it appears most likely that we will have the type of package outlined by the Tanaiste last week.

Some widening of bands and allowances, probably a small cut off the basic rate of income tax and perhaps a little more than the 4 per cent limit on capital expenditure.

Whether or not this proves to be seriously inflationary will depend on the progress of the next round of pay claims in the public sector.