ANALYSIS:We have a deficit to fix, a banking system to repair, and a regulatory framework to rebuild

THE VERY fact that we had an interim Budget highlights the extent of the fiscal challenge facing our economy. Press reports over the last several weeks have been filled with speculation as to the size of the “hole” to be filled, how much of that “hole” the Minister should fill, how much of the “hole” is due to cyclical rather than structural reasons, and, most sensitively of all, what exactly the Minister should use to fill the “hole” – tax increases or spending cuts?

In his speech the Minister announced spending cuts of €1.5 billion and taxation increases of €1.8 billion in the current year. This is in the context of a revised borrowing target of 10.75 per cent of GDP and a predicted GNP decline in the order of 8 per cent.

One of the key announcements yesterday was the creation of a new National Asset Management Agency. The intention is that this new agency will purchase development loans from the Irish banks in return for the issuance of Government bonds. The hope is that once these assets are removed from the banks balance sheets, credit systems will once again begin to operate normally and banks will provide finance to families and businesses.

On the tax side, the Minister has been somewhat constrained in the tools available to him, particularly on the personal tax side as it is not practical to change tax bands, tax rates and thresholds midway through the tax year. As expected, the Minister doubled the rates of the Income Levy to 2, 4 and 6 per cent and has reduced the entry levels for each of these rates. In addition, the PRSI threshold has been increased and the Health Levy doubled.

In effect, it would appear that these measures are blunt placeholders – they achieve a particular fiscal objective in that they collect the desired amount of tax in the current year, but are intended to be temporary until a more sustainable restructuring of the income tax system can take place.

The Commission on Taxation began its work before the severity of the current economic position became apparent, and in the interim, the significance of its role has increased. It is now expected to report in July next with a focus on a number of areas including carbon taxes, child benefits, and the tax regime applying to research and development, and property taxes. This report is likely to be the framework for the next budget. Some of the other tax-raising measures announced yesterday included the restriction of mortgage interest relief for both owner-occupiers and investors and an increase in the Capital Gains Tax and Capital Acquisitions Tax rates.

In a very welcome move for business, the Minister announced the introduction of an intellectual property tax regime. Whilst little detail was given in his speech, this development should allow Ireland to further develop its knowledge economy and allow Irish and international businesses in Ireland move up the value chain.

There are some potential pitfalls for Ireland Inc on the fiscal front as we move forward in a volatile climate. Clearly the Lisbon vote will be key. There is no question but that our future lies in Europe – the events of the last 12 months will have highlighted the risks that we would run as a small open economy on the periphery of Europe, but also the benefits of being members both of the single currency and of one of the largest social and economic regions in the world. Our trading partners and investors expect Ireland to continue to offer a stable positive and supportive business environment as part of this region and will view a positive vote in the Lisbon treaty as a clear statement of intent in this regard.

Equally, the Irish authorities need to continue to ensure that Ireland’s low tax environment is sustained and does not come under any threat from within the EU or elsewhere.

Tumultuous change tends to offer opportunity. The rules of the game for international business, trade and finance are changing faster than perhaps at any time in history. Countries which are likely to prosper in the medium term are those which offer business an open and stable environment with the required skills available at an appropriate cost and a competitive effective tax rate. We clearly have work to do – we have a deficit to fix, a domestic banking system to repair, and a regulatory framework to rebuild. But most countries find themselves in a very similar position – and some are considerably worse off.

We should see the necessary steps as part of the solution, and resist the temptation to see them as only indicative of the problems we clearly need to respond to.

The image that we present to the international community, and to each other, as we work our way through these challenges can be as influential in re-building confidence as the measures themselves. It is well within our ability to address these problems, and to do so with a view to looking forwards and outwards, and not just backwards and inwards.

Colm Kelly is head of tax and legal services with PricewaterhouseCoopers