Opportune time to pay down national debt

This year's Budget has already gone down as one of the most controversial in recent memory and although the immediate furore has abated, further debate is inevitable as the year unfolds.

This time the issue will be how to cope with a Budget surplus, which will be much larger than envisaged by the authorities, unless the current growth in tax receipts slows dramatically. Revenue could exceed the 2000 target by some £2 billion (€2.5 billion), and a figure of more than £1 billion is virtually certain, which would re-ignite the arguments about whether the Government should cut taxes more aggressively, spend more or reduce the national debt at a much faster clip than currently envisaged.

The EU's concern about the Irish economy's pace of growth adds a further strand to the debate, with the Commission looking to the Irish authorities to take more money out of the economy via a tighter fiscal policy. An overshoot on the tax side is nothing new: revenue has exceeded the Budget target in every year since 1990, which in itself suggests a bias in the Department of Finances forecasting. The 2000 Budget was therefore always likely to include conservative revenue assumptions and this was compounded by an underestimation of the 1999 outturn, which reduced the required growth in tax receipts in 2000 to 8.6 per cent over the year.

This always looked a modest target in the light of expected real GDP growth of 8 to 9 per cent and on the evidence of the first two months the forecast risks being spectacularly wrong. Total revenue to end-February was £3 billion, a massive 18.7 per cent above the corresponding period of 1999, with all headings showing strong gains.

Corporation tax, for example, was 62 per cent up on the previous year (the Budget target is 15.5 per cent). Capital taxes were 47 per cent ahead and VAT receipts some 19 per cent higher.

Income tax is the largest tax heading, contributing about one-third of total receipts, and it too was well ahead of expectations, with revenue more than 14 per cent up on the previous year, against a Budget projection of just 2.8 per cent.

This strength in income tax receipts illustrates a simple rule of taxation; revenue is the product of two factors, the tax rate and the tax base (the number of people paying the tax). In the 1980s, the Irish authorities learnt this the hard way (as did the unfortunate taxpayer) because almost 200,000 people left the State during the decade in response to tax rates as high as 65 per cent on income, which in turn reduced the tax base and therefore the potential tax take. The 1990s, in contrast, has been a spectacularly vindication of the low tax rates and supply side reforms advocated in the US by President Reagan a decade earlier: lower tax rates generates higher receipts because the tax base expands.

This is clearly illustrated in the income tax data where cuts in individual rates have been more than offset by the rise in the numbers at work and therefore paying tax: employment rose by 103,000 or 6.6 per cent through 1999, for example.

This implies that the growth of income tax receipts will not slow dramatically from April, when the Budget cuts come into effect, because the loss in revenue from each individual PAYE worker will be offset by the growth in the numbers at work. Similarly, halving the rate of capital gains tax has resulted in a ballooning of revenue as more taxpayers comply with the tax code.

Nevertheless some slowing in overall tax receipts is likely, but even at this stage it appears a massive overshoot in revenue is on the cards, if not by £2 billion then certainly by more than £1 billion. Moreover, this does not include any privatisation receipts, so the Government may end up with revenue of a massive £6 billion or so in excess of current spending, instead of the £4.6 billion anticipated. What to do with such good fortune.

At a simple level if tax revenue exceeds current spending by such a large amount then tax rates are too high, and so should be cut, and much more aggressively than envisaged under the new pay agreement. For this year, however, the tax die is cast. Spending on infrastructure and outlays on the State Pension Plan have also been decided. Consequently, the most likely response is a more rapid pay down of the national debt, which stood at more than £33 billion in 1999 or around 50 per cent of GDP.

Any excess budgetary proceeds could be used to buy back debt in the form of bonds listed on the Irish stock exchange or an alternative would be to cancel the regular monthly auctions whereby new debt is issued. In the past the government has tended to spend a proportion of any unplanned receipts but with the EU Commission breathing down the neck of Finance Minister Mr McCreevy, the option of injecting more cash back into the economy is likely to be rejected this time in favour of a debt paydown.

Dr Dan McLaughlin is chief economist at ABN-Amro Stockbrokers