Tax revenues looking less buoyant

Yesterday's GDP forecast may cause some alarm bells to ring, writes Marc Coleman, Economics Editor

There is no crystal ball when it comes to predicting the economy's performance this year. There are forecasts, of course, and these are useful for the year that's in it and, perhaps, the two years after that.

Similarly, data for the final quarter of last year will not dictate what's going to happen in 2007, but no government would be wise to ignore them.

In one respect, yesterday's national accounts statistics are similar to recent forecasts from both the Government and the Economic and Social Research Institute (ESRI) - which is some cheer to the political parties that are basing their election promises on them. In two respects they are different.

According to both of them, the economy will grow by between 4 and 5 per cent over the term of the next government - ie between 2007 and 2012. Judging by yesterday's figures for economic growth over last year as a whole and in the final quarter, that assumption will stretch to this year at least. At 6 per cent, growth in gross domestic product (GDP) - the economic output of goods and services in a given period - was one percentage point higher than the Government had estimated. In the final three months of 2006, GDP grew by 5.0 per cent.

This year the economy is forecast to grow by 5.3 per cent. Yesterday's figures suggest it ended the year running a tad slower, but only a tad.

For both Government and Opposition the devil is in the detail.

With promised tax cuts ranging between €1 billion and €5 billion, not only do all political parties need the recent forecasts to come true, they need each percentage point of GDP growth to be power-packed with tax revenues.

Are they? Up to now, with the property market powering growth in taxes such as stamp duty and capital gains tax, they have been.

And now to the two respects in which yesterday's figures differ from forecasts. For the first time since records began in 1997, the level of new house-building in the last three months of 2006 was lower than in the final quarter of 2005, down 1.7 per cent year-on-year.

This year the Government forecasts investment to grow by 5.4 per cent, an expectation that needs to hold if its forecast for total GDP growth, 5.3 per cent, is to be realised.

If house-building continues to stall, the National Development Plan (NDP) will be there to take up some of the slack.

But as a major exercise in public spending, the development plan is a drain on the Exchequer rather than a source for it.

This means that even if its magnitude holds up, the "tax revenue friendliness" of investment growth will decline.

Another respect in which alarm bells should be ringing relates to the behaviour of the external economy. The Government accepts that this side of the economy is performing modestly and has pencilled in a negative growth rate of 2.8 per cent for net exports next year.

That seemed prudent - until yesterday, that is, when it became clear that net exports fell 10.2 per cent in the final quarter of last year.

Carrying that performance into this year will make it difficult for the Government even to achieve its modest forecasted decline. This is particularly so when you consider three things. Firstly, although still healthy, the global demands for exports this year will not be as strong as last year. Secondly, the weakness of the dollar against the euro in recent months is likely to crystallise, if not worsen. Last but not least, the slow creep of high inflation is killing Irish competitiveness with the death of a thousand cuts.

For sure, the Government will have the NDP to supplement domestic demand - and provide needed infrastructure. But even the mighty National Development Plan won't be enough to counteract a serious decline in the construction and consumption sectors if they materialise post-2008. This is so because the NDP is (a) state-funded and (b) far less employment-intensive than most existing construction activity.

Lest anyone think this view biased, let me hand the last word on the matter over to the Minister for Finance, Brian Cowen. "Without economic growth, we will not have the resources to reform our taxes, to fund improvements to our public services," he said yesterday.

Each political party should put that statement in its election manifesto. And smoke it.