The 2008 Budget will have failed the Government's own test if it does not achieve equity, writes Paul Tansey. Reduced tax revenues and a sluggish economy have narrowed Cowen's options

There will not be much in the way of spare cash to give taxpayers a dig out in the 2008 budget. As the public finances stand, taxpayers have little chance of seeing a reduction in their tax burdens in the year ahead. Two factors are conspiring against real reductions in average tax burdens in the Budget.

First, the flow of additional tax revenues into the Exchequer next year will be very sluggish, reflecting the weakening pace of economic activity. The Receipts and Expenditure White Paper, published last Saturday, anticipated that total tax revenues would increase by €1.45 billion or 3.1 per cent in 2008.

However, even this tepid increase in tax receipts overstates the strength of the Exchequer's revenue position. For the White Paper also projected that there would be a €1.75 billion shortfall in tax revenues this year. As a result, the projected increase in 2008 tax revenues will not even make good the forecast shortfall this year. As a result, even if next year's tax targets are achieved, the tax take in 2008, at €48,776 million, will be lower than the €49,075 million tax yield originally estimated for 2007 in last year's budget. This is illustrated in the table.

Two other important trends are shown in the table.

First, notwithstanding this year's tax shortfall, total tax revenues have risen from €31.8 billion in 2003 to a prospective €47.3 billion in 2007. This represents a remarkable increase of almost one-half in the annual tax take in the space of just four years.

Second, as the economy snapped out of the 2001-2002 slowdown and domestic demand soared, tax revenues consistently beat budgetary expectations. As a result, between 2003 and 2006, the Exchequer pocketed a handy €8 billion it had not expected.

This year, however, the wheels have fallen off. As economic performance failed to match the 5.3 per cent real growth rate forecast in Budget 2007 - principally due to the slump in house building - tax yields nosedived below targets and the tax variance has turned negative to the tune of €1.75 billion.

As a result of tax undershooting in 2007 and anaemic revenue growth projected for 2008, Minister for Finance Brian Cowen has been left with little money to play with on Wednesday,

The second problem for taxpayers is that most of the cash that Cowen has on hand has already been spoken for.

The Minister has announced that he plans to raise day to day Government spending by 8 per cent in 2008, at a cost of close to an additional €4 billion. In addition, he has said that he will increase public capital spending by 12.5 per cent in 2008 to hasten the implementation of the National Development Plan. This will add almost an extra €1 billion to the Exchequer's bills for 2008.

Thus, total public spending is set to increase by some €5 billion in 2008, a year in which tax receipts at unchanged rates are projected to rise by just €1.45 billion.

These trends indicate that the scope for tax concessions will be very limited on Wednesday. When resources are scarce, priorities must be ranked. The Programme for Government, finalised in June 2007, defined clearly its principal objective in the sphere of taxation.

It stated: "Our first priority remains low and middle income earners - therefore our first task will be to use tax credits and bands to keep low income earners out of the standard rate band and average earners out of the higher band."

Presently, personal tax credits are set at €1,760 for single people and €3,520 for married couples. The Employee Tax (PAYE) Credit stands at €1,760. On these figures, the present tax code ensures that, at a minimum, single employees earning up to €17,600 are exempt from income tax.

Single people must earn at least €34,000 before paying tax at the higher 41 per cent rate. Married couples, where only one spouse is earning, fall into the top tax bracket where earnings exceed €43,000. Married couples where both are working can earn up to €68,000 before attracting a marginal income tax rate of 41 per cent.

Average earnings are forecast to increase by 5.5 per cent this year and consumer price inflation is projected at 4.9 per cent in 2007. Thus, to ensure that more low-paid workers do not fall into the tax net and that average tax rates on ordinary workers do not rise next year, tax credits would need to increase, and tax bands broadened, by a minimum of 5 per cent next year.

If Cowen does less, then he will effectively be hiring wage and price inflation as invisible tax collectors next year. This may not be a smart idea given that national pay negotiations are pending.

The problem, however, is that indexing tax credits and bands upwards by 5 per cent in 2008 would be a costly exercise. On the basis of Department of Finance calculations (Taxation Statistics, Budget 2008, Department of Finance, November 2007, page 9), the full-year costs would amount to almost €700 million while the cost in 2008 would reach €500 million.

Nonetheless, the Government has set the test by which it must be judged on Wednesday. If Cowen is unsuccessful in keeping low earners out of the tax net and average earners out of the top tax band in the Budget, then the 2008 exercise will have failed the Government's own tax test.