Which way will Charlie go?

Charlie McCreevy enjoyed delivering Budgets in the good times, writes Cliff Taylor , Economics Editor

Charlie McCreevy enjoyed delivering Budgets in the good times, writes Cliff Taylor, Economics Editor. For the first few years of his "reign" in the Department of Finance he was able to distribute the fruits of the economic boom, slashing taxes and adding billions to spending.

But now the fizz has gone for "Champagne Charlie". Next week he will present spending plans which will aim to slow very sharply the rate of growth of Government spending. This will form the prelude to the tightest Budget in years, due to be presented on December 4th.

The Exchequer figures for October, published this week, illustrate clearly the difficulties. Day-to-day Government spending on providing services is costing 19.6 per cent more than last year.

Meanwhile, tax revenues are up just 2.3 per cent. For the first time in years the Exchequer position has moved into deficit and sizeable borrowing will be required next year to bridge the gap between revenue and spending. A slip into the red next year is unavoidable.

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The challenge for the Minister and his Government colleagues is to stop the rot - to address the spending and revenue trends which, if left unchecked, could quickly return the economy to the bad old days of soaring deficits. So what options does the Minister have?

Five Easier Options

Hit the "old reliables"

This one looks a dead cert. Reasonable sums can be raised through adding to the excise duties on cigarettes, alcohol and petrol. There has been speculation about a substantial increase in tax on a packet of cigarettes - a 25 cent increase on a pack of 20 would yield around €80 million for the Exchequer and a general rise in this and other excises would yield €250 million or more. Another rise in the standard VAT rate, which rose last year from 20 to 21 per cent, is also possible, though this rate is now high by EU standards. However the downside of higher excises or VAT is that they boost the rate of inflation, and in turn this can lead to demands for higher wage increases and a loss of competitiveness.

Lower the contribution to the

National Pension Fund

In 2000, in a more prosperous time, McCreevy committed to putting 1 per cent of GNP (national output) into a special fund to pay for future pensions. This was a prudent move. He could decide to lower the contribution for next year - halving it would save about €500 million. Doing so would require the eating of substantial humble pie by the Minister, who said in last year's speech that the commitment to the fund should not be a "fair-weather" one. But it could be justified if the money was diverted to investment under the National Development Plan.

Cut back on investment in

roads and infrastructure

The politically easiest way to save money would be to cut back on spending on big infrastructure projects set down in the National Development Plan. (The National Roads Programme alone will cost some €1 billion this year.) However, doing so would damage long-term growth prospects - the cutbacks in this area in the late 1980s and early 1990s is one reason why our infrastucture is now in such a poor state. A crucial conundrum for the Minister, however, is that much of the money being spent on major capital projects is being eaten up through higher inflation - in other words, in the case of roads it is going to landowners and contractors rather than to laying down the tarmac.

Take money from the Central Bank

or some other Exchequer funds

In the last Budget, the Minister raided the Central Bank, the Social Insurance Fund and the Capital Redemption Fund, raising some €2.5 billion. It will be much more difficult to do this for the 2003 Budget. The EU has indicated that any further money from the Central Bank fund would be disregarded in its calculations of State borrowing, which lessens the attraction for McCreevy. The Minister is likely to find some hidden funds to support his position, but nothing on the scale of those found for the 2002 package.

Go for "creeping tax increases"

Tax credits and tax bands need to increase each year to compensate for rising wages - otherwise the real tax burden increases as a greater proportion of income becomes liable to tax, at either the lower or higher rate. Chances are the Minister won't push the credits and bands up to compensate fully for rising wages, hoping that taxpayers won't notice these creeping tax increases. He might even raise or (ouch) abolish the employee's PRSI ceiling, which would be very expensive for better-off employees.

Five Harder Options

Cut day-to-day spending

Or, as the Minister would put it, adjust the rate of increase. Current spending is growing at close to 20 per cent and the Government needs to slow it to 7-8 per cent next year. Given the momentum of public spending and the need to adjust social welfare rises at least for inflation, lowering the rate of spending increase to single figures will require substantial cutbacks. Services to the public will suffer, even though the Government will claim it is spending more.

Postpone public service pay increases due under benchmarking

This is the big one. The Government faces a bill of €550 million for the public sector pay increases, recommended in the benchmarking report, that it has promised to backdate to last December. The full cost of implementing all the benchmarking plan is €1.1 billion - and possibly considerably more if knock-on increases emerge. If the Government pays this, then it will probably be impossible to meet its target of reducing spending growth to single figures. If it doesn't, it could face a revolt from the public sector unions.

Cancel or cut back on SSIAs

Guaranteed to raise the hackles of the middle-classes. The Minister could abolish the whole Special Savings Investment Account scheme - which offers tax relief to savers - though this might be legally difficult. Or he could, as the ESRI suggests, decide to cap the cost at this year's €550 million by saying that anyone who increases their contributions under the scheme will not benefit from the tax advantages.

Increase tax rates

McCreevy is unlikely to increase the main income tax rates of 20 and 42 per cent. Doing so would generate a significant windfall, but it would be a major reversal of Government policy. What price a rise in the 20 per cent capital gains tax rate? Probably unlikely too. The Minister also has an expensive promise to reduce corporation tax further, and is unlikely to renege on this.

Tax child benefit

The Government has announced successive increases in child benefit rates as its main route to tackling poverty. However, these have cost it dearly, as the better off get the same cash benefit as the lower-income households who need it most. There is an unanswerable economic case for taxing child benefit, but the furore when the then finance minister, Bertie Ahern, moved to introduce this in the early 1990s was so great that the government was forced to abandon it. Fearing the wrath of Mná na Foxrock and Montenotte, the Government may again pass on this option.

Has anyone seen my billion?

At the end of September, the Exchequer finances were in surplus to the tune of €600 million, but by the end of October they were in deficit by €400 million, a €1 billion turnaround. So how did the Exchequer "lose" so much money so quickly?

Moving into deficit last month meant that - for the first time - the total amount the Exchequer has spent this year now exceeds the amount it has taken in from taxes and other revenue sources. This trend had been going on for months, as spending has been rising faster than taxation. Last month, spending rose by some €3 billion and revenue by some €2 billion - hence the turnaround.

With the Exchequer spending over €26 billion so far this year, a deficit of €400 million is not large. But the worry is that if current trends continue - with spending up 19.6 per cent so far this year and tax revenue up only 2.3 per cent - the deficit figure will quickly grow.