The Minister for Finance, Mr McCreevy, is not short of advice as he starts to prepare next year's Budget. A number of prominent economists here, the EU Commission, and the Organisation for Economic Co-Operation and Development have advised him not to cut taxes further, as this may unduly stimulate the already rapidly expanding economy which is expected to grow by 10 per cent or more this year . The trade union movement, meanwhile, insists that the tax-cutting commitments made in the Partnership 2000 programme must be kept and this view has found some support from the Economic and Social Research Institute. Politically, the Government came to power on a mandate of reducing taxes and the voters will be expecting the Coalition to deliver.
Next year, of course, we will enter monetary union and this brings a number of new factors into the Budgetary equation. As we are losing the power to set our own interest rates, the Budget is the only tool left with which policymakers can try to influence the overall level of economic activity. Also, the 10 other states with which were are entering monetary union now have a much greater interest in the way we manage our economy, just as we will pay much closer attention to the way they handle their affairs. If the inflation figures over the rest of the year show a progressive increase, then Mr McCreevy will face increasing pressure from the other euro members to introduce a tight Budget.
However the strong state of the exchequer finances will put Mr McCreevy under intense pressure from his Cabinet colleagues to increase exchequer spending and will encourage the trade unions to seek generous tax reductions. So what should the Minister for Finance do? His first priority must be not to do anything which could add further to the risk of rising inflation. In a small economy like Ireland, which is very open to outside forces, the annual Budget can only do so much to influence the overall level of economic activity. But with the economy growing so fast, it would be foolhardy to introduce a Budget which would add further fuel to its fires. This means that the Government must keep its commitment to maintain a strict rein on day-to-day spending and, particularly, to ensure that inflationary wage pressures do not take hold across the public service. While current spending should be kept under tight control, there will still be a case to invest further in infrastructure - which comes under the heading of capital spending - to continue to build the economy's productive capacity.
What about taxation? There must certainly not be a repeat of the 1998 Budget package which targeted its main benefit towards higher income earners, principally through reducing income tax rates. To repeat this prescription next year would be to risk giving a further push to consumer spending at a time when it is already growing rapidly.
However this does not mean that the Budget need not contain any tax reductions. Instead of targeting higher income earners, the Government should direct modest tax reductions next year at lower-to-middle-income earners through measures such as adjusting income tax allowances and exemption limits and widening the standard rate income tax band. Further attention must also be given to making it more profitable for those on the live unemployment register to move into employment. Introducing such measures would offer something for all taxpayers, while providing the greatest benefit to the lower income earners. Provided the reductions are not too sizeable, they should not be overly inflationary. Such a Budget package would be in keeping with Partnership 2000. It would also be fair, in that many more highly-paid workers are already getting increases well in excess of the Partnership 2000 terms, and a Budget along the lines suggested would concentrate the gains at the lower end of the income spectrum. Provided a tight rein is kept on spending, it would also be unlikely to draw the ire of our EU partners. However it would mean that the Government would have to abandon the strategy of cutting income tax rates which it put before the electorate. Given that cutting income tax rates is not the best route to reforming the tax system, this would be no bad thing.