The Exchequer figures published on Tuesday are clearly disturbing. A projected surplus of over £2.5 billion now looks like turning into one of £1 billion or even less, simply because tax revenue is likely to rise by about two-thirds less than projected at Budget time last December.
At that time GNP was forecast to rise by 6 per cent this year. This seemed reasonable because, at the time of the Budget, growth was continuing at a rapid rate. Consequently, even if economic activity levelled off, the high level of economic activity at which we entered 2001 would have been sufficient to yield an average growth of 6 per cent, given the lower output of 2000.
But the tax receipt figures for the third quarter, together with industrial output and export data for the three months to July, now suggest that a downturn in output began in the second quarter, with the result that year-on-year growth in 2001 is now likely to turn out at less than 6 per cent - perhaps even below 5 per cent.
With national output at year-end now likely to be running below the end-2000 level, recent stockbroker economists' forecasts of 4 per cent to 5 per cent growth in 2002 seem quite unrealistic. An average growth rate of that size for the whole of 2002 would imply, quite unrealistically, high growth in the latter part of next year.
Accordingly, even assuming a global recovery during 2002, last week's ESRI projection of an average growth rate of 1.8 per cent in 2002 might, in fact, be too high, rather than too low, as these observers have been suggesting.
But lower than expected growth does not explain the scale of the shortfall in tax revenue disclosed by the end-September figures. It is difficult to avoid the impression that the Budget day revenue estimates based on what then seemed a reasonable 6 per cent GNP growth rate were too high - even though the tax buoyancy calculations were, no doubt, made on the same basis as in previous years.
First of all, on the basis of a 6 per cent overall growth rate, the Budget forecast of a rise of 8.5 per cent in private consumption in a year of uncertain prospects was from the outset far too optimistic. Moreover, even if that had been a reasonable estimate, and even after allowing for the (correctly forecast) 4.5 per cent increase in consumer prices, it is difficult to see how that could have yielded a 17.5 per cent increase in VAT receipts.
Even in the early months of this year, when consumer confidence was still strong, the volume of private consumption was running only 5.5 per cent higher than a year earlier. This was due to the fall in car sales, which was not compensated for by increased spending on other goods or services. Between then and July the retail sales volume index was running only fractionally above its 2000 level - and that index has always tended to exaggerate the growth of private consumption, which includes items that are not sold retail.
Thus, although consumer prices have, as forecast, been rising at a rate of about 4.5 per cent, since last March the value of consumption has at best been running at about 5 per cent above last year's level - compared to the Budget projection of more than 13 per cent . It should be added that, given that VAT receipts are paid almost three months in arrears, the shortfall in VAT receipts to end-September can have owed little to a third-quarter fall in output. It seems that the VAT receipt forecasts were flawed from the outset.
As to income tax, the Budget estimated that, after extensive tax cuts estimated to cost £727 million in the current year, income tax receipts would rise by 7 per cent. That meant that, at unchanged tax rates, these receipts had been expected to grow by 17 per cent. Given that employment was estimated to rise in 2001 by 3.5 per cent, this seems to imply an increase of no less than 13.5 per cent in incomes. That was unrealistic for, while it is true that, at the time of the Budget, wages of unskilled workers in the construction industry were rising at a rate of over 20 per cent, elsewhere pay increases were then in the range of 7 per cent to 9 per cent - where indeed they seem to have remained.
The Budget forecast of income tax buoyancy thus seems to have been over-optimistic, and it is therefore not too surprising that income tax receipts in the first nine months should have run 3.5 per cent below their projected level.
To have to start preparing next year's Budget with a revenue figure running over £1.5 billion short of that expected is a formidable challenge. Nevertheless the Minister will have available to him a starting Budget surplus that will still be close to £1 billion - or, in the way this figure is calculated for EU purposes, £2.5 billion.
That provides some leeway to cope with the recession that will further erode government revenue next year: it should make it possible to get through this crisis without having to cut spending or raise taxes - as we have had to do in similar circumstances in the past.
But this challenging situation will demand prudent budgeting, and that will not come easy to some members of our Government who have got used to huge increases in their Departments' spending in the current year.
For "prudent budgeting" in our circumstances means holding current spending to existing levels and avoiding further real cuts in taxation. But it does not mean cutting our investment plans. Indeed, with private investment, both external and domestic, declining during this recession, spare capacity will be released, in the construction industry in particular. That will provide an element of slack which can - and should - be taken up by public investment which would otherwise have continued to be squeezed out by pressure from the private sector.
In particular this will provide a welcome opportunity to address the serious shortfall in social housing, tackling belatedly the disturbing growth of our housing lists in the past few years. There can be no excuse for not doing so.
If such a development-oriented budget strategy is adopted, then our recovery in later years from the current recession could be rapid, bringing our growth rate for a period up again to something like 5 per cent to 6 per cent. In turn, that would mean that within half-a-dozen years from now the ground temporarily lost in 2001 and 2002 would be fully recovered.
The danger is that this prospect could be destroyed by panic actions by a government facing an election and tempted to try to buy support by taking a more relaxed approach to current spending and by offering more tax cuts in the forthcoming Budget - both of which would be at the expense of highly damaging cuts in the Government's well-designed investment programme.
Already in one of last Sunday's papers there was a story along these lines, which looked as if it might have come from an indiscreet Government source. A vigilant Opposition would be on the qui vive from now on for any such damaging policy shift.
gfitzgerald@irish-times.ie