ANALYSISThe Government should trim excess fat from the National Development Plan to avoid a yellow card from Brussels, writes Paul Tansey

"THIS IS an ambitious plan. Nothing on this scale has ever been attempted before in our history. We are talking about a total investment commitment of €184 billion of, in the main, taxpayers' money over the next seven years to secure the further transformation of our country, socially and economically, within an environmentally-sustainable framework."

So wrote Brian Cowen, then minister for finance, in a foreword to the National Development Plan (NDP) 2007-2013, when it was launched in January 2007.

As minister for finance, Cowen invested much of his own political capital in the plan. In his Indecon public policy lecture last November, Cowen was emphatic: "I have made it clear time and again that my first priority is the delivery of the National Development Plan. Its implementation in full is central to our long-term economic prospects."

Now, as Taoiseach, Cowen faces a difficult call. Does he renege on the full implementation of the NDP or does he risk breaching the 3 per cent budget deficit target in the EU Stability and Growth Pact?

The NDP is the most expensive project in the history of the State. Moreover, the financing of the plan falls squarely on the shoulders of Irish taxpayers. For, this time around, the EU is standing on the financial sidelines, contributing just €3 billion.

As shown in the table, the exchequer has been pencilled in for a direct contribution of €143.1 billion over the plan's seven-year span. In other words, taxpayers today and tomorrow are being called upon directly to fund the NDP to the tune of some €20 billion annually in the years to 2013. Local authorities, State agencies and public/private partnerships are expected to contribute the remainder.

While the plan is identified in the public mind with investment in physical infrastructure, it covers a much wider spectrum and includes a large chunk of current Government spending.

As shown in the table, the economic infrastructure component - roads, public transport and the like - comprises less than 30 per cent of total investment and less than 20 per cent of the exchequer funding commitment. More than half of all exchequer financing is earmarked for social inclusion and social infrastructure priorities.

The financing strategy for the NDP was simplicity itself. In the boom years, the exchequer was generating an operating surplus of increasing magnitude on its day-to-day activities.

While Government current spending increased rapidly, tax revenues flowing into the exchequer grew at an even faster pace. As a result, the current budget surplus - the excess of Government current income over its current spending - increased from 0.7 per cent of gross national product (GNP) in 1996 to 6.1 per cent of GNP a decade later. In 2006, the current budget surplus exceeded €9 billion.

Economic growth of 4 per cent to 4.5 per cent annually was stated explicitly as a necessary condition for financing the plan over its life. Growth rates on this scale would ensure that the tax revenues kept rolling in. Once the economy kept growing at a decent clip, all that was required was to channel the current budget surplus to finance the capital spending component of the NDP. Topped up with a dash of borrowing, as needed, and the NDP was home and hosed.

The exchequer got off to a flying start on the funding front. In 2007, with the economy still growing by more than 5 per cent, the exchequer fronted up some €19 billion to finance the plan's first year. A further €20.7 billion was allocated to the plan in Budget 2008. To date, there have been no attempted clawbacks.

However, with the economy slowing, the exchequer's tax take has nosedived. In the 2008 Budget, the Department of Finance projected a modest €1.6 billion or 3.3 per cent growth in tax receipts this year. In the four months to the end of April, tax receipts fell €736 million below the department's expectations. Figures due tomorrow will reveal the extent to which this deteriorating tax trend has continued into May.

With current spending ramped up on the approach to last year's general election and proving difficult to drag down thereafter, the stalling of tax revenues is depleting the size of the current budget surplus. This is forcing the Government to fund a larger part of planned NDP capital spending from borrowing.

The Economic and Social Research Institute (ESRI) ran the rule over the public finances in its Spring Quarterly Economic Commentary. It forecast that the current budget surplus would decline from €9 billion in 2006 to a projected €2.7 billion next year. At the same time, reflecting the impact of the NDP, borrowing for capital purposes was set to escalate from €6.8 billion in 2006 to a forecast €10.2 billion in 2009.

With the current budget surplus falling far short of capital borrowing, the exchequer's financial position swings from an overall surplus of €2.7 billion in 2006 to a projected deficit of €7.5 billion in 2009. In sum, the ESRI calculations indicated a €10 billion turnaround in the exchequer's finances in the space of just three years.

Most worrying of all, the broadly-defined Government sector has slipped into the red this year and is heading towards the 3 per cent budget deficit limit flagged by the EU's Stability and Growth Pact.

The general government balance (GGB) shows the Government's financial position in its totality and is the litmus test for assessing Ireland's adherence to the pact's budget deficit limit.

The GGB includes, in addition to the exchequer deficit, the surplus on the Social Insurance Fund and additions to the National Pension Reserve Fund.

The ESRI projections show the total Government sector moving from a surplus equivalent to 2.9 per cent of gross domestic product (GDP) in 2006 to a deficit of 2 per cent by 2009.

Moreover, the budgetary outcomes for this year and next are likely to be worse than the ESRI anticipated when it finalised its forecasts at the beginning of March. In the intervening three months the economic news has been unrelentingly bad.

A more recent assessment, published last week by Davy Research, concludes: "Based on its Budget 2008 estimates, the Government may breach the 3 per cent deficit limit in 2009."

Davy revised downwards its forecasts for GNP growth to 1 per cent this year and 2 per cent in 2009. On the back of these revisions it estimated that the overall Government deficit this year would reach 2.7 per cent of GDP and increase to 3.3 per cent of GDP in 2009.

In other words, on a strict interpretation of the 3 per cent EU budget deficit limit, the Government is flirting with the financial out-of-bounds next year.

With the irresistible force of declining tax receipts meeting the immovable object of fixed NDP spending plans, something has to give. Either the NDP must be reshaped or the Government

gets a yellow card from Brussels next year.

So what to do? What is needed is to invest in relieving infrastructural bottlenecks and in quickening productivity growth. It is also necessary to invest in strengthening social cohesion if a decent, functioning society is to be maintained.

The future of the current spending commitments in the NDP should be subjected to Cabinet review in the context of drawing up overall current spending plans for next year. In the case of capital spending, projects should be ranked in order of priority. Rankings should be determined by the total potential return on investment. Where a capital investment project cannot demonstrate a return on investment - economic or social - in excess of the cost of funds, it should be shelved. Major economic infrastructure projects, where full-scale cost-benefit analyses have not yet been undertaken, should be shelved. This exercise would trim a lot of excess fat out of the NDP.

The Government should restate its adherence to the 3 per cent budget deficit limit. While the downturn would provide Ireland with a legitimate excuse for circumventing the limit, this would not be advisable. The Government needs to demonstrate its capacity for fiscal prudence, showing it can manage the public finances in bad times as well as good. Breaching the limit would damage the credibility of Irish public policy, particularly in the eyes of foreign investors.

Finally, the duration of the plan should be stretched to 2016. Assuming that the ESRI's Medium-Term Review proves accurate, the economy can look forward to an annual GNP growth rate averaging 3.8 per cent between 2010 and 2015. This would allow many of the NDP projects delayed by the downturn to be reinstated at a later date.

Stretching the plan would also allow the NDP to mirror the duration of the social partnership agreement, Towards 2016.