ECONOMICS:DAY-TO-DAY Government spending has ballooned since the beginning of the decade. But the balloon is about to burst because of declining tax revenues, writes Paul Tansey.

The flow of tax revenues into the exchequer's coffers is faltering already. Tax receipts fell €1.45 billion or 7 per cent below budgetary expectations in the first half of 2008. The Department of Finance's current prediction that the tax shortfall for the full year can be held to €3 billion now looks decidedly optimistic.

As a result, total tax receipts in 2008 are likely to be back where they were in 2006.

Moreover, it will not be a happy new year for the exchequer on the tax front. As hopes of a growth rebound in 2009 recede, the prospects of any appreciable growth in tax revenues next year have all but disappeared.

Plugging the revenue gap by raising tax rates is simply not an option in the current recessionary environment. Taking this route would represent a return to the failed fiscal policies of the 1980s. During that unfortunate decade, government raised tax rates in the hope of closing budget deficits. The increase in tax rates further depressed economic activity while the budget deficits remained unbridged.

With the tax door closed, curbing the growth of public spending - current and capital - represents the only option available to halt the alarming deterioration in the public finances.

In essence, Minister for Finance Brian Lenihan should seek to balance the current budget - equating day-to-day current spending with current income - while restricting capital borrowing to 3 per cent of Gross Domestic Product. In this way, the Government can demonstrate its fiscal prudence by adhering to the 3 per cent limit on budget deficits set out in the European Union's Stability and Growth Pact.

But achieving budgetary balance on the current account will be no easy task. It will require a marked deceleration in the rate of current public spending growth relative to the trend in evidence since 2000.

The two principal components of current public spending are social welfare spending and the public service pay and pensions bill. Together, they account for two-thirds of current public spending. Both have exhibited extraordinary growth since 2000.

As shown in Table 1, annual spending on social welfare has risen from €6.7 billion in 2000 to a projected €16.9 billion in 2008, an increase of more than €10 billion or 154 per cent over the eight-year span.

This increase has financed very generous additions to social welfare benefits. Thus, the personal rate for the contributory old age pension has climbed from €121.89 in 2000 to €223 today. Similarly, over the same period, monthly child benefit rates have risen from €53.96 to €166.

Commenting on these trends, an internal Department of Finance memorandum noted: "Irish social welfare payment rates are now far in excess of their UK equivalents: our State pension (contributory) is 94 per cent higher than the UK; jobseekers' benefit is 160 per cent higher; and child benefit rates are 60 per cent higher. Conversely, Irish PRSI rates to help fund these higher rates are significantly lower than in the UK."

Similarly, the annual cost of the public service pay and pensions bill has risen by €10.5 billion or 118 per cent since 2000, increasing from €8.9 billion to €19.4 billion in the process. The addition to the pay bill reflects two factors: increased rates of pay for public servants; and a very large addition to the numbers working in the public sector.

As shown in Table 1, between 2000 and 2007, the numbers working in the public sector have grown by almost one-third, increasing from 233,298 to 308,811.

Over this period, the public sector health workforce has risen from 72,859 to 106,273, an increase of 45.9 per cent. In education, the numbers of public service workers have increased from 65,937 to 89,263, a growth rate of 35.4 per cent over the seven-year span.

At a political level, the rise and rise of Irish public spending since 2000 has been driven by two simple rules implicitly adopted by successive governments. First, if you've got it, spend it. The boom in employment, housing and consumer spending in the first half of the decade filled the exchequer's coffers to overflowing with tax revenues. Governments were only too eager to spend the spare cash as quickly as possible.

Second, where an election looms, crank up the pace of public spending further. Hence, the growth in current public spending was ratcheted up on the approaches to both the 2002 and the 2007 general elections.

This overall approach has imparted a distinctly pro-cyclical flavour to Irish fiscal policy. Governments were adding extra demand to the economy in the middle of the biggest boom in living memory. Now that the rainy season has arrived, there's little left in the public purse.

As a result, the Government will be forced to slam on the spending brakes next year, curbing the growth of current public spending substantially. Otherwise, the Government will again embark on the road that leads to excessive indebtedness.