The Government could raise the PAYE tax bands by at least 5 per cent in the next Budget without causing any problems for the Exchequer, the Economic and Social Research Institute (ESRI) has concluded. Una McCaffrey reports

The public finances could support tax cuts worth up to about €500 million next year, it adds.

Based on this "envelope", the average industrial worker could be removed entirely from the higher 42 per cent tax band.

The average industrial wage is just below the standard 20 per cent rate threshold of €28,000, but many workers on such pay find themselves pushed into the higher rate when overtime or bonus repayments are considered.

ESRI senior economist Mr Danny McCoy said there was a "symbolism" attached to a move on the tax bands, particularly since they have remained static in the last two budgets.

In 2004 alone, this has led to some 50,000 workers losing out as inflation pushed their wages into the 42 per cent tax bracket, leaving them paying higher taxes without gaining any real additional income.

Mr McCoy, who was launching the ESRI's Quarterly Economic Commentary, said an increase in the tax bands of "5 per cent plus" was affordable. He believes two years of fiscal drag, when coupled with increasing tax compliance, will make taxpayers "less inclined to be fooled" by another year of non-movement on bands.

He sees no compelling reason for a move on the actual tax rates however.

A presumption that renewed strength in the public finances could support substantial tax reductions would be "seriously misplaced", according to the institute.

It is also cautious on calls for substantial growth in public spending, warning that such expectations need to be "tempered" by the knowledge that large windfall receipts have flattered the current Exchequer picture.

The ESRI expects the Exchequer to end this year in deficit by slightly more than €1 billion. This compares to the Department of Finance's Budget Day forecast of €2 billion. The difference is attributed to a combination of buoyant economic conditions and "one-off factors" such as €650 million in receipts from the Revenue's offshore accounts investigation.

The general government balance, which is seen as a broader measure of the State's financial position, is expected by the ESRI to be in surplus by about €53 million at the end of December.

This would leave the Republic well within the fiscal management guidelines set by the Stability and Growth Pact governing EMU, even allowing for a deterioration in the public finances next year as various windfalls drop out of comparisons.

The ESRI has substantially raised its growth expectations for this year and next on the basis that the international recovery will continue to feed through to the Republic.

Gross domestic product (GDP) will grow by 4.6 per cent this year and by 5.2 per cent in 2005, according to the latest commentary. This compares to earlier forecasts of 3.5 per cent and 4.5 per cent respectively.

Gross national product (GNP), which is seen by many as a better measure of how the economy is performing, is forecast to grow by 4.3 per cent this year and by 4.5 per cent next year.

Before real evidence of the growing economic recovery had emerged in the spring, the ESRI was expecting GNP growth of 3.3 per cent in 2004 and 4.4 per cent in 2005.

The institute is also expecting a "benign" picture in the labour market, with the unemployment rate forecast to fall from 4.5 per cent to 4.3 per cent in 2005.