If increases in tobacco taxes are to be contemplated in the future the nextbudget might be an opportune time to begin the process, writes Austin Hughes.

You have to be careful when getting rid of old clothes. What might have looked completely ridiculous in recent years could become next season's hottest item. And the same is true of economics.

Hair-shirts last worn in Ireland in the late 1980s now threaten a big comeback. According to the Minister for Finance, the backdrop to next year's Budget is extremely difficult.

Clearly, it will be cut from an altogether different cloth to Mr McCreevy's previous offerings. As in the past, the key question is whether Budget 2003 will fit the present needs of the Irish economy.

The task facing Mr McCreevy in framing the next Budget is simple. He must ensure that whatever changes he makes do not make an already difficult situation altogether worse for the Irish economy.

In my view, this means he must not introduce an unnecessarily tough package.

A very restrictive budget could dent sentiment among households and businesses and depress domestic spending. Because we are not in a crisis situation, I would also be concerned that it would be difficult to sustain an extremely tough approach.

Within a year or two, we might well return to "giveaways".

The main focus in Budget 2003 must be to restore order to public spending. However, in the run-up to December 4th, it is likely that most talk will be of tax changes. Already, there have been suggestions that the Minister will not adjust income tax bands or allowances, effectively increasing the income tax burden.

Similarly, "stealth" taxes encompassing increases in various public sector charges are feared. Finally, there have been rumours of large increases in duties on the "old reliables": petrol, alcohol and tobacco.

If public spending is adequately controlled, there should be no need for a rise in the tax burden on Irish business and households. In any event, there is a risk that tax increases could backfire. If they hit spending and put upward pressure on domestic costs, higher taxes could damage the Irish economy, thereby weakening rather than strengthening the budget position.

These concerns must be weighed against a likely need for higher tax revenues, particularly as major headings such as income and corporation taxes are unlikely to show any great buoyancy in a sluggish economy. Higher taxes on tobacco products could play a key role.

If, for example, the duty on a packet of cigarettes was increased by €2, something approaching €600 million in additional revenues would be raised next year. This would go some way towards preventing tax increases in other areas. Alternatively, it might be channelled into priority spending areas such as health.

I must admit that, when the Minister added 50p to the price of a packet of cigarettes in the budget before last, I thought it was an extremely bad idea. That tax rise gave further impetus to an accelerating inflation rate in Ireland.

Although the measure added a significant 0.75 percentage points to the consumer price index, it was just one of a range of factors adding to price pressures at the time. So, analysts and wage bargainers didn't isolate it from other influences driving up the cost of living.

Clearly a €2 rise in duties on tobacco would have a dramatic impact on Ireland's consumer price index in 2003, but it could be less inflationary than the rise of two years ago or than alternative revenue-raising measures might be in the current climate.

A Big Bang approach to cigarette duties would have to be accompanied by a freeze on other duties and indirect taxes and by a commitment that other public sector charges would not add materially to Irish inflation. If this was done, the tobacco duty increase might be seen as a policy-driven change in the relative price of tobacco rather than just another symptom of general upward pressure on prices.

For example, Irish inflation - excluding the impact of higher cigarette duties - might rise by a shade under 4 per cent next year, whereas the Consumer Price Index including the impact of higher duties would increase by about 6 per cent. The gap between the two measures should be sufficiently large to force analysts and wage bargainers to clearly distinguish this tobacco increase from general trends in the cost of living.

If increases in tobacco taxes are to be contemplated in the future, Budget 2003 might be an opportune time to begin the process. This is because the measures would take effect as talks on a new pay deal begin in earnest. Negotiators could be encouraged to take into account health and revenue considerations and focus on measures of inflation that exclude tobacco taxes. Unfortunately, the timing of the 50p hike two years ago aggravated pressures on the current deal.

This is not to say that a large increase in tobacco duties would be an entirely risk-free strategy. Such strategies simply don't exist in the current climate. Higher taxes would need to be accompanied by strong anti-smuggling measures. A case could also be argued for budget largesse towards lower income groups, which might be hardest hit by this increase.

These caveats aside, alongside health considerations, it should be remembered that revenues raised in this manner would likely have a far smaller direct impact on the cost of doing business in Ireland than many other measures Mr McCreevy may currently be contemplating.

Austin Hughes is chief economist at IIB Bank