The Government will either have to raise taxes or borrow if it wants to deliver any appreciable improvements in public service provision next year, Dr Alan Barrett of the ESRI said yesterday.

Dr Barrett told the ESRI's "Budget Perspectives 2008" conference in Dublin that raising taxes a little in the Budget would "not cause a collapse in civilisation".

Placing higher taxation back on the public policy agenda, Dr Barrett said that limited tax increases "would not be economically damaging" and would provide the Minister for Finance with "wriggle room" on the expenditure side in December's Budget.

He added that he was "not entirely convinced" that the proposed reduction in the top rate of income tax from 41 per cent to 40 per cent was the most pressing change required in the tax code.

The ESRI forecasting team estimates that, on the basis of broadly unchanged spending policies and allowing for indexation and public service pay increases, current public spending will increase by 7.1 per cent or €3 billion next year.

With the economy slowing to a real growth rate of about 3 per cent, the ESRI anticipates that tax revenues, at unchanged rates, will increase by just 4.2 per cent or €2 billion in 2008. On these calculations, the General Government Balance for 2008 comes out at zero.

Current public spending is set to increase by 13 per cent this year.

The Minister for Finance, Brian Cowen, already has made clear his intention to reduce substantially the rate of growth in day-to-day public spending in 2008, perhaps to the 7-8 per cent range.

The Pre-Budget Outlook, published last week by the Department of Finance, indicated that the cost of maintaining existing public services through 2008 will add 4.8 per cent automatically to next year's bill for current Government spending.

This leaves limited latitude for engineering any improvements in public services next year.

"The Minister will have to make choices along lines not seen for many years in Ireland," Dr Barrett told The Irish Times after yesterday's conference.

Raising additional tax revenues or undertaking borrowing would provide the Government with "room for manoeuvre on the spending side", Dr Barrett said, professing himself agnostic on which option it should choose.

However, if taxes are to be raised, Dr Barrett said this should be achieved by widening the tax base rather than by raising tax rates.

If borrowing is favoured, it should be a short-term expedient, as a prolonged spell of Government borrowing "would be dangerous".

The economy will experience below-trend growth next year, "but the trend itself is slowing a bit also", Prof Philip Lane of Trinity College Dublin told yesterday's conference.

While the proximate cause of the economic slowdown is the downturn in residential construction, the Irish economy's trend growth rate is also faltering.

While public investment should be maintained at high levels to compensate for past under-investment, the growth in current public spending "has to be considerably restricted" during the current adjustment process, Prof Lane said.

If the community wants permanently higher levels of public spending, then it must also accept higher taxes.

The conference also heard a proposal that tax relief on pension contributions be allowed only at the standard 20 per cent tax rate.

Prof Brian Nolan of UCD and Prof Tim Callan of the ESRI estimated that the additional tax revenues generated would be sufficient to finance an increase of €50 a week in the social welfare old age pension, greatly reducing the risk of poverty for elderly people.

They said that three-quarters of the value of tax relief on pension contributions goes to the top one-fifth of households