The Minister for Finance still has an opportunity to make some major fiscal reforms in the Budget, writes Marc Coleman.

As the McCreevy era of Irish fiscal policy draws to a close, our national debt, direct taxation rates and unemployment rate are now lower than in most other European countries. It might seem that another epoch of fiscal reform is unnecessary and that political considerations can henceforth dominate the framing of budgetary policy.

But much of our public expenditure is still wasted, and many of our public services are poorly delivered. More pressingly, our national cost of living is so high as to threaten fundamentally our future competitiveness and prosperity. This week's Budget must pay more than lip service to these challenges.

In the Book of Genesis, Joseph explains to the Pharaoh the wisdom of saving, rather than consuming, surplus harvest grain during seven years of plenty in preparation for seven years of famine. The Stability and Growth Pact says more or less the same thing, albeit less elegantly.

In practical terms this wisdom says that as an economy improves and tax revenues climb and expenditures fall, the Government should not spend the resultant windfall, but plan for the long-term.

The Minister for Finance, Mr Cowen might recall to some of his colleagues what happened in 2000 and 2001 when public expenditure growth was allowed to surge on the back of strong Exchequer returns. Much of that strength turned out to be self-reversing, forcing the Government into painful and costly changes in policy.

Particularly regrettable were the disruption of capital expenditure programmes and the increases in indirect taxation the Government resorted to to fill the hole left in our finances by lower than expected tax revenues. This interrupted badly needed infrastructural development, while increasing the cost of living and threatening competitiveness.

Moving fiscal policy towards a smoother basis is an important challenge and should be a defining characteristic of the "Cowen era". The "McCreevy era" saw this process begin, but there is much further to go.

First, there can be no more pressing long-term economic issue than the appalling cost of living. A policy of reducing indirect taxation could be a powerful instrument in changing inflationary expectations, as well as bringing some needed relief to consumers.

Second, the lack of indexation of income tax bands constitutes a persistent lack of transparency into our system of personal taxation that should be eradicated once and for all. As a believer in social partnership, Mr Cowen should accept that such a system can only operate if the tax reductions specified in itsagreements are not eroded by inflation.

Third, the inefficiency of public expenditure in many areas of the public sector must be accepted as the main reason both for the unsustainable growth rates in expenditure seen in recent years, as well as the poor state of our public services.

An ECB working paper from last year showed our health and education services are the second least efficient in the OECD. Similar signals have come from respected international sources such as the OECD and IMF, not to mention considerable evidence from domestic sources, such as the Hanly and Brennan reports, which relate to the health sector.

As a former health minister, Mr Cowen doesn't need an ECB working paper to tell him about the problems we face in this area. He knows the reforms that are needed. As the new custodian of the benchmarking process, he is in a pivotal position to extract from the public sector every possible ounce efficiency in return for whatever spending increases he decides to allocate to departments. Such a quid-pro-quo should also apply to the granting of benchmarking pay awards.

Finally, the other half of Joseph's prescription is that grain surpluses should be run down in years of famine. In a modern economywhen tax revenues increase and welfare payments decline, fiscal balances improve in good years without any need for government intervention. The reverse happens in bad years.

This symmetrical "breathing", is healthy provided that the average balance (or "structural" balance, as economists would call it) is sensible and prudent.

But what is sensible and prudent? Targeting an average deficit of around 1.5 per cent of GDP over the medium term seems reasonable. Borrowing the full five per cent of GDP that we currently invest in public infrastructure would be inappropriate not only because of the implied breach of the Stability and Growth Pact, but also because of the high level of wastage and overspending in capital expenditure.

However, following EU enlargement and the entry of new countries with huge investment requirements, the Pact should be more flexible and should tolerate medium-term budgetary deficits of around one percentage point for low-debt countries. This should ensure that there is no risk of breaching the 3 per cent deficit limit.

Ireland has adhered to the Pact faithfully and a reform should simply give low-debt countries like Ireland and the new member-states more freedom to run medium-term budget deficits, provided that the hard targets for budget deficits and debt ratios are adhered to.

Borrowing to fund capital investment expenditure is one thing. Borrowing to fund wasteful expenditure is another, however. There is huge scope for cost savings in the public sector if more efficient methods of operation are adhered to.

Mr Cowen should exercise leverage to ensure that whatever increases in expenditure are agreed for line departments are matched as far as possible by contingent and measurable improvements in the cost of delivering public services in the relevant department. A similar approach must also underscore the second benchmarking exercise.

In summary, Mr Cowen should ensure that the ebbs and flows of our exchequer are not interrupted for short-term considerations, but that our budgetary position rises and falls around a golden mean whose position on the plus/minus axis is defined by sensible criteria. The goal of a fiscal balance over the medium term is excessively strict while the National Development Plan is still in operation and if by its end in 2006 the government is running an average or "structural" deficit of around 1.5 per cent of GDP, no one should have grounds to object.

In using whatever room for manoeuvre he can find, Mr Cowen's main challenge will be to claw back from the public sector some real and quantified gains in terms of cost efficiency and service quality for any increases in spending, as well as for benchmarking pay awards.

Otherwise, any extra fiscal largesse, whether funded by borrowing or taxation, will have been a wasted exercise and the next Budget will be merely an exercise in pouring more water into a leaking bucket.

Marc Coleman worked until recently as an economist with the Fiscal Policies Division of the European Central Bank. He is currently on scholarship at the Michael Smurfit Graduate School of Business.