Public spending has been pushed higher by unexpected bills for unemployment benefit, writes Paul TanseyEconomics Editor

THE GOVERNMENT has cut its forecast for economic growth this year to just 0.5 per cent from 2.8 per cent at the time of the 2008 budget, Minister for Finance Brian Lenihan announced yesterday.

The virtual evaporation of economic growth this year is expected to cause tax revenues to fall short of budget targets by €3 billion during 2008, the Minister said.

Government spending - current and capital - was broadly in line with budgetary expectations in the first half of the year, with core current public spending rising by 8 per cent.

However, day-to-day public spending will be pushed higher in the second half, principally because of rising bills for unemployment benefit.

The average numbers on the live register during 2008 are expected to rise from a budget estimate of 170,000 to some 210,000, adding almost €500 million to the annual bill for benefit payments in 2008.

The Government will announce a package of savings after next Tuesday's Cabinet meeting to offset this unanticipated increase in public spending.

Even with spending growth contained within the levels targeted in the budget, the steep decline in tax receipts this year will cause the Government's overall budget deficit to swell to some €5.2 billion.

The overall deficit - the general government deficit - was projected at €1.8 billion for 2008 when the budget was launched last December. In consequence, official expectations are that the Government's budget deficit will rise to 2.75 per cent of gross domestic product (GDP) in 2008.

At budget time, a deficit equivalent to 0.9 per cent of GDP was anticipated.

The budget deficit now projected for 2008 is within hailing distance of the 3 per cent deficit limit imposed by the EU Stability and Growth Pact.

The economic downturn was mirrored in the Exchequer Returns for the first half of the year, published yesterday.

Tax receipts gathered by the exchequer in the first six months of 2008 fell €1.45 billion or 7 per cent short of budgetary expectations. Three tax headings - VAT, capital gains tax and stamp duties - accounted for 82 per cent of the total tax shortfall.

In turn, the weak performance of these taxes indicates both the steep decline in housing markets and slower consumer spending growth.

The trend in tax receipts continues to worsen as the year progresses. While tax revenues were 7 per cent below budget targets for the first half of 2008 overall, during the month of June they fell 12.4 per cent short of expectations.

The weakening tenor in tax receipts reflects the downward turn in economic activity.

This marked deterioration in the economy's performance is captured in the revised Department of Finance forecasts for economic activity this year.

The department has cut its forecast for the growth in real gross national product (GNP) to 0.5 per cent. This is down from 2.8 per cent in last December's budget.

As can be seen from the table above, the downward revision is based principally on a much steeper decline in gross fixed investment than was anticipated at the time of the budget.

The volume of fixed investment is now projected to fall by more than 15 per cent this year - triggered by the construction collapse - where a decline of just 1.6 per cent was forecast in the last budget.

The Department of Finance's revised forecasts for 2008 are broadly similar in approach, if not in detail, to those released by the Economic and Social Research Institute (ESRI) last week.

Projecting a recession this year, the ESRI anticipated that the economy would contract by 0.4 per cent in 2008.

The principal difference between the two forecasts lies in the fact that the Department of Finance is somewhat more optimistic on the shape of consumer spending this year - it is forecasting a 2.3 per cent volume advance.

In support, it can point to the 3.5 per cent volume increase in consumer spending that was shown in the national accounts this week for the first quarter of 2008.

It is also still projecting a 0.6 per cent advance in employment during 2008.

By a hair's breadth, the Department of Finance has managed to avoid the embarrassment of forecasting a recession.