A pay rise totalling 3 per cent to compensate for the impact of rising inflation was agreed last night between unions and employers on the eve of the Budget.
The breakthrough came as the Minister for Finance, Mr McCreevy, prepared to cut two percentage points off the standard rate of tax and two percentage points off the top rate in tomorrow's Budget.
Under the deal agreed at Government Buildings, workers will be paid 2 per cent from April 6th, 2001, and 1 per cent from April 2002, in a once-off lump sum.
This means that for next year the second-phase pay increase under the PPF will increase from 5.5 per cent to 7.5 per cent.
The executive of the Irish Congress of Trade Unions said it would be meeting on Friday to examine the new deal in the context of the Budget.
Meanwhile, the standard rate of tax will drop to 20 per cent and the top rate to 42 per cent when Mr McCreevy unveils his fourth Budget. The Minister has agreed to reduce the top rate following sustained pressure from the Progressive Democrats.
It is understood that the tax cuts were finalised over the weekend following intensive discussions last week between the Tanaiste, Ms Harney, and senior Fianna Fail Government colleagues.
The Taoiseach had made it clear that his preference was to leave the top rate unchanged, or at most to cut it by only 1 per cent.
However, the Progressive Democrats argued that if both rates were cut by 2 per cent the Government would have delivered on its commitment in the Programme for Government to bring the rates down to 20 per cent and 42 per cent. The Programme for Government promised further that, if the economic climate allowed, the top rate would come down to 40 per cent.
The extent of the Government's room for manoeuvre was underlined yesterday by the latest figures from the Department of Finance, which showed a surplus of Exchequer revenue over spending of £3.84 billion at the end of November.
According to official estimates, revenue will increase by about £1.3 billion in December and, with spending of £2.7 billion, the surplus at the end of the year will be £2.45 billion.
According to Dr Dan McLaughlin, chief economist at ABN Amro, the Government may even have £100 million more than this at the end of the year if, as expected, it fails to spend all the money it has officially earmarked.
The total Budget package is expected to deliver about £1 billion in tax cuts as well as substantial spending increases.
Sources told The Irish Times that there was some tough talking between the Government partners before it was agreed that the two rates of tax would be cut by two points each.
The Minister is also expected to announce significant widening of the tax bands and allowances. Increases of about £1,000 in the personal allowance or tax credit and the PAYE allowance will ensure that thousands of people are taken out of the tax net. Ms Harney has pressed continually for workers on the minimum wage to be exempt from tax.
A significant widening of the personal tax band to about £21,000 will also take thousands out of the top tax net.
Mr McCreevy is also likely to cut VAT by 2 percentage points as part of a three-year transition towards EU norms of around 16 per cent.