ANALYSIS: The Exchequer figures for early 2002 are casting serious doubt on the election promises. John McManus reports
Something has gone very wrong with the Government's sums. The amount of income tax collected in the first four months of the year is now more than 10 per cent less than was collected in the same period last year. According to the Budget forecasts, it should be the same if not more.
In the normal way you would expect such a dramatic decline in income tax receipts to be a consequence of something like a sharp rise in unemployment or some other obvious economic factor. However, in recent months the income tax take is falling at a time when the number of people at work remains roughly stable and data suggests that the average salary has gone up by something like 10 per cent over the last 12 months.
There are a number of explanations mooted, ranging from the simple to the cataclysmic. The most dramatic is that the outgoing Government's grip on the economy was so shaky that the tax cuts introduced over the last five years have reduced the number of people paying tax and the amount they are paying beyond the level needed to sustain the Exchequer.
On the face of it there does seem to be some merit to this "black hole theory". The key tool used by the Government to plan their policies is the Department of Finance's computer model of the Irish economy. This simulates how the economy and, more specifically, the Exchequer finances work. When the Government wants to establish what will be the impact of its economic policies - such as tax cuts - it puts them into the model and sees what figures come out the other end for things such as income tax receipts, based on various assumptions on items such as growth and inflation.
This was all done as part of the process of putting together the last Budget, but the income tax receipts predicted have not materialised. Is it possible the Department of Finance no longer understands how the economy works?
Yesterday, the Minister for Finance, Mr McCreevy, strongly denied there was a looming crisis in the public finances and said the Exchequer balance will be in line with his Budget predictions.
Mr McCreevy, speaking at a campaign briefing, said the tax revenue figures for this year were distorted by a number of events: the taxation changes taking effect from January 1st, social welfare increases taking effect earlier, while the 1 per cent VAT increase was only kicking in now.
"I would be quite confident taxation is going to rebound" in line with the Budget projections, he said.
However, a strong recovery will be needed over the rest of the year if the Budget predictions are to be met. And much will depend on precisely why the shortfall has occurred in the early months.
One of the more plausible explanations is that many employers are responding to the economic down- turn by cutting things like overtime and bonuses, rather than staff numbers. The reason employers would do this is that most believe the downturn will be short-lived and it makes sense to retain experienced staff in anticipation of the upturn. As a result payrolls - and income tax - are falling while unemployment remains static.
Another - more technical - possibility, and one which Mr McCreevy believes is part of the explanation, is the impact of the decision last year to change the end of the tax year from April to January. There have been two rounds of tax cuts since April last year, rather than the usual one. The tax cuts announced in the December 2000 Budget were introduced in April 2001, while the tax cuts announced in the December 2001 Budget were introduced in January 2002. This affects the comparison of the figures from the early months of 2002 with those from the comparable period the previous year. If this is a significant factor it should work itself out of the figures in a couple of months.
At present the jury is out, but if the income tax numbers do not start to bounce in the next couple of months there will have to be a critical examination of the impact of the last five years' tax policies to see if that is where the problem lies.
"There will have to be a very serious analysis to establish who is now actually paying tax and how many people are paying tax at the top rate," predicts Dr Dan McLaughlin, chief economist with Bank of Ireland Treasury
By the time the root cause of the income tax shortfall is established the damage to the Exchequer fin- ances may already be done. "The bottom line impact is that overall tax revenue is down almost 2 per cent in the year to date compared with a Budget forecast of an 8.6 per cent rise for the year as a whole. If the Budget target is to be achieved then tax receipts in the final eight months will need to be 13 per cent above the same period last year," according to a sceptical Mr Robbie Kelleher, Head of Research at Davy Stockbrokers.
A substantial fall in income tax revenue will result in the Exchequer running a deficit for 2002 rather than the small surplus which Mr McCreevy insisted yesterday was still on the cards.
The growing hole in the Department of Finance tax projections makes the current debate on the accuracy of the fiscal projections in the various election manifestos "look rather silly", according to Mr Kelleher. All the manifestos are based on the Budget prediction of a small surplus of €171 million for the year.
Mr Kelleher is now predicting that the tax shortfall could be as much as €1 billion. The problem this creates for the national finances will be compounded if Government spending continues to rise at its present rate. Day-to-day spending is currently 21 per cent ahead of last year for the first four months of the year. Given that the incoming Government will be under pressure to deliver on election pledges the 14 per cent increase in overall spending that is pencilled in for the full year already looks hopelessly optimistic.
The income tax shortfall and current spending increases also make the Government's 2002 forecasts and the various parties' election manifesto projections based on them all start to look fairly meaningless. "If the forecasting errors on a one-year time horizon can be as large as this, what chance has anybody with projections that go out over five years?" asks Mr Kelleher.
The mystery of the disappearing income tax receipts may take the shine off the political parties' election manifestos, but it is no cause for panic, according to Dr McLaughlin.
The amount of money accruing to the Exchequer in the first four months from other taxes such as VAT and excise duty are growing pretty much in line with the Department's projections. This indicated that there is no wider black hole in the economy and that the problem is confined to income tax.
At this stage it looks almost certain that the final year figures for income tax will out by at least €500 million, but this should be seen in the context of a €2.5 billion shortfall in tax revenue in 2001.The economy will grow strongly towards the end of this year according to most observers and the finances may rebound with it. But the jury remains out on the extent of the problem until we see figures from a few more months of this year.