Public and social services cannot be maintained by our minuscule levels of income tax, writes Garret Fitzgerald
SINCE PAUL Tansey's return to The Irish Times the quality of his insights and the clarity of his exposition had encouraged me to spend somewhat less time on economic issues. Paul's economic skills will be greatly missed by Irish Times readers - just as his great personal qualities will be missed by all who knew him.
As to the forthcoming budget, whatever it may contain, I would say that it is important that it make the kind of provision that my government made in the 1980s to ensure that at no point will social welfare payments fall short of increases in the cost of living.
Next, spending cuts must as far as possible spare the less-well-off. In so far as such cuts are made they should concentrate on forms of expenditure that are regressive - such as child benefit payments to higher income groups.
That said, at last Tuesday's ESRI budget conference several distinguished economists made it clear that the emerging budget deficit is not due to excessive current expenditure - which up to end-September remained close to its budgeted level - but has in fact been caused by problems on the revenue side.
Philip Lane told the conference that "it is not credible that the required adjustment can simply land on spending, in view of the considerable demand for improved public services and the added burden of increased spending on unemployment-related welfare payments". Patrick Honohan agreed with this, saying that we should have as a current expenditure target a proportion of GDP something around last year's figure.
To finance our 2007 spending level within the eurozone 3 per cent borrowing limit it would now be necessary to increase tax revenue by about 6-7 per cent. But both Honohan and Lane insist that this necessary increase in taxation must be implemented on a phased basis, aiming at a gradual reduction of our borrowing rate from the figure of around 5.5 per cent of GDP to within the eurozone 3 per cent figure.
Lane also said that it would be foolhardy to attempt to return inside the 3 per cent limit too quickly in view of the negative impact on the economy of excessively large increases in taxation, or cuts in spending. Honohan agreed, suggesting that this process should be planned to be completed over a period of at least five years.
This recommendation is very important, because, despite the risk of thus doing even more damage to the economy, the Government might be tempted for political reasons to get as much as possible of the pain over now, when people are prepared for tough action, rather than spreading the burden over the run-up to the next election.
This increased taxation is needed primarily to deal with the the consequences of the Government's very foolish decision in recent years to make use of an essentially temporary trebling of receipts from asset-related taxes to finance populist and unrealistic income tax cuts. Already by end-September receipts from these asset-related taxes (stamp duty, capital gains tax, and capital acquisitions tax) had been virtually halved, with further heavy falls yet to come.
In the years since 1997 the now-disappearing boom in these asset-related tax receipts was used to reduce the share of revenue from income tax by an unsustainable 25 per cent. At last Tuesday's conference Lane showed that what this did was to reduce the tax paid by a married man with €33,000 a year to half of what such a person would pay in Britain or the United States and one-third of the French or German tax level on such an income.
The idea that when the boom ended our public and social services could be maintained with such a minuscule level of income tax payments was patently absurd, although clearly many people fell for it - including our economically unsophisticated business community. At the conference Lane made it clear that "it is inevitable that the burden of higher taxation must fall on these groups, in addition to any extra revenues that are obtained from the higher income cohorts".
How can the Government start the process of increasing tax receipts, with a view at least to keeping our borrowing rate for next year at around 5.5 per cent of our GDP?
It could take steps to modify considerably the regressive capping of social insurance payments which exempts all those with incomes over €50,700 from paying their share of what in reality is a disguised form of supplementary income tax rather than a social insurance scheme.
The Government may also seek to increase tax revenue by not raising, or raising only marginally, the income tax band thresholds.
Finally, the 41 per cent rate of tax payable by those with higher income levels could be reviewed. I have always believed that, while it was absolutely right to bring our top tax rate down from the very high level to which it was raised during the crisis of the 1980s, it was a mistake to bring it down as far as 42 per cent.
And it was a blunder to reduce the higher rate further to 41 per cent just two years ago. I suspect Brian Cowen did this with reluctance, because of pressure from the PDs. There is currently room for some increase in this rate to help reduce the scale of borrowing.
Such measures could, perhaps, hold next year's borrowing rate at 5.5 per cent, but a much larger group of taxpayers will have to bear the brunt of getting this figure down to, or below, 3 per cent over a period of years.
The Taoiseach was right in principle to have declared some time ago that in choosing what spending cuts to make in our developing financial crisis, he would try to preserve our infrastructural investment programme - much of which is necessary if we are to be able to grow our economy without creating further inflationary pressures.
But not all of our capital projects are equally meritorious and some of those projected have failed the criteria which the Taoiseach himself laid down when he was minister for finance. This is the case with the western rail project, which the Government authorised despite the fact that it appears to have failed the viability test. I also doubt whether the Metro West project and the plan to build two rail lines between St Stephen's Green and O'Connell Street could now have passed the Cowen viability test.