THE new Fianna Fail/Progressive Democrats Government has inherited an economy that has been performing better than any in the industrialised world. However, this new Coalition has also brought into Government some unfortunate baggage in immediate commitments to tax cuts that could, in the short term, prove destabilising economically.
At the same time, its programme seems deficient in social policy commitments and, as far as taxation is concerned, in distributive justice. All these dangers may yet be remedied, but not without changes in direction which could create stresses within the Coalition.
On the economic side, the scale of the tax reduction commitments in relation to the next budget poses risks of overheating an economy that has been growing at an unprecedented rate. This could be true even if the Government succeeded in holding the growth of supply service expenditure (i.e. current spending other than national debt interest) to 4 per cent a year.
For it now seems that between 1993 and 1997 the economy will have grown at a rate of almost 7.5 per cent a year, clearly well beyond the medium- term output growth capacity of any industrialised economy. This spectacular growth has involved using up slack in the economy that had developed between 1990 and 1993, when Europe's growth rate was reduced to barely 0.5 per cent a year.
With Irish growth down during that period to an annual 2.3 per cent - a low figure for this country - room was clearly left for an exceptional spurt of growth in the succeeding years, 1993 to 1997. However, four years later we are today starting to come up against significant capacity constraints, particularly in the supply of labour adequately educated and trained to meet the needs of high-grade employment creation.
Our growth constraints are far less stringent than those of our neighbours: whereas in the rest of western Europe capacity seems unable to grow by more than 2.5 per cent to 3 per cent a year, in our case a sustained growth of 5 per cent to 5.5 per cent appears attainable, at any rate for the next decade. The problem is that, as yet, there has been no sign of growth dropping back to that sustainable level.
For this to happen, our next budget would need to avoid excessive stimulation of growth; especially as last January's budget is judged, I believe, by most economists to have erred on the generous side. This year's November budget ought, therefore, to be quite cautious if we are to avert serious over-heating of the economy next year.
This is even more necessary if approaching EMU leads to a fall in Irish interest rates during the next 12 months, although uncertainties about EMU, together with a possible raising of German interest rates, may postpone such a development.
Unhappily, however, the incoming Government seems to have promised expensive tax cuts next November on a scale which could prejudice our economic future. In theory, this could be avoided by reining in current spending even more drastically than has been promised by the FF/PDs Coalition.
Such a policy, however, would be seriously disruptive to our public services: already the proposal to hold the growth of supply service expenditure at 4 per cent a year in current terms poses dangers to these services.
What Fianna Fail may not have taken into account in arriving at this 4 per cent maximum target is that the inflation rate for public spending over the next five years is likely to be quite high due to commitments on public service pay increases.
Taking account of these commitments, the ESRI has estimated at 4.4 per cent a year the average increase in public service pay over the next five years. And as pay accounts for over 75 per cent of the resources used in the process of public administration, the average price component for this half of State spending can scarcely be much below 4 per cent a year.
As to the other half of State spending - transfer payments, such as social welfare - even if one assumes that the price element here is no higher than the price index for personal consumption as estimated by the ESRI, that would involve a rise of 2.1 per cent a year during the next five years.
Taking these two elements together, I find it difficult to see the overall price index of public spending rising by much less than 3 per cent a year. And that would leave just 1 per cent of the proposed 4 per cent annual growth available for actual improvements in public services.
And nothing in our experience during the current decade suggests that the volume increase of current expenditure can, without considerable disruption of public services, be held down to the 1 per cent a year.
I do not believe growth in the volume of such spending will be reduced to such a level. Nor do I believe that, over the next five years, it will need to be kept so low.
For, if early budgetary action was to succeed in reining in the rate of economic growth to around 5 per cent a year, then, on the basis of the data in the ESRI Medium-Term Review, that would still leave room for the following combination:
Reducing the burden of income tax by 25 per cent - which would involve reliefs totalling Pounds 1.5 billion, as provided for in the FF/PDs joint programme
Cutting corporate tax rates by 2 per cent a year.
Building up a current budget surplus which, by 2002, could reach Pounds 1.7 billion.
By 2002, financing out of this surplus without any Exchequer borrowing a volume of public investment almost 30 per cent higher than today.
In the intervening period, increasing by up to 5.25 per cent a year current Exchequer spending, exclusive of debt interest.
I am afraid that in restricting itself to a rate of current expenditure growth significantly lower than this 5.25 per cent, Fianna Fail has been led by the PDs and some conservative elements in its own higher ranks into committing itself to socially regressive taxation policies.
This is a package which it may regret and one which, I believe, it will come to modify significantly as there are enough socially-concerned people in its ranks to create pressures for such a policy review.
The danger is that, instead of deciding now in a planned way to allocate additional resources to key social and economic needs, the Government will find itself stumbling into incoherent concessions to emerging political pressures for unplanned spending increases, leaving the key social problems unresolved.
AS TO the tax reduction issue, both sides in the Dail are agreed on the total amount to be allocated to income tax reliefs over the next five years - Pounds 1.5 billion - but disagree on how this should be deployed.
For my part, I have to say that I remain unhappy about the tax proposals to which Fianna Fail has committed itself. And I believe that if its members, or its parliamentary party, had understood just where they were being led by tax-cutting competition with the PDs, a very different set of proposals would have emerged.
Before explaining why I feel this, I should state what I understand the Fianna Fail proposals to be and how much each is likely to cost using for the latter the data on the cost of tax changes that were circulated to the social partners and to members of the Oireachtas last November.
1, Reduce top tax rate from 48 per cent to 42 per cent - Pounds 298 million.
2, Reduce lower tax rate from 26 per cent to 20 per cent - Pounds 537 million.
3, Increase Personal Allowances at least in line with inflation - Pounds 270 million.
4, Increase 27 per cent band so as to bring 80 per cent of taxpayers into that band - Pounds 430 million.
Inflation of 11 per cent
Now, I have sought to apply these tax changes to people with incomes currently ranging from Pounds 10,000 to Pounds 100,000 a year but increasing by 22.5 per cent over this period- the average personal income increase expected by the ESRI between 1997 and 2002.
In the case of a single person with Pounds 10,000 a year today and Pounds 12,250 in five years' time, these arrangements would reduce that person's tax take by three percentage points and his or her after-tax income would increase by just under 27 per cent in current money terms. The increase in the purchasing power of post-tax income would be 15 per cent.
However, at the other end of the income scale, a single person with Pounds 100,000 a year today, and Pounds 122,500 in five years' time, would have his or her tax take reduced by almost seven percentage points and that person's after-tax income would increase by 44 per cent in current money terms, or no less than twice their increase in pre-tax income.
Moreover, the purchasing power of such a person's income would rise by just under 30 per cent - once again twice the increase in purchasing power that these tax changes would offer to someone who is today earning Pounds 10,000 a year.
For married people, the effect of these tax proposals would be to within one or two percentage points.
By any standards, the differences between the treatment of the low-paid and of wealthy tax-payers proposed by this Fianna Fail-led Government is quite phenomenal. Did Fiannn Fail canvassers know what they were trying to persuade people to support and did the electorate consciously vote for such a remarkably regressive set of tax changes? I really don't think so.
The fact is that these proposals were not well explained, for the FF/PDs Coalition obviously had no interest in letting people know the effect of what they were proposing, and despite the efforts of certain journalists, including some in The Irish Times, this key issue was eventually pushed into the background by the media generally
Finally, it seems unlikely that a tax reduction scheme as regressive as that proposed by the new Coalition could be fully compatible with that accepted by the trade unions in the Partnership 2000 agreement. And if these two programmes are out of line with each other, then the cost of implementing both simultaneously could exceed the annual Pounds 300 million for tax reliefs upon which both are based.