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Supply-side emphasis in tax reform should be continued Back  
Dermot O’Brien believes that overall budgetary strategy should emphasise supply-side measures within a framework of targeted budget surpluses.
Overall budgetary strategy should emphasise supply-side measures within a framework of targeted budget surpluses. Although the pace of growth in the economy is slowing from the exceptional rates of the last five or six years, there is every reason to be confident that relatively fast growth will persist for a number of years yet, under the impetus of strong growth in labour supply and of a shift in the age composition of the population that is producing a structural expansion of domestic demand. Economic growth above the historic 4 per cent trend will not last forever but while it does, it will be of significant benefit to the public finances. This gives the government room to pursue a variety of objectives. To my mind, the main emphasis in the choice among these objectives should continue to be on unwinding the negative effects of fiscal policy mistakes made in the 1970s and 1980s that left the country with inadequate physical infrastructure, a tax burden at disincentive levels and a substantial level of debt. Headway is being made in addressing the infrastructure deficit and there has been a perceptible lessening of tax disincentives. Reducing the absolute size of the national debt has not been an explicit target of fiscal policy but is a legitimate use to which part of the growth-enhanced public financial resources should be put. This requires explicitly targeting an ongoing budget surplus.

Such an explicit objective might also have the benefit of inducing some measure of control over current spending. One of the most worrying aspects of fiscal developments in the last few years is the acceleration in the growth of such spending. Although Charlie McCreevy originally set a target of keeping growth in nominal net current spending to an annual average 4 per cent over the life of the government, actual spending growth has been nearly twice the target rate at about 7.5 per cent. This year, current spending other than on the service of debt is set to rise by almost 18 per cent. The buoyancy of the public finances in recent years appears to have made it difficult for government to withstand pressure for extra spending. Yet, lack of control over current spending was the key mistake made in the 1970s and 1980s and failure to control spending now risks a repetition of the depressing experience of the 1980s at some point in the future.

In this connection, and in order to provide some perspective within which to view the budget, it would be useful if the Department of Finance went further than three years in its budget forecasts. Longer-term budget simulations on varying assumptions - along the lines of those produced in the US by the Congressional Budget Office and Office of Management and Budget - would hopefully expose any risks inherent in the continuation of current policies.

The supply-side emphasis in tax reform should be persisted with. Income tax adjustments in Budget 2001 were substantial. Repetition of their scale in 2002 is probably not warranted and, indeed, a less ‘generous’ approach has already been signalled. However, care should be taken not to go too far down the parsimonious path and allow the tax burden to rise again through fiscal drag. At a very minimum, therefore, the principle of the annual indexation of tax bands and allowances should be enshrined in the budget. To allow for a reasonable growth in real incomes, the indexation factor should make allowance for productivity growth as well as general inflation.

As far as other specific measures are concerned, the removal of the ceiling on employers’ PRSI contributions should be rescinded. This is a direct tax on employment, especially at the higher end of the skills spectrum, which flies in the face of industrial development and employment policies.

Last year I advocated rescinding the decision to apply penal stamp duty rates to non-owner occupier house purchases. I repeat that recommendation this year. It is clear that the 9 per cent stamp duty rate for such purchases has discouraged investor interest in the housing market. If anything, this has exacerbated the lot of those squeezed out of the market by the house price inflation of the past five years because the cost of alternative, rented accommodation has accelerated sharply.

According to CPI data, rents rose by about 61/2 per cent in 1999. Last year the average increase was 11 per cent and in the year to July 2001 the rate quickened to over 16 per cent. Government interventions in the housing market in the last few years have not been marked with success. There is no shame in reversing a mistake.

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