The ESRI has urged the Government to adopt a tight fiscal policy in the coming Budget and to provide tax cuts of £100 million or less for the next two years, rather than the £200-£250 million which was the norm under Partnership 2000.

The change in direction, which is likely to be highly unpopular with the electorate, is justified by the ESRI on the grounds that extensive investment in the country's infrastructure, necessary to underpin continuing economic growth, has to be balanced by a tightening of fiscal policy elsewhere.

Once the economy slows down - possibly in 2002 - the ESRI envisages cuts in income tax of between £700-£800 million a year being introduced. And, it says, these could continue for a number of years.

The ESRI identifies two main threats to continuing rapid economic growth - a "potential bubble in the housing market" and demands for unsustainable pay increases from within the public service. A rise in industrial strife within the public service, it says, would have a serious knock-on effect on other sectors of the economy.

The proposal to cut tax concessions by half, at a time when SIPTU has proposed a four-fold increase, runs counter to the broad approach being taken by the National Economic and Social Council in relation to a new partnership agreement.

This is recognised by the ESRI, whose report states: "This advice runs counter to the expectations of the vast majority of the population, who see very large surpluses in the Government finances as promising large cuts in taxation or improvements in public services. It is true that the public finances are strong enough to allow for significant tax cuts or spending increases but it is wrong to expect that the Government should fuel the current boom in domestic demand at this time. In particular, rising disposable income translates into more demand for housing. One instrument available to the Government to ease housing market pressures is to take money out of the economy."

Earlier, the report advises that the potential housing bubble is a matter of "serious concern". If faced with an external economic shock, which caused a sudden deflation in house prices, there could be a recession, instead of a mild slow-down, bringing "a number of painful years of unnecessarily high unemployment".

The direct economic costs of pursuing too tight a fiscal policy for one or two years were likely to be very small, the ESRI declares. However, it recognises that this cost could rise if industrial unrest was to increase because of a rejection by employees of a policy of fiscal restraint.

It goes on: "While the probability of a drastic collapse in house prices may not be very high, the potential social and economic costs of such an out-turn would be so serious that it is advisable for economic policy to err on the side of caution. Once the economy slows down in two or three years' time there will be an opportunity for a major relaxation in fiscal policy."

Arguing that fiscal policy had been fairly consistently pro-cyclical over the past 25 years - wrongly accentuating both booms and recessions - the ESRI calls for a new fiscal approach that would adopt the proper stance of "leaning into the wind" by raising tax rates or cutting expenditure in the good times, while helping to cushion periods of slow growth through fiscal expansion. Such an approach was now much more important than in the past because of our membership of EMU, according to the ESRI.