Next week, Mr Charlie McCreevy will deliver his seventh budget as Minister for Finance and faces a number of interesting issues on taxation, notably in terms of excise duties and income tax.
The choices he makes have bigger implications for growth and inflation in 2004 than for the level of Exchequer borrowing.
Raising revenue by increasing the excise duty on the "old reliables" of drink, fuel and tobacco has been a staple of budgets the world over, and the Irish variant is no exception. The 2003 budget, for example, raised excise duties on cigarettes and spirits, with the intention of boosting tax receipts by over €230 million.
The increase in tax is normally passed on to the consumer in higher prices so the expectation of higher revenue is based on the presumption that the demand for products like alcohol and tobacco will not respond excessively to the price change. In fact this has generally been the experience and the temptation for any finance minister is to go back to the well every year, with the result that tax now accounts for a very high percentage of the price of some consumer items.
Take cigarettes, where the total tax accounts for almost 80 per cent of the price, or petrol, where it generally exceeds 60 per cent. For beer, the figure is much lower at 30 per cent, because successive finance ministers have generally spared pint drinkers.
The dilemma now facing Mr McCreevy is that the consumption of cigarettes and alcohol appears to have fallen in 2003, perhaps indicating that demand is responding to the scale of price increases seen in recent years.
Cigarette consumption, for example, is estimated to have fallen by 10 per cent in 2003, and tax receipts may undershoot the Budget target by over €100 million. Similarly, the demand for spirits may have fallen by 20 per cent leading to a €40 million shortfall on expected revenue. Even beer is not immune, with consumption down by 2.5 per cent on last year. So the implication is that hefty increases in excise duties may no longer deliver the bounty once assumed, and in 2004 there is the specific complication of the proposed ban on smoking in the workplace, which will add a further degree of uncertainty to any projections of cigarette demand.
A second related point is that last year's tax increases added 0.9 per cent of the annual inflation rate, so if the Minister chose to leave excise duties unchanged, the impact would be pronounced and observable in the December and January CPI readings. Indeed, inflation could fall to 1.2 per cent by March if the Minister left excise duties unchanged and could average only 1.7 per cent for 2004 as a whole, which would be a positive backdrop to any negotiations on a new national price deal.
On the income tax front, the key decision is whether to raise the bands and tax credits in line with expected inflation. So called 'stealth taxes', actually higher user charges for public services, have received much publicity of late but the 2003 budget had a significant impact on disposable incomes by freezing tax credits and the tax bands - anyone receiving a 3.5 per cent pay rise in 2003, for example, would be broadly matching inflation, and hence receiving no increase in real income, but would pay more tax on the higher income.
For some, the fall in real disposable income would be sizeable if they were pushed into the top tax bracket. This phenomenon is known as fiscal drag and does not get the attention it deserves - 30.5 per cent of tax payers now pay at the top rate of tax, up from under 28 per cent in 2002, a tax increase by any other name.
Moreover, if the Minister repeats the exercise in next week's Budget, over one-third of taxpayers would be paying the 42 per cent tax rate, the highest percentage since the 1980s, with clear implications for consumer spending in 2004. Again though, a low inflation environment means it is less expensive to index bands and credits.
Overall, I expect the improved economic outlook, with a concomitant rise in projected revenue growth, will leave the Minister with little to do on the tax front, perhaps making for one of the shortest Budget speeches on record.
He may raise credits by 3 per cent and widen the tax band by a similar percentage, so reducing the impact of 'fiscal drag', and pay for this and higher social welfare payments by tax buoyancy. Consequently, there may be little or no excise increases, leaving the Exchequer borrowing requirement around €2.7 billion . For EU purposes it is the General Government deficit which counts, and that may be around €1.3 billion , the difference largely reflecting payments to the National Pension Reserve.
A deficit of this magnitude would be less than 1 per cent of GDP and so very conservative in an economy growing below potential, but Charlie McCreevy's record suggests he will not budget for a much higher figure even if France and Germany are willing to run deficits of 4 per cent of GDP, in the process driving a coach and horses through previously agreed fiscal rules for the euro area.
Dr Dan McLaughlin is chief economist at Bank of Ireland
