Budget 2007:Political rather than economic factors dominate the framing of budgetary policy, writes Antoin E Murphy

If you were the managing director of a publicly-quoted company and you set out three main budgetary targets which you missed by more than €4 billion in each case, you might expect to be issued with a P45 by irate shareholders concerned about your inability to guide the company.

Yet, this is exactly what the Minister of Finance Brian Cowen has done in his recent Budget without the merest hint of disapproval on this issue from either the media or the politicians in Leinster House.

Welcome to the strange new world where macroeconomic targeting appears to have disappeared from the radar when it comes to Irish budgets.

In Wednesday's Budget, the Minister set targets for the current budget balance, the Exchequer balance and the general government balance, the main budgetary elements influencing the country's macroeconomic performance. These, along with their outcomes are summarised in the table.

Mr Cowen's intent, as expressed in the target, was to run deficits for both the Exchequer balance and the general government balance. Generally these type of deficits are planned to stimulate the economy further.

However, the targets did not become an economic reality. It is quite evident from the outcomes as listed in the table that Mr Cowen's main macroeconomic targets were transformed into macroeconomic fiction over the budgetary year of 2006.

Although he targeted for a Budget surplus of €4.4 billion, he produced one that was more than double that, at €8.9 billion.

Although he wished to run a deficit with the Exchequer balance of €2.9 billion, he actually produced a surplus of €1.9 billion, while the general government balance, meant to be in deficit of nearly €1 billion, became a surplus of nearly €4 billion.

The story behind these major macroeconomic errors is important and raises the issue as to whether political factors have come to dominate, at the expense of economic factors, in the framing of budgetary policy.

The reason given for these widely varying Exchequer outcomes was that tax revenue had been unusually buoyant.

Last year the Minister of Finance forecasted that tax revenue would be €41,650 million, an increase of 6 per cent on the outcome for 2005. It now appears that the actual amount of tax raised will be €45,452 million - an increase of 9.1 per cent over this targeted figure.

This tax revenue buoyancy in turn threw everything out of kilter, transforming the projected Exchequer balance and general government balance from deficits to healthy surpluses. So does the story end here? Was it just a case of a serendipitous tax windfall assisting the Minister of Finance? Not quite.

Tax revenue buoyancy is in reality a euphemism for inaccurate forecasting of tax revenue by the Department of Finance.

In framing the Budget, officials at the Department of Finance have to pay considerable attention to estimating the returns from major sources of taxation namely excise, capital taxes, stamp duties, income tax, corporation tax and VAT.

They balance what is happening to a wide range of indicators in the economy and the way in which these indicators will influence each of these different sources of taxation.

Forecasting is a difficult business. Economic forecasting can be prone to error.

However, when errors are made economists generally attempt to produce new forecasts making allowances for errors made in the past. This does not appear to have happened during the period that Mr Cowen has been Minister of Finance.

Over his last three budgets he has reported major jumps in tax revenue buoyancy. For 2006, as has been shown, the forecast was wrong by €3.8 billion, an error of 9.1 per cent; for 2005 the error was €1.8 billion, an error of 4.8 per cent and for 2004 it was €2.3 billion, an error of 6.8 per cent.

These errors compare most unfavourably with the outcomes for 2003 (€108 million, an error of only 0.3 per cent) and 2002 (€256 million, an error of 0.9 per cent) when the outcomes and the targets were very closely linked.

How come the department with a different Minister was able to be so right in 2002 and 2003 and yet so wrong over the last three years? There are two plausible answers to this question. The first is that it has become far more difficult to estimate tax returns over the last three years.

If this is the case, and I do not understand what recent circum- stances have made it so difficult to estimate these tax returns, then the Department of Finance needs to establish an early warning system which would indicate when tax returns were varying widely with their targets, and so give the Minister the opportunity to modify his budgetary strategy in the light of these new circumstances.

If the Minister intends to run an Exchequer Balance deficit and the returns are showing that the opposite is happening, surely some modifications are needed in the existing budgetary strategy. This early warning system would be used for both scenarios that would also incorporate falling revenues.

For example, suppose house sales stagnate in 2007. It will be most unlikely that €3.7 billion will be collected through stamp duties. Add to that a major downturn in the construction sector and the income tax and Vat returns might be subject to considerable change.

There are obviously serious economic issues to be addressed when the tax returns move either side of their targeted estimates, and it is too late to wait until November/December to start taking action to counter undesirable developments.

The second answer is that it may suit the Minister of Finance a great deal to create a scenario of surging tax returns towards the end of the tax year. As these tax returns are manifested at the end of November and beginning of December, they create a feel good environment against which he can launch the next budget.

Mr Cowen has been able to do this for three years because the surging tax returns have only been flagged within a couple of weeks of each of his budgets.

However, this is playing politics with the budget rather than economics. With a better continuous flow of information on the tax returns, the Minister might be in a position to give more serious attention to using such money either to reduce taxation or increase much needed public sector infrastructural investment.

Antoin E Murphy is a lecturer in the department of economics at Trinity College Dublin.