The next Minister for Finance will have to cut spending or increase income tax to avoid a clash with Europe, according to Goodbody Stockbrokers. The broker - which is part of AIB - has concluded that the current rate of increase in day-to-day Government spending is unsustainable.

Spending on supply services rose by an average of 12.3 per cent a year over the five years of the current Government. A continuation of that trend would produce a deficit of 4.7 per cent of the Gross National Product by 2006, according to Mr Colin Hunt, economist with Goodbody.

The figure would represent a General Government Deficit of 2.2 per cent of Gross Domestic Product. The general government deficit is the measure used by the European Commission to measure compliance with the Growth and Stability Pact, and any member- state that runs a deficit of more than 3 per cent faces being censured and fined.

The Goodbody analysis assumes that tax rates remain unchanged and that the Government meets all its spending commitments under the National Development Plan. The model also presumes that the economy grows by an average of 4.3 per cent. The average increase in day-to-day spending would have to be trimmed back to 6 per cent before the economy would start to return a surplus, according to Goodbody. This would not occur until 2005 however.

Limiting growth in day-to-day spending to 9 per cent would see the deficit stabilise at 1-1.5 per cent, the broker predicts.

"In 2002, we are going to see a return to the old maxim that to govern is to choose," said Mr Hunt. High spending and low taxes were incompatible in a mature economy and the next administration would be forced to cut spending growth or raise income taxes, he said.

The most likely tax to be hit would be income tax, he predicted. Indirect taxes such as excise and VAT would adversely affect inflation and run contrary to the EU's desire to see harmonisation in these areas. Increasing corporation tax would break the Government's "covenant" with business to reduce corporation tax. "There is no alternative but to increase income tax," he said.

The situation has arisen because of a rapid deterioration in the fiscal stance of the Government last year. The loosening of spending controls in 2001 - when day-to-day spending rose by 22 per cent - was greater than the cumulative improvement in fiscal prudence seen in the previous four years, he said. Goodbody reached this conclusion by examining the underlying budgetary position after taking account of growth.