Hamish McRae: Ireland's harsh medicine holds important messages for UK

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The tail does not wag the dog, but the fiscal decisions of another jurisdiction in these islands last week deserve more attention than they have received.

The Irish draft budget for next year was unveiled on the same day as our pre-Budget report. Unlike the UK, and notwithstanding the even more serious dip in output this year, Ireland has started to get to grips with its deficit. One key element in Ireland's plan is a cut in public-sector pay of 5 per cent at the bottom end and 15 per cent at the top. (The salary of the Taoiseach, the prime minister, comes down by 20 per cent.)

There are cuts in all the various spending programmes and also a controversial cut in child-welfare payments. Taxes overall are not being increased and there is a small cut in VAT. Crucially, the 12.5 per cent corporation tax, which has helped attract a lot of inward investment, is unchanged.

It is difficult, very difficult, and we will have to see how the country reacts. There have already been sharp cuts in private-sector wages so, in one sense, what is happening is that the public sector is coming into line. But cutting wages is never easy.

However, the harsh facts are that even with these measures the budget deficit is projected to be 12 per cent of GDP, much the same as the UK's. Indeed, proportionately, the numbers are quite similar: tax revenues a bit below 35 per cent of GDP and spending pushing towards 50 per cent.

Where Ireland has done somewhat worse is in the overall shrinking of the economy: next year, the economy will be back to the size it was in 2005, there has been a corresponding collapse in tax revenues and so public spending has to shrink in line.

So, what are the messages for the UK? I suggest there are three.

First, the main change has to come on the spending side, not on taxes.

Second, since public-sector salaries are such a large proportion of total spending, you have to do something there.

And third, the one thing you must not do is attack business because signalling that the country is business-friendly is crucial to recovery.