* Further reductions in the labour tax wedge are needed to improve work incentives, but, tax reform should not endanger the deficit reduction path presented in the up dated Convergence Programme, so as to ensure the sustainability of public finances.
* The gaps in housing and transport infrastructures need to be addressed, not least to facilitate labour mobility, reduce regional disparities and ease the restraints on aggregate supply.
A tightening of macro policies is desirable from both short and medium term perspectives. The economy continues to grow at above potential rates, further stoking capacity pressures at a time when headline inflation has already surged well beyond the official target. To prevent jeopardising hard won credibility, the process of policy rate increases initiated already in April 2007 should be continued. Also, the release of additional information to markets about the Central Bank’s expectations of future economic and interest rate developments should be considered insofar as it bolsters perceptions of its commitment to price stability in the medium term. The structural budget deficit narrowed in 2007, but the stance of fiscal policy is expansionary in 2008, complicating the task of monetary policy. With further tax cuts planned, the authorities need to provide a credible plan for containing spending so as to cut the deficit to sustainable levels.
Further cuts in the labour tax wedge would raise work incentives but should be funded. Cuts should be targeted on low income earners so as to ensure cost effectiveness and can be partly funded by reforming early retirement pensions, but other sources of financing will need to be tapped. There is little scope for raising VAT or corporation tax. Yet, revenues from taxes on immovable property – one of the least distortive bases – are low, offering scope for some increase.
Better labour market outcomes would result from greater labour mobility. The first priority would be to overhaul housing policies. The supply of housing is hampered both by the absence of urban zoning plans and by regulatory barriers to the development of a rental market. This limits access to affordable housing, especially in major cities. The solution is to further ease controls on rent increases and enforce eviction of non paying tenants. More efficient means to facilitate access to home ownership than subsidising borrowing costs should also be considered. For instance, eliminating stamp duties on house purchases would do so with less harm to labour mobility.
Future growth prospects are also darkened by several other barriers. Closing the gaps in transport infrastructure is a key to raising potential. A major challenge is to implement the ambitious spending plans sufficiently rapidly so that the substantial EU funds can be fully and efficiently absorbed without massive cost overruns. Access to the labour market for foreign construction workers should be further facilitated. Public procurement legislation should also be reformed, notably to limit the abuse of appeal procedures and to simplify the delivery of building permits and environmental impact assessments. Public private partnerships should be given more consideration as they have the potential to enhance efficiency. Growth would benefit from efforts to strengthen competition so as to foster entrepreneurship and innovation.
