-- Margaret Doyle is a Reuters columnist. The opinions expressed are her own --
By Margaret Doyle
LONDON, April 9 (Reuters) - Ireland's budget is painful, but insufficient.
Brian Lenihan, the finance minister, is taking an additional 3.25 billion euros out of the economy each year, largely in higher taxes. But that will simply trim the budget deficit to 10.75 percent of national income. The 3 percent eurozone target is a distant dream.
Ireland's position looks uncomfortably like Latvia's, only delayed by a few months. It is on the second round of public spending cuts since the International Monetary Fund rescued it last autumn.
Like Latvia, Ireland enjoyed galloping growth. In the decade to 2006, an economic strategy that focused on attracting foreign direct investment, with a super-low corporate tax rate of 12.5 percent, helped generate an additional 1 million jobs, net immigration and higher incomes.
The growth was accompanied by a construction and property boom that saw house prices triple in a decade. The fuel was cheap money following the one-size-fits-all interest rate which came with the adoption of the single currency in 1999.
Thanks to the higher inflation that accompanied the boom, the real interest rate was negative: householders were effectively paid to borrow.
Now this process has gone painfully into reverse. Costs have risen rapidly, while Ireland's main trading partner, Britain, has seen its currency fall heavily against the euro over the past year.
Irish companies must accept lower margins to safeguard long-term supply relationships, and earnings will suffer. Falling tax revenues make the hole in the public finances bigger.
DEVALUATION OR INFLATION
The traditional ways out are devaluation or inflation, or a mixture of the two, but membership of the euro prevents the first, and makes the second dangerous to corporate competitiveness.
Latvia - not a formal member of the euro, but pledged to peg to it - has chosen to deflate to fit the monetary straitjacket, and going through this painful hot wash cycle has so far shrunk its national income by around 10 percent.
Ireland has no choice but to do the same. National income is forecast to drop by 8 percent this year, and unemployment is soaring. Hence Lenihan's draconian income tax increases, which include an income levy of 6 percent for those earning above 175,000 euros ($232,000) and a doubling of a health tax to 5 percent for higher earners.
In this budget he has increased taxes by more than he has cut spending, but he will have to borrow a leaf from the Latvians' book. The tiny Baltic state slashed public sector pay by 15 percent after its IMF bailout last year, and another 20 percent reduction is on the cards. It is also cutting jobs.
Ireland allowed public sector pay to balloon in a "benchmarking" process, the price for social harmony during the go-go years.
Now private sector pay is falling, even for those workers who are not being laid off by struggling companies. Private sector employees have expensive and uncertain pensions, while those in the state sector enjoy the certainty of payments linked to their salary.
The government recognised this in last emergency budget, introducing a pension levy averaging 7 percent of pay on public sector workers.
POLITICAL PAY
Lenihan has made a start by taking a scythe to politicians' pay and perks. But the exercise has simply shown how far out of line Ireland's political pay had become.
Brian Cowen, Ireland's Taoiseach (prime minister), for example, earns more than either Germany's Angela Merkel or France's Nicolas Sarkozy. He is stopping the practice of paying ministerial pensions to those still serving as members of parliament.
For all the pain of euro membership, there is no chance that Ireland will get out. For starters, there is no procedure for countries to leave the euro. In fact, Ireland is likely to huddle even closer to the European Union, and especially to Germany, the EU paymasters.
Lenihan likes to claim membership of the euro as a bulwark against the storms in international financial markets. It is true those Central European countries with floating exchange rates, especially Hungary and Poland, have endured their own pain.
Thanks to hopes of rapid euro convergence and easy credit (much from Western European banks), many borrowed in euros or Swiss francs to invest in local property. With the forint and zloty well down against the euro, those repayments are proving painfully expensive.
Not all investors are convinced that the euro is forever. The yield on 10-year Irish government bonds has ballooned to more than 200 basis points (2 percentage points) over the equivalent German 10-year debt.
Like Greece, Spain and Portugal, Ireland's credit rating has been downgraded, from AAA, but the prices are anticipating further downgrades as the credit squeeze worsens.
As with the Balts, previous hubris about their flexibility and dynamism has gone now that "old Europe" may be called upon to stand behind Ireland's debt.
Lenihan signalled that the Irish people would be much more likely to accept the Lisbon treaty now that its "false sense of invincibility" had been shattered.
Even so, it was notable that Lenihan did not do the one thing that the Germans would have liked above all in the budget. Among all the tax rises, he did not touch the 12.5 percent corporate tax rate.
That is very unpopular with Germany, which sees it as unfair tax competition. But Ireland can see that retaining a competitive edge will be the cornerstone of its attempts to re-establish economic independence.
($1=.7553 Euro)
(Editing by Richard Hubbard)