Oct. 14 (Bloomberg) -- Irish Finance Minister Brian Lenihan said he plans to raise income tax for the first time in a quarter century and slash public spending as the economic slump opens a hole in the public finances.

A 1 percent tax will be added to all personal incomes, rising to 2 percent on earnings over 100,000 euros ($136,570), Lenihan, 49, said in his budget speech in the parliament in Dublin today. The levy marks the first increase in Irish income tax since 1984.

``We must take the right decisions now,'' Lenihan said. ``The soft option would have grave consequences for the future of this country.''

Ireland became the first euro area economy to enter a recession in the second quarter as construction and consumer spending slumped. Today's budget, Lenihan's first, comes against a backdrop of tumbling house prices and a financial crisis that has sent share prices crashing and forced the government to guarantee all the deposits and debts of Irish banks.

The budget was brought forward from its usual date in December as the outlook deteriorated.

Since Lenihan took over five months ago, the banking crisis has worsened and Ireland now faces its bleakest prospects in 25 years. The benchmark ISEQ stock index has dropped 55 percent this year, Western Europe's worst performer. Bank of Ireland Plc and Allied Irish Banks Plc, the country's largest lenders, have fallen more than 75 percent.

Recession

The economy, as measured by gross national product, will contract at least 1.5 percent this year and 1 percent in 2009, according to the forecasts announced today.

The budget deficit will widen to 6.5 percent of gross domestic product in 2009 from around 5.5 percent this year.

Lenihan said he plans to conduct a review of the National Pension Reserve Fund before the end of the year. Ireland contributes 1 percent of GNP to the fund every year to meet future pension needs. He also said the government and some senior civil servants will take a 10 percent pay cut.

``There is too much at stake; we all have too much to lose by not taking action now,'' Lenihan said. ``We face the most challenging fiscal and economic position in a generation.''

While the income tax levy will raise funds for the government, it may further damp an economy where retail sales are tumbling and consumer confidence is close to a record low.

In the U.K., Chancellor of the Exchequer Alistair Darling has ruled out immediate tax rises or spending restraint, saying now is not the time to take money out of the economy, but has hinted measures will ultimately be needed to reduce the deficit.

To contact the reporter on this story: Fergal O'Brien in Dublin at fobrien@bloomberg.net.

Last Updated: October 14, 2008 11:35 EDT