The Greek government is under pressure from its own backers and society in general to lighten the tax burden at the same time as international lenders are demanding ambitious fiscal targets be met. To deliver tax reductions that will ease the political pressure and help strengthen economic recovery, the government may have to do more to contain public expenditures without making poor citizens even worse off.
Government officials are expected to raise the issue of tax cuts with representatives of the European Commission, the IMF and the ECB in Paris in the next few days. The public reaction to mistakes in the calculation of the new real estate property tax, ENFIA, has made tax relief for political, social and economic reasons imperative.
The government’s line is in the right direction but its proposals will have to be carefully calibrated to underpin economic recovery without endangering the attainment of the primary budget surplus-to-GDP target of 1.5 percent this year and 3 percent in 2015 – it will be very difficult to have revenues exceed expenditures excluding interest by 4.5 to 4 percent of GDP from 2016 on without hurting future GDP growth. So, this high fiscal target will have to be re-examined by the lenders and the government at talks on debt relief later this year.
One of the biggest mistakes of the first Greek economic adjustment program for the 2010-2012 period was its heavy reliance on taxes rather than spending cuts to bring down the budget deficit. Measures to decrease expenditure amounted to 22.4 billion while tax increases were equal to 26.5 billion in this period. The mix of fiscal measures mainly reflected the unwillingness of the socialist PASOK government in 2010 and 2011 to cut primary spending more in the face of fierce opposition by trade unions and the party’s rank and file. It also reflected the troika’s priority to cut the budget deficit by any means and its fixation with revenues.
The result of this policy mix is clear. Greece hiked taxes and cut state spending by a total of 19.1 billion euros in 2010, resulting in a deficit reduction of 12.5 billion euros. The relatively smaller decrease in the budget deficit compared to the adopted fiscal measures reflected the impact of the bigger-than-anticipated recession on the budget that year. The situation got worse in 2011 as the economy got weaker after another strong dose of austerity equal to 18.2 billion euro. The general government budget deficit narrowed by just 3.8 billion euros in 2011.
The same restrictive policy continued in 2012 and 2013, with taxes and expenditure cuts totaling 11.5 and 10.2 billion euros respectively, trimming the deficit by 2.5 billion euros in 2012 and 13 billion in 2013, according to government figures presented in Parliament some time ago. However, spending cuts exceeded tax hikes in 2013 and the deficit reduction estimate may have been revised for the better. It is noted that the 2012 and 2013 deficit figures have been affected by the largest-ever sovereign debt restructuring (PSI) and the Greek bank bailout. Greece paid much lower interest on its public debt after the PSI than before, cutting the budget deficit accordingly.
It is time for Greece to start undoing some of the past policy mistakes, beginning with taxes. The task has been complicated by court decisions returning several hundred billion euros to judges, the military and the security forces. Although budget expenditures and revenues seem to be doing better than expected so far this year, the burden of the court decisions cannot be ignored, limiting the space for tax cuts.
We argued in the past that Greece should try to lighten the burden on income taxes to encourage labor productivity and savings rather than focus on reducing consumption taxes such as VAT. Undoubtedly, it would have been better if the country were in a position to reduce all taxes but this is impossible at this point. Choosing consumption over income tax cuts may help prop up private consumption spending but it will also increase imports, aggravating the current account deficit.
In any case, pursuing a policy of tax relief may also entail some spending cuts to achieve the primary budget surplus goal. This does not necessarily lead to worse public services as the example of Sweden, cited by some academics, shows. Swedish public spending today is some 9 percentage points lower than in 1995 but its social model has not changed altogether. The re-examination of the cost effectiveness of some areas, like the healthcare system, could result in substantial savings over the years. Moreover, Greece can do more to reduce public pension expenditures in the future without affecting the welfare of its citizens by mandating employees to subscribe to an industry fund. It is like substituting private for public pension schemes.
The government is right to seek tax cuts to help the economy and give people some hope. However, its proposals should aim at boosting labor productivity and savings rather than consumption. Given the fiscal burden of recent court decisions, it may have to propose some targeted spending cuts that will not hurt the poor.