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Election results actually bought govt time for tax cuts

 Athens will have to make sure that the measures are compatible with the countrys new economic model
Taxes on urban properties must be cut, as they have hurt the middle class and contributed to the collapse of construction activity and house prices, creating collateral damage to the banking sector and the economy.

By Dimitris Kontogiannis

The outcome of the European elections in Greece could lead to a longer period of political stability than thought a week ago, provided the coalition government sticks to reforms and the economy starts recovering. Prime Minister Antonis Samarass plan to provide a roadmap for tax reductions should be welcomed in the context of fiscal consolidation. However, the thrust of tax cuts should be consistent with the countrys intended new economic model and should not reward consumption but productivity and savings.

The odds for the coalition government surviving the presidential election in February or earlier have increased after the results of the EU ballot on May 25. The defeat of the right-wing Independent Greeks party, viewed by pundits as a potential partner in a future government led by the leftist SYRIZA party, is key to this assessment. According to politicians of various stripes and analysts, the anti-bailout party could fall below the 3-percent threshold if national elections were held early and would not be represented in Parliament. This makes it more likely that its deputies, along with many other independent deputies, may vote for a moderate candidate as the next president in order to avoid snap elections.

Assuming the candidate could also be voted by all or the majority of deputies belonging to the moderate Democratic Left (DIMAR) party, he or she could easily get more than 180 votes needed in the third round of voting in the 300-seat Parliament. It is no secret that this candidate could be Fotis Kouvelis, the resigned leader of DIMAR. In that case, the New Democracy-PASOK coalition government could stay in power through the end of its term in June 2016 and hope the economy will turn around in the next two years, benefiting the two parties politically.

Of course, this is just a scenario and it could fall apart if New Democracy and PASOK fail to maintain a coalition government that will broadly adhere to fiscal consolidation and reforms. In that case, policy paralysis will ensue, hurting the economy and increasing the odds for snap general elections. However, we think at this point that the outcome of the EU ballot favors the former scenario where the coalition government survives the presidential vote. This means Samaras will have more time to implement the tax reduction plan.

This will not be easy because of the large primary budget surpluses Greece has to deliver in coming years. It is reminded that revenues must exceed expenditures excluding interest payment by 1.5 percent of GDP this year, 3 percent in 2015 and 4.5 percent in 2016. It is a challenging but not impossible task if the economy grows according to projections. It is encouraging that fiscal data for the first four months show the primary surplus target will be met this year and may even be surpassed for a second consecutive year. If this is the case, there will be some room for tax cuts but the fiscal outperformance should continue in 2015 and beyond for more tax cuts.

In this regard, the government could first try to convince the countrys creditors to lower the targets for the annual primary surpluses to create more room for tax cuts. The negotiations for debt relief with the EU offer a window of opportunity since the measures could lead to interest savings. However, there are limits. Greece is paying a small interest rate on the EU bilateral loans (GLF) equal to Euribor plus 50 basis points and has secured a 10-year interest deferral on EFSF loans since 2012. So, the annual interest savings would not be that great from this source alone. On the other hand, Greece could help convince its creditors to accept a lower cost of funding than assumed in the debt sustainability analysis for the 2014-2020 period. The ECBs accommodative monetary stance and the drop in bond yields could help to that extent.

In addition to trying to create more space for tax cuts by lowering the target for primary surpluses as a percentage of GDP and decrease primary spending, the government should also make sure the tax cuts are compatible with the countrys new economic model. The latter favors investments and exports but not consumption spending like in the past. Of course, this is a paper plan at this point but this does not mean it should not be taken into account. So, the tax cuts should aim at bolstering productivity and savings rather than consumption.

In addition to cutting taxes related to direct investments, including corporate profits, the government should provide tax relief to labor income in the form of lower marginal tax rates and income tax deductions. This will help productivity and make it easier for people to save. On the contrary, plans to cut the VAT tax on some items will either boost consumption and likely imports or/and increase the profit margins of certain professional groups. The fiasco with the VAT cut on restaurants, fast food outelts etc, last year, where most of the gains were pocketed by businessmen, is indicative of what should be expected in similar cases.

Of course, the government should also cut taxes on urban properties that have gone up six to seven times since 2009. These taxes have hurt the middle class and contributed to the collapse of construction activity and house prices, creating collateral damage to the banking sector and the economy.

Samaras is right in making tax reduction a priority for the coalition government. However, the best way to ensure its success in boosting economic activity will be to create enough fiscal space to accommodate large tax cuts and make the latter compatible with the new economic model.

ekathimerini.com , Sunday June 1, 2014 (22:32)  
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