Deficit reduction and tax cuts jostle for attention in Greek economic officialdom

Greece has embarked on tax-cutting and simplifying strategies in a seemingly high-risk and deficit-defying, but potentially also high-reward, effort to improve its long-term economic competitiveness in the global marketplace. While this has been prompted by withering, post-Olympics political pressure in EU circles to clean up its public finance act, it also stems from a growing self-realization about the need for lasting adjustment rather than quick-fix stimulus. The Karamanlis government’s task is daunting because it must simultaneously tackle two related yet different challenges: the multifaceted deficit problem being fingered by the EU, and the low-investment syndrome that long has been Greece’s bane for social and bureaucratic as well as economic reasons. The potential ramifications if both are not tackled head on help explain Finance Minister Giorgos Alogoskoufis’s recent hogging of the daily headlines. The government’s biggest challenge, and much of its credibility, rests on how it fares on these twin issues. Mr Alogoskoufis announced this week that corporate and some individual tax rates would be reduced to provide relief for citizens while stimulating investment and jobs. Following the recent lead of Austria (and, earlier, of Ireland), which cut its corporate taxes and saw a surge of its national bourse in partial response, the Greek effort should enhance inward foreign investment, which amounted to a paltry 50 million euros in 2002 – far and away the lowest in the EU. Corporate tax rates are to be reduced from 35 to 25 percent over the next three years, and for small businesses, 25 to 20 percent. For individuals including pensioners and lower-wage employees, it also raises the non-taxable threshold, while the whole effort is aimed, usefully, at increasing transparency and long-term planning. Taken alone, of course, cutting revenues to around 150 million euros annually seems a recipe for exacerbating Greece’s already thorny problem with the EU, its deficit spending. At a projected 5.3 percent of GDP for 2004, this is far above the Stability Pact’s 3 percent ceiling for EU governments (and far above the original estimate of 4.6 percent), while its total debt, at over 110 percent of GDP, is nearly double the allowed nominal limit. At a meeting in late October, EU finance ministers chastised Greece’s overhauling of its debt/deficit arithmetic as well as the high numbers themselves, with Dutch Finance Minister Gerrit Zalm saying that such rejigging «must not occur again,» not just in Greece but throughout the EU. The revision also implicitly questions the veracity of the information from the late ’90s, on which Greece’s eurozone membership was based. EU analysts are still poring over figures from these years, and a fuller – and chilly – EU response will likely issue from next Tuesday’s Ecofin meeting. Greece, however, is not alone in surpassing the 3 percent Pact limit; Germany, Portugal and Italy have also been warned, while nine of the EU 25 will likely exceed it by next year. The defiance queue is lengthening. Mr Alogoskoufis has been careful to de-link the two problem areas. He has said that the impending tax cuts would have a «negligible» effect on Greece’s public finances, at least in terms of the 2005 budget. He could well be right, in that the corporate cuts are being phased in, rather than implemented in one go. Seeing red Deficit reduction will be tackled through various other means. One is fortunately a passive one, namely the ending of obligations to construct now-completed Olympic projects. With the relief of pulling off a successful Games came relief from a big chunk of the public financing requirement. Games costs were 7-8 billion euros (the total still must be tallied), of which about 1.8 billion came in 2004; this will drop to around 100 million euros a year for venue maintenance. More privatizations are also on the cards (amounting to 1 percent of GDP) – including a sell-off of the State’s remaining share in the National Bank of Greece – along with social security adjustments, crimped salary increases to public sector workers, cuts in the public investment program, and a (hoped-for) windfall from repatriated funds. A crucial underlying assumption is a 3.9 percent growth rate, which many believe is optimistic given slowing growth in the euro area, notably Germany. It is a complicated package and time will tell if Greece’s ambition of nearly halving its deficit from 5.3 percent of GDP to just 2.8 next year – from a lower tax base – is to be realized or even approached. With oil prices moderating, the macroeconomic situation is less dire than it seemed a month ago (and the stock market’s surge over the past two weeks verifies this), but the country, like the world economy, is far from out of the woods yet.