Value-added tax may help Greece find road to fiscal recovery soon

Greece’s success in substantially cutting next year’s budget deficit may rely on a number of factors but the key may be the collection of value-added tax (VAT) where evasion seems to have taken on great proportions in 2009. According to the Greek central bank, the general government budget deficit will total around 12.5 percent of gross domestic product (GDP) this year – almost double the size projected by the previous conservative government just a few weeks ago. Whether the gap will end up at around 12.5 percent of GDP remains to be seen, since some economists argue we will have to wait to find out whether Eurostat accepts these estimates derived by different accounting methods. It is known that the central bank follows and reports the budget deficit on a cash basis and will also have to take into account an estimate of surpluses in social security funds, local governments and other entities belonging to the central government and which are calculated using another accounting methodology. This has also reportedly included the debt owed by public hospitals and the state to construction companies and others in the 2008 and 2009 budgets. Still, regardless of whether the country’s general government budget deficit comes to a figure of 9, 10, 12 or 13 percent of GDP, there is no question that it will have to be slashed next year to give a positive signal to the capital markets and EU Commission. After all, no one wants to once again hear the sarcastic statements made by high-level EU officials about the quality of Greek statistical data and the country’s fiscal credibility. Finance Minister George Papaconstantinou has already said next year’s budget will aim at bringing the budget deficit to below 10 percent of GDP. Assuming this year’s budget deficit ends up at around 12.5 percent of GDP and given that it was burdened by considerable one-off charges, such as paying off overdue debts to the state’s suppliers, one may say it would be a feasible target if the economy stayed afloat after sinking an estimated 1.5 percent in 2009. Optimists could go a step further and say that it is feasible for the budget deficit to be lowered to close to 8 percent of GDP or lower in 2010 if the economy grows by about 1 percent and state departments start functioning normally. It is known that the state tax-collection mechanism in particular relaxes during an election year, especially when a change in power is coming, and this scenario was repeated again in 2009. We have argued before that the government has no option but to raise both excise and some indirect taxes, especially the special tax on oil, to collect more revenues and convince Greece’s suspicious EU peers it really means business this time around. According to a recent study by the Foundation for Economic and Industrial Research, a 10 percent increase in the final price of oil brings in additional revenues of 800 million euros to state coffers, while an increase of equal size in the price of the most popular cigarette brand brings in about 350 million euros. Of course, the containment of public expenditures would help equally but it is unlikely that spending will freeze next year. Although the Socialist government wants to do away with many personal and corporate income tax loopholes to make the distribution of the tax burden fairer and collect more tax revenues, its success in attaining a much smaller budget deficit in 2010 will be determined by VAT. VAT taxes accounted for more than 30 percent of total tax and non-tax revenues in the 2008 budget. It is known that the first priority of most companies prior to 2009 was to first pay the VAT owed to the state. Of course, there was still tax evasion, as some companies withheld it but this was the trend overall. It now appears that, this year, this has changed and has contributed to the shortfall in tax revenues, according to various tax and corporate sources. This is partly due to the worsening economic situation and the cash flow problems facing many businesses. However, the state appears to have played a role in this occurring by enabling companies to pay 30 percent of the VAT tax on time and the rest in installments, with a very small charge. According to the same sources, the state’s initiative has apparently given the wrong idea to other companies and it is likely to learn that paying their VAT obligations is not the priority it used to be. Given Greece’s precarious fiscal situation, the new government has no option but to «kill» this new business habit as soon as possible by penalizing offenders. This means it will have to do away with the decree on VAT of its predecessor and go after all businesses that withhold these taxes if it really wants to tidy up public finances and seriously cut the budget deficit.