Analysis Fiscal inconsistency

11/07/2018

Santiago Lago Peñas is a Professor of Applied Economics and Director in GEN (University of Vigo)


The financial logic of the public sector is different from that of the private sector. In first place, because public deficit is a macroeconomic management tool. Fiscal policy is especially important in those backgrounds where monetary policy has been assigned to higher instances, as it is the case of Spain and the European Central Bank. In second place, the public sector has a fiscal power that allows the application of different rules. Not to bore the reader, I will summarize in the idea that the sustainability and solvency of public sector are guaranteed if the debt ratio on the gross domestic product (GDP) maintains itself in a reasonable level. In the case of the European Union, this limit has been stipulated up to 60%.

If things are done in the right way, the above is a wide range of opportunities. It is possible and reasonable to see public deficit, and it is not a catastrophe that the debt rises some years subsequently if the departure point is low. Therefore, it is not true that the current regulation in the European Union about deficit and debt seems like a straitjacket. Reference figures (3% from the total deficit and 60% of public debt, with exhaust valves for extraordinaire situations) are, essentially, reasonable. In addition, this regulation does not prejudge that the level of public debt must be placed in 30% or 40% of GDP. This is a political decision about the fiscal choice that is most desired on each country. Then, which is the problem that Spain has ahead?

Essentially, the lack of responsibility and budgetary cohesion. It is true that, in the past two decades, we have legislated in the position of the fiscal stability as no competition; laying down laws (as the “zero deficit”) that goes beyond the European regulation. The main problem is that such legislative will has not had any bound with the collective decisions. To understand it better, it is necessary to start from a deficit’s conceptual decomposition or from the public surplus that we can observe.

In one hand, it does exist a cyclical component, that concerns the effect that expansion and recession produce in the public accounts, disturbing expenditure items such as unemployment benefits or tax collection. On the other hand, and calculating a difference between the total and the cyclical, we come up to the structural balance; this would be the balance we would have if the effect of the cycle was neutral. It is true that cyclical and structural balance are only estimations. They are difficult to make in many occasions; therefore, they should always be observed carefully. However, they are a very useful and informative tool, especially if what we are comparing is the change from one year to another to evaluate the expansive or contractive nature of the fiscal policy.

Unfortunately, in Spain, we have got used to life with a structural deficit. Even though in the years where we glimpsed a surplus (2006 and 2007), we were having a structural deficit if we deducted correctly the effect of the real-estate and credit bubble. This condemns us to confront big difficulties to comply with the objectives agreed with Brussels, to be incapable of reducing the public debt to security levels and the affordable cost in a scenery of standardizing rate interest, and leaving us with limited room to respond to a future crisis which will require fiscal incentives.

The analysis of actual fiscal circumstances reveals the above. We have been for nearly five years of an intense economic growth. We have recovered the level of GDP prior to the crisis and the cyclical component of the deficit is very close to zero in 2018 (in fact, according to the calculation of the European Commission we would already have a slight cyclical surplus). We have agreed a deficit of -2.2% for this year and the current projections, even before the measures announced by the new government, bring us to -2.7%. At this time, we should be discussing how we redirect the situation and not how we renegotiate the objective upward. We are taking steps backwards instead of moving forward.

It is true that the level of public spending in Spain is not high comparing it with an international perspective. But the cost of service portfolio of service and income programs (pensions) is excessive fo our tax collection. We must resolve the incoherence, raising the resources or lowering the expectations of the Spanish population. That is the political decision that we must make among all. But technical analysis can also help in this process.

Regarding to income, the reality is that Spanish tax rates are similar to those of neighbouring countries, What differs between them is that there are grater tax benefits in practically all taxes from VAT to IRPF, passing through Corporate Tax); a submerged economy and superior tax fraud; and an obsolete fiscal system that requires an urgent in-depth reform that allows it to improve in equity, efficiency and, in this case, tax collection capacity. We need a new fiscal system already agreed between the main political force and that will serve, altering tax rates as necessary, to reach income levels of 35% of GDP to 45% according to the preferences of the government in office and the parties who support it.

Regarding spending, it is true that there is always room to improve efficiency. But the reality is that the portfolio of services in Spain is quite generous and that has a cost. If we do not want to increase the collection, we will have to choose, from the responsibility, for cheaper menus.

It is not reasonable that Spanish deficit could end the year 2018 close to 3%. We should be in a very close position to the budget balance. Deciding how we do it is a political decision and there are different possibilities. What we can not do is be fiscally incoherent.


Translated by Nerea Eiroa González

 

#Economy #Taxation #The national budget and public spending