Spain’s government raised its growth forecasts for 2015 and 2016 by 1 percentage point each, saying it plans to spend more to boost growth next year. The government raised the ceiling for public expenditure by 2.7% for 2014 to €133 billion, which will push the fiscal deficit from 5.5% to 5.8% of GDP. The European Commission extended until 2016 Spain’s deadline for lowering its government deficit to 3% of GDP.
Additional government spending will be funded by tax increases on alcohol and tobacco, which took effect last week. Corporate tax deductions will be reduced and taxes on greenhouse gas emissions will be increased beginning in January, as requested by the European Commission. And a reduction in property tax rates that was to take place by the end of 2013 will be postponed for two years.
Tax increases can slow growth by discouraging economic activity. Moreover, Spain’s tax system needs much deeper structural changes to make it more efficient. The main problem is the high government dependence on property-related taxes, which dropped by more than €50 billion per year after the housing market bubble burst in 2007. This lowered government tax revenue to only 32.4% of GDP by 2011, from 38% in 2007. The eurozone average is 40.8%. Spain needs to broaden its tax base, for example by extending its full value-added tax rate to a larger share of goods. Currently the 21% VAT covers only 42% of all goods sold in Spain, compared with 82% in Germany.
has until the end of 2013 to tap the remaining 59 billion euro in bailout money, but the country will likely decide in October whether to apply for an extension. This would give Spain more flexibility if more capital is needed. Stricter regulations have contributed to tighter credit, although the IMF encouraged banks to improve their capital ratios by lowering cash dividends or issuing new shares, instead of cutting lending. The lack of bank lending put further strain on the real estate market. Mortgage lending fell by 14.1% in year-ago terms in May, following a 13.9% drop recorded in the previous month. At the same time, Spanish house prices fell for the 20th consecutive quarter in the three months to June. In fact, prices have fallen around 30% from their peak in the first quarter of 2008. Still, the property market is starting to revive as the improved outlook and higher rates of return encourage foreign investors. SAREB, the “bad bank” created to absorb toxic properties poisoning banks’ balance sheets, received a large number of bids this month for foreclosed bank property. Yet despite some initial optimism, Spanish officials now expect SAREB to lose money since asset sales are progressing slowly.
Further, the economy still lacks one of the most important components of all if growth is expected to be sustainable – the gross fixed investment. After deteriorating at a pathetic rate of -9.1% in 2012, the rate of gross fixed investment has continuously been falling since the start of 2013: -9.0% in Q1 2013 and -7.3% in Q2 2013. In fact, the rate is expected to deteriorate further as the weak economy erodes profit margins and puts downward pressure on capacity utilisation.
Clearly, the Spanish economy is in a difficult situation at the moment requiring the pursuit of ambitious and demanding policies to correct the fiscal imbalances. However, this can only be possible if Rajoy government moves back to the drawing boards to restructure and recapitalise the country’s financial system by focusing on the expenditure side and going in for some major tax reforms. This will not only strengthen public confidence in the capacity of the government to regain sustainability of public finance, but will also stop the economy from faltering. But then, this needs to be done really fast. Because if this 1,000-pound ‘PIG’ falls, it would mean the end of the single currency area.
