Fiscal Policy in the Eurozone: The Case of Spain

Introduction to Macroeconomics

Fiscal Policy in the Eurozone
The Case of Spain
Carla M

Fiscal Policy in the Eurozone – The case of Spain

Index
Context
Fiscal Policy in the Eurozone ……………………………………………….…………………………. 2
The Role of the ECB ………………………………………………………………………….……………. 3

The Case of Spain
Spanish Tax System …………………………………………………………….…………………………. 4
Measures to deal with the crisis (2008 -2012) ………..……………………….……………. 4
Evolution of the collection of Taxes ……………………………………….………….. 7

Conclusion ……………………………………………………………..…………………………………….……. 8
Bibliography ……………………………..………………………………………………………………….….. 9

1

Fiscal Policy in the Eurozone – The case of Spain

Fiscal Policy in the Eurozone
The Eurozone differs from other types of unions in some aspects. First of all, it doesn’t have a specific government to control the operations of the ECB or the fiscal policy. Fiscal policy in the euro area, unlike most monetary unions, doesn’t have a central authority to determine a specific way of action. This is a result of the denial of some of the members to delegate or transfer the decision power they have in terms of taxation or expenditure policies to an upper organism. It’s obvious that, as a result, differences between policies among countries would arise. That’s why Maastricht Treaty (signed in 1992) and the Stability and Growth Pact (signed in 1997) provided some performing guidelines.
Some of these guidelines that the different countries of the EMU (European Monetary Union) have to follow are:






Deficit held to 3% of their GDP. Exceeding this requirement would imply a fine between the 0.2 and the 0.5% of their GDP. In fact, these fines are only applied is the deficit is not corrected in a period of 2 years. Moreover, the fines are sometimes not applied if the Council declares the economy of the country under exceptional circumstances. This situation appears when the country is experiencing a huge recession or an important crisis is taking place due to external facts (natural disasters…). This measure was established in order to maintain balance in the medium term. A maximum 60% of the gross debt-to-GDP ratio. This is one of the indicators of the status or health of an economy. It represents the total amount of debt of a country over the total value of its GDP. This measure wouldn’t be applied if the deficit excess were being reduced at a reasonable speed. However, it would be a decision of the
Ecofin to decide to apply or not these penalties and to elaborate some recommendations for the governors of the country to solve the situation.
Surveillance: The different countries also have to present a program containing some information about their policies (objectives to reach a determinate budget (medium term), their measures to achieve this goal, their expectations about the different economic perspectives such as employment, inflation, growth…)

One of the failures of the SGP (Stability and Growth Pact) is the fact that it doesn’t provide a mechanism or a way to achieve aggregate fiscal outcomes which are compatible with the monetary policy imposed by the ECB.
The Commission is considering some proposals to revise the SGP to include the effects of economic cycles and the ageing population.
At the present time, almost all countries in the Eurozone have gone through a reduction
(fiscal contraction) to meet these requirements.
For some experts, a more flexible fiscal policy and a more strict monetary policy would have led to greater exchange rate stability for the Eurozone, providing that when the fiscal policy is so tight, the monetary authority is dominated by the imposed fiscal policy.
Last Friday (2nd March), 25 of the countries of the EU signed a treaty which contained the following ideas or restrictions:


The Treaty was agreed on the 9th of January but it won’t be effective until the 1st of January of 2013.

2

Fiscal Policy in the Eurozone – The case of Spain









United Kingdom and the Czech Republic are not included in the treaty but they have free access to join it.
The main goal of the Treaty would be to make the different countries from the
Eurozone follow the most important rule: To limit the annual budget structural deficit (not including the cyclical revenues and expenditures) to the 0,5% of the
GDP.
It also includes the possibility for the MEDE (European Mechanism of Stability) to offer a rescue or a recovery to all these countries included in the Treaty.
The different countries would have to introduce a mechanism to control and correct their deficit levels.
It includes the possibility for some countries to divert from the aim of maintaining the deficit in the medium run just in case of a huge economic contraction.
It also introduces a new measure which stands for the possibility of reaching a structural deficit of the 0,1% only in the case of the countries with a deficit lower than the 60% of their GDP.

The Role of the ECB
As we well know, the aim of the ECB in the European Union is to achieve a certain level of stability in prices and in general, the control of the monetary policy.
Providing that the ECB is an independent body, the inflation of prices is lower and less variable
(more static or stagnant).
The fact that the ECB is the one and only organism which is responsible for the stability of prices makes some experts think this is not a constructive or effective fact when dealing with crises. Otherwise, there are some theories which stand for the idea that the legal independence of the Central Bank is not enough providing that the inflation control is reduced once other variables take part in the economy.
The ECB is restricted from extending credits to any public body (neither national nor local or from the EU). This is known as the “no Bailout” clause. In case of a huge recession or excessive deficit, the Council can decide to make some kind of recommendations to improve the situation. The European Union makes exceptional and limited transfers to national governments and always and never in the case of economic cycle effects.
The level of independence between the EU and the ECB is higher than in most federal states and this is a positive fact. Besides, this level of independence sometimes leads to a higher risk of financial crisis as fluctuations caused by economic cycles are larger.

3

Fiscal Policy in the Eurozone – The case of Spain

Spanish Tax System
The actual tax system structure was implemented in Spain in 1977 in order to achieve the characteristics to be more integrated in Europe.
The State tax system collects different types of taxes in order to achieve the maximum wellbeing.
Direct Taxes
IRPF: Impuesto sobre la renta de las personas físicas
IRNR: Impuesto sobre la renta de no residentes IS: Impuesto de sociedades
Impuesto sobre Sucesiones y Donaciones

Indirect Taxes
IVA: Impuesto sobre el valor añadido
Impuestos especiales
Impuestos sobre las primas de seguros
ITP: Impuestos sobre transmisiones patrimoniales y actos jurídicos documentados
Tributos sobre el juego

Normally each Autonomous Community has its own methods to regulate the different taxations following some basic guidelines such as: not creating customs taxes, avoiding the existence of social or economic privileges, being supportive with the rest of autonomous communities… Euskadi and Navarra have different economic agreements and they regulate the tax collection in their region, contributing to the state total tax collection with a certain amount of money.

Fiscal Policy in Spain from 2008
Spain closed year 2007 with a surplus of 2% with respect to the GDP. Fiscal policy for year 2008 was designed for trying to achieve more expansion and more growth in an environment where the growth was foreseen to slow down. In previous years the government had took some measures related to the decrease of some taxes as the IRPF and the Corporate Tax. These measures were those which were in part the responsible of the high deficit of next years. In
2008 public administration spent about an 8% more with respect to the “Presupuestos
Generales Del Estado”. So, the orientation of the fiscal policy was keep going with the expansion because as more they spent more employment, more income for families and more consumption. By then, the GPD was falling a lot and we were in a terrible recession. The aggregate demand has gone down a lot because of the financial crisis, people were laid off and banks stopped giving credits to consumers and enterprises because they clients most of them were able to repay their mortgages anymore. All that made investments, consumption and employment fall a lot at the same time and the Spanish economy entered in an economic stagnation.
As in year 2008, with the obvious slowing down of the economy, some measures were taken as for example a reduction of IRPF. Another one would be the “PLAN E” policy pack which involved a lot of measures to basically try to push up the economy and get higher output temporary by increasing the government spending, and then the consumption increases and the unemployment is reduced. This policy involved a lot of investments that weren't really necessary like infrastructures that aren't used that much or renewals of cities, towns and buildings that could have been definitely done in the future. Other from that this policy also subsidized the purchase of an automobile that passed all the minimum environmental

4

Fiscal Policy in the Eurozone – The case of Spain

requirements, the more environmental friendly the more subsidies you got. This was used to stimulate the car manufacturers sector that was affected hugely by the crisis.
In the end this policy was just a temporary solution because the even that they managed to get a year with growth of the GPD, the next year the economy didn't grow. But now more importantly we face another problem, due to the huge amount of money spend by the expansionary policy, Spain got really indebted and there was a huge deficit really difficult to refinance, so now we enter to a really difficult ground with the skeptical markets due to the banking crisis and the huge deficit of Spain.
The result after applying these measures was not as the government would have wished mainly because people had a lot of uncertainty about the new situation and they saved more money than before, which implied less consumption. Then, automatic stabilizer started working and it mainly had an impact on a high increase in the unemployment benefits. In this way, Spain closed year 2008 with a public deficit of 3.8% with respect to GDP.
Investors have to think twice before they lend money to Spain, and that is why the Spanish government started to face really big interest to refinance their debt, and that was really costly because they had to pay more to borrow so the deficit will keep rising if nothing is done.
In conclusion, economist and professionals questions if the expansionary policy was really useful in the medium or long run since now the county faces difficulty of refinancing their debt due to the high deficit of the expansionary policy. So, was it worth to spend all that money to just get a slight boost in the output? Or would have been wiser to start applying a contractionary policy instead? Even though that would have meant more sacrifices and a recession in few years but a better medium and long run perspective, but in the end we would have needed to face the really and that introduces us to the second stage of the Spanish policy, the contractionary policy which is now harder because of the previous expansionary policy. In 2009, the government will keep taking measures in order to encourage the economy, so they increase the public expenditures since they want to increase the confidence of agents and to moderate the decrease in demand and then reactivate economy. With these measures, everybody foresee the increase in public deficit that will take place in that year. This situation requires adopting any measures to get back to the stability in the public budget. Spain closed this year with an 11.2% of public deficit, which was decided by the European Union as an excessive deficit in Spain. EU recommended Spain to adopt new measures to reduce public deficit and having corrected this situation in
2012, as maximum.
These both last years were characterized by a decrease in public income because of the reduction of the tax collection. Specifically, those which were more affected were the
Corporative tax (because of less business benefits) and the Value Added Tax (because of less consumption). Public expenditures increased since government increased the salary of government employees, the unemployment benefits, the retirement pensions (because they increased), investment among others.

5

Fiscal Policy in the Eurozone – The case of Spain

2010 starts with a process of fiscal consolidation which was a clear objective decrease the public deficit in the next years. The new measures were basically reducing public expenditure and increase public income. For instance, one of these measures consisted of reducing the salary of government employees, decreasing subsidizes and so on. However, social benefits increased in terms of retirement pensions and unemployment benefits. About income, it increased thanks in part to the higher Value Added Tax collection, which increased from a 16% to an 18% in July 2010. To encourage employment, Corporative Tax would be reduced for those small and medium companies which create employment. Public debt also increased because of the high public deficit and the increase in the interest rate. Comparing Spain with other European countries, we see that here the public expenditure in education, health, pensions and unemployment benefits are quite high. These expenses form an important proportion of the public expenditure. In 2010 government starts to think about reducing expenses in these aspects. They started with a pensions freezing. It was followed by the public employees’ salary reduction. The result of all these measures was a reduction of public deficit with respect to 2009. In 2010 the public deficit was 9.3%.

In 2011, the main objective of the fiscal policy kept being the same, reducing public deficit by increasing public income and decreasing public expenditures. Some of these new measures were: 





Salary freezing to public employees and reduction of public personnel.
Reduction
in public health expenditure. Reduction in education, not renewing contracts between 2000 and 3000 professors and decreasing salaries. Reduction in social benefits. Except the minimum retirement pensions, the rest of them keep being freezing. Elimination of the called
‘cheque bebé’ (help for parents of babies who have just born) among others

6

Fiscal Policy in the Eurozone – The case of Spain




Reduction in subsidizes, for example the elimination of the discount in the contribution to Social Security.
Reduction in public investment, which will imply less employment (more unemployment). Evolution of the tax collection in Spain
As we can see from 2002, the year in which the Euro was adopted as currency in Spain, the tax collection has been increasing reaching its pick on 2007.

150000000
100000000
50000000

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

In 2007 Spain had a budget surplus so the government decided to
0
decrease taxes during the next 2 years. As that was when the global economic and financial crisis started, it was a good measure in order to encourage consumption and thus the GDP. But in
2009 the crisis affected deeply the economy and Spain had very little tax collection, so the public deficit reached 11.2%. It was then when the government had to increase taxes, and we can see that in 2010 the numbers increased.
Although there is not reliable data of 2011 yet, we know that the government policy was to keep increasing taxes, so we can assume that collection was higher than in 2010.
A negative effect of the crisis can be that in spite of the government increasing the % citizens must pay in taxes, if income, consumption and firm benefits drop, so does the total collection of taxes. This can be a counterproductive effect of this kind of policy.

7

Fiscal Policy in the Eurozone – The case of Spain

Conclusion
After studying the behaviour of Spanish government in relation to the fiscal policy, we can conclude that Spain made a mistake in 2008 and 2009 since they carried out an expansionary fiscal policy. Then, they reacted too late so the consequences came to the surface; in 2009 we had an 11.2% of public deficit with respect to GDP. This percentage comes from a bad management of public income (from taxes) and public expenditure.
In these both years, Government wanted to keep growing and they arrived to the conclusion that Spain could keep increasing even decreasing taxes (as they did with IRPF and Corporate
Tax in 2008). The problem was that people had a high uncertainty and they started to consume less (which implied a more reduced tax collection from VAT and Corporate Tax and less employment). With all of this, Government spent too much in order to encourage again the economy but they also received less than they expected. So, here was the big mistake which led to a high public deficit in 2009 and in 2010 was also very similar.
Nowadays, from 2010 Spain realized that it was in wrong way so they had to completely change his way of focusing the fiscal policy. From 2010 they took new measures in order to change to a fiscal contraction policy and try to solve this situation by reducing the public deficit year by year. The only way of doing that, is reducing public expenditure and increasing taxes and that is what they have already done.
The main problem that nowadays we are having is that by taking these measures we are also increasing unemployment because as more taxes, people have less disposable income and they consume less, which leads to lower benefits to companies and then more dismissals.
Also, now that we have studied what European fiscal policies are, what treaties have been done among European countries and how they works, we will sum up all information relating this European Fiscal Policies with Spain.
We clearly see that Spain fiscal policy is limited as we must complete objectives promoted for the policies appointed. Then, it restricts their power as they can’t decide how many cash to use and how to do. It makes more difficulties to develop Spanish economy. We must appoint that Spanish economic must cut a lot of benefits an increasing in tax in order to achieve these objectives. Lastly, Spain cannot depreciate their value in order to follow another economic system to get more efficiency as it is euro and in Eurozone.
We can conclude saying that European fiscal policies does not all effective as they should be and in crisis moments have a lot of disadvantages.

8

Fiscal Policy in the Eurozone – The case of Spain

Bibliography












http://www.bde.es/webbde/SES/Secciones/Publicaciones/PublicacionesAnuales/Infor mesAnuales/08/inf2008.pdf http://www.bde.es/webbde/SES/Secciones/Publicaciones/PublicacionesAnuales/Infor mesAnuales/09/Fich/inf2009.pdf http://www.bde.es/webbde/SES/Secciones/Publicaciones/PublicacionesAnuales/Infor mesAnuales/10/Fich/inf2010.pdf http://ec.europa.eu/europe2020/pdf/nrp/sp_spain_es.pdf http://www.burbuja.info/inmobiliaria/burbuja-inmobiliaria/131972-crisis-financiera-ypolitica-fiscal-espana.html http://www.sciencedirect.com/science/article/pii/S0164070407001085 http://es.wikipedia.org/wiki/Pol%C3%ADtica_fiscal http://www.bde.es/webbde/Secciones/Publicaciones/PublicacionesSeriadas/Docume ntosTrabajo/03/Fic/dt0311e.pdf http://www.slideshare.net/oscarm/spain-economic-policy-and-2010-funding-strategy http://es.scribd.com/doc/49795065/spain-fiscal-policy http://www.cincodias.com/articulo/economia/lideres-25-paises-ue-firman-pactofiscal/20120302cdscdseco_7/

9