Rajoy wields brutal budget ax to placate EU colleagues

Prime Minister Mariano Rajoy on Wednesday unveiled another batch of budget savings worth 65 billion euros over the next two-and-a-half years in what constitutes the biggest fiscal adjustment in Spain since democracy was restored over 30 years ago.

The measures — which include a rise in the standard value-added sales tax rate to 21 percent from 18 percent and an increase in environmental levies, as well as cuts in benefits and wages for civil servants and the unemployed — came just a day after the European Union agreed to give Spain another year to bring its public deficit back within the EU ceiling of three percent of GDP, albeit with a number of strings attached.

Spain’s fellow euro-zone members also approved a bailout for the country’s beleaguered banking system.

The latest cutbacks are in addition to savings of 27 billion euros introduced by the newly elected Popular Party (PP) government in December and an austerity package worth 18 billion imposed on the regions. The new measures also come just two weeks after the 2012 budget was approved.

Government sources said the latest initiative to get the country’s financial house back in order will be approved by the Cabinet on Friday. According to Reuters, the hike in VAT, which the administration had pledged not to increase because of its impact on household spending, will take effect as of August 1. The reduced rate was raised from eight percent to 10 percent, while the super-reduced rate remains at four percent. The increase is expected to bring in six billion euros a year. The reduced rate applies to most food and health products as well as transportation.

The hike in the sales tax is almost certain to depress consumer spending further at a time when the economy is already expected to shrink by 1.7 percent this year.

The government is cutting jobless benefits after the sixth month of unemployment

“We have to get out of this mire, and we need to do so as soon as possible,” Rajoy said. “Whether we want to or not, I said I would lower taxes and I am raising them. I haven’t changed my way of thinking but circumstances have changed, and I have to adapt to them.”

Analysts said the measures unveiled by the prime minister mirror the recommendations made by the European Commission and form the counterpart to Brussels granting Spain some leeway in the deficit and the approval of the bank bailout.

The European Commission was quick to laud the new measures announced by Rajoy. “We do welcome the announcement of the new fiscal measures by the Spanish government,” Simon O’Connor, the commission’s economic affairs spokesman, told a news briefing in Brussels.

“It’s an important step to ensure that the fiscal targets for this year can be met,” O’Connor said.

The deficit in central government spending in the first five months of the year came in at 3.41 percent, almost reaching the target for the whole of the year. Brussels on Monday agreed to allow Spain to bring the deficit back below three percent of GDP in 2014 instead of 2013 as was previously planned. The target for the whole of the country’s public administrations was increased to 6.3 percent from 5.3 percent previously for this year and to 4.5 percent from 3 percent for 2013.

Tax benefits for employers taking on workers will be slashed

“We welcome the determination indicated by the government to take measures. We welcome the fact that the announcement has come swiftly one day after [EU finance ministers] adopted this revised recommendation,” O’Connor added.

The labor unions were also quick to react, calling for a nationwide protest on July 19 against the new measures, which they argued would further aggravate the economic crisis, pushing the number of unemployed to over six million — more than a quarter of the working population — by the end of this year.

The other measures unveiled by Rajoy include eliminating the extra payment made at Christmas to civil servants at all levels of the administration, as well as to lawmakers for this year, which will save some five billion euros. The extra payment will be restored in 2015 but in the form of contributions to workers’ pension pots rather than in cash.

Public-sector workers will also see the number of free days they are granted reduced, while the government will promote the mobility of workers within the public administrations

Ministries will see their budgets cut by 600 million euros over the course of the rest of this year, while Rajoy announced that next year’s budget will include a cut of 20 percent in subsidies for labor unions and political parties.

The government is also cutting jobless benefits after the sixth month of unemployment, and will revise the system of benefits for carers of dependent people. The maximum period for entitlement to unemployment benefits remains at 24 months.

Tax benefits for employers taking on workers will be slashed but Social Security contributions will be lowered by one percentage point in 2013 and by another point in 2014.

Across-the-board tax relief on mortgage payments on the family home will also be eliminated from next year for new homebuyers.

Rajoy also said his government plans to slim down the public administrations, with a cut of 30 percent in the number of city hall representatives. This is expected to save some 3.5 billion euros, while a rationalization of the system as a whole will shave a further 10.5 billion off spending.

Tax benefits for employers taking on workers will be slashed.

Another number of public companies are due to be scrapped, while rail, air and maritime transport companies will be privatized.

Rajoy said his government will also introduce proposals to amend the rules governing the state pension system to make it more sustainable.

The government also plans to overhaul the energy sector, introducing a new tax regime to eliminate the persistent deficit that exists between what consumers pay for electricity in the regulated sector and what it costs to produce it.